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CFP Reaffirms Model Code Recommendations on Entertainment, Confirmations

The Committee for Professionalism (CFP) has reacted to recent high profile events in the financial markets by issuing two press releases reaffirming the framework laid out in the Model Code of ACI – The Financial Markets Association surrounding the issue of back office payments and confirmations, as well as personal conduct issues.

The press release on conduct was in response to recent articles in the media concerning lavish restaurant and club entertainment amongst London derivatives dealers and brokers, which were highlighted in reports on the legal proceedings between Cantor Fitzgerald and ICAP. The CFP reminded all members of the recommendations in this area, stating that, “The code states quite clearly that neither gifts nor entertainment should be excessive in value or frequency and advocates a strong management role in the monitoring and control thereof.”

The CFP adds, “It would appear from many of these reports that amongst some broking companies and financial institutions, management involvement in this area is lacking and appropriate controls are not in place.”

The press release quoted, in full, the recommendations in chapter II.2, and stressed that these should be “strictly adhered to”.

The other press release focused on the written confirmation procedure, especially in light of the revelations of the Ludwig Report on the losses at AllFirst Financial (see Profit & Loss, April 2002). The CFP adds that the subject is being actively re-appraised by way of discussions with the Euribor ACI Derivatives group.

The committee is concerned with reports that indicate the practice of one-way confirmation of transactions is on the increase, particularly in certain short-term derivatives markets. The strict conditions under which this practice may be acceptable – which include the necessity of the sender to chase a response from the receiver within a few hours – are clearly stipulated in the Model Code.

The release notes, “There is no doubt that continuing changes in our markets with new and complex instruments, products, strategies and electronic delivery have impacted on the significance and may in some cases reduce the effectiveness of written confirmations as a control measure. However, these are no grounds on which the practice should be changed or discontinued. Moreover, we consider the immediate written confirmation of all deals and independent of the deal consummation process, preferably by electronic means, to be a fundamental and essential discipline in our markets. Any deviation from this practice could open the way for other serious abuses and loss of control.”

In the Ludwig report, attention was drawn to the importance of the Model Code as the most up to date and widely used code of conduct among the world’s foreign exchange and money market traders. On the issue of confirmations (page 15 of the report) there is a significant mention of the extent to which the alleged perpetrator of the fraudulent transactions, “was somehow able to bully and cajole the operations staff responsible for confirming Mr Rusnak’s trades into not confirming them”.

On page 21 of the Ludwig Report, the CFP adds, there is the further observation that, “The failure of treasury management to follow through on back office enquiries may have contributed to an attitude among operations staff that the confirmation process was a pointless formality.”

“In our view,” states the press release, “The very existence of the practice of one-way confirmations amongst some derivatives markets participants almost certainly created a more plausible opportunity for Rusnak to impose his will on the issue. Although other controls should have highlighted the fraud from the outset, the resulting interception of outward confirmations of the fraudulent in-the-money options in particular was a vital factor in disguising over a long period both the massive risk position and the loss it carried.

“In our current review and discussions,” it continues, “We are seriously considering a further tightening of the conditions under which any deviation from full and immediate confirmation of all consummated transactions, by both principals is acceptable.”

The CFP would welcome the written opinions of market practitioners on this subject, but in the meantime, it has recommended that the existing framework also be strictly adhered to.

The existing recommendations are as follows:

Chapter III

2. Confirmation procedure (written)

All transactions have to be confirmed in writing. Although the style and means of despatch have changed considerably in line with modern trends in information technology and communications, there are certain essential disciplines particularly concerning timing and checking which must be adhered to.

The issue and checking of confirmations is a back office responsibility, which should be carried out independently of those who initiate deals.

Confirmations should be sent out as quickly as possible by both counterparties through an efficient and secure means of communication (preferably electronic) after a deal has been done and should be addressed to the back office or settlements department of the counterparty.

The practice of sending two confirmations (eg, an initial one by fax or other acceptable electronic means) followed by a written confirmation is not recommended as the latter, if posted might not arrive until after the settlement date and could cause confusion and uncertainty.

The format and content of a confirmation will vary according to the instrument dealt in and reference should be made to any applicable Terms and Conditions published in order to ascertain the correct content and format for any particular instrument (see appendix Terms and Conditions for Financial Instruments). As a minimum, however, all confirmations should include the following information:

a) Date of transaction

b) By which means effected (broker, phone, telex, dealing system, etc)

c) Name and Location of Counterparty

d) Rate, Amount and Currency

e) Type and Side of Deal

f) Value Date, Maturity Date and all other relevant dates (eg, Exercise Date, etc)

g) Standard Terms/Conditions applicable (eg, FRABBA, BBAIRS, ISDA, ICOM, etc)

h) All other important, relevant information

Brokers should confirm all transactions to both counterparties immediately by fax or other acceptable electronic means.

It is vital that principals check confirmations carefully and immediately upon receipt so that discrepancies can be quickly revealed and corrected. If the counterparty confirmation is considered incorrect, the counterparty must immediately be informed (preferably in writing or by electronic means).

A new confirmation (or written agreement to a correction) must be requested from and be provided by the bank or counterparty whose original confirmation was incorrect.

It is not uncommon in some derivatives markets, and perfectly acceptable if the two principals involved agree, for only one party (rather than both) to the deal to send out a confirmation. But where this is so, it is imperative not only that the recipient checks it promptly, but that it also in good time responds to the issuer of the confirmation agreeing/querying the terms. It is also essential that the issuer of the confirmation have in place procedures for chasing a response if one is not forthcoming within a few hours of the confirmation being sent.

Many automated dealing systems produce confirmations automatically. Provided these are verified in the back office, no additional confirmation need be sent.

Profit & Loss

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