Document Maintenance: Schedules and Agreements in Derivatives Trading

Derivatives_Novice_Notes_Week19: Document Maintenance: Schedule and Agreement in Derivatives Trading

Document maintenance is crucial for managing risk in derivatives trading by ensuring clarity and mutual understanding between parties. The systematic management and administration of all derivative contract documents, ensuring compliance, controlling risk, and enabling seamless trading activities, all depend on this procedure. This process helps facilitate smooth trading operations.

Effective Document maintenance lowers the likelihood of conflicts and regulatory problems by assisting parties in precisely tracking their rights and obligations.

Key Components of Document Maintenance

• Agreements: Establish the legal framework for trading relationships, including standard terms and conditions.
• Schedules: Customize specific terms related to the trading relationship, supplementing the master agreement.
• Trade Confirmations: Confirm the details of individual trades to ensure mutual understanding between parties.
• Legal Documentation: Ensure compliance with laws and regulations, including transaction reporting requirements.
• Audit Trails: Maintain comprehensive records of transactions and changes for transparency and accountability.
• Data Management Systems: Utilize technology to organize and store documents for easy retrieval and updates.

Agreements & Schedules

?A schedule and an agreement serve distinct yet complementary purposes. Let us understand about Agreements and Schedules in Detail.

What is an Agreement?

An agreement is a formal contract between parties that outlines their mutual obligations and terms of engagement. It serves as the foundation for all derivative transactions describing the general terms and conditions under which trades are executed.

Key components of agreements include:

• Brokerage Agreements: Contracts between a broker and a client specifying the services provided, commission structures, and regulatory compliance.
• Clearing Agreements: Contracts that detail the responsibilities of clearing houses and the terms under which trades are cleared and settled.
• Legal Framework: Establishes the legal relationship between the parties, defining rights, obligations, and remedies.
• Standard Terms: Provides a consistent set of terms for transactions, reducing the need for extensive negotiations for each trade.
• Events of Default: Specifies the circumstances under which a party may default, helping manage counterparty risk.
• Termination and Netting: Define the processes for terminating contracts and netting obligations, which simplifies settlements and reduces exposure.

Regular assessments are necessary to maintain agreements' compliance with changing rules and to make sure they accurately reflect the trading practices of the involved parties.

What is a Schedule?

A schedule typically refers to a detailed outline or plan that specifies the terms and conditions related to certain transactions or agreements. They provide detailed operational specifics and flexibility to the standardized framework of the master agreement. It Includes

• Fee Schedules: A breakdown of the commissions and fees associated with executing trades.
• Payment Terms: Specific timelines for when fees are due or how payments will be processed.
• Trade Details: Information about the types of derivatives being traded, quantities, and pricing structures.
• Supplementary Information: They may contain additional clauses or conditions that are not included in the master agreement, enhancing the overall clarity of the contractual relationship.

Schedules must be kept up to date in order to correctly reflect the revisions that have been agreed upon and to be in line with the overall agreement.

Schedule and Agreement in Give-In, Give-Up, and Full-Service Trades

Schedules and agreements showcase the conditions of give-in and give-up trades and highlight the responsibilities of each party, including the clearing broker and the executing broker. These documents project the details of trade execution, including pricing, commissions, and settlement instructions, ensuring clarity and compliance throughout the process.

Give-In Trades: This occurs when a trader executes a trade with one counterparty (the executing broker) but wants the trade to be cleared or settled through a different clearing broker. This is common when a trader has a relationship with a specific clearing house or when the executing broker does not provide a clearing service.

Purpose of Schedule/Agreement:

• Fee Structure: The schedule includes the fees associated with the trade, including commissions for both the executing broker and the clearing broker.
• Trade Details: It specifies the terms of the trade, including the asset type, quantity, price, and timing.
• Settlement Instructions: The schedule provides clear instructions for how the trade will be settled, including payment terms and the role of each party.
• Regulatory Compliance: Ensures that the trade complies with applicable regulations and internal policies.

Give-Up Trades: It involves a broker executing a trade on behalf of a client but then "giving up" the trade to another broker for clearing or settlement. This is often used when a client prefers a specific broker for clearing due to better rates, services, or relationships.

?Purpose of Schedule/Agreement:

• Agreement Terms: The schedule outlines the specific terms of the give-up arrangement, including the roles and responsibilities of each party involved.
• Commission Agreements: It details the commission structure, including how fees will be shared between the executing broker and the clearing broker.
• Trade Confirmation: Provides a clear confirmation of the trade details, ensuring that all parties are on the same page regarding execution and settlement.
• Regulatory Considerations: Addresses compliance with relevant regulations, such as reporting obligations and record-keeping requirements.

Full-Service Trade: The agreements cover a wider variety of broker services in full-service trades, such as risk management, advisory services, and trade execution. The scope of services, costs, and performance standards are all outlined in these agreements.

Schedule in full-service transactions, the schedules outline certain parameters related to the services provided, including trade execution dates, reporting specifications, and any customized tactics that the parties have decided upon. They guarantee that each aspect of the service partnership is well-defined and comprehended.

Role of DMS (Document Management System)

A centralized document management system (DMS) plays a crucial role in the maintenance of schedules and agreements in derivatives trading. Its key functions include:

• Document Storage and Organization: A DMS provides a structured central repository for storing and organizing documents, making it easy to retrieve and manage all schedules and agreements. Allows for categorization by type, date, parties involved, or other criteria, facilitating easy access.
• Version Control: By keeping track of document versions, the system makes sure users always have access to the most recent data and may go back to earlier iterations if necessary.
• Audit Trails: It maintains detailed logs of document access and modifications, providing transparency and accountability for audits and compliance checks.
• Security: A DMS enhances document security by implementing user permissions and encryption, protecting sensitive information from unauthorized access.
• Interoperability: Integrates with other financial systems, such as trading platforms, CRM systems, and compliance tools, ensuring seamless data flow.
• Workflow Automation: The DMS can automate document-related processes, such as approvals and notifications, improving efficiency and reducing manual errors.

Some companies that provide DMS and agreement-related services and clearing services in the U.S. markets:

• DTCC (Depository Trust & Clearing Corporation): Offers a range of clearing, settlement, and data management services.
• CME Group: Provides clearing services for futures and options, along with contract and agreement management.
• ICE (Intercontinental Exchange): Offers clearing services for various derivatives and related documentation management.
• FIA-Tech DOCS: it provides a centralized platform for managing and storing documents related to trading, including confirmations, agreements, and regulatory compliance documentation.

Let Us understand Agreements and Schedules using a Scenario

JPMorgan Chase (JPM) acts as the executing broker for Citadel, while UBS serves as the clearing broker. DTCC is used as the document management system (DMS).

The below steps denote the creation of a give-up schedule and agreement for multiple products traded by Citadel, executed by JPMorgan Chase, and cleared by UBS, with documentation managed through DTCC.

• Client: Citadel
• Executing Broker: JPMorgan Chase (JPM)
• Clearing Broker: UBS
• DMS: DTCC

Step 1: Schedule Creation (Give-Up)

JPM creates a Give-Up Schedule for Citadel, outlining the terms of the trades, including the commission structure for all the products. The schedule is uploaded to DTCC with information

• Trade Details: Product names, contract sizes, prices, and total notional values.
• Counterparty Information: Citadel (client), JPM (executing broker), UBS (clearing broker).
• Product Details?

Total Notional Value for All Products:

• Gold Futures: $195,000
• S&P 500 Futures: $225,000
• Iron Ore Futures: $120,000
• Crude Oil Futures: $80,000
• Natural Gas Futures: $40,000

Total: $195,000 + $225,000 + $120,000 + $80,000 + $40,000 = $660,000

Fee Structure:

• Commission Rate: 0.10% for all products.

Commission Fees:

• Gold Futures: $195
• S&P 500 Futures: $225
• Iron Ore Futures: $120
• Crude Oil Futures: $80
• Natural Gas Futures: $40

Total Commission Fees: $195 + $225 + $120 + $80 + $40 = $660

Clearing Fees: $100 per product (Total for 5 products: $500)

Settlement Instructions:

• Settlement Date: 18-dec-2024
• Payment Instructions: Payments are to be made to UBS on the settlement date.
• Delivery Instructions: Specify if the trades will settle physically or through cash settlement.

Regulatory Compliance:

• Ensure compliance with CME, SGX, and NYMEX regulations and include necessary disclosures.

Additional Terms:

• Risk management provisions and collateral arrangements if applicable.

Signature: Digital or physical signatures of authorized representatives.

Step2: UBS Agreement (Give-In) with JPM

UBS has a Give-In Agreement with JPM that governs the terms for accepting trades for clearing outlining how UBS will manage the trades and includes details such as the fee structure for clearing services.

Step3: Order Placement and Trade Execution

• Order Placement: Citadel places orders for all listed futures contracts with JPM
• Execution: JPM executes the trades in the market at the specified prices:
• Gold Futures: $1,950 per ounce
• S&P 500 Futures: 4,500
• Iron Ore Futures: $120 per metric ton
• Crude Oil Futures: $80 per barrel
• Natural Gas Futures: $4 per MMBtu

Step4 Trade Confirmation

Once the trade is executed, JPM generates a confirmation that includes Products, Contract Size, Price, and Total Notional Value.

Step5: Trade Submission to DTCC

JPM submits the executed trade details to DTCC for processing, including: Trade date, execution price, and all relevant trade identifiers including Citadel’s instructions for clearing through UBS.

Step6: Verification by Citadel

Citadel reviews and confirms the trade details with JPM.

Step 7: Clearing Process

UBS receives the trade information from DTCC, including the trade details submitted by JPM.

UBS assesses the trade for risk and calculates the required margin based on current market conditions. UBS processes the trades through its clearinghouse, ensuring compliance with margin requirements based on the total notional values. UBS will charge clearing fees for processing the trade, which may be a flat fee per contract or a percentage of the notional value.

Step8: Settlement

Once the trade passes UBS’s risk management checks, UBS confirms the settlement with DTCC. The settlement involves the transfer of the contract from Citadel to UBS, along with any margin requirements.

Settlement Prices remain as executed:

• Gold Futures: $1,950 per ounce
• S&P 500 Futures: 4,500
• Iron Ore Futures: $120 per metric ton
• Crude Oil Futures: $80 per barrel
• Natural Gas Futures: $4 per MMBtu

Step9: Payment and Delivery (On Settlement Date)

Cash Settlement: If not physically delivering the products, Citadel will settle the contracts for the total notional values:

• Gold: $195,000
• S&P 500: $225,000
• Iron Ore: $120,000
• Crude Oil: $80,000
• Natural Gas: $40,000
• Total Payment: $660,000

Physical Delivery: If applicable, arrangements for the physical delivery of commodities will be made.

Step10: Record Keeping

All actions, confirmations, and settlements are recorded in DTCC DMS for compliance and auditing purposes.

That is all on this topic. Stay tuned for next week's article.