Market Structure (The Complete Guide 2019)

Global Market Structure

Global Market Structure

Understanding the market structure is an essential part of learning derivatives processing and operations.  This blog outlines the various players and their market segments and discusses their respective roles in the market.


Close attention is given to the key players: buy-side institutions, sell-side institutions, exchanges, clearinghouses, and service providers. Finally, regulatory and non-regulatory organizations from key world markets are discussed.


The objectives of this blog are to identify and explicate, in the context of the global market structure of derivatives and cross-border trading, the following players, including each player’s role in different derivative markets and the relationships among players:


Market Players

The following sections explain the roles of the various types and subtypes of market players and the relationships among them.


Buy-Side Firms (Clients)

Buy-Side Firms

A wide range of market participants trade derivatives, including financial institutions, manufacturers, hedge funds, asset managers, and other corporations.


These entities are variously called buy-side firms, institutional investors, and end clients. Clients trade derivative contracts for various reasons, including risk management, speculation, arbitrage, and physical delivery of the underlying asset.


Clients are typically divided into two major categories: hedgers and speculators. Hedgers enter into a derivatives contract in an effort to hedge (eliminate) or reduce the risk.


One of the risks they could potentially manage is a downside risk, which is the risk that the value of an asset could decline. Another risk they could potentially manage is an upside risk, which is a risk of the cost of inputs they use in their business, such as raw materials, potentially rising.


In contrast, speculators are looking to take advantage of events in a market in order to produce a profit. These market players could try to profit from a change in the value of an asset or in a market variable such as interest rate.

The following section explores each type of institutional investor that participates in a derivative market.


Asset Managers

Asset Managers

Asset managers typically include managers of large mutual funds, commodity trading advisors (CTAs), commodity pool operators (CPOs), and other investment advisors.


Asset management activities include traditional fiduciary services, retail brokerage, investment company services, custody, and security-holder services. Asset managers use various distribution channels for their products and services.


For example, a large banking company may establish an asset management group consisting of several interlocking divisions, branches, subsidiaries, and affiliates that provide a broad range of asset management products and services on a global scale.


A small community bank may simply operate a separate trust division that provides traditional fiduciary services and that may also provide access to retail brokerage services through an unaffiliated third-party vendor located within the bank’s branch network.


Asset managers typically use derivatives for either just hedging or for both hedging and profit-making (speculation), based on the size and nature of their business.


Banks and Loan Portfolio Managers

Banks and Loan Portfolio Managers

Banks and loan portfolio managers are exposed to credit risk by issuing loans (lending) to consumers and businesses. These entities rely heavily on credit derivatives in their effort to manage this exposure (credit risk).


They often use derivatives such as credit indices, credit default swaps, and interest rate swaps to manage credit and market risks.


Hedge Funds

Hedge Funds

Hedge funds are large, relatively unregulated pools of capital open only to accredited investors. Financial institutions structured these as limited partnerships in order to comply with fewer regulatory requirements than other investment management institutions.


Hedge funds try to beat the returns created by the broader market by harnessing a wide range of investment strategies including long-short, global macro, event-driven, and value arbitrage.


These financial institutions often make high use of leverage in their efforts to produce robust returns. Hedge funds typically include a range of alternative investment companies.


Hedge funds are typically involved in trading both derivatives and cash products (securities). Due to the fact that these institutions face fewer regulatory restrictions, they are likely to take riskier positions by using derivatives.


These organizations require both risk management and sophisticated products to carry out their strategies.

Hedge funds depend on broker firms to supply most services needed, such as execution, clearing, financing, administration, and accounting. Note that broker firms provide personalized services to hedge funds.


Insurance Firms

Insurance companies need to manage not only their assets but also several risks, including equity risk and interest rate risk. These entities use various derivatives in the hedging process.


Private Banks

Private banks engage in wealth management, advising wealthy individuals and corporations on legal and regulatory matters and investments. They offer innovative and lucrative investment portfolios to their clients. Most private banks include derivative instruments in their investment strategies for hedging, speculating, or both.


Day Traders, Scalpers, and Position Traders

Day Traders, Scalpers

In fast markets such as a listed market, there are speculators who simply take risk and profit from market movements. Apart from institutions such as hedge funds, there are other players that are known by the names of scalpers, day traders, and position traders, who engage in speculative trading.


A scalper offers to buy or sell contracts, holding the position for only a brief period of time—often from a few seconds to a few minutes. Scalpers attempt to profit by buying at the bid price and selling at the higher asking price.


A day trader holds the position open for longer but closes all positions by the end of the day, whereas a position trader holds positions open overnight.


Day traders and position traders are different from scalpers. Day traders and position traders try to profit from the anticipated direction of the market, while scalpers try simply to buy at the bid price and sell at the asking price, thus earning the spread (the difference between the bid and ask).


Treasury Departments

Treasury Departments

Corporations are required to effectively manage and forecast cash, foreign currency, and commodity demands. The need to promptly address capital allocation and liability management issues are theirs as well. They face different risks from their business activities. In addition, these entities face risks that do not stem from their business activities.


They are responsible for hedging the balance sheet and income statement against risks such as market risk, currency risk, credit risk, and liquidity risk, and asset-liability management (ALM) (funding).


They hedge their positions in commodities, foreign exchange, securities, and cash flow using derivatives such as swaps and option contracts.


Retail Investors

Retail investors include professional traders, private clients, and individual investors. They have mostly involved in trading listed derivatives on a small scale.


They typically rely on retail brokerage firms to provide execution services and to maintain their accounts. Retail investors are beyond the scope of this blog. In addition, the topics discussed in this blog might not be applicable to retail markets.


Sell-Side Firms or Dealers

Sell-Side Firms or Dealers

sell-side firm is a much broader term than it sounds. Sell-side firms are key players in the derivatives market and play many roles. In general, all intermediaries are known as sell-side firms.


They include broker-dealers and other brokerage firms. They are also sometimes referred to simply as dealers, brokerage firms, brokerage service firms, or just banks. Broker-dealer is a term synonymously used with the sell-side firm.


Sell-side firms are typically commercial banks or professional brokerage firms specializing in the capital market business. In financial markets, commercial bank is synonymous with investment bank because most commercial banks also engage in investment banking, although not all investment banks are commercial banks.


Sell-side firms play a critical role in running financial markets. They are even more crucial in the OTC derivatives market because they provide liquidity by acting as counterparties. Sell-side firms provide the following services:

  • execution broker (trade execution services)
  • market maker (market-making operations)
  • clearing broker (clearing and settlement services)
  • prime broker (brokerage services to private investment firms such as hedge funds)
  • local and global custodian
  • treasury and liquidity management
  • securities lending and borrowing
  • cash management
  • treasury and foreign exchange
  • fund administration
  • middle-office outsourcing
  • proprietary trading



Based on the size of the brokerage firm, it may provide few or many of these different services.

In derivative markets, sell-side firms profit from service charges and the spread charged from their execution activities. Some of the main sources of their revenue are commissions from agency execution, commissions from clearing services, markups from principal transactions, and spreads from market making and fees paid for other services.


The second part of this blog explains the organizational structure and further details of a sell-side firm.


The following section explains the various roles and services provided by sell-side firms.


Execution Broker

Execution Broker

Execution brokers provide order execution services to their clients in various markets. Execution brokers are well connected to all execution venues. Brokers receive orders both over the phone, which is known as voice broking and through proprietary online platforms.


Online platforms enable clients to electronically send their orders to brokers. These platforms may also execute orders by matching orders from different clients.


Execution brokers provide high-quality, price-efficient access to the major world markets. They play different roles in executing a trade. Client orders are executed either on an agency basis or a matched-principal basis, as explained below.


Agency Execution

In an agency role, a broker simply routes the client order to the corresponding market—the listed product order to the corresponding exchange—and OTC product order to OTC market, where this order is matched with another order placed by a different participant.


If allowed by existing market rules, a broker-dealer executes trades internally instead of executing through an exchange or the OTC market. Doing so involves matching trades with those placed by their other clients.


Matched-Principal Execution

The broker executes an order on a matched-principal basis by entering into the opposite side of a client’s trade. Consequently, the broker usually enters into an offsetting trade with another market participant, often within a matter of minutes or during the same trading day to cancel out (eliminate) market risk.


Dealer firms may manage their risk at a portfolio level (on aggregate) instead of by each trade individually.


Principal Trading

Principal Trading

Broker-dealers may also execute trades taking the role of the counterparty (principal), possibly to hedge their own exposure (risk management). This is known as principal trading—also known as for firm’s book, position keeping, and proprietary trading.


Clearing Broker

Derivative contracts can either be bilateral or centrally cleared. All exchange-traded contracts and cleared OTC contracts are cleared through a CCP.


All other OTC derivatives remain between the trading partners on a principal-to-principal basis (bilateral clearing). It was also discussed that clearing is done through a clearing broker firm that is a member of a clearinghouse.


Some of the sell-side firms act as clearing brokers, providing clearing services to their clients. Clearing brokers maintain their memberships on most popular derivative exchanges.


Most executing-broker firms also provide clearing services, but not necessarily both services. In other cases, a clearing firm may not be a member of clearinghouse and may use another clearing member who is a member of the clearinghouse. These firms are known as non-clearing members or carry brokers.


A financial institution can become a member of a clearinghouse by completing a prequalification process and depositing required funds with that clearing-house. The money contributed is held as a security deposit towards the clearing fund maintained by a clearinghouse.


Clearing members are subject to regulatory and clearinghouse requirements on maintenance of client margin, minimum capital, and other related matters. Actual membership requirements vary by the clearinghouse. There are many brokers, both domestic and foreign, operating in the derivatives market.


The clearing broker is responsible for the performance (obligation fulfillment) of its clients. The clearing broker follows clearinghouse guidelines to maintain client margin accounts. They hold client collateral in a margin account of each client. The clearinghouse maintains the aggregated collateral of each member in that entity’s margin account.


Normally, the collateral of a clearing broker held with a clearinghouse (member margin account) is maintained in separate accounts—one for end-client positions and another for proprietary positions. Typically, margin accounts hold liquid collateral such as cash and securities. 


Clearing brokers are known by other names such as derivative clearing member (DCM), futures clearing member (FCM), clearing member firm (CM), and clearing firm (CF).




There is another clearing model in OTC markets. In cleared OTC markets, clearing members have a similar role as in the listed market—they are members of a clearinghouse and provide clearing services to end clients.


Alternatively, it is also possible that a clearing member firm may provide clearing services without going through the clearinghouse.


But in this case, the clearing firm is taking all the risk. It continues to maintain the margin account and collect collateral from its clients. However, a limited number of firms provide this kind of clearing service.


Market Maker

Most broker-dealers are involved in market making. Market making is the process of executing trades by entering into the opposite side of a client’s trade, and then quickly entering into an offsetting trade with another market participant.


The institution involved in market making is called the market maker. Market makers publish both their bid and ask price at the same time, usually over electronic platforms.


The key objectives of market makers are to profit from the bid-ask price spread and provide liquidity. Although this spread is very small in most cases, they profit by trading large volumes. They operate both in listed and OTC markets. Usually, market makers are exposed to market risk.


They are able to reduce this risk by quickly offsetting their positions. Market makers are more common in listed markets due to the speed and large volumes of trades executed there. However, market makers are large providers of liquidity in the OTC market as well.


The difference between market making and matched-principal trading is that market makers must provide both the bid price and ask price at any given time and must be licensed in each trading venue as market makers.


On the other hand, in matched-principal trading, brokers can trade any side as needed. In addition, market makers always close their blogs, meaning they offset all positions, and they usually do so by the end of the trading day.


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Designated Market Maker

Designated Market Maker

Designated market makers (DMMs) are the typical market makers that are authorized by a specific exchange and the product. An exchange authorizes certain market makers to serve as DMMs to further increase the market liquidity of their products.


DMMs need to follow the rules of the exchange in maintaining the two-way prices (bid and ask) and volumes during specified periods of the trading day. Sometimes, as in the case of the New York Stock Exchange, the term specialists also refers to DMMs.


Futures Commission Merchants

A futures commission merchant (FCM) is an exchange-authorized execution broker. An FCM is a member of a derivatives exchange and is allowed to accept orders for the purchase or sale of any products listed on the exchange. An FCM is subject to exchange membership rules.

FCMs originated in the futures market, which explains the name. Today’s FCMs deal not only in futures but also in all types of products traded on exchanges.


Electronic Trading Platforms

Electronic Trading Platforms

Large sell-side firms have built their own trading platforms to allow their clients to execute their orders with other participants electronically and with broker assistance, as needed.


Trading platforms provide connectivity, reliability, and a choice of markets, products, clearers, and execution styles.


In addition, these platforms may also provide straight-through processing (STP) and easy integration with a variety of systems. They may also provide other required services such as access to real-time and historical market information, as well as the pricing of complex products.


Introducing Broker

Introducing Broker

An introducing broker (IB) is a person or institution other than an FCM that is engaged in soliciting or accepting orders for the purchase or sale of derivatives. The IB then passes these orders to other executing brokers or exchanges.


An IB typically works as a simple intermediary (similar to an independent salesman) without being involved in the contract. An IB simply collects an IB fee. IBs introduce client accounts to FCMs on a fully disclosed basis.


After the execution, clients will deal directly with the execution broker and clearing broker who actually executed and cleared the trade. The IB generally does not accept any money or securities in order to maintain margin or for any other purpose.

Typically, the IB owns the relationship with the end client. Sometimes, the sales department of a large brokerage firm is referred to as an IB.


Prime Brokers

Prime Brokers

Prime brokerage is a full service provided by sell-side firms to buy-side institutions (mostly hedge funds). Prime brokerage covers a wide range of services designed to address most of the needs of clients.

In the derivatives industry, some of the services offered by prime brokers include the following:

  • global execution 
  • financing and securities lending
  • clearing, custody, and settlement services
  • portfolio management and administration services
  • strategic advisory services
  • technology services
  • cash and liquidity management
  • reporting (real-time P&L and position management, risk reporting service)
  • collateral and margin management services


The next major benefit of using professional services by a prime broker is reduced operational costs and increased operational efficiency. Small and mid-size clients can delegate all operational functions to a prime broker.


Fundamentally, prime brokerage targets not only the large hedge funds but also the hedge funds that are of modest size and institutional investors. Prime brokers typically provide funding through their extensive network of relationships with institutional investors, corporations, and private families.


To protect position information of their clients, brokerage firms strictly enforce access restrictions (referred to as Chinese wall) between the prime brokerage and other businesses such as sales and trading.


Fund Administration

Fund Administration

Fund administrators provide professional services required to manage financial portfolios containing various financial products including derivatives.


They offer various services such as portfolio valuation, position keeping, accounting, reporting, financial statement preparation, cash management, reconciliation, and regulatory reporting. Typically, small to midsize funds use professional fund administrators.



An exchange is an organized trading venue that provides the orderly trading of financial instruments. The key objectives of an exchange are to provide price transparency, standardized products, liquidity (bringing large numbers of buyers and sellers together), and guarantees of trade executions.


Many exchanges around the world offer to trade of standardized financial instruments, including derivative contracts. Exchanges employ sophisticated systems to provide robust and reliable trade matching as well as confirmation and other services.



Only authorized members can participate in trading on an exchange. All non-members must execute their trades through exchange members. Although large end clients can also obtain membership on the exchange, execution brokers typically hold membership and provide execution services to their clients. In the derivatives industry, an exchange member is known as an FCM or IB.



Historically, trading in exchange markets was restricted to standardized contracts based on traditional and physical commodities such as agricultural products. Today, however, these markets have expanded to cover different market sectors such as interest rate products, foreign exchange products, and stock indices.


Most popular types of derivative products on exchanges are futures contracts, options on futures contracts, and options on securities.

All exchange products are cleared through a designated clearinghouse that virtually eliminates the counterparty risk.


Execution Models

Execution Models

The exchanges themselves do not take any proprietary trading positions in derivative contracts. Rather, they simply link the buyer and seller and function as a neutral marketplace for their participants. The prices are determined by open and continuous trading. Exchanges do not set or control prices of any products traded.


An exchange may provide a physical location, computer-based electronic network, or both for trading. There are two trading models that are common on derivative exchanges: pit trading and electronic trading. The details of trading methods may vary by exchange. The following sections explain them in general terms.


Pit or Open-Outcry Trading

Originally, trading took place exclusively through face-to-face interaction on a physical trading floor of an exchange, also known as the pit, through an auction process known as open outcry or crowd trading.


In an auction market, prices are established publicly by participants posting bids (or buying indications) and offers (or selling indications). For instance, many derivatives products are traded on CME trading floors.


The exchange floor is organized into multiple pits, and each pit trades a set of products. Traders (floor brokers) are located around the pit in a crowd. Traders are either employed by an executing broker firm (member of exchange) or individually licensed by the exchange.


A trader receives orders from an executing broker firm or directly from clients. The trader then participates in an auction with the crowd.


A specialist who runs the auction process controls each pit. Traders in a pit present their bids and offer in public to others. They use specific language and hand signals in this process. Trades are facilitated and recorded by specialists in centralized systems of exchange.


After execution of the order, both traders (buyer and seller) create tickets that they pass on to their corresponding clerks. Clerks are the trader assistants who perform all the nontrading tasks supporting the trader. Clerks send trade tickets (execution) back to their firms for further processing.


The auction process on an exchange is anonymous. Although floor brokers may know each other intimately, they do not disclose the end client who owns the order they are executing. In addition to transactions between traders, traders also trade with specialists who play the role of market makers.


All details, including the price of an execution, are recorded with the exchange (either manually or electronically). The exchange, in turn, publishes trading prices to other participants as well as to the outside world continuously throughout the trading day. Furthermore, trade information is transferred to their corresponding firms electronically or by clerks.


Today’s pit trading runs using the most advanced technologies, promoting high volume and fast-paced trading. Floor brokers use wireless, handheld devices that connect both to the trader’s firm and exchange systems to automate the order, execution flow, market data, and communication.


Electronic Trading

Electronic Trading

As a result of technological advances, many derivatives exchanges have expanded their markets by replacing their floor-based trading systems with an electronic market or by supplementing open-outcry trading with electronic market access.


In listed derivative markets, there are many systems that stream live trading information, including market prices and volumes from exchanges to all licensed traders (executing brokers).


These systems are known as dealing screens or dealing systems. Using dealing systems, traders (clients) submit their orders to exchanges. An exchange’s electronic order matching system will then match orders and return the execution details to both side traders.


The vast majority of trading today is done over electronic matching systems. This is also known as direct market access (DMA). Many financial derivative markets no longer have pit trading. However, a large part of the commodities market still uses pit trading.


Market Data and Closing Prices

Market Data and Closing Prices

Exchanges publish market quotes throughout the trading day and the closing prices at the end of the trading day. A market quote includes bids, offers, quantities, last trade price, and so on.


Closing prices are the final settlement prices of the day. These prices are used for all settlement purposes and to mark-to-market (valuation) the current positions at the end of the day.



Exchange members are regulated by their exchanges and governmental regulatory agencies. Exchanges are licensed and regulated by local governmental agencies. The exchange acts as a self-regulatory organization (SRO), implementing and monitoring with its own rules in addition to industry rules.


An electronic trading platform (ETP) is a nontraditional, electronic-based market for professionals and institutions trading financial instruments. ETPs are capable of matching buy-and-sell orders automatically without the intervention of a human broker, market maker, or an exchange. They increase the speed and transparency of trades while reducing the cost of the execution.


In the derivatives market, there are both fully automated platforms as well as hybrid platforms that allow participants to communicate via platform tools and execute their orders.


Such platforms are known by various names including alternative trading system (ATS), liquidity pool, electronic communication network (ECN), swap execution facility (SEF), organized trading facility (OTF), and multilateral trading facility (MTF).


Types of Trading Platforms

Types of Trading Platforms

Electronic trading platforms can be classified into the following different types based on the participants:


Single dealer. A broker-dealer provided a trading platform for its own clients. On these platforms, clients can trade only with the dealer that provides the platform. These are known as dealer platforms.


Interdealer or dealer-to-dealer. A trading platform that is accessible only to broker-dealer institutions to trade with one another. These are typically known as Alternative Trading Systems (ATS) and Liquidity Pools (LP).


Dealer-to-client or multi-dealer. Trading platforms that are accessible to dealers as well as clients. These are typically known as the Electronic Communication Network (ECN), Swap Execution Facility (SEF), Organized Trading Facility (OTF), and Multilateral Trading Facility (MTF).


Some popular derivatives trading platforms are listed below:

  • Electronic Trading Platforms
  • GLOBEX by the Chicago Mercantile Exchange
  • LIFFE Connect
  • IntercontinentalExchange by ICE Futures
  • Blackbird
  • Creditex (CreditMatch)
  • e-MID
  • ICAP Electronic Broking
  • IDX Capital
  • Dealer-to-Client Platforms
  • 360T
  • Bloomberg
  • MarketAxess
  • Tradeweb
  • RediPLUS (Goldman Sachs)
  • Instinet


Swap Execution Facility

Swap Execution Facility

The SEF was created as a result of Dodd-Frank Act regulations. The objective of this entity is to bring transparency and more liquidity into OTC markets. These are simply dealer-to-client electronic trading platforms that adhere to the rules introduced by Dodd-Frank.


These platforms trade OTC products that are treated as swaps according to these regulations. A SEF is also known as a multilateral trading facility (MTF). Like exchanges, SEFs are regulated by market regulators. 


According to Dodd-Frank rules, a SEF’s minimum requirements are to create an open trading environment by bringing bids and offers from multiple dealers, thereby providing the greatest number of choices to market participants

  • promote pre-trade and post-trade transparency while maintaining liquidity
  • maintain automated audit trails of bids, offers, and execution details follow other regulatory rules


The typical roles of a SEF are pre-trade compliance, trade execution, allocation, and surveillance. SEFs also provide additional services such as connectivity to clearing brokers, CCPs, trade warehouse, and service platforms.


Central Counterparty (CCP) (Clearinghouse)

Central Counterparty

After the trade execution during the clearing process, the central counterparty (CCP) steps into the trade and becomes the only legal entity that market participants face. (Note that in the case of bilaterally cleared trades, there is no CCP.) This section explains the role of a CCP, how it operates, and the importance of this organization.


It is important to note that there are different terms used to refer to a CCP. Some even spell out CCP as a central clearing party or central clearing counterparty. Other terms used are a clearinghouse, clearing corporation, and clearing organization.


The most widely used term is a clearinghouse. CCP and clearinghouse are synonymously used in the industry. In addition, most people write clearinghouse as one word; however, some chose to write it as two words: clearinghouse.


Many traditional clearinghouses now serve OTC cleared markets along with listed derivatives.


Unlike securities trading, derivatives trading involves no immediate transfer of assets. The life of the contract may extend over many years. This creates a counterparty risk that needs to be managed continuously until termination. CCP can step in to help market participants to mitigate this risk.


CCP plays the role of a central counterparty and delivers the guarantee of contractual performance. However, market participants still face the counterparty risk from the CCP itself. This risk is usually considered to be negligible because CCPs are professionally managed and employ strong risk management strategies.


There are some clearinghouses that serve multiple exchanges and clear selected OTC derivatives as well. Some of the major responsibilities include the following:


Central counterparty. A CCP plays a counterparty role to both trading partners and creates two trades. Clients “face” the CCP instead of dealing with each other, which avoids incurring counterparty risk from each other.


Legal responsibility. CCPs are legally responsible for settling any counterparty’s defaults or failure to honor their obligations.


Settlement netting. Positions are netted to reduce the number of open positions resulting from increased capital efficiency. This is known as multilateral position netting.


Position management services. Position updates, give-up, and take-up.


Settlement routing. Most CCPs also provide the settlement instructions to its members.


Benefits of Central Clearing

Benefits of Central Clearing

The preceding section discussed the role of CCP. The benefits of central clearing include the following:

  • Contract performance and counterparty risk management. Both trading partners (buyer and seller) of the contract are guaranteed performance (obligation fulfillment) by the CCP. This virtually removes any counterparty credit risk.


  • Multilateral netting. Clients get the opportunity to close out the position with any other market participant when needed (known as the fungibility of contracts).


  • This reduces the volume of open positions and, in turn, reduces total counterparty exposures. In addition, it will introduce operational efficiencies by reducing the total number and value of transactions to be settled.


  • Transparency. Central clearing promotes the uniform market through marketwide transparency. In cleared markets, transaction prices and exposures are all open to regulators and the public.


  • Systemic risk. Due to strong risk management strategies and the financial strengths of CCPs, systemic risk is virtually removed. Typically, CCPs calculate midday margins along daily margins to reduce the exposure.


  • In addition, netting across multiple counterparties reduces the overall exposure by reducing the systemic risk (that is, the risk of knock-on failure from one counterparty to the next).


  • Capital efficiency. CCP may promote reduced regulatory capital for institutions through cross-margining (margin netting among multiple product classes).


  • Reduced costs. Due to heavy automation and larger volumes of CCPs, the overall cost of trade processing may be less.


  • Operational efficiency. CCPs introduce centralized, safe, and controlled post-trade process, increasing operational efficiency.


Limitations and Risks of CCP

Although clients are protected from credit exposures from other trading partners, they are still exposed to the risk of the CCP defaulting. Regardless of their strength, there is still a slight chance of the CCP itself defaulting. Historically, however, no CCP has ever defaulted.


Another fact is that there are a limited number of CCPs in the market, which results in a concentrated exposure to CCPs. Although CCPs are strong, defaults cannot be completely ruled out. CCP failure may create major damage to the entire system.


Most OTC products are complex and hard to standardize. As a result, CCP clearing is limited to plain vanilla contracts, leaving a large number of OTC contracts still in the bilateral market.


Types of CCPs

Types of CCPs

There are two types of CCPs: traditional clearinghouses and independent corporations.


Traditional Clearinghouses

Traditional clearinghouses are typically owned and operated by exchanges. Each clearinghouse clears all transactions of one or more exchanges (listed derivative contracts). They have also started clearing some of the OTC products (cleared OTC contracts).


Independent Corporations

In OTC markets, there are independent corporations that provide only clearing and/or settlement services. They run on their own financial backing. These firms are trying to adopt methods similar to traditional clearinghouses in order to manage their risk. Independent CCPs are growing, and these firms vary at their level of service and products they support.



End clients access clearinghouses through a clearing broker who is a member of a clearinghouse. In the case of listed markets, buy-side firms execute their trades through the execution brokers and use clearing services used mostly by the same firm or a different clearing broker firm. 


Clients may also use clearing services from a brokerage firm that is not a member of the clearinghouse (non-clearing member). This type of entity is also known as a carrying broker. Non-clearing member firms, in turn, use other clearing member firms to access the clearinghouse.


Risk Management Strategies

CCP takes over counterparty risk from all its clients (clearing members). Besides counterparty risk, it faces other types of risks explained below. The CCP must be financially robust and adopt sound risk management practices.


The success of the CCP depends on its financial strength, risk management strategy, and underlying operational efficiency. Technology plays a key role in achieving operational efficiency.


In general, CCP manages risk through its rigorous membership standards and adopts prudent margin requirements. It also maintains a large guarantee fund to provide confidence to its members. The clearinghouse collects deposits from each member which go toward its guarantee fund.


Its members must also maintain certain standards and provide extensive data on financials and operations before obtaining membership. In order to cover its obligations, the clearinghouse maintains its own capital base and bank facility guarantees and collects member margin payments. The following are key strategies used to manage credit risk by the CCP:


a large guarantee fund used in case of member defaults initial margin for each transaction daily settlement of variation margin (losses and gains of the day) intraday margin calculations, collecting margin (making calls) if required liquidation of open positions when a trading party is in default equity capital of the firm


In addition to credit risk, the CCP faces the following risks:


Market risk is the change in contract value from the change in market factors. The daily margining (daily settlement of losses and gains) mitigates the market risk. Margining also includes the deposits to mitigate the credit risk. 


Liquidity risk is the risk of fulfilling obligations in a timely manner. CCP uses margin or collateral posted by the defaulting member to mitigate this risk. Apart from this, the CCP also maintains large amounts of credit lines to fulfill obligations on time.


Settlement risk is the risk of a custodian defaulting after the money is transferred from the member and received by the clearinghouse custodian (bank). While there is no full protection from this risk, strategies such as netting of payments and spreading the risk over multiple entities are used to reduce this risk.


Operations risk is the risk due to system failure and human error due to the complexity and the criticality of the CCP operations. Errors or system breakdowns may lead to a serious financial loss. Operations risk is managed through various strategies such as redundant networks, robust systems, employee training, business continuity planning, and execution.


Licensing and Regulatory Oversight

Since the clearinghouses are the most important entities in financial markets, they are licensed and regulated by industry regulators. For instance, the CFTC and SEC in US markets and the Financial Services Authority (FSA) in European markets issue license and regulate CCPs.


Default Handling Process

Default Handling Process

It is always possible that one of the trading partners or the clearing member can default. This section explains the general rules followed by CCPs. The membership rules, risk management, and default handling process vary by CCP and applicable regulations.


In case of default, the CCP uses the following sources to cover the losses in the order listed below:

  • funds from the liquidation of all open positions of the defaulting entity
  • collateral obtained from a margin account
  • funds from the guarantee fund
  • credit insurers
  • equity capital of the clearinghouse itself


These sources make it virtually impossible for the CCP to default. CCPs usually have the highest reputation for credit trust in the market.


Customers are also protected in case of clearing member defaults. First, clearing members are monitored and audited regularly by the CCP and internal auditors.


They are required to maintain adequate capital and comply with the rules and regulations established by the CCP. In case of a member default, all client positions and collateral are transferred to another member.


Any proprietary positions are liquidated to cover any losses incurred. If those funds are not sufficient enough to cover losses, the CCP may step in to assist.


In the case of a non-clearing member default, the corresponding clearing member tries to cover these losses from open position liquidation and collateral. For further losses, the CCP may step in.


If a trading party (client) defaults, first the clearing broker (member firm) will handle the default. It will liquidate client positions and use collateral to cover the losses. If those funds are not sufficient enough, the CCP may again step in.


A CCP’s guarantee fund is used to compensate fellow CMs in case of any CM default, but not to benefit the customers of the defaulting CM. Further details on default handling are prescribed by the respective regulatory agencies.


Give-Up and Take-Up

Give-Up and Take-Up

Give-up is the process of the clearing member accepting the trade that is executed and submitted by the executing broker. The give-up process confirms that the clearing member accepts its role in the transaction.


That means the executing broker is performing a give-up of the trade to the clearing member for the clearing services, and the clearing member is performing a take-up of the trade. Their corresponding clearing members take the two sides of the trade unless one clearing member represents both counterparties.


Popular Derivative CCPs

Popular CCPs in the derivative market include the following:

  • CME Clearing (US) (owned by CME Group)
  • ICE Trust (US)
  • IDCG (US)
  • CME Clearing Europe (UK)
  • ICE Clear Europe (UK)
  • LCH.Clearnet Ltd (UK)
  • NYSE Life (UK)
  • Eurex Clearing (Germany)


Cross-Border or Global Clearing

If the trade is cleared by a CCP located in a foreign country, it is known as cross-border clearing. A global clearing firm that holds membership in a foreign clearinghouse through a local counterpart normally arranges cross-border clearing.



A custodian is a financial institution that holds cash and securities on behalf of its clients and provides services such as position management, dividend processing, taxation, transaction settlement, and collateral management. The custodian may also provide additional services to its clients in many different ways. These services are also referred to as custody.


Custodian services are usually provided by either a brokerage firm or a commercial bank. Brokerage firms maintain their own accounts and client accounts separately without leveraging clients’ funds to their proprietary collateral or for any such purposes. Custody services are defined by the custody agreement between the client and its custodian.


In the derivatives market, custodians provide the following core services:

  • Safekeeping of client cash and securities.
  • Payment and settlement, including the following primary functions:
  • periodic cash flow and exchange of principal
  • collecting contingent payments in case of a credit event
  • close-out netting in case of a default by a counterparty or early termination of contract processing the delivery of collateral and posting collateral amount on behalf of the client


  • Contract lifecycle management. From origination to the expiry, including processing of events and corporate actions


  • Valuation and payment calculation. Valuation of open positions and calculation of the payment obligations (cash flows) throughout the life cycle of the contract


  • Collateral management. Collateral management service throughout the life cycle of the OTC, including calculating collateral, processing delivery, and receipts of collateral


  • Reconciliation. Reconciliation of cash/collateral movements throughout the life cycle of the contract


  • Client reporting. Supplying various reports to support client needs


  • Policy and process documentation. Providing required documentation related to policies and procedures


  • Regulatory reporting. Providing all reports required by regulatory agencies.


Apart from these core services, most custodian institutions offer other additional services, including the following:

  • investment/fund accounting, cash management, funding, and liquidity management
  • record-keeping
  • securities lending
  • fiduciary and trustee services
  • portfolio valuation/performance measurement
  • collateral management
  • middle-office outsourcing


Settlement Agent

Settlement Agent

A settlement agent is a firm (or branch of a firm) that manages the settlement process, determines the settlement positions, and monitors the exchange of securities and payments.


The payment of funds is generally done through a custodian or settlement bank (private or central). It is also common practice in some situations that firms exchange payments through check or certified check.


This function is sometimes provided by the exchange itself and sometimes by a central securities depository, as discussed in the next section.



A central securities depository (CSD) is an institution holding securities in a central repository. It holds securities either in physical certificated or dematerialized/electronic certificated form to enable a book entry transfer of securities. CSDs prevent the movement of physical securities between owners. Also, securities in the form of electronic records make the transfer easier.


An international central securities depository (ICSD) is a typical central securities depository that settles trade in international securities as well as in various domestic securities. They usually deal with local CSD either directly or through local agents.


In some cases, these institutions provide other services, too, such as clearing and settlement services. Although CSDs and ICSDs may not be directly involved in derivative transactions, derivative transactions result in securities settlement. Popular ICSDs include Clearstream, Euroclear, and the Depository Trust Company (DTC).


Global Custodian

In today’s market, an institution’s business is spread across the globe. Many institutions deal with international securities, derivatives, and their international counterparts.


In global markets, custodians provide services safekeeping securities issued around the world and dealing with institutions located around the world.


The term global custodian is becoming a synonym to the term custodian. The term domestic custody is used to refer to custodian services in local markets; global custody refers to custodian services in global markets.


Most large custodian firms operate globally. Typically, firms run their operations in many countries through their local franchises (known as sub-custodians).



The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is a cooperative society owned by member financial institutions from around the world. SWIFT provides a messaging platform—including a network, standards, and applications, known as SWIFTNet—that enables financial institutions worldwide to send and receive information about financial transactions in a secure, standardized, and reliable environment.


Most of the world’s financial institutions use SWIFTNet for local and international interbank communications for financial transactions. In addition, SWIFT also facilitates many other operational messaging services for securities processing, settlement, and financial operations.


Servicing Firms

Servicing Firms

The exchange and exchange-appointed clearinghouse facilitate confirmation and other post-trade processing. In an OTC market, however, multiple servicing firms provide post-trade processing, middle-office, and accounting services.


Post-trade processing services include allocation management, trade matching, trade confirmation (affirmation platform), trade submission to CCPs, and regulatory reporting.


Middle-office services (such as lifecycle management, P&L reporting, risk reporting, portfolio reconciliation, innovation, event processing) and back-office services (such as fund accounting) are all provided by one or multiple servicing firms at different capacities.


Affirmation platforms (post-trade processing) have taken on major roles in OTC markets. Today’s affirmation platforms employ advanced technology to provide a sophisticated servicing platform that serves clients of different sizes.


Although their main focus is post-trade processing, they have been expanding by serving middle-office operations as well. Typical services include the following:


  • allocation services
  • electronic affirmation (affirmation and two-way automated matching in real time)
  • services to support multi-asset class OTC products
  • connectivity to custodians, CCPs, and regulatory agencies
  • electronic connectivity and monitoring and administration systems for clients
  • portfolio reconciliation services


Trade Repository or Trade Warehouse

Trade Repository

The trade repository is the central trade warehouse that collects and stores all market transactions required by the regulators. The key objective of the warehouse is to provide information to authorities and the public that could promote financial stability and assist in the detection and prevention of market abuse while enhancing market transparency. The trade repository plays an important role in monitoring systemic risk.


As various market regulations were introduced over the time, a number of warehouses evolved for collecting different types of transactions. Today, many warehouses around the world serve different markets and product lines.


In a listed derivatives market, exchange and other entities involved directly feed to regulatory agencies. The OTC market has been anonymous and private until recently, and there was no transparency or full access to regulatory agencies.


Dodd-Frank and similar regulations (EMIR in Europe) around the world have introduced trade repositories, otherwise known as a Swap Data Repository (SDR), to collect OTC transaction.


In an OTC market, all confirmed trades (electronically executed, brokered trades, cleared, bilateral) are reported to the warehouse assigned to that market. Confirmed trades are supposed to be submitted to the warehouse in real time by one or more agencies such as the following:

  • electronic execution platforms
  • affirmation platforms
  • clearinghouses (CCPs)
  • inter-dealer brokers
  • custodians other service providers mandated by regulators


Trade repositories produce appropriate reports and feed to regulatory agencies. These reports include the details required by appropriate regulatory agencies—such as the SEC and CFTC in the United States and the European Securities and Markets Authority (ESMA) in Europe. To preserve counter-party confidentiality, public reporting is done anonymously and at an aggregate level.


The warehouse may also promote central netting (offsetting) of payment obligations that may enable a significant reduction in the number of settlements.


The major player in this field is the Depository Trust and Clearing Corporation (DTCC), which runs various trade repositories through its subsidiaries in various regions of the world. The following list shows various DTCC-run warehouses:


Trade Information Warehouse (TIW) (US). Operated by The Warehouse Trust Company LLC, TIW collects OTC credit product trades. The Federal Reserve and the New York State Banking Department regulate TIW. In addition to regulatory reporting, TIW provides post-trade lifecycle processing.


Global Trade Repository (GTR). The DTCC provides global repository services for the commodity, FX, equity, credit, and interest rate derivative asset classes.


The repository supports Dodd-Frank regulation and complies with future global regulatory initiatives as well. Each of the asset classes roll up into DTCC’s Global Trade Repository, providing regulators and the industry a snapshot of the market’s overall risk exposure.


DTCC’s Global Trade Repository is based on its original TIW, which acts as one of the industry’s first repositories for credit default swaps. GTR operates globally through its local agencies such as US DDR SDR, GTR-EUROPE, GTR-JAPAN, GTR-HONG KONG, GTR-SINGAPORE, and GTR-AUSTRALIA.


Data Vendors

Data Vendors

Derivatives heavily rely on various data items for pricing, valuation, and processing. There are two major types of data: market data and reference data. In addition, information such as research, corporate events, and market news is used by organizations.


Market Data Vendors

Derivatives contract management depends on copious ongoing supplies of reliable market data to accurately compute pricing, valuation, risk analysis, and collateral management parameters. Firms acquire market data from multiple sources to fulfill their needs.


While some sources provide free access, others charge subscription fees. Some of the important market data sources are Exchanges, Bloomberg, Markit, Reuters, Super Derivatives, US Federal Reserve, and local central banks.


Reference Data Vendors

Reference data is information on financial instruments, identifiers, market conventions, business calendars, and other details. It is also known as static data. Reference data is critical for transmission of contract and transaction details among internal systems as well as among market players. Reference data includes CUSIP, ISIN, RED Code, and other identifiers.


Major sources of reference data in the derivatives industry are exchanges, Bloomberg, Reuters, Markit, and Interactive Data.


Payment Processing Institutions

Payment Processing Institutions

A payment processing institution (PPI)—also known as payment processing service (PPS) organization—provides safekeeping, transference, delivery, and settlement services. A PPI holds funds and securities in a client’s account and transfers funds and securities between organizations.


It is similar to a custodian, except that a PPI deals only with cash and securities and, for the most part, will provide no other service. Typical custodians are commercial firms that sell many other services in a package. The custodian, in turn, uses a PPI to process the actual cash and securities transfers.


Various institutions, including banks and non-bank financial institutions, provide these services. Most payment and settlements between institutions are done electronically using the SWIFT network.


When PPI receives payment instruction, it actually transfers funds or securities from one client account to another. It may also send or receive funds or securities from an outside institution to deposit in a client’s account.


Well-known PPIs include the following:

Fedwire securities service.

A book-entry securities transfer system that provides participants with cost-effective safekeeping, transfer, and delivery-versus-payment settlement services.


Fedwire fund services

A real-time gross settlement (RTGS) run by the US Federal Reserve serving US customers. It serves large-value domestic fund transfers and safekeeping and transfer services of US government, agency securities, and mortgage-backed securities.


Fedwire is a credit transfer system, and each fund transfer is settled individually against an institution’s reserve or clearing account that is maintained by each institution in the Reserve Bank.


National settlement service

A multilateral settlement service offered to depository institutions that settle for participants in clearinghouses, financial exchanges, and other clearing and settlement groups. It is owned and operated by the US Federal Reserve banks.


Clearing House Interbank Payment System (CHIPS)

A privately owned online system used to settle foreign exchange spot transactions. Spot transactions usually settle within two business days.


Compression and Reconciliation Service

In addition to post-trade processing, derivatives management involves services such as portfolio compression and reconciliation, explained in the following sections.


Portfolio Compression

Portfolio compression (or simply compression) is a risk-reduction practice in which OTC dealers with substantial opposite (two-way or pay-and-receive) positions terminate offsetting contracts before they actually expire.


Portfolio compression reduces the overall notional size and number of outstanding contracts in a portfolio without changing the overall risk profile or the present value of the portfolio.


This is done through periodically terminating existing trades and replacing them with a smaller number of new trades that carry the same risk profile and cash flow as the initial portfolio, but that requires a smaller amount of regulatory capital to be held against the position.


The benefits of compression include reductions in counterparty credit exposure and reductions in operational risk and cost, as well as lower legal and administrative expenses in the event of a default of any participating dealer.


Portfolio Reconciliation

Portfolio reconciliation is the process of reconciling the positions between organizations, so helping to minimize the operating risk of undiscovered discrepancies between counterparties and other sources. Frequent reconciliation processes help organizations in maintaining accurate transaction information and reducing operational risk.


Reconciliation service providers allow market participants to load contracts onto their platforms. They then reconcile positions by comparing details from different parties. The reconciliation results are then sent to clients.


Portfolio reconciliation helps the collateral management function by reducing collateral mismatches. The reconciliation process allows firms to detect and remove any discrepancies at the trade level.

The following sections describe some of the popular service providers.



TriOptima is an independent firm that provides services in the OTC market as detailed below.


A portfolio reconciliation, margining, and dispute prevention and resolution system, which provide the following services: Proactive Portfolio Reconciliation is a multilateral portfolio reconciliation service available for a variety of OTC instruments.


TriOptima collects contract information from dealers and puts it in a central database. It then checks matching contracts from counterparties (legal entity level) with identical terms. This service provides key performance reports to clients.


Margin Call Management follows ISDA’s standard Credit Support Annex (CSA) in order to calculate and administer a margining process. Using triResolve, its clients can issue, accept, and dispute margin calls.



A multilateral portfolio compression service. Using this service, trades can be terminated simultaneously across a number of counterparties (also known as a tear-up or multilateral termination).


This reduces the number of outstanding trades, reduces the overall notional size, and helps efficiently manage the counterparty exposure and capital.


triBalance. A post-trade risk management service that provides tools to manage portfolio risk proactively. It allows clients to simultaneously manage bilateral and CCP exposures. It also helps clients to allocate capital and collateral more efficiently.



Creditex is an inter-dealer broker that provides portfolio compression services for credit derivatives in addition to other services such as execution.

As explained in the “Portfolio Compression” section, the compression process reduces the overall risk in the derivative marketplace, especially among broker-dealers who hold relatively large portfolios.


Application Service Providers

Application Service Providers

Application service provider (ASP) firms provide all tools and technologies needed for clients to perform their business activities. ASP provides processing capability, connectivity, and other services, eliminating the need for owning and administering systems. This, in turn, provides cost benefits and mitigates operational risks that arise from performing those tasks in-house.


ASPs cover most services required by today’s market participants. APIs tend to be the experts in the areas they serve.

Typically, ASP services are ideal for small to midsize asset management firms. However, even large firms outsource certain complicated tasks to professional firms due to the complexity involved in performing those tasks internally.


ASP services are also known as hosted services or managed services. In the derivatives industry, ASPs provide all or some of the following services:

  • contract lifecycle management
  • risk assessment and pricing services
  • settlement and reconciliation services
  • collateral management
  • fund administration
  • accounting and taxation services
  • middle- and back-office processing (allocations, confirmations, valuations, settlements, and payment processing)
  • connectivity to institutions involved in trade processing such as DTCC and MarkitServ
  • regulatory compliance and reporting
  • pricing and valuation
  • Regulatory Agencies and Market Associations


Various agencies monitor and regulate derivative markets around the world. Basically, there are three types of agencies:


  • Government agencies. Formed by and given the authority to monitor and control the market through laws and regulations.


  • Self-regulatory agencies. Nongovernmental and market participant-driven agencies that control members through self-governance (in addition to government regulations). For example, all exchanges are SROs.


  • Market associations. Associations formed by market participants to share and introduce guidelines to operate businesses. They also work as intermediaries between market participants and regulatory agencies. Examples include ISDA and NFA.


Market regulations are enforced at different levels by various institutions starting from broker to governmental agency. Every client is responsible for having its own surveillance department (audit). Next, the broker is responsible for monitoring its clients’ activity in varying aspects.


Although the broker, exchange, and clearinghouses enforce their own rules, there are also industry regulations to contend with. Self-regulatory agencies and governmental agencies introduce and enforce laws and regulations of their own as well. They are involved in issuing licenses and performing overall market surveillance.



Classification of Buy-Side Firms

Classification of Buy-Side Firms

Buy-side firms include nonfinancial institutions—such as major corporations—and financial institutions—such as asset managers, banks, loan portfolio managers, hedge funds, and insurance firms. This classification is based on their core business activity.


However, buy-side firms are also classified from other dimensions such as regulatory requirements. Although the derivatives market is open, governments around the world control how public firms can use derivatives.


This has been triggered due to the dangers of derivatives and many debacles that led to the failures of some major corporations. Based on the regulatory framework, buy-side firms fall into one of these two categories:


1.   Regulated or hedge-only firms.

These firms can use derivative contracts only to hedge their asset portfolios or to hedge the risks that arise from their core business activities. For example, certain types of firms (such as insurance companies) can use derivatives only according to the guidelines of industry regulators.


2. Unregulated firms.

These firms can use derivatives for both hedging and profit-making (speculation). For instance, hedge funds are free to use almost any type of derivative.


Furthermore, under Dodd-Frank, all OTC market participants are divided into three major categories:

  • OTC derivative dealers. Primarily financial institutions acting as dealers in OTC markets.
  • Financial entities. All financial entities other than OTC derivative dealers.
  • Nonfinancial entities. Commercial entities other than those mentioned in two previous categories, performing some kind of business that uses OTC derivatives to mitigate risk from their business activity.


A buy-side category includes both the financial and nonfinancial entities mentioned above. All rules are defined and applicable based on the type of the organization.


Essentially, this classification forces institutions to use only cleared contracts (in OTC markets) unless authorized by the regulators. Even if a particular institution is allowed to use non-cleared contracts, it is obligated to certain reporting requirements.  In general, ESPs include the following:


  • banks and investment companies subject to regulation under the Investment Company Act of 1940 (buy-side)
  • commodity pools and broker-dealers subject to regulation under the Securities Exchange Act (buy-side and sell-side)
  • Futures Commission Merchants (FCMs) subject to regulation under the Commodity Exchange Act (sell-side)
  • corporations with assets exceeding $10 billion (buy-side)
  • institutions such as hedge funds and private funds that are allowed to participate in almost any type of transaction


Organization Structure

Organization Structure

This section briefly explains the logic of organization structure from the perspective of investment activities. It is not, however, the overall organizational structure of a typical corporation. Also, note that this structure is applicable to firms that perform core operations in-house. 

Core activities related to derivatives trading of a buy-side firm include the following:

  • Trade management. Trading and post-trade processing.
  • Position management. Contracts life-cycle management.
  • Risk management. Risk analysis and management.
  • Delivery and settlement management. Processing of settlements.
  • Collateral management. Processing margin and collateral.


Investment division (or trading department) is logically divided into three major groups known as the front office, middle office, and back office. Overall, the key departments are the following:

  • portfolio or investment management group
  • front office (trading activities)
  • middle office (operations, risk management, and other)
  • back office (accounting and finance)
  • information technology (investment technology systems and services)
  • other departments related to core business activity


Order Origination Groups

After the need for the derivatives, the contract is identified or the decision is made by a business to enter into a derivatives contract, the request known as an order typically goes through formal analysis and subsequent approval process.


The overall process, known as order management, varies by the organization’s regulatory requirements and internal controls that are in place. In general, during this process, orders are validated by compliance, hedging, and documentation perspective.


Portfolio Management Group

Portfolio Management Group

The portfolio management group is also known as the investment management group or asset management group. A financial portfolio is a collection of various types of assets including securities and derivatives. Portfolios are constructed in various ways with different objectives and supporting strategies.


An investment management group is typically formed with portfolio managers, analysts, and others. The core responsibilities of an investment management group include the following:

  • establishment of investment objectives and policies
  • development of an investment strategy
  • construction of a portfolio
  • evaluation of the performance of the portfolio regularly


Corporate Treasury

Corporate Treasury

Corporate treasuries are another type of a user of derivatives. They use derivative contracts to manage risks from their business activities as well as to address the needs of capital allocation and asset liability management.


Treasuries typically employ financial risk managers who develop risk management strategies, including the use of derivatives.


Unregulated Firms

In unregulated firms such as hedge funds, portfolio management teams typically make decisions. They may have fewer procedures and controls in place, unlike professional institutional investors.


Front Office

Front Office

The front office is a well-known term in financial markets. The most action happens in the front office. However, a derivatives front office is not as noisy as a securities front office.


Front offices face the outside world and serve the firm’s trading needs—hence, the name. A front office is made up of traders, trader assistants, and analysts supporting trading activities.


The front office is also known as the trading desk. Typical functions of a derivatives front office include, but are not limited to the following:

Pre-trade analysis. Pricing, structuring, research, and compliance.

  • Trading. Executing trades with counterparties or at execution venues.
  • Valuing live contracts. Computing the value of live contracts regularly.
  • Position keeping. Perform operations such as amend, offset, scenario analysis, and stress testing
  • Intra-day risk monitoring. Performing risk analysis during the trading day.


The key objective of any trader is to get the best execution. Traders typically evaluate available venues and choose the best-suited venue or counterparty to execute the trade. Based on liquidity and complexity, a trader may perform complex pricing and market analysis before executing the trade.


Most traders in the derivatives market specialize in a specific product class such as interest rate, credit, and currency derivatives. The front office maintains different desks based on these categories.


Each desk contains a team of trading professionals and is called by its appropriate descriptors such as the rates desk for interest rate product trading, the credit desk for credit products trading, and the currency desk for FX derivatives trading.


Middle Office

Middle Office

The middle office covers a broad area comprehending multiple business functions such as operations, risk management, analytics, reporting, collateral management, and most other functions that are not part of the front office and back office. In practice, risk management and compliance are typically treated as separate groups due to their level of importance.


They are discussed separately in the following sections. Middle-office responsibilities include, but are not limited to, the following:

  • Post-trade processing. Trade validation, matching, confirmation, clearing, and contract documentation.
  • Compliance. Pre-trade and post-trade compliance.


  • Market data management. Market data validation and maintenance and interest rate fixing.
  • Reference data management. Maintenance of reference data such as counterparty information, ratings, and security identifiers.


  • Risk management. Generates various risk reports for market risk and credit risk.
  • Limits management. Trading and exposure limits monitoring and enforcing controls.


  • Event processing. Process events such as corporate events and credit events.
  • Collateral and margin management. Activities such as processing margin calls, collateral exchange, reconciliation, and dispute resolution.


  • Portfolio analysis. Daily marked-to-market of positions and computation of official profit and loss.
  • Reporting. Generate reports such as daily trading activity, profit, loss, and risk reports.


Note Derivative book or D-book is the report showing the firm’s derivative investments and the hedge effectiveness of each contract.


Back Office

Back Office

In the derivatives world, the key responsibility of the back office is to process all cash and non-cash settlements generated from all derivative transactions. As discussed earlier, during the term of the contract, derivatives result in various transactions including fee, margin/collateral, and periodic obligation settlement.


All transaction entries are generated on a daily basis for the immediate and near future (as much as 30 days, in some cases). The back office validates these transaction entries before they are processed.


All processed settlement entries are sent to the treasury and accounting department for the release of funds or assets and for log keeping. The key functions of the back office include the following:


Trade validation. Validation of new trades from a financial perspective such as cash flow, fees, and other financial details during trade processing (before the contract goes live).

  • Settlements. Cash-flow validation and processing settlements (cash and securities).
  • Reconciliation. Resolve mismatched entries (breaks) of settlements and general ledger entries.
  • Reporting. Reconciliation reports, cash-flow projections, derivative activities, and other reports.
  • Investment accounting. Accounting of all transactions according to standards.
  • Cash management. Managing the cash flows.


Risk Management

Risk Management

 Typically, risk management is done at multiple levels and final reports to a corporate level risk management department known as corporate risk management or enterprise risk management.


While each business unit is responsible for managing its own risk, the corporate risk management sets up policies and oversees the risk management activities across all business departments. The key responsibilities of corporate risk management include


  • setting up risk management policies
  • researching and analyzing business risks
  • monitoring the business risk
  • providing reports to corporate boards and senior management
  • providing training and required resources to individual departments


In the case of an institutional investor or a large investment division, the main business activity is investment management. Risk management activity, however, is the critical process.


A dedicated department oversees the risk management of investments. This department is usually referred to as investment risk management or just the risk management department.


It is considered a part of the middle office. The role of this department is to manage the risk arising from the assets the firm owns and the derivatives themselves.


The risk management group’s key responsibilities include developing risk management strategies, monitoring, and advising investment management groups.


The practice of using derivatives for risk management is sometimes referred to as derivative trading programs or derivatives use plan. The risk management group is responsible for defining and monitoring these derivative trading programs.


The derivatives program typically outlines the trading limits, type of instruments allowed, accounting, tax descriptions, and the purpose of the trade. Periodically, these programs are evaluated to ensure the effectiveness of the hedging.


Over the period of the programs, due to a change in the value of the asset and/or derivatives contract, there may be an impact on the hedge. The valuation will expose any such changes.


In summary, the overall responsibilities of the risk management department include, but are not limited to, the following:

  • developing risk management policies
  • producing risk analytics, exposure calculations, and performs stress tests
  • researching and analyzing risks such as market and credit risk
  • setting up and overseeing investment compliance
  • generating reports for senior management


Collateral Management

Collateral Management


Collateral management is the most critical part of credit risk management. Most institutional investors run different groups to manage the collateral process.


Logically, collateral management falls under middle-office responsibility, but some consider it a back-office function. Regardless of how it is structured, collateral management includes the following key activities:

  • managing the inventory of eligible collateral including cash and securities
  • evaluating positions to assess the current exposures
  • processing margin calls
  • reconciling margin calls with internal assessments
  • reconciling collateral movements
  • optimizing the use of collateral
  • managing the risk arising from collateral such as concentration limits


Legal and Compliance

The purpose of the legal and compliance department is to provide oversight of investment and noninvestment activities within the firm while guaranteeing compliance with internal and regulatory requirements.


Duties of the Legal and Compliance Department may vary based on the size of the firm and whether it is regulated or unregulated.


The key responsibilities of the legal and compliance department are the following:

  • Legal document management. Reviewing and executing legal agreements between the firm and counterparties, dealers, service firms, and all other entities dealt with by the firm.


  • Compliance controls. Develop and implement better monitoring, compliance, and control policies to satisfy corporate goals as well as regulatory needs.


  • Auditing. Monitor and audit operations across the board, from the deal capture through the settlement and communication, in order to meet corporate as well as regulatory compliance.


  • Reporting. Compliance and regulatory reporting to senior management and regulatory authorities.


Finance and Accounting

Finance and Accounting

The finance and accounting department takes responsibility for performing the financial and accounting activities. The main responsibilities of this department include the following:


  • bookkeeping. Track all transactions of purchases, sales, and capital spending. These transactions are known as ledger entries in accounting terms. Ledger refers to an accounting book.


  • Reporting. Generate financial reports such as the balance sheet, income statement, cash flow, and other management reports.


  • Management accounting. Includes budgeting, performance evaluation, cost management, and asset management.


  • Compliance. Complying with all accounting regulatory requirement such as IFRS.


  • Capital Allocation. Addressing the capital needs of the firm.


All derivative cash flows are sent to the finance department after final approval. The finance and accounting department provides taxation, accounting, budgeting, and other services to the firm.


Multi-branch or Global Organization

There are many large buy-side firms with branches around the world. These firms have head offices located in one country. Each branch complies with the legal and regulatory system of the country they are located in while they report to their head office. 


Each branch typically operates its own front office serving the trading needs of the local market. Note that there may be certain front-office desks reporting to a single middle office, while all middle offices report to a central back office. In small branches, there might be only a front office, and a common middle office handles processing.


Typically, the back office is a single, large organization processing transaction from all branches. However, certain back-office operations could split into multiple subdepartments and feed into a central head office.


A front-office and back-office department from different branches may work together in certain transactions.


Small-Scale Buy-Side Firms

Most small-scale buy-side firms use hosted solutions or prime-broker services. Previous books explained how hosted services and prime-brokers operate.


These firms rely on outside entities to serve their business for all infrastructure needs and other services. They primarily focus on their core business and investment management processes.


The Sell-Side Organization

Sell-Side Organization

Sell-side firms play a central role in financial markets, providing a variety of services and continually adapting to the changing demands of markets. Sell-side firms are large and complex. The focus in this blog is on trading activities of sell-side firms that are especially related to derivatives.


The sell-side firm is made up of many different business units providing various types of services to buy-side firms. Based on the size of the firm, the array of services varies from single simple services to specialized packages of services.


To review, the major roles of sell-sides include the following:

  • Execution broker. Trade execution services in listed and OTC markets.
  • Market-maker. Execute trades as a market-maker or a designated market-maker.


  • Clearing Broker. Provide clearing and settlement services as a member of a clearinghouse
  • Prime Broker. Provide full service to private investment firms, such as hedge funds.


  • Local and global custodian. Provide custody services in local and global markets.
  • Securities lending and borrowing. Lend and borrow securities to serve client needs.
  • Fund administration. Provide full fund administration services to buy-side firms of all sizes.


Middle office outsourcing. Provide operational services allowing buy-sides to outsource various life-cycle operations such as post-trade processing, profit and loss calculations, and other reporting services

  • Proprietary trading. Trade and manage portfolios for profit making.
  • Collateral management services. Allow buy-side to outsource the collateral management process.
  • Portfolio valuation services. Provide reliable valuation services to firms such as hedge funds and other asset managers.
  • Other services including corporate finance, mergers and acquisitions, and securitization.


The sell-side firm’s revenues come from various business activities such as trade execution commissions, spreads from market-making, fees from clearing services, fees from underwriting, and profits from proprietary trading.


Most sell-side firms also focus on retail investors through wealth management and investment advisory services, which are beyond the scope of this blog.


As mentioned earlier, sell-side firms are also known by diverse terms such as an investment bank, commercial bank, dealer, broker-dealer, and financial services firm.


Conspicuous examples of sell-side firms include the following:

  • BNP Paribas (France)
  • BNY Mellon (US)
  • Citigroup (US)
  • Crédit Lyonnais (France, Britain)
  • Crédit Suisse (Switzerland)
  • Deutsche Bank (Germany)
  • Goldman Sachs (US)
  • HSBC Bank (UK)
  • JPMorgan Chase (US)
  • Morgan Stanley (US)
  • Royal Bank of Scotland (UK)
  • Société Générale (France)
  • Swiss Bank Corporation (Switzerland)
  • UBS (Switzerland)


The sell-side organization structure is usefully approached by dividing the trading organization into three major logical functional units: front office, middle office, and back office.


The focus in this blog is to review these three units’ functions specifically in respect of derivative operations and processing rather than of the entire sell-side organization.


 The following list shows the various functional groups, each of which is discussed in turn in the following sections:

  • Front office
  • Sales traders
  • Trading Desks
  • Research or quantitative analysis
  • Middle office
  • Risk management
  • Collateral management and margining
  • Trade processing and operations
  • Back office
  • Finance and accounting
  • Compliance and legal
  • Information technology


Note An interdealer broker (IDB) acts as a middleman between dealers. IDBs are also known as a broker’s broker. This term is commonly used in corporate debt markets. An interdealer market represents transactions among dealers.

In certain situations, a broker can match and execute orders from two of its clients. This is known as broker crossing.


Sell-side Front Office

Front Office

The front office is responsible for executing orders received from clients and internal business units. The front office provides services to a broad range of clients including institutional investors, corporations, and affluent individuals.


Most sell-side firms have a global footprint supporting most of the derivative classes such as credit, rates, and equity derivatives in all global markets.


The key focus of the front office is to maximize profits while minimizing risk and providing the best services to clients. Because derivatives are risky and complex products, the front office pays particular attention to risk management.


In addition to executing client orders, the front office also caters to other needs of their clients, such as investment and hedging, in order to serve client needs and win new business to the firm.


Front office staff includes sale traders, traders, research analysts, and support staff. The functions of the front office can broadly be divided into three major sections: sales, trading, and research, which the following sections discuss in turn.


Sales and Client Relationship

Sales and Client Relationship

The sales department interfaces with clients directly and develops and manages the client relationship. It is primarily responsible for attracting new clients, maintaining existing client relationships, determining what products meet clients’ needs, and providing services by client request.


Typically, the front office employs a large number of sales professionals with extensive derivatives market experience within the trading community. Sometimes this sales group is also known as introducing brokers.


The sales team connects clients to the specialized derivatives desk, which is transparent to the client. For instance, rates from one trader from a buy-side may have a direct relationship with a rates trader of a sell-side.


In a traditional environment, the sales department receives client orders and then routes these orders to the appropriate trading desk. Typical responsibilities of the sales team include the following:

  • Receiving orders from clients
  • Splitting orders and routing to desks
  • Communicating executions back to the clients
  • Processing allocations
  • Managing the client relationship
  • Studying client needs, introducing or suggesting products, and generating new business


Sell-side Trading Desks

Trading Desks

Derivative traders work with non-derivative traders and sales teams in serving the demands of clients. For instance, a sales team may work with one or several traders (desks) to serve the specific needs of a client.


The fiduciary responsibility of a trader is to get the best execution for the client—that is, the execution that most closely matches the client’s instructions.


At a sell-side, trading activities are typically separated into product classes and markets. Each trading unit is called a desk. The most common desks in derivatives are the following:

  • Listed Products Desk
  • Equity Derivatives Desk
  • Rates Desk
  • Credit Derivatives Desk
  • FX Desk
  • Commodities Desk


The number and organization of desks in a given firm vary with the firm’s size, trading volume, and market demand.


Sell-side Research and Analysis

It is critical for sell-side firms to stay on top of the market in order to provide the best possible advisory services to their clients as well as to inform their own proprietary trading and risk management. The sell-side firm employs expert analysts for research activities in various areas of the market.


In derivatives, research involves the areas such as the study of market news, events and trends, the study of client business needs, documentation of derivatives product structure, risks and mechanics, development of new products, and development of valuation and risk models.


In addition, sell-side analysts publish their views on different aspects of the market such as interest rates, volatility, and commodity prices.

Research teams are also known as quantitative analysts or analysts, strategy teams, or planning teams.


Note A trading division is also known by several names such as dealing room, trading floor, floor, trading desk, or simply front office.

To comply with regulations that are intended to control the abuse of information and market manipulations, sell-side firms separate the trading floors and certain research teams. This separation is known as a Chinese wall.


Sell-side Middle Office

The middle office is a broad conceptual division of the organization containing a multiplicity of functional units. Most operation groups fall within the middle office.


In a sell-side, the middle office has to process client transactions on one side, and on the other side, it has to process the transactions of exchanges, clearinghouses, and external service providers such as affirmation platforms.


In addition, sell-side firms have to operate their own servicing platforms such as collateral management and other business lines. Typically, each business function operates as a quasi-independent unit.


The following are the core functions of middle office groups:

Post-trade processing and life-cycle management. Process trades after execution such as allocation, confirmation, and clearing.

  • Reporting. Report profit, loss, trading activities, and so on.
  • Documentation. Obtain all signed contracts and other legal documents from clients for all derivative transactions.
  • Risk management. Manage different risk types such as market risk, credit risk, and risk reporting.
  • Data management. Manage data such as transaction data, market data, reference data, and fixings.
  • Portfolio reconciliation and break resolutions. Match transactions with counterparties and resolve differences.
  • Collateral and margin management. Manage client accounts and the firm’s account with clearinghouses.


Sell-side Back Office

The back office of the sell-side has a similar role to that of the buy-side, but it deals with a much larger number of clients and clearinghouses. The back office of a sell-side is accordingly much larger and more global.


The back office settles a large number of transactions in local and global markets. Because a sell-side involves many other types of services, the back office also deals with transactions generated from various other services.


A back office is a conceptual division and comprised of many processing units of the firm. Most transaction processing units that are not part of a middle office are typically considered as part of the back office.


The key responsibilities of back office groups are the following:

  • Settlement and accounting of all transactions from clients as well as clearinghouses
  • Settlement reconciliation
  • Portfolio valuation
  • Securities administration
  • Corporate actions monitoring and processing Custody services
  • Reporting profit and loss and other financial reporting


Sell-side Risk Management

Sell-side risk management

Sell-side risk management is a complex undertaking. One reason for this is that a sell-side takes the risk that a buy-side is trying to remove. The strength and profitability of the sell-side are largely dependent upon the risk management strategies they employ. Each sell-side adopts its own risk management strategy.


In response to the pressure to increase profitability, some of the sell-side traders tend to take excessive risk. The acceptable limits of each firm and desk are set by risk management.


It is the risk manager’s responsibility to keep track of risk limits at different levels such as trader, desk, and division. In addition, the risk is measured by risk type, duration, trader, desk, and other dimensions.


Risk measure and control activities are spread across the firm from the front office to the back office and at the enterprise level. Most groups take part in risk management at different levels—desk, division, and enterprise.


A global sell-side firm faces many different types of risks. Analyzing and controlling these risks requires advanced skill and continuous effort. Sell-sides employ critical resources for risk management. They hire the smartest of the crowd to work on their risk management teams.


Team members are mostly mathematicians and financial engineers with an in-depth understanding of financial products. They continually develop and introduce new strategies and models to better manage the firm’s risk.


It is not uncommon, however, that sell-side firms fail to recognize and manage certain risks, and they may eventually face large losses or even collapse.


While each trader and desk monitor their risk periodically during and at the end of trading day, the firmwide risk division is responsible for assessing, monitoring, and controlling the level of risk being taken by all business lines across all products.


The risk management group acts as an independent oversight group and periodically quantifies risk taken by the business. Various risk measures are computed from different dimensions.


The risk management team directly reports its observations and numbers to senior management. To ensure maximum transparency of trading activity and optimal firm-level controls, the risk management group is kept separate from the trading division, and the risk managers who work on the trading floor do not report to trading floor managers.


In addition, the compensation of the risk management group is tied not to trading profits but to the overall performance of the firm.


As well as setting firmwide risk management strategies, the risk team helps in developing and analyzing new products and research.

  • Legal, Compliance, and Controller
  • In practice, legal, compliance, and controller are independent departments.
  • Sometimes they are counted in the back office rather than the middle office.
  • In their case, the difference in classification is nugatory.



As the name implies, the responsibility of the compliance department is to ensure that the day-to-day activities and overall business practices comply with the relevant laws, exchange regulations, and industry best practice standards.


The department’s responsibility starts with training—in other words, ensuring all employees are sufficiently knowledgeable about rules and regulations, and that they are licensed when required in order to perform their job.


The next key responsibility is to monitor and control business activities and internal procedures in order to adhere to the set standards.

Sell-side firms are subject to exchange, clearinghouses, market association, and governmental rules and regulations. Failure to comply with any one of these may lead to fines, sanctions, or a loss of license to operate their business.


The compliance at the trading level includes the monitoring and control of assigned limits of notional and different risk measures, trading practices, and adherence to predefined strategies.



The legal department provides such legal services as interpreting laws and court rulings that help define the firm’s governing policies and business practices.



Controllers are the independent bodies of the firm that check financial reports (P&L, accounting, and so on) for accuracy and consistency. Essentially, they cross-check all final numbers computed by the corresponding teams.


They basically provide independent oversight into economics and help firms to avoid any intentional or unintentional mistakes or manipulations performed by business teams.


Information Technology

Information Technology

Sell-sides are involved in a variety of services in financial markets. Sell-side business operations are highly dependent on IT. These business activities require efficient and innovative systems. Innovative IT systems help a sell-side to stay competitive and provide state-of-the-art services to the market participants.


There are many IT departments comprised of sell-side IT organizations. Some of the key IT departments related to the derivative area are the following:

Front-office derivative trading systems (typically multiple systems serving different trading desks)

  • Dealer’s proprietary trading platforms
  • Post-trade processing systems
  • Derivative life-cycle management systems, also known as portfolio management systems
  • Collateral and margin management systems
  • Derivatives accounting systems
  • Derivatives exchange, connectivity systems, and others


Global Organization

Most large sell-side firms are global. Due to local laws and regulations, each domestic branch of a firm legally operates as an independent entity. In the case of global transactions, however, business activities are shared among these entities.


They allow access to foreign markets via their counterparts in different countries for their local clients. Global sell-side firms are typically known as international banks.


Boutique Sell-Side

The sell-side firms that are small and specialized in specific areas are referred to as boutique sell-side firms. Most boutique firms specialize in specific areas such as rare asset classes or specific research services.


Besides derivatives, sell-side firms provide key services in capital markets such as investment banking (underwriting), mergers, and acquisitions and research. These were not discussed in this blog, exclusively concerned with derivatives.


Finally, the sell-side market is quite competitive. Large established firms serve most of the needs of market participants.


There are two major data types: market data and reference data. Market data represent the prices or rates of instruments currently traded in financial markets.


Reference data represent a broad range of items including static information such as instrument information, issuer, counterparties, currencies, and almost all other information except market data and transaction data.


While market data are continuously changing throughout the trading hours, reference data are static until any changes happen to instruments or issuers, such as the introduction of new instruments, or when one entity is merged with another. Market data is critical for portfolio valuations and risk analytics.


For computing accurate profit-and-loss numbers and various risk measures, firms must collect and use reliable market data.


The Importance of Data

Importance of Data

In the derivatives area, contract valuation, portfolio analytics, and risk analytics are the most critical numbers. They are essential for effective risk management, collateral management, and reporting. The data are key to the underlying models to generate expected results, so it is necessary to collect the data in a timely manner and maintain quality.


The major uses of market data are the following:

  • Profit and loss analysis (P&L) and portfolio analytics. P&L numbers, P&L variance (the period over period), and portfolio analytics are computed at trader, desk, and entity level.


  • Risk analytics. Computation of intra-day and end-of-day risk measures at the trade, desk, and portfolio levels by traders as well as risk managers.


  • Cash flow. Generation of future cash flow and the fair value of that cash flow, both at inception and throughout the contract term.


  • Collateral calculations. Exposure and margin calcu-lations and collateral valuations.

The benefits of efficient reference data management are reduced trade failures and operational risks. Most computations rely on market data rather than reference data.


Market Data

Market Data

Derivative portfolio management depends on a variety of market data. Market data includes real-time market prices, end-of-day prices, and historical data. Live data represent quotes with a bid and ask price and other details of instrument trading in the market at any given point of time during trading hours. Historical data represents official prices in the past.


Market data fall into two stages: raw data, which include actual market values, and derived data, which are computed by applying mathematical models to the raw data. Types of raw data items include the following:

  • FX rates (currency prices)
  • Interest rates
  • Credit data
  • Equity and equity index prices
  • Bond prices
  • Option and futures prices
  • Commodity prices
  • Credit spreads


Swap rates

Derived data are either produced by the firm itself or obtained from an external data supplier or aggregator. For instance, interest rate curves are smoothened using mathematical techniques such as interpolation. Derived data are manipulated in the following ways:

  • Logarithmic returns
  • Standard deviations
  • Correlations
  • Volatility measures for interest rates, options, and so on
  • Interest rate curves
  • Index values


Note Sometimes the terms price and rate is used synonymously, even if the actual data is not the price of the referring instrument. For instance, an index value is also referred to as an index price.

The cash flow dates of contracts to be valued rarely exactly match the dates defining a data curve. Interpolation is used to derive additional data points. This process is also known as curve fitting.


FX Rates

FX Rates

Foreign exchange rates are retrieved from a market data vendor for all the currency pairs that the firm has any type of transaction with. Each currency is identified by an ISO code three characters wide such as USD, EUR, and JPY.

FX market data elements include the following:

  • Spot prices. Current exchange rates for immediate settlement.
  • Forward prices. Exchange prices for future settlement.
  • Swap points (forward points). The difference between
  • spot and the forward rate of different maturities.
  • Volatilities. FX price volatilities, option volatilities.


Security Prices

The securities and security derivative data most commonly used in various transactions affecting derivative portfolios include the following:

  • Bond prices
  • Bond future prices
  • Bond option prices
  • Bond spreads
  • Stock prices
  • Stock future prices
  • Equity option prices
  • Equity repo margins
  • Volatilities (equity, bond, and futures)
  • Dividends
  • Index Values
  • Credit spread curve
  • Benchmark spread curve
  • Bond repo margins


Note All exchanges publish live market data known as exchange feed to their subscribers. It is typically used by sell-side firms, ETPs, data vendors, and some large buy-side firms.


Exchange feed contains live quotes of listed products trading on the publishing exchange. Buy-side firms typically get this data through the data vendor, who supplies aggregated data from multiple exchanges.


Interest Rates

Interest Rates

In addition to interest rate derivatives, interest rates are used in the valuation of contracts, computation of cash flow, and other functions. Types of interest rates available for different maturities, currencies, and instruments include the following:

  • Treasury rates
  • Zero rates
  • Swap spreads (swap rate)

LIBOR and other interbank offer rates such as Euribor

  • Repo rates
  • Forward rates
  • Interest rate volatilities
  • Yield curves
  • Credit Data

Credit data affect interest rate derivatives. Market data in credit markets include the following:

  • Single name CDS prices
  • Credit index prices
  • Loan CDS prices
  • Recovery rates
  • Default probabilities
  • Credit ratings
  • Credit events
  • Commodity Prices


Credit Ratings

Credit ratings are another important item that affects the interest rate and credit instruments. The credit rating represents the creditworthiness of an instrument issuer such as a corporation or government.


Ratings are given by professional rating agencies. These agencies study and analyze corporations and sovereigns around the world. Ratings are updated periodically or on any change impacting the issuer’s financial condition.


Popular rating agencies Standard and Poor’s (S&P), Moody’s, and Fitch.


Research and News

In addition to the data types mentioned above, market participants also rely on professional firms for news and research updates. Most sell-side firms have research departments that supply research data in specific areas.


In addition, there are independent firms that provide research data. Typically, research data includes news, in-depth analyses of company financial and nonfinancial data, expert views, and opinions.



Financial information on various corporations includes such data as corporate dividends, corporate actions, earnings reports, and corporate filings.


Historical Data

Historical data play a critical role in analyzing portfolios using historical simulation, backtesting, and P&L analysis. Historical data are used to derive standard deviations, volatilities, and correlations that are especially valuable in relation to stress-testing of portfolios and banks during market crises.


Real-Time vs. Closing Data

During trading hours, the latest market data is available as trading proceeds throughout the day. At the end of the trading day, the final prices are collected as the closing data (official prices).


Similarly, other data, such as LIBOR interest rates, are finalized by the BBA (British Bankers’ Association), which prepares official rates of the day.


Live data changes continuously as the market moves. Live data snapshots at a specific time can be used to compute flash reports (intraday). Final reports (official end-of-day), P&L statements, and risk numbers are computed using closing prices.


Based on the type of data, closing prices are also known as settlement prices, settlement rates, official prices, official rates, and fixing rates.


Reference Data

Reference data represent a broad range of items, including instrument information, issuers, counterparties, currencies, and almost all other information except market data and transaction data.


However, firms may not need all data from all markets. Instrument information is also referred to as master data. Typically, firms obtain only the data that are required. Reference data include the following:

  • Securities information such as bonds and equities
  • Indices information such as equity and bond indices
  • Option contracts information
  • Futures contract information
  • Interest rate indices information


Data Sources

Professional data vendors generally supply data. These corporations collect data from multiple sources such as exchanges, electronic trading platforms, and market makers.


Then they normalize, cleanse, validate, and distribute the data. In addition to raw data, vendors also supply derived data computed by feeding raw data into mathematical models.


There are many data vendors in the market. Most firms use more than one data vendor for their data needs, aggregating and cleansing disparately sourced data before using it.


Some of the popular data vendors that supply both market data and reference data for derivatives are Bloomberg, Reuters, SuperDerivatives, and Markit.


Data Management

Data Management

To the extent that market data is a critical component, data management strategy plays an important role in the operations department. To represent current market conditions, data must be up-to-date. Traders rely on real-time daily data, whereas risk managers use end-of-day data.


Collecting and transforming market data into usable data for valuation and risk analysis requires significant time, technology, and resources. Data management strategy includes the following key elements:

  • Comprehensive data capture
  • Quality data production
  • Storage in a well-formed structure
  • Efficient and quick access platforms and tools
  • Historization
  • Managing multiple data sets
  • Data Capture and Quality

Essential to data capture is the production of clean, consistent, and complete data. The key elements of data capture are the following:


  • Collection. Comprehensive data collection.
  • Cleansing. Often data has outliers such as inconsistencies among different sources, unrealistic illiquid prices, missing data points, and human errors. These errors are resolved using different techniques to produce a clean, consistent, and complete data.
  • Quality control. Validate and analyze data for quality and accuracy.


Firms generally have dedicated data analysts who are responsible for procuring high-quality data from external resources and maintaining it in readiness for processing.


Data Storage and Access

Data captured from multiple resources is stored in a well-structured database, usually in a central data repository. To provide quick access, live data is typically stored in a separate faster database, while historical data is stored in a larger separate database.


Multiple systems and users throughout the trading day heavily access real-time market data storage. Historical market data is accessed on demand by a limited set of processes. At the end of each business day, the closing prices (official data) are copied to the historical database.


While the live database is purged daily to maintain a smaller size and faster access, historical data is kept for years based on the firm’s data management strategy. To provide faster access, better technology platforms and access tools are employed.


Reference data is mostly static, and most firms refresh this data on a daily basis. In addition, they may refresh the data on demand in case of new issues or to complete missing information.


Data Sets

Multiple departments including trading, reporting, and risk management groups use market data. Typically, firms maintain multiple sets of data, one for each of these groups—sometimes even a set for each trading desk and trader, as required.


Trading departments may use their own models or standards in choosing derived data. They may even manipulate certain elements to suit their valuations, whereas the middle office may need a clean set of data for official reporting.


Similarly, risk management looks for the most accurate data. All these departments use their own set of data to produce independent results. Typically, it is also a compliance requirement for risk management to use an independent set of data. Hence, firms must be capable of maintaining multiple sets of data.



The data analysts manage market and reference data. Although most operations are automated, extra care is taken to guarantee the timeliness and accuracy of data. During the business day, typically the following activities are performed:

Schedule market data snapshots for flash reports and intra-day analysis

  • Verify external data loads
  • Review and validate data elements
  • Resolve data issues (cleansing)
  • Reset interest rates (fixing process)
  • Build and verify various curves
  • Load closing prices to the historical database
  • Refresh reference data elements and run on-demand loads