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Settlement entails carrying out a series of duties in respect of all transactions emanating from the front office effectively leading to making an actual payment.

Settlement risk is the risk that after having sent the payment instructions, there is a delay in receiving the payment or the payment is not made at all, i.e. there is a default.

Price discovery

Price discovery is the process by which buyers and sellers interact to determine the fair market price of an asset. Trading in the financial markets is about obtaining prices. In efficient financial markets prices reflect the future risk and return associated with a security. But trading decisions also impact how prices will move and trading activities continuously feed new information into market prices.

Rate reasonability

A mechanism or process for checking that the rate entered by a dealer is a rate that is likely and reasonable based on the expected daily fluctuations possible in that rate. For example under normal conditions interest rates and exchange rates will move within a certain daily range and a rate reasonability check will flag any rates that are outside that boundary.

Proprietary Trading

Proprietary trading is the means by which the bank trades stocks, bonds, options, commodities, derivatives or other financial instruments for its own account i.e. for its own profit rather than trading on behalf of its customers. It involves active position taking with a view to capital gain. Banks involved in this form of trading believe that they have a competitive advantage that will allow then to earn excess returns. Their aim therefore is to directly benefit from the market rather than through the commissions they could earn from processing trades on behalf of their customers. Due to the volatility in the markets, earnings from proprietary trading tend to be more volatile as compared to the bank’s earnings from processing client trades.

Banks engaged in proprietary trading usually have separate desks that are solely devoted to prop trade. These desks work in isolation from those processing trades on behalf of the banks clients. The objective of these desks is to earn profits that are above those that could be earned in their normal market- making trades. Another reason why the trading desk is kept separate from the other desks is to avoid conflicts of interest or situations where the prop desk’s trades could harm the bank’s customers’ interests. One such activity is fronting running a customers order where the prop desk knowingly purchases shares ahead of the customers’ trades, so as to benefit from the price increases that could result when the customers’ deals are processed. This results in profits for the prop desk at the cost of the banks customers who end up paying higher prices on their trades.

Operational Risk

Transaction risk: Execution error, Product complexity, booking error, settlement error, commodity delivery risk, documentary/ contract risk

Operational control risk: Exceeding limit, rogue trading, money laundering, security risk, key personnel risk, processing risk

Systems risk: Programming error, model/ methodology error, IT systems failure, telecommunications failure

Business events risk: Currency convertibility risk, shift in credit rating, reputation risk, legal risk, taxation risk, disaster risk, wars, collapse/ suspension of market

Regulatory risk: Breaching capital requirements, regulatory changes