Chapter 17
The STP Flow of Debt Instrument Trades
17.1 INTRODUCTION
Most trades in debt instruments are executed by sell-side firms as principal; there is no stock exchange involved. Instead, market makers publish bid and offer prices and compete with each other. Their bid and offer prices are published on Reuters and Bloomberg.
17.2 ORDER PLACEMENT
Orders may be placed by any of the following means:
- By researching best bid and offer prices and telephoning a market maker direct
- By researching best bid and offer prices and sending orders through hub and spoke services such as Omgeo Oasys or Autex
- By using the electronic bond trading platforms provided by information vendors such as Bloomberg, Reuters and Thomson Financial
- By using the services of a money broker. The money broker will aim to provide “best execution” subject to and taking into account the nature of the order, the prices available to the broker in the market and the nature of the market in question. The money broker will charge a fee for its services, which is usually invoiced at the end of the month in which the order was executed. Money brokers offer both telephone-based services and also electronic order entry and matching services.
17.3 ORDER EXECUTION
The sell-side firm will normally execute the trade as principal, and earn its income from the spread between the average price of its position in the securities and the price of the order. The sell-side firm may be running a short position in the security concerned.
17.4 TRADE AMOUNTS
Because trades in debt instruments are normally executed in a principal capacity, there are not usually any commissions or other fees charged on trades in these instruments. In section 3.2 we examined the reasons why accrued interest forms part of the trade computation. The different elements of a debt trade are therefore usually those shown in the following example and Table 17.1.
Table 17.1 Trade elements – debt principal trade
| Trade date | 05-Feb-08 |
| Value date | 08-Feb-08 |
| Currency and face value of bonds bought or sold | £100000 |
| Principal amount: £100 000 face value @ trade price 96% | £96 000.00 |
| Accrued interest days | 23 |
| Accrued interest £100 000 face value * 4% for 23 days | £252.75 |
| Consideration | £96 252.75 |
| Profit on trade | £500.00 |
The Cable and Wireless 4% Convertible Bond Maturing 16 July 2010 last paid a coupon on 16 January 2008. On trade date 5 February 2008, for value date 8 February 2008, Investor A sells £100 000 face value of this bond to Investor B at a trade price of 96%.
Because Investor A had purchased these bonds earlier at an average price of 95.5%, it makes a profit of £500.00 on this transaction.
Accrued interest needs to be calculated using the appropriate interest calculation formula for the particular bond. These formulae were described in Chapter 3.
17.5 TRADE AGREEMENT
All the components shown in the example in section 17.4 would need to be matched as part of the trade agreement process. In Europe, debt market makers are normally members of the International Capital Market Association (ICMA), a self-regulatory organisation and trade association representing the financial institutions active in the international capital markets worldwide.
ICMA provides a central matching engine known as TRAX2 that may be used to compare trade records. Not all buy-side firms will be participants in TRAX2, so many sell-side firms will offer the following variants.
- Mutual exchange of confirmations in paper form
- Mutual exchange of conformations via SWIFT
- Variants of the confirmation, affirmation and allocation model including direct links between the two firms’ systems and the use of hub and spoke service providers.
Note that not all sell-side firms will provide all the alternative methods of trade agreement.
If the transaction was arranged by a money broker, then the money broker will also send a confirmation that needs to be checked by the trade party.
17.6 REGULATORY TRADE REPORTING
TRAX2, the central matching engine, is typically used to fulfil the sell-side firm’s trade reporting obligation.
17.7 SETTLEMENT
For many government bonds, standard settlement is T + 1, i.e. one business day after trade date. For corporate bonds it is usually T + 3.
Sell-side firms will normally use one of the following types of settlement agent:
- For securities issued by governments, they may use the CSD of the country concerned, e.g. for UK government securities they will use Euroclear UK and Ireland, for US government securities they will use the DTCC.
- For securities issued by corporate borrowers, they will normally use an ICSD such as Euroclear Bank in Brussels or Clearstream in Luxembourg.
Many corporate bond issues are relatively illiquid, therefore there can be a high proportion of failed trades in these instruments.
The settlement messages sent to and received from the firm’s settlement agents were described in section 12.2.
17.8 GENERAL LEDGER POSTINGS FOR THE TRADE AND THE SETTLEMENT
As the example trade is a sale and it results in a realised profit, the entries posted on trade will be as shown in Table 17.2.
Table 17.2 Trade date accounting entries for bond purchase as principal
When the trade settles (the trade can of course settle in more than one event) the posting (for the settlement of a sale) will be as shown in Table 17.3.
Table 17.3 Settlement date accounting entries – sale
The signs would of course be reversed for a purchase.
17.9 STOCK RECORD POSTINGS FOR THE TRADE AND THE SETTLEMENT
As the example trade is a sale, the stock record postings will be as shown in Table 17.4.
And when the trade settles, it will be as shown in Table 17.5
Table 17.4 Debt principal trade – stock record postings on trade date
Table 17.5 Debt principal trade – stock record postings on settlement date
17.10 POSITION-RELATED EVENTS
A single principal transaction in a debt instrument gives rise to a position in that instrument. The position-related events for a debt instrument include coupon fixing, coupon payment, mark-to-market and interest accrual, and these are all examined in Chapter 23.