Trading and Capital-Markets Activities Manual provides guidance on trading operations and related capital-markets banking activities. Details sound management practices and key examination and review considerations for trading and capital-markets activities.

Includes discussions of a wide range of risk management issues encountered in trading and dealer operations, including market risk, counterparty credit risk, legal risk, financial reporting, accounting, and ethics. Profiles thirty-five specific financial instruments commonly encountered in trading and capital-markets-related activities.

USING THIS MANUAL
This manual seeks to provide the examiner with guidance for reviewing capital-markets and trading activities at all types and sizes of financial institutions. The manual will be updated periodically as products and activities evolve.

The manual codifies current procedures used in the review of capital-markets and trading activities. It discusses the risks involved in various activities, risk-management and -measurement techniques, appropriate internal controls, and the examination process from the following perspectives:

• Global applicability. The manual is not directed at trading at any one type of institution (commercial bank, branch/agency, other) but is meant to apply to capital-markets and trading activities at all financial institutions to be examined.

• Portfolio. The manual attempts to broaden our review of trading operations from a productby-product approach to a portfolio and functional-activity approach. This method better reflects the multiple uses of financial instruments by institutions, their relationship to other instruments and activities on or off the balance sheet, and attendant correlations.

• Types of risk. The manual identifies the range of risks—market, credit, liquidity, operational, legal, and other risks—relevant to the review of capital-markets and trading activities, and discusses their management on a functional and legal-entity basis.

The manual is divided into four basic sections. The first section consists of broad introductory remarks regarding the examination of most capital-markets and trading activities, including important considerations in preparing for the examination and review of capitalmarkets activities. It also discusses the importance of examiner review of the management organization of the activity to be examined.

The second section presents supervisory guidance regarding trading and dealer operations at banking organizations and specifically details certain aspects of the examination process for these operations. In general, the discussion of each topic has the following four subsections:

• discussion of the general topic
• examination objectives
• examination procedures
• internal control questionnaire

The focus of the examination objectives, examination procedures, and internal control questionnaires is to provide examiners with a practical guide to examining the core areas of any trading operation. Examination objectives describe the goals that should be of primary interest to the examiner and determine the scope of the examination for the specific area of interest. The examination procedures include procedures to be performed during a comprehensive examination. In some instances, not all the procedures may apply to all financial institutions.

Thus, examiners have the flexibility, depending on the characteristics of the particular institution under examination, to determine the examination scope and procedures. The materiality and significance of a given area of operations are an examiner’s primary considerations when deciding the scope of the examination and the procedures to be performed. Examiner flexibility results in examinations tailored to the operations of the banking institution.

After determining the proper objectives and procedures, the examiner will have an organized approach to examining the institution’s trading processes. Core topics include the following:

• market risk
• credit risk
• settlement risk
• liquidity risk
• operations and systems risk
• legal risk
• financial performance
• capital adequacy of trading activities
• accounting
• regulatory reporting
• regulatory compliance
• ethics

The third section of this manual offers supervisory guidance regarding various banking activities and functions that are not tradingrelated but are directly linked with capitalmarkets and Treasury operations. While targeted primarily at larger institutions, the general principles identified in this section are applicable to activities at institutions of all sizes.

This section presents the latest Federal Reserve interestrate risk management within the banking book, securitization and secondary-market credit activities, securities and end-user derivative activities, and other topics. In some cases, the guidance consists of Federal Reserve supervision and regulation (SR) letters on specific topics. In others, formal examination-manual treatments are presented that include exam procedures and internal control questionnaires.

The fourth section of this manual presents profiles of specific financial instruments commonly encountered in capital-markets and trading activities. An examiner’s understanding of these instruments is crucial to successful implementation of a capital-markets examination.

While the write-ups are not intended to provide in-depth and fully comprehensive coverage of each instrument, they do present basic instrument characteristics and examination considerations.

In general, each instrument profile contains discussions in the following areas:

• general description
• characteristics and features
• uses
• description of the instrument’s market
• pricing conventions
• hedging issues
• discussion of the risks involved
• accounting treatment
• risk-based capital considerations
• bank-eligibility requirements
• references for further information

When assigned to review a particular product, the examiner should first review the appropriate instrument profile to become familiar with the characteristics of and the marketplace for the product. The examination objectives, examination procedures, and internal control questionnaires will often be applicable across any number of instruments and products. Therefore, coordination with examiners who are reviewing other products is essential.

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Prepared by: Federal Reserve System

CONTENTS
1000 EXAMINATION POLICY
1000 Preparation for Examination
1010 Organizational Structure
2000 TRADING ACTIVITIES
2000 Overview of Risk Management in Trading Activities
2010 Market Risk
2020 Counterparty Credit Risk and Presettlement Risk
2021 Counterparty Credit Risk and Settlement Risk
2030 Market Liquidity Risk of Trading Activities
2040 Operations and Systems Risk (Management Information Systems)
2050 Operations and Systems Risk (Front-Office Operations)
2060 Operations and Systems Risk (Back-Office Operations)
2070 Legal Risk
2100 Financial Performance
2110 Capital Adequacy
2120 Accounting
2130 Regulatory Reporting
2140 Regulatory Compliance
2150 Ethics
3000 CAPITAL-MARKETS ACTIVITIES
3000 Investment Securities and End-User Activities
3005 Liquidity Risk
3010 Interest-Rate Risk Management
3020 Securitization and Secondary-Market Credit Activities
3030 Futures Brokerage Activities and Futures Commission Merchants
3040 Equity Investment and Merchant Banking Activities
4000 INSTRUMENT PROFILES
4000 Introduction
4005 Federal Funds
4010 Commercial Paper
4015 Repurchase Agreements
4020 U.S. Treasury Bills, Notes, and Bonds
4025 U.S. Treasury STRIPS
4030 Treasury Inflation-Indexed Securities
4035 U.S. Government Agency Securities
4040 Structured Notes
4045 Corporate Notes and Bonds
4050 Municipal Securities
4055 Eurodollar Certificates of Deposit
4105 Asset-Backed Securities and Asset-Backed Commercial Paper
4110 Residential Mortgage–Backed Securities
4205 Australian Commonwealth Government Bonds
4210 Canadian Government Bonds
4215 French Government Bonds and Notes
4220 German Government Bonds and Notes
4225 Irish Government Bonds
4230 Italian Government Bonds and Notes
4235 Japanese Government Bonds and Notes
4240 Spanish Government Bonds
4245 Swiss Government Notes and Bonds
4250 United Kingdom Government Bonds
4255 Brady Bonds and Other Emerging-Markets Bonds
4305 Foreign Exchange
4310 Forwards
4315 Forward Rate Agreements
4320 Financial Futures
4325 Interest-Rate Swaps
4330 Options
4335 Currency Swaps
4340 Swaptions
4345 Equity Derivatives
4350 Credit Derivatives
4353 Collateralized Loan Obligations
4355 Commodity-Linked Transactions

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