ICS Develops Over-the-Counter Forex Derivatives Trading Desk to Meet International Bank Client Demand and Regulatory Risk

I. CHALLENGE:

The client needed to implement a system-wide process to provide the Bank’s customers with the ability to hedge their manufacturing foreign currency exposure earned on sales of textiles, garments, and other goods. These goods, manufactured in either China or Korea, are paid in US dollars into either Korean Won or Chinese Yuan through the use of over-the-counter currency derivatives.

The Bank had never previously participated in the over-the-counter market and did not have a framework to manage the market risk, the credit risk, the documentation risk, or the operational risk. Furthermore, they did not have the infrastructure, systems, or practical business experience to support this business initiative. As such, the Bank was losing customers at a rapid pace from competitor banks who were offering the desired hedging capability.

II. FACTORS:

The Bank had to implement an end-to-end process to enable it to have the ability to provide this product. Complicating matters, the NY Branch had to follow mandates from their home office in Korea that often was not in line with United States law. Key points of contention involved a number of regulatory requirements required by the NYS Banking Department. For instance, NYS required systems architecture to enable the Bank to manage valuation, credit, collateral, and documentation risk in a real-time format. The home office in Korea did not have the appetite to implement all of NY State’s requirements; NY State would not approve this business activity without all of their regulatory requirements being satisfied.

Additional headcount would be required, as well as training, to ensure that the Bank had the proper expertise to engage in these markets. The Bank also needed a major systems upgrade, including as the development of a structure and process to manage and control the risks associated with over-the-counter foreign exchange derivatives on a 24-hour basis, as these products trade continuously. This meant that the NY Branch had to pass the book of business around the globe to satisfy customer demands and requests made when the NY Branch was closed, requiring the NY Branch to devise a way to apportion market and credit risk with their foreign branches in London and Asia.

III. SOLUTIONS:

• We started by developing policies and procedures and internal controls that would be adhered to globally for this business.
• ICS prepared a Customer Agreement that encompassed all of the required disclosures that needed to be provided to the Bank’s customers.
• ICS then built out an operational framework for which the Bank would utilize to manage market, credit, operational and other relevant risks.
• ICS worked closely with the NYS Banking Department to develop systems, reports and processes that would satisfy NY State’s requirements.
• These processes were intensive and involved significant coordination with the Bank’s branches around the world. ICS coordinated the interaction between the foreign branches and the NY branch.
• ICS beta tested the systems through dummy transactions to ensure that all systems and process were operating as expected.
• ICS then provided the NYS Banking Department with a roadmap of the entire end-to-end process for their review and comments.
• ICS corresponded with the NYS Banking Department and implemented all of their recommendations.

IV. RESULTS:

At the conclusion of the engagement, the structure to engage in foreign exchange forward contracts is now set-up. The client has enhanced their ability to serve their clients using Forex trading to repatriate U.S. dollars to Korean Won / Chinese Yuan, and vice versa. Growing this competency not only reversed the departure of clients to competitors, but also enhanced the client base by offering new services to meet the market demand.