BACK OFFICE PAYMENTS AND SETTLEMENTS

Every time a deal to buy or sell foreign exchange is agreed upon by two traders in their trading rooms, a procedure is set in motion by which the “back offices”of the two institutions confirm the transaction and make the necessary funds transfers. The back office is usually separated physically from the trading room for reasons of internal control—but it can be next door or thousands of miles away. For each transaction, the back office receives for processing the critical information with respect to the contract transmitted by the traders, the brokers, and the electronic systems. The back offices confirm with each other the deals agreed upon and the stated terms—a procedure that can be done by telephone, fax, or telex, but that is increasingly handled electronically by systems designed for this purpose. If there is a disagreement between the two banks on a relevant factor, there will be discussions to try to reach an understanding. Banks and other institutions regularly tape record all telephone conversations of traders. Also, electronic dealing systems and electronic broking systems automatically record their communications. These practices have greatly reduced the number of disputes over what has been agreed to by the two traders. In many cases, banks participate in various bilateral and multilateral netting arrangements with each other, instead of settling on the basis of each individual transaction. As discussed in Chapter 8, netting, by reducing the amounts of gross payments, can be both a cheaper and safer way of settling. Payments instructions are promptly exchanged—in good time before settlement—indicating, for example, on a dollar-yen deal, the bank and account where the dollars are to be paid and the bank and account where the yen are to be paid. On the value date, the two banks or correspondent banks debit-credit the clearing accounts in response to the instructions received. Since 1977, an automated system known as SWIFT (Society for the Worldwide Interbank Financial Telecommunications) has been used by thousands of banks for transferring payment instructions written in a standardized format among banks with a significant foreign exchange business. When the settlement date arrives, the yen balance is paid (for an individual transaction or as part of a larger netted transaction) into the designated account at a bank in Japan, and a settlement occurs there. On the U.S. side, the dollars are paid into the designated account at a bank in the United States, and the dollar settlement—or shift of dollars from one bank account to another—is made usually through CHIPS (Clearing House Interbank Payments System), the electronic payments system linking participating depository institutions in New York City.

BACK OFFICE PAYMENTS AND SETTLEMENTS