Lesson 8: Treasury Operation PDF

Lesson 8: Treasury Operation TREASURY Treasury ○ Also known as Bank's market division. ○ A highly specialized area that meets individual and institutional customers’ investment and risk coverage needs. ○ It is based on four fundament...

Lesson 8: Treasury Operation TREASURY Treasury ○ Also known as Bank's market division. ○ A highly specialized area that meets individual and institutional customers’ investment and risk coverage needs. ○ It is based on four fundamental pillars: 1. Technology → Essential to access real-time information on financial markets. → It is also crucial to develop systems that make it possible to calculate the price of the different products for sale and the associated risks. → It also enables the proper confirmation and liquidation of operations. → It is the key to comply with current and future regulatory requirements. 2. Products → The Treasury offers customers risk coverage and investment solutions for the simplest to the most complex products (structured products) and for all kinds of financial assets – generally fixed income, interest rates, equities and exchange rates. 3. Distribution Channels → The capacity to provide the product to customers at a competitive price, when and where they need it. 4. Capability to manage and hedge the risks associated with the products being sold → A BSFI's treasury activities may be a significant source of operational risk (the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events) apart from giving rise to market, liquidity and credit risks. → Losses to the institution may arise from the failure to meet professional obligations to clients, faulty product design, unethical business practices, and the failure to execute transactional processes. → The institution must likewise be cognizant of the increased exposure to reputational risk in the presence of such factors. → In this regard, the operational risk management framework for treasury activities shall include the following elements: a. A strong governance structure that safeguards the integrity of the Treasury unit, especially the trading function b. Comprehensive policies and procedures c. Effective internal controls d. A reliable management information system that facilitates the comprehensive monitoring and timely reporting of exposures e. A robust process for dealing with clients → The BSFI shall: a. Conduct its treasury activities with a high degree of integrity. – The board of directors shall: i) Be primarily responsible for establishing the tone of good governance from the top and setting standards First Semester Page 1  good governance from the top and setting standards of appropriate and ethical behavior for itself, senior management, and other employees. ii) Ensure compliance with market conduct rules, and the relevant requirements and standards of any regulatory body, professional body, clearing house or exchange, or government and any of its instrumentalities/agencies. iii) Adopt a code of conduct and standards of practice that are binding on the Treasury unit, especially personnel involved in risk-taking. The code and standards should highlight and provide specific guidance on upholding market integrity and professionalism. b. Conduct treasury activities within a board-approved structure that is designed to meet the BSFI's objectives while enabling the strict enforcement of controls. – The structure shall clearly distinguish between different functions (e.g., between asset-liability management, trading/leadership, underwriting, and brokering) and recognize the need for effective separation between operational units. – The scope of authority and responsibility of each personnel shall be adequately defined, documented, and clearly communicated. c. Appoint personnel who possess a high degree of integrity and sufficient expertise to understand the financial instruments dealt and transactions entered into by the Treasury unit. – These qualifications shall not only apply to personnel who originate and process the transactions but also to those who are responsible for reviewing the transactions' conformity to the BSFI's accepted trading practices. – There shall likewise be manpower adept at operating and maintaining the management information system (MIS). d. Segregate the duties of the front, risk control and back-office functions. – There should be comprehensive and well-documented policies and procedures that describe the activities performed by each function. – The dealers in the front office are primarily responsible for transacting and managing positions. – In this regard, the settlement and confirmation of transactions, the recording of contracts in the accounting system, the revaluation of positions, the reconciliations and procedures required to avoid errors, and other related processes in the back office shall be performed outside the dealing room to ensure objectivity and to prevent manipulation or fraud. e. Provide for the prompt evaluation and escalation of suspicious trading trends and patterns, and unusual gains or losses. – While the primary responsibility for ensuring that transactions are undertaken with integrity lies with front First Semester Page 2  transactions are undertaken with integrity lies with front office personnel, there should be units tasked to perform reviews of treasury activities. – The unit responsible for executing such reviews shall be independent from the risk-taking function and accorded sufficient resources and stature in the institution. – In this way, it shall be empowered to quickly escalate any activity that seems unusual or inconsistent with compliance, the financial and operational controls to the appropriate authorities. – Appropriate authorities refer to persons, units, or committees that are independent of the Treasury function and its management but possess equivalent or higher stature, such as the chief executive officer, the chief compliance officer, or the board-level committee. – Personnel tasked to perform reviews shall have, among others, sufficient understanding of the strategies engaged in by trading desks to allow them to evaluate whether trading activities are aligned with the risk appetite of the financial institution. f. Regularly and actively engage the control functions namely, risk management, internal audit and compliance, in the oversight of treasury activities. – Owing to their inherent responsibilities and stature within the BSFI, the control functions are well placed to perform reviews and render assessment of the Treasury unit and its activities. – The operational risk management framework shall include tools and mechanisms to identify, measure, monitor and control risks in all aspects of treasury operations. – The compliance function/system is responsible for the regular conduct of reviews to ensure that the BSFI’s activities conform to applicable laws, rules, and regulations, including securities laws, as well as its obligations as a market participant. – The internal audit shall be tasked with evaluating the Treasury unit’s compliance with the BSFI’s own policies and procedures, especially in the conduct of trading activities. g. Employ treasury systems that are able to support the volume and complexity of the treasury transactions in the areas of deal entry, confirmation, settlement and accounting. – Institutions that engage in heavy trading should endeavor to move to the use of straight-through processing to minimize input errors. – Institutions whose processes involve manual intervention should ensure that the integrity of data is preserved through proper controls. h. Ensure that the MIS is able to serve the needs of its users. – The MIS should enable the accumulation and production of accurate and timely financial, regulatory, and management reports. i. Subject new products to a rigorous approval process. First Semester Page 3  i. Subject new products to a rigorous approval process. – The handling of new products shall be embodied in an internal policy that, among others, defines the circumstances under which a product shall be considered "new". – The policy shall likewise contain guidelines for the review of the product, including the conduct of an analysis of its risks, costs and benefits to the institution; the identification of product features, uses, and target markets, as applicable; potential risks and mitigants to such risks; and the procedures involved in operationalizing the product. – The policy shall identify the stages within the product development process at which approvals shall be obtained and from whom. – All relevant units should sign off on the product program as part of the new product approval process. j. Act with honesty, fairness, and professionalism, and pursue the best interests of its clients. – A BSFI acting as a dealer or broker shall have a clearly articulated strategy for the sale and marketing of financial products. – The BSFI is expected to manage the risks arising from such activities and protect the interest of its clients. – A BSFI shall have appropriate policies, procedures and controls in place to ensure the suitability of products being offered to its clients. – It shall ensure that: i) The client understands the nature of the transaction and the risks involved. ii) The transaction meets the client's financial objectives and is aligned with his/its risk tolerance. – It shall provide sufficient, accurate and comprehensible information about the products, including inherent risks, in a clear and balanced manner to enable its clients to make informed financial decisions. – The BSFI shall likewise use reasonable diligence to ascertain the best market for the products offered to customers and buy and sell in such market so that the result to the customer is as favorable as possible under prevailing market conditions. k. Uphold accountability in its treasury activities by retaining reliable, accurate, and complete records of transactions. SALES AND MARKETING FOR FINANCIAL PRODUCTS Financial Products ○ Refer to various investment instruments: → Debt securities (e.g., bonds) → Equity securities (e.g., stocks) → Hybrid securities (e.g., convertible bonds) Derivatives (e.g., options, futures) First Semester Page 4  → Derivatives (e.g., options, futures) → Securitization structures (e.g., mortgage-backed securities) → Similar products with substantial investment characteristics. Broker ○ A person engaged in the business of buying and selling securities for the account of others. Dealer ○ A person who buys and sells securities for own account in the ordinary course of business. Complex Products ○ Refer to financial products whose terms, features, and risks are not reasonably likely to be understood by a non-sophisticated client because of their complex structure. ○ These products are also difficult to value, particularly when there is a very limited or no secondary market. BSFI Responsibilities ○ BSFI (Banks, Securities Firms, and Insurance Companies) shall always act with honesty, fairness, and professionalism. ○ They must pursue the best interests of its clients. ○ A BSFI acting as a dealer or broker shall have a clearly articulated strategy for the sale and marketing of financial products. ○ The BSFI is expected to manage the risks arising from such activities and protect the interests of its clients. ○ A BSFI shall have appropriate policies, procedures, and controls in place to ensure the suitability of the products being offered to its clients. ○ It shall ensure that: → The client understands the nature of the transaction and the risks involved. → The transaction meets the client’s financial objectives and is aligned with the client’s risk tolerance. ○ It shall provide sufficient, accurate, and comprehensible information about the products, including inherent risks, in a clear and balanced manner to enable its clients to make informed financial decisions. ○ The BSFI shall be guided by the principle of proportionality in setting policies and procedures for its sales and marketing activities. ○ It shall differentiate between less and more sophisticated clients and tailor the manner by which they are engaged in accordance with such sophistication. ○ Controls shall be in place to ensure that the BSFI complies with its internal policies and procedures, as well as relevant rules and regulations. CLIENT SUITABILITY PROCESS A BSFI shall ensure that the financial products it recommends to a client are appropriate for that client through a client suitability process, which involves: 1. Obtaining client information 2. Classifying a client according to financial sophistication and risk tolerance 3. Conducting a suitability review 1. Obtaining Client Information The BSFI shall obtain necessary and sufficient information about the client that will serve as bases for its suitability assessment. At a minimum, the following information shall be obtained in addition to the First Semester Page 5  At a minimum, the following information shall be obtained in addition to the basic account information: ○ Investment amount/investible funds → Or amount of exposure to be hedged. ○ Financial situation → The client’s financial standing, which includes information on assets, net worth, financial commitments, regular income, and capacity to withstand losses arising from financial transactions. ○ Knowledge of financial products → The client’s knowledge and understanding of the financial markets and products and the risks involved. ○ Investment/hedging experience → The nature of investments and/or derivatives transactions undertaken by the client, including the length of time, frequency of dealings, and the extent to which he/it has relied on the advice of a bank or a financial advisor, if any. ○ Financial objectives → The client’s goal or purpose for entering into a transaction, whether it be for regular income, capital appreciation, capital preservation, maintenance of purchasing power, hedging as against investment, and/or long-term buy and hold as opposed to short-term active trading. ○ Risk appetite → The level of risk a client is willing to take. ○ Holding period or investment horizon → The length of time over which the position or exposure to be hedged will be held by the client. ○ Regulatory and legal constraints → Prohibitions or limitations imposed on the activity of the client by existing laws, rules, and regulations. ○ Liquidity needs → The client’s need to convert positions into cash and the timing of such requirement. To foster cooperation from the client, the BSFI shall explain the reason for assessing suitability. ○ If the BSFI is unable to obtain sufficient information, it shall refrain from offering or recommending any financial product. A BSFI may design and use its own system for obtaining client information, which may include questionnaires and interviews. ○ However, pre-formatted questions and responses shall be fit for the purpose and presented in a clear and understandable manner. ○ Likewise, technical or unfamiliar terms shall be explained as needed, in order to prevent different interpretations and/or erroneous responses. While the client is responsible for providing accurate and updated information, BSFI personnel shall exercise diligence in reviewing the consistency of the responses and reliability of the information provided based on available documents, such as publicly disclosed information and those obtained from the client’s existing contractual relationships with the BSFI. ○ Subsequent changes to client information, if any, shall be adequately documented and concurred with by the client along with the discussions and/or clarifications made. For a legal entity or a group of two (2) or more natural persons, the BSFI shall First Semester Page 6  For a legal entity or a group of two (2) or more natural persons, the BSFI shall obtain evidence that: ○ The client is specifically authorized to enter into all or specific kinds of financial transactions. ○ The client’s representative/s is/are authorized to carry out transactions on behalf of the entity/other parties, in accordance with the applicable legal framework. Client information, including client classification, shall be reviewed and updated prior to transacting in a product that is new to the client, or earlier in case of material changes in the client’s financial situation or goals. Adequate controls shall be implemented to ensure the confidentiality and security of client information. 2. Client Classification Based on the information obtained from a client, a BSFI should be able to classify a client into one of the following categories according to financial sophistication: ○ Market counterparty → Refers to any financial institution, only with respect to the instruments in which it is authorized to engage as a broker dealer. ○ Sophisticated institutional client → Refers to an institution that is not a market counterparty but has the level of net worth, knowledge, expertise, and experience to deal with financial products. ○ Sophisticated individual client → Refers to an individual who has demonstrated to the BSFI that he has the level of net worth, knowledge, and experience to deal with financial products. ○ Other clients → Refer to all other institutional or individual clients not categorized as market counterparty, sophisticated institutional client, or sophisticated individual client. BSFIs are encouraged to adopt a more granular categorization according to financial sophistication ○ Provided that the categories can be mapped into the broad classifications above and the differences between categories are clearly set out. A BSFI shall classify a client according to risk tolerance. ○ This entails assessing the client’s preferences, willingness to take on the risks associated with a product, and ability or capacity to absorb the losses that may arise from such product, as well as whether such losses will have a detrimental impact on the client’s financial condition. At a minimum, a BSFI’s classification of a client according to risk tolerance shall include, but need not be limited to, the following categories: ○ Conservative → Client prefers an investment and/or hedging strategy where the primary goal is to prevent the loss of principal. ○ Moderate → Client is willing and able to expose funds to a moderate level of risk in consideration for higher returns or to meet certain objectives. ○ Aggressive → Client is willing and able to accept higher risks involving volatility of returns and even possible loss of investment in return for potentially higher long-term results. First Semester Page 7  higher long-term results. Whenever a scoring system is used for client profiling, the BSFI shall ensure that the system is robust, fit for the purpose, and adequately tested. ○ Any limitation in the system shall be mitigated through client discussions and the suitability review process. ○ The system shall be calibrated as necessary to reflect appropriate results. The BSFI shall make a record of the classification under which each client is categorized, including sufficient information to support the categorization. The classifications of the client according to sophistication and risk tolerance shall serve as bases for the BSFI’s product offerings and the level of disclosures required. --- not organized 3. Suitability Review Before proposing or recommending a particular product to a client, a BSFI shall determine that the product is: Suitable to the client’s needs, financial situation, and objectives. Consistent with the client’s mandate, risk tolerance, and constraints. Aligned with the client’s knowledge and experience, such that he/it understands the nature of and risks associated with the product. The BSFI shall inform its client of alternative products that are suitable to his/its circumstances. A BSFI shall maintain a record of the assessment as well as all information used as bases of its suitability review. This includes written documentation created to evidence interviews and analyses made in the performance of its due diligence process. It is highly recommended that a BSFI requires a client to sign his/its conformity to the suitability assessment (including the information on which it is based) to avoid disputes with the client. A BSFI shall only offer the range of products that is viewed as suitable for the client. In certain instances, a client may insist on transacting in a particular product that has previously been assessed as unsuitable for his/its profile. In such cases, the BSFI shall obtain the client’s confirmation in writing that: The BSFI has informed the client of the protections he/it may lose and the risks that he/it is exposed to. The client still wishes to proceed with the transaction despite the BSFI’s assessment. The client fully understands and is willing to take the risks attendant to the product to be availed of. In no case shall the BSFI offer its clients the option to automatically and comprehensively waive the outcome of the client classification process and the resulting protections offered by the rules on client suitability. TREASURY PRODUCTS Government Securities (GS) ○ Debt instruments issued by the Republic of the Philippines or any of its instrumentalities to finance public expenditures. Scripless securities registered under the National Registry of Scripless Securities First Semester Page 8  ○ Scripless securities registered under the National Registry of Scripless Securities (NRoSS) System of the Bureau of the Treasury. ○ The safest investment instrument in the market. ○ They are backed by the full taxing power of the government, making them practically default risk-free. ○ There may be market risks due to changes in interest rates, but the safety of your principal is assured. ○ GS are high-yielding. ○ Rates are at par or higher than other investment instruments in the market. ○ The presence of an organized, transparent fixed-income exchange, the Philippine Dealing and Exchange Corporation (PDEx), ensures you get the best price available in the market. ○ GS are marketable and highly liquid. ○ They can be traded easily in the secondary market anytime the market is open. ○ The market for GS is open every day, from Monday to Friday, 9:00 am to 12:00 nn and 2:00 to 4:00 pm. Treasury Bills (T-bills) ○ Short-term promissory notes issued by the National Government. ○ They are direct, unconditional, and fully-guaranteed obligations of the Republic of the Philippines. ○ The most actively-traded zero-coupon debt instruments. Issuer Republic of the Philippines Status/Credit Fully guaranteed by the National Government Issue Date Various Maturity Date Various Original Tenor Up to one year (91, 182, 364 days) Interest/Coupon on Issue Date None (issued at a discount) (Gross) Taxation (subject to 20% Applicable on interest withholding tax, except for tax- exempt institutions) Interest Payment Period None Minimum Investment P200,000.00 Requirement (Secondary Market) Tradable via Organized Yes Exchange Fixed Rate Treasury Notes (FXTNs) ○ Long-term financial obligations issued by the National Government. ○ Promise to pay a specific sum of money with frequent fixed-rate coupon payments at a specified future date. ○ Have a known maturity and yield. Issuer Republic of the Philippines Status/Credit Fully guaranteed by the National Government Issue Date Various Maturity Date Various First Semester Page 9  Maturity Date Various Original Tenor Up to 25 years (3, 5, 7, 10, 15, 20, 25 years) Interest/Coupon on Issue Date Various (Gross) Taxation (subject to 20% Applicable on coupon withholding tax, except for tax- exempt institutions) Interest Payment Period Semi-annually Minimum Investment P200,000.00 Requirement (Secondary Market) Tradable via Organized Yes Exchange Retail Treasury Bonds (RTBs) ○ Medium-term financial obligations issued by the National Government. ○ Promise to pay a specific sum of money with frequent fixed-rate coupon payments at a specified future date. ○ Small denominated securities suitable for small investors offered through book- building or initial public offering. Issuer Republic of the Philippines Status/Credit Fully guaranteed by the National Government Issue Date Various Maturity Date Various Original Tenor Up to 25 years (3, 5, 7, 10, 15, 20, 25 years) Interest/Coupon on Issue Date Various (Gross) Taxation (subject to 20% Applicable on coupon withholding tax, except for tax- exempt institutions) Interest Payment Period Quarterly Minimum Investment Primary Market: P5,000.00 Requirement (Secondary Secondary Market: P200,000.00 Market) Tradable via Organized Yes Exchange Corporate Securities/Corporate Notes ○ Debt instruments issued by public or private corporations to finance their operations. ○ They are medium to long-term financial obligations. ○ Promise to pay a specific sum of money with frequent fixed-rate coupon payments at a specified future date. ○ They are not deposit products and are, hence, not covered by PDIC. ○ They offer fixed coupon rate and enjoy better yields than GS. ACRONYMS First Semester Page 10  ACRONYMS Bangko Sentral-supervised Financial Institutions (BSFIs) Management Information System (MIS) National Registry of Scriptless Securities (NRoSS) Bureau of the Treasury (BoT) Government Securities (GS) Philippine Dealing and Exchange (PDEx) Treasury Bills (T-bills) Fixed Rate Treasury Notes (FXTNs) Retail Treasury Bonds (RTBs) First Semester Page 11