Trade validation is the final step of checking the trade after the investment bank through a security trading organisation completes the trade purchase or sale.
This basically means that I am going to check, whether we got what we intended to purchase.
Moreso is it finally in our dematerialised account with the custodian?
You may say, why is that even a step?
That’s what I discuss in this article, so read on.
Refresher on the Trade Process & Trade Validation
So, in case if you don’t want to read through the entire trade life cycle process, which is by the way you can in my separate article.
Then I am going to quickly nail this!
So, the blue box you see above is where the validation takes place.
Which is after the front office orders the trade and then the middle office, lands up with the task of cross-checking work.
For example; Allen is the front office trader at Goldman Sachs, he identifies a stock that he wishes to purchase at $500.
Accordingly, he calls up the sales guy at a securities trading organisation( Which can be brokers). Afterwards, the sales broker contacts the dealer through an internal communications network.
Furthermore, if the sales at the broker side return with the good news, that it’s possible then we start the game of operations.
Indeed a lot of work.
In brief, after the good news, the trade passes through the execution team, then the validation team.
Later landing up in the clearing and settlement team side and finally the reconciliation team.
Straight Through Processing- Trade validation Process
That’s a mouthful but may sound cool at a dinner party!
Never mind, it’s just a simple process terminology used by not just investment banks but also most of the large e-commerce companies like amazon.
However, STP might be a thing for e-commerce and work excellent.
In contrast in investment banking operations, manual interventions are needed because automation is as good as a code.
The difference between a code and a human lies in learning.
Just as a trader faced with a situation of crisis, can tap into his previous experiences to find the correct solution. On the contrary, a code cannot.
Errors in Trading Operations-Trade validation Process
As soon as I start listing the errors, you would understand why validation is needed.
- The dealer (I) for eg; by mistake enters the wrong scrip code. Instead of putting AAPL, he puts AAP
- Another can be that I recorded the wrong quantity of stocks purchased
- Moreover, while the trade was correct, I incorrectly selected the wrong custodian
So, the validation step is essential to make sure that these are detected as fast as possible.
There is the urgency factor here.
Firstly, let’s say I purchase $1 Mn worth of U.S Treasury bonds, which I am going to hold only for two days.
If the validation doesn’t capture any mistake in the trade execution, then I might be slapped with a penalty.
Moreover, I might also lose a lot of money if the trade goes in the opposite direction.
Finally, If I purchased this on borrowed cash, then I also incur wasted interest costs.
Trade Validation Steps
On a normal sunny day, this is how the trade validation takes place.
- First, I check the trading date: The date should be today for a new trade, not past and neither future
- Second, I confirm the correct trade time, again making sure it's today
- Third, I confirm the value date, which also means the settlement date i.e T+3. Also, make sure that it's not earlier than the trading date.
- Afterwards, the quantity needs to be cross-checked, with the minimum denomination of the security. For eg; if I want to buy the U.S Treasury bond, then it might be available in lots of 1000.
- Also cross-checking the price and validating the security i.e I cannot validate a bond that's already matured.
- Finally nailing it with cross-checks on cash value, and counterparty identification.
So much for making sure that you don't go wrong.
Systems Used for Trade Confirmations
This is just for my information and not part of the validation process.
Companies(clients) frequently will use third-party systems to ensure that the trade is authenticated and to avoid a brawl with the STO.
Oasys global, now also known by DTC is a system used by large institutions for trade affirmations.
That is to say, the custodian who actually holds the security and the broker both are aware that this trade is authenticated.
Finally, this is how the CTM trade management system looks like in real life
Trading Operations Career Prospects
Trading operations is an exciting career and I would say rewarding too. It's been growing and for the foreseeable future doesn't look like it's going to lose its steam.
So if you want to learn more then do care to check out our Certificate in Investment Banking Operations course for placements in India