Effective Product Control. Nash Peter

will not be consistent across the industry.

      As we touched on earlier in the book, product control can also be situated within middle office, but for the purposes of this chapter, we will cover those middle office tasks where product control are located within finance.

      Middle office are closely aligned with the desk as they are responsible for:

      • Trade bookings on behalf of the desk.

      • Effecting the daily fixings for indices such as LIBOR.

      • Saving down into the RMS (or equivalent) the desk's end of day marks which will be used to revalue their portfolio.

      Product control rely on middle office for:

      • Information on new and amended trade bookings, particularly those which generate significant day one P&L.

      Market Risk

      Market risk is the risk that the desk's portfolio will rise or fall in value due to changes in market prices, which can lead to either profits or losses for the bank. As a bank wants to limit the losses incurred from market fluctuations, they will set an overall market risk limit for the group at board level. These group-level limits are then transformed into smaller business- and desk-level limits, which are applied across the various trading desks. Limits cover such things as:

      • Maximum loss for moves in interest rates, foreign exchange rates, credit spreads or volatilities.

      • Concentration limits on exposures in various maturities or even various countries.

      • Types of products that can be traded.

      • Daily P&L amounts.

      The market risk function within a bank, sometimes known as market risk control, falls within the mandate of the chief risk officer, who is also responsible for the credit and operational risk of the firm.

      Market risk is responsible for:

      • Agreeing on, with the board and heads of business, the market risk limits that the trading desk can run.

      • Quantifying, monitoring, and reporting the market risk exposures of the trading desk.

      • Authorize short-term limit extensions or ask for positions to be closed to bring a desk back within agreed limits.

      • Running stress-testing scenarios to highlight the bank's potential P&L in exaggerated market movements.

      • Escalating market risk limit breaches to the senior management in market risk and the business.

      • Model validation and approval.

      As with any control function, it is important that market risk remain independent of the trading desk that they are aligned to.

      Market risk rely on product control for the following:

      • The official daily P&L which highlights what positions are generating the desk's P&L.

      • A clean MTM P&L, which will be used for VaR back testing.

      • Independently verifying the end of day marks (prices, rates and volatilities) used to revalue the desk's open positions.

      • Advice on the availability of market prices when new products are proposed.

      Product control (including valuation control) rely on market risk for:

      • Market risk exposures (used for risk based P&L estimates).

      • Approving and calibrating the financial models used to generate fair values.

      • Assistance in quantifying financial model reserves.

      • Assistance in determining the banking book and trading book classifications.

      • Insights into the financial markets, particularly when quantifying prudential valuations for regulators.

      • Allocating trading positions in the fair value hierarchy and determining fair value through the independent price verification process.

      Financial Reporting

      Historically, the role of financial reporting (which can also be known as financial control) in banking was a little secondary in finance. Reporting was not as stimulating as the front office facing product control and was regarded as a bit of a backwater by some. The key perspective in financial reporting is that of the legal entity and the governance around it is often set in law.

      The role of financial reporting is in many ways at least as important, if not more so, as product control. The role was to report to an external body the results of the legal entity under the relevant rules or requirements. This would cover:

      • Management reporting to the board of a legal entity.

      • Financial reporting, audited financial statements and filing as part of the Companies Act requirements under IFRS and local GAAPs.

      • Regulatory reporting to the local regulatory bodies – in the UK this is to the Prudential Regulatory Authority (PRA) and the European Banking Authority (EBA).

      • Statistical reporting – in the UK typically this is the Bank of England (BoE).

      • Other local filings and enquiries – for example, the Financial Conduct Authority (FCA), Office for National Statistics (ONS), and so forth.

      The risks associated with financial reporting are high. The board members are personally responsible for shareholder or creditor loss if they knowingly act in a fraudulent or illegal manner. Regulators can impose fines, custodial sentences, and close the business down if they are not satisfied.

      In recent years the importance of this has become particularly focused as the misdemeanours of the industry and lack of vigilance by the regulators have resulted in the media and politicians baying for blood and a large number of new requirements across the regulatory bodies.

      The financial reporting team review and challenge the results presented to them, the role of product control is to provide an explanation and rationalization of the business results in the legal entity and thereby allow for onward explanation to stakeholders.

      Management Reporting

      The management reporting team, sometimes known as performance reporting, is responsible for providing a bank's management and external stakeholders with insight into the bank's performance.

      At its core, this function will:

      • Work with the businesses to establish budgets for revenue and expenses.

      • Monitor the relative performance of the business against these budgets and obtain commentaries (usually from product control), which explain the performance drivers, on a weekly, monthly, quarterly and annual basis.

      This function is heavily reliant on product control providing transparency into the business's performance through commentaries that describe both the outright performance and relative performance to plan (budget/forecast) or prior period (quarter, half or year).

      The management reporting team expects that the performance data they are consuming (P&L and balance sheet) is accurate, rendering them completely reliant on product control executing the necessary controls over the business to ensure the data they are consuming is valid.

      Where this function delivers added value is by providing senior management (e.g., group CFO) with transparency into the drivers of a business's performance in a clear and succinct manner. Consequently, this team's communication skills, both written and verbal, need to be of a very high quality.