Middle- and back-office operations managers for global investment firms should be aware of the complexity of international fixed income security features.
When first setting up a fixed income security, it is important to ensure that the security data calculates correctly for trades, so that your operational performance meets your firms’ and clients’ expectations.
Some of the most difficult fixed income securities to work with, from an operations standpoint, are international bonds. Some of the largest trading systems today, such as Bloomberg or Charles River IMS, employ hardcoded workarounds to ensure that debt from other countries calculate correctly. An incorrect trade calculation will create errors in your performance and reconciliation reports.
Whether an international security requires additional care during setup can be determined by
examining the following key data points.
Fixed Income Security Features To Consider for International Bonds
Most bonds issued from Western countries use one of five common day count conventions:
Day count is used in accrued interest calculations. At a high level, day count measures the time between two interest payments, but that time can differ based on which day count convention is used.
Most trading systems are well-equipped to handle any of the five common conventions, but a few countries have custom conventions that eschew rules the rest of the world abides by, Brazil being an example.
Nearly all of Brazil’s conventions around issuing debt differ from the rest of the world, and this can be seen in how the country uses a 252-day count to represent their fiscal year. Brazilian bonds do not count weekends in accrued interest calculations.
Contract Size and Unitized Bonds
Some issued debt is traded in contract sizes, which means that it’s only possible to buy these fixed income securities in lots of 1,000 or larger.
Commonly issued through South American countries such as Argentina and Brazil, this type of debt can be noticed by finding a “Unit Factor”, “Lot Size” or “Contract Size” attached to the raw security data. Any non-zero or non-one number in this field indicates that the security trades in lots.
Improper handling of unitized bonds will result in your traders placing orders that can be far too large or too small, as your system will not be taking lot sizes into account. If a unitized bond has a contract size of 1,000 and your system fails to recognize this, a million-dollar order may suddenly become a billion-dollar order.
Negative, Multiple, and Zero Interest Rates
Interest rates can be quite bizarre in the international bond market, and it’s not impossible for international interest rate peculiarities to flow into the United States.
When European interest rates dipped below zero in 2014, a number of trading systems were unable to cope because negative interest rates were never considered a valid trading scenario. Today, the interest rates of Switzerland and Japan are still negative. Ensuring your trading system can handle negative rate calculations is essential when trading international debt.
Certain international bonds may also use multiple interest rates in their yield-to-maturity calculations, such as Mexican Bonos. Being able to identify and support multiple interest rate curves for a single security is critical to trading complex international debt securities. They are also a requirement for any swaps calculations.
While some have negative interest rates, many Middle Eastern securities may have no interest rates in accordance with Islamic finance principles. These securities behave much like collateralized loans.
Fixed Income Securities: What Your Operations Team Should Know
Countries will issue bonds in their own way, and while a variety of international debt offerings means more opportunity for traders, it means more challenges for operations.
Make sure your middle-and back-office teams are aware of the complexities surrounding global fixed income security setup.
By identifying potential pitfalls associated with “non-traditional” international bonds, you’ll avoid reporting errors and the time wasted trying to fix everything.
Running a world-class operation requires good documentation for training your reconciliation reporting team, as our previous blog highlighted.
And if you can document the procedures for global fixed income security setup, you’ve taken one step in ensuring better operational performance.