Re: Standardizing the Confirmation Process
June 27, 1995
The Foreign Exchange Committee's Guidelines for the Management of Foreign Exchange Trading Activity are intended to enhance the integrity of the foreign exchange market through the promotion of sound business practices. As part of our continuing efforts in this regard, the Committee is issuing a set of recommended management principles to serve as an elaboration of the existing guidelines for the purpose of improving trade confirmation practices.
The Committee's recommended guidelines stem from the understanding that all foreign exchange market participants have certain duties. Perhaps the most fundamental of these in relation to trade confirmation practices is the duty to maintain an efficient operating staff. Management's attention to a foreign exchange trading operation is usually directed toward establishing trading policies, managing risk, and developing trading personnel. Equally important, however, is a rigorous back office. Details of each trading transaction must be accurately recorded, payment instructions must be correctly exchanged and executed, accounts must be quickly reconciled and financial results must be properly evaluated. Time-consuming and costly reconciliation of improperly executed transactions mars the efficiency of the market, undermines profitability, and impairs the willingness of others to trade with an offending institution. Accordingly, management should be aware of its responsibility to establish an operations staff consistent with the scope of its trading activity.
The Committee believes that the confirmation procedure is a mutual obligation between the two counterparties, and that the obligation should apply equally to fund managers and corporations, as well as members of the interbank community. The confirmation process is a fundamental first line of defense against fraud. As such, market participants should keep in mind that the time between trade execution and trade confirmation is not a window of opportunity, but a window of risk. The Committee underscores the importance of minimizing the number of transactions that are confirmed after 4:00 p.m. on trade date to narrow this window of risk as much as possible.
The Foreign Exchange Committee has identified four specific duties that follow from the fundamental duty of market participants to maintain a rigorous back office. These duties, along with the Committee's existing recommendations in its Guidelines, represent the basis for the procedures that are recommended regarding the internal management of trade confirmation by foreign exchange dealing institutions and brokers.
- Trades Should be Confirmed Within 1 to 3 Hours of Execution: Institutions in the foreign exchange market should make every effort to exchange confirmations of all foreign exchange transactions to which they are party including both interbank and corporate, spot and forward, within 1 to 3 hours of execution of the transaction. The prompt exchange of confirmations and their immediate and thorough checking upon receipt is vital to the orderly functioning of the market place and provides a first defense against fraud. To further reduce the risk of fraud and error, counterparts should agree to exchange standard settlement instructions. If there has been a misunderstanding between counterparties regarding transaction terms, it will usually be discovered upon the review of the confirmation. Counterparties to brokered transactions should exchange confirmations, including from spot transactions, even though the parties may have received confirmations from the broker.
- All Splits Should be Confirmed by the End of the Day on the Same Day as the Transaction: For all investment advisors, every effort should be made to identify allocations to specific accounts and confirm all transactions by the end of the business day on the day of the trade. For corporate customers, every effort should be made to confirm all transactions within 3 hours of the trade, but no later than the end of the business day. The Committee recommends that all participants make every effort towards confirming splits by 4:00 p.m. Both counterparties should exchange and review confirmations and identify any errors on the trade date. The Committee strongly urges all participants to have a clear separation of duties between the trade staff and back-office staff handling confirmations. Someone other than the person that executed the trade should confirm.
- All Errors Should be Resolved on the Same Day of Execution: Institutions in the foreign exchange market should make every effort to resolve any disputes relating to foreign exchange transactions including both interbank and corporate, spot and forward on the day of execution. Given the volatility in the foreign exchange market, timely error resolution is essential in reducing potential market risk.
- All Market Participants Should Move Towards Autoconfirmations: Autoconfirmation is the most reliable method of confirming transactions. The Committee recommends that all market participants make every effort to evolve their systems toward use of an electronic confirmation process that utilizes a standard industry format when settling foreign exchange transactions. The implementation of automatic confirmation allows faster and more complete trade confirmation, minimizes market risk and trade errors, minimizes settlement risk and compensation payments, reduces potential errors caused by human intervention (phone and paper), reduces operational and overhead costs, and reduces or eliminates paper storage.
Confirmations should identify (I) the parties to the foreign exchange transaction and the designated offices through which they are respectively acting, (ii) the broker, if applicable, (iii) the transaction date, (iv) the amounts of the currencies being bought or sold and by which parties, (v) the exchange rate at which the currency amounts are being bought or sold, and (vi) the value date.
The non-receipt of expected confirmations, the receipt of unexpected confirmations, or any inconsistencies or inaccuracies in confirmations, should be queried and if appropriate, disputed as soon as the confirmation is received. Identification and resolution of errors should be the responsibility of all counterparties because failure to cooperate in the immediate resolution of errors could exacerbate losses.
Automatic methods of communication of confirmations are superior to mailed confirmations, which, particularly in the case of spot transactions, often do not arrive in time to bring problems to light before the settlement date. Institutions should make an effort to automate the confirmation process, since unautomated confirmation systems tend to break down during periods of heavy activity, precisely when they are most critical.
Attached is a copy of the Committee's Document of Organization and a list of its 1994 Membership. Please feel free to contact myself, members of the Committee, or the Committee's Executive Assistant with any questions or comments regarding this letter.