How financial organizations are structured
Operationally, a financial organization such as broker/dealer, a bank, or a hedge fund is broken up into three intertwined groups: Front Office, Middle Office and Back Office. A Front Office is comprised of traders, marketers and corporate finance employees. This is the area where revenues are generated. Accessibility to live information plays a critical role in the success of this critical function. Here a talented and highly educated personal are in short supply. Information Technology (IT) is the backbone where sophisticated tools are needed to make quick decisions. Most of the trades are done and executed electronically through secure trading platforms where funds move at the speed of light.
There are times when traders and marketers do not seem to see eye to eye on many trades. The marketers eager to make a deal and to satisfy the clients rush into closing deals that are less profitable to the organization. Here conflict arises when traders find out that their numbers were marginalized. Normally traders prefer to make as much money as possible on trades as their commission is based on how much hair cut is generated from each deal.
The line between the middle office and back office is often blurred. Many organizations, especially small ones, do not specifically distinguish between the two. These groups are entrusted with monitoring and reporting risk to management and FO. Here profit and loss are calculated. Also they share different vital functions. The documentation department handles the drafting, reviewing and chasing of signed documents. The individuals drafting or reviewing these documents need to be well versed in the latest ISDA definitions. Errors are normally found during the process of drafting and are mostly due to manually misbooking trades in the system. Definitely these have great impact on risk. Unconfirmed deals could result in substantial losses if only one of the parties acknowledge the deal while the other does not, or when one party has different notional amounts on swaps deals by great margin. A dedicated team of highly skilled people are needed to resolve these issues before any major risk could result.
Middle and back office groups are also oversee settlements and reconciliations. The main function of the settlements group is to make sure all parties agreed on flows that need to be exchanged if any. Often times, trades are unrecognizable by either party or trade discrepancies are prevalent. Settlements people work closely with the middle and front office to resolve outstanding breaks in a very short period of time, usually less than 5 days. Unsettled flows, especially large ones, expose the company to potential risk. Due diligence are needed by all parties to reduce the number of failed trades.
As we can see, the operation side of any organization is critical to its well-being. Many well known companies suffered huge losses due to lack of supervision and control. Management needs to be vigilant at all time to this costly business that do not directly get involved in generating revenues.
