Treasury operations – Front office, back office and mid office

operations

INTRODUCTION

Treasury is the treasure or the valuables of the government, centre and states and extended to semi-government bodies, corporate and non-corporate bodies, and financial institutions including banks that operate this treasury.

Treasury management therefore refers to all activities involving the management of revenues, inflow and outflow of governments, banks and corporate. Treasury is a special term within a compass of the broader term finance.

Historical Evolution

• Historically, the treasure was gold, silver and precious metals mined from inside the soil of the land of a kingdom and belongs to the king.

• When British India Company came to trade with India, these treasures were used to exchange goods and for trade by both Indian and foreign traders.

Treasury as Money Management

• The basis of treasury operations is money and near money assets like money market instruments, government securities, new and existing securities of corporate units, etc. the money in terms of foreign currencies is traded in the FOREX market.

Domestic Money Foreign MoneyCredit Inter-bank money Government Securities

(Gilt-Edged) MarketForeign currency and

credit instruments

Cash Demand Drafts Mail Transfers

ChequesTelegraphic

TransfersBankers Draft and

PayordersEtc.

Treasury Bills EquityPreference Shares

Debentures

Foreign Currency Notes

Created by RBI

Commercial BillsParticipation Certificates

Commercial PapersCertificates of

DepositsFactorization Bills

Public Sector BondsUTI Bonds

Other Bonds

Foreign currency Bonds

Forward CurrenciesNet Balance

Discount and Finance House of

India

Created by Banks Money Market Stock Market New Issues Market

FOREX Market

Case Study

Barings Bank &

Nick Leeson

Introduction • Barings Bank, the oldest merchant

banking company in England, was founded in1762

• In 1890 it faced bankruptcy in the aftermath of a significant amount of investment lost in South America following the Argentinean revolution

• At that time, they had been bailed out by the Bank of England and other London banks

• Brings continued in traditional merchant banking, building up a reputation based on corporate finance, strong investment management

• In 1984 it acquired the stockholding business of small stock broking company

• Baring Brother and Company (BB and Co) then established Baring Securities Limited (BSL)

• 1980s Tokyo Stock Market boom, and specialized in Japanese equity warrants – bonds sold with warrants exercisable into shares

• Board of the Bank was very satisfied with the presence on the Asian market and in order to develop much faster it perceived in the field of derivates a good source of profits and therefore decided to establish Baring Futures (Singapore) Pte Ltd ("BFS")

• On1992, BFS applied for clearing membership of SIMEX Singapore International Monetary Exchange Ltd

• Nick Leeson, the chief trader for Barings Futures in Singapore, who deals in derivatives

Facts of The Case Barings collapsed on February 26,

1995, due to the activities of one trader.

Nick Leeson, who lost almost $1.4 billion

As the market fell more than 15 percent in the first two months of 1995,

The bank had given a trader a lot of freedom in his activity.

Barings Futures suffered huge losses, which were made even higher due to the sale of options, which implied a bet on a stable market.

As losses mounted, Leeson increased the size of the position, in a stubborn belief he was right.

Finally, on 25 February 1995 he walked away, when he realized that bank was unable to make the cash payments required by the exchanges

He left behind huge liabilities totaling $1.4 billion, more than the entire capital and reserves of the British institution

In the aftermath of the activity of Leeson,

Barings collapsed and was purchased by the Dutch bank/insurance company ING

• The Barings board decided to send to Asia in 1992 a young trader from a humble background, Nick Leeson, who seemed to know how to deal in derivatives, a quite new game that few in the financial fraternity really understood.

• The Bank wanted to become one of the first active banks in this region of the world and also from this reason the board gave a trader a lot of freedom in his activity. In 1993, Nick Leeson was appointed general manager of the bank's Barings Futures subsidiary in Singapore.

• Trader was authorized to conduct both proprietary and clients account trading on Far Eastern exchanges, on behalf of other Barings companies, specifically, Baring Securities Limited (Singapore), Baring Securities Limited (London), Baring Securities (Japan), Baring Securities Hong Kong Limited and Banque Nationale de Paris (Japan).

Activities of nick leeson

• Leeson created an error account numbered “88888” as a holding area for any premiums or losses that he made. A trader claimed that he initially had opened the account to conceal a single loss of 20,000 pounds sterling that had resulted from an accounting error until he could make up the difference through trading. However, he continued booking various losses on the account and also continued to increase his volume of trading and level of risk taking.

• Leeson increased the size of his open positions even as his losses increased due to volatility in the markets. When an earthquake (23 January 1995) in Japan caused a steep drop-in the Nikkei 225 equity index, Leeson's unauthorised trading positions suffered huge losses and his operation unravelled.

• On March 3, 1995, the Dutch bank ING purchased Barings for the princely sum of £1, providing the final chapter in the story of the 223-year-old bank.

Conclusion

• This was a wake-up call for many financial institutions all over the world.

• Leeson had control over both the trading desk and the back office.

• The function of the back office is to confirm trades and check that all trading activity is within guidelines. In any serious bank, traders have limited amount of capital they can deal with and are subject to closely supervised “position limits”.

• To avoid conflicts of interest, the trading and back office functions are clearly delineated.

• In addition, most banks have a separate risk-management unit that provides another check on traders

Treasury dealings and operations

Functions of Merchant desk

• The merchant desk act as in intermediary between the branch offices, maintain orders, receives reports as they

come in, responds to branch queries, advises rates obtained from the dealing desk to branches, passes on

information and transactions meant for the branches, tracks balances.

• The merchant desk is also required to make sure that the branches put through transactions only at the

permitted rates. To that extent, they are required to scrutinize reports emanating from the branches.

Provisional rates are finalised to the merchant desk. Competitive rates are offered to customers at the

branches by the IBD/ FD through the merchant desk, which carries out this task in consultation with the dealing

room.

• The chief dealer, and through him the other dealers, keep continuous track of transactions using the position

books and gap statement, maintain manually or in a computerised environment.

Merchant Transactions

• Branch offices of commercial banks have limited reasons to initiate transactions on their own

account. The majority of transactions are on account of their clients. Transactions also arise

overseas meant for customers at various branch offices of a bank.

• These transactions, originating inland and overseas, must be processed at the International Banking

Department (IBD) as soon as they occur. An essential part of this ‘processing’ is the reporting of

these transactions by the originating branches to their respective merchant desks.

• The two key maintained by the merchant desk are the position Book and the Gap Register. The

position Book records all foreign exchange transactions, spot or forward, and tracks the overall

exposure of the bank on a running account basis. The gap Register is used to track maturities, and

hence the cash flows, in foreign currencies in which the bank deals.

Life cycle of dealing room transactions

Front office ActivitiesThe bank needs to optimize its cash flows in order to ensure that shortfalls are fully funded, and any surpluses are invested in order to maximize its returns. Doing the deal is classed as ‘front office’, where as the reconciliation of payments is ‘back office’.

Historically the dealer wrote the details of the deal on a slip of paper, which was later input into the system by the back office. A good treasury function will expect the treasury team to develop new ways of attracting the cheapest funds.

It is a necessary for the bank to attract deposits on a long term.

One of the banks objectives therefore will be to have depositors roll over their money held on deposit, so that short term deposit effectively becomes medium term fund for the bank basis.

Mid office Activities Produces the risk management

reports and checks for compliance with internal limits.

Tends to be link with the back office. Thus manual dealing slip are collected by middle office staff for onwards transmission to the back office.

Check that dealing slips are completed correctly and the settlement instructions are proper.

Queries from the back offices on

deals would be filtered through the middle office.

Back Office Activities

• The back office sees to accounting records, compliance with government regulations, and communication between branches.

Example -• In banking, the back office

includes a strong IT processing system that handle position keeping, clearance, and settlement

How does it Operate

• Clearance of trade comparison and matching , trade netting , securities message and if applicable securities lending.

Steps involved

• First part is trade comparison and matching with both counterparties.

• Next step may involve netting of trades.

• Check to ensure that transactions are appropriately executed.

• Transfer of ownership.

Take an example of BNP Paribas Securities Services

Deal with transactions upon the clients’ request Booking of transactions involving securities (shares, bonds,

UCITS) that have been executed by the front office (purchase and/or sales orders)

Registration of transactions in the electronic settlement systems

Ensure timely feedback of information, alerting the front office to any difficulties encountered

Contribute, within your team, to improving the efficiency and reliability of all financial transactions carried out

Conclusion

Thank You