In the financial market, a trade is the conversion of an order placed on the exchange which is said to be completed when the buyer gets the securities and the seller gets the payment for the same. There is a number of steps involved in the successful completion of the trade. All the steps together create a ‘Trade Lifecycle’. The Trade lifecycle consists of various trading and operational activities. Once, the trade is captured and enriched, the next step is of validating the trade to reduce the possibility of errors in the process ahead.
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Meaning of Trade Validation:
Validation refers to the action of checking or proving the validity or accuracy of something. So, trade validation is the process of validating and registering the trade that has been entered. Trade Validation is a mechanism to reduce risk by the way of adopting a final check of the data contained within a fully enriched trade. It is performed with a view to reducing the possibility of erroneous information being sent to the outside world.
Tasks considered in trade validation are:
- Issuing trade confirmation
- Reporting trade to regulatory authorities
- Instructions for issuing settlement
- Custodian selection
Reasons for performing Trade Validation:
- To ensure timely and accurate servicing of clients
- To avoid operational risk
- To minimize the operational costs
- To ensure that the received information in back-office systems fit with the front office records
Various reviews performed during trade validation:
The reviews which are to be performed on various trades can be categorized as follow:
- Fundamental Checks: Fundamental checks include checking of value date, quantity, trade date, and others.
- Trade date: The trade date is determined for all types of trade and transactions in the securities. It refers to the month, day, and year on which the order execution takes place. It is different from the settlement date which occurs after some lag. Settlement date commonly denoted as ‘T + Lag days’ such as T+1, T+2, and so on. Here, ‘T’ is the Trade date.
- Value date: The value date must be a business day and after the trade, date depending on equities or bonds or depending on country. The meaning of value date differs for different types of transactions. For the forex market, it refers to the date when a trade is expected to be settled. For spot transactions, it is usually two business days after the date upon which the transaction was agreed to.
- Quantity: Quantity means the trading volume of shares or contracts that belong to given security traded on daily basis. It provides the measure of the number of transactions between a given period.
- Others: Other reviews which must be performed are as followed. The financial securities which are to be traded must be identifiable. In case of rights and warrants, they must be alive.
- Special Trades: It includes validation of certain trades such as,
- Trades that are deemed to be large include the trade with settlement value above a specified minimum threshold.
- Trades in a specific market, for example, trade performed in a new market or trading in a stock that is not traded frequently
- Trades with a specific counterparty, For example, trade with a new broker
- Trades with prior value dates
- Trades with prices outside of a specific range, for example, stock valued at 8% above or below the current market price
- Trade setting on a Free of Payment basis
- Exception Handling:
Exceptions are trades that cannot be fully processed due to some errors. For example, Pending trade agreements, means trade agreements issued by STO but, not responded to or confirmed by counterparties. Exception handling is important to make sure trades giving rise to exceptions or trades consisting of errors need to be identified and reconciled in an appropriate period. Trades that are subjected to exception handling are sent to the appropriate person for further investigation. If the issue is solved then the trade will be released again for settlement. If the trade needs to be amended or canceled, then, it will be returned to the front office. If the trade issue does not resolve within the acceptable time period, it will be passed on to more knowledgeable members of the operation area.
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To complete the trade life cycle without any errors, trade validation measures play a vital role. It is performed by validating the received trade information in the back-office systems. Trade validation stands out to be an important activity to reduce the risk.
Author: Hetvi Shah
About the Author: Hetvi is a BBA(Finance) graduate. She is currently pursuing an MBA with Finance specialization. She has a keen interest in Financial Market, Financial Management, and Financial Analysis.