Transfer pricing in Investment Banking: A 360 degree view - Part II

June 05,2018
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Abhay Kumar (Director- Transfer Pricing, BDO India LLP)

IDENTIFICATION OF INTERNATIONAL TRANSACTIONS IN GLOBAL TRADING OF FINANCIAL INSTRUMENTS:

A number of functions (sales, trading, capital provision, central risk management, support services etc) are performed for rendering services to the client under global trading of securities. Refer Annexure 2 to read more on Global Securities, Financial Instruments and Global Trading/ Dealing of Financial Instruments.

In global trading, these functions are performed by more than one entity in more than one location. Each entity’s functions are inextricably linked to providing the service to the client. Although the revenue from the contract is booked in one entity (more often in the capital provider entity), other significant functions like managing the market risk arising out of the contract may be performed by the traders employed by other group entities. Such transactions in global trading are popularly known as remote booking, ie, trader books the trade from another location in the trading book held by another entity. Besides trading there are several other functions like sales, structuring, other back office support etc. may be performed by another set of group entities. Such an arrangement give rise to inter-company transactions under global trading. In a nutshell various group entities provide routine and non-routine services, viz, sales, structuring, trading and other support and back office services to booking entity requiring a remuneration for various routine and/or non-routine services.

Further, there may be a situation where entities of the multinational IB contracts with the client in their respective locations and take a position and offset/close/hedge their open positions with a central treasury group entity who in turn manage the risk and provide capital. This gives rise to intra-group trading of financial instruments with a view to shift the risk from contracting entity to trading and capital providing entity.

FUNCTIONS, ASSETS AND RISK (FAR) IN GLOBAL TRADING:

Functions performed in global trading of financial instruments include- sales and marketing, structuring, quantitative analysts, trading, research analyst, legal, accounting and operations. Detailed explanations of these functions have already been explained earlier in the Part 1 of this series of articles.

Capital and risks in the global trading are closely related with each other. The extent of capital and mix of capital depend upon several factors including regulation prevailing in the home country of the entity providing capital. In fact, many a times, location of booking entity is significantly influenced by the regulatory norms prevailing in a country. For example, the group may decide to book trading revenue in a country where regulatory norms are simpler and allows for more effective use capital thereby allowing for additional assumption of risk for a given level and mix of capital.

The risks in the global trading business may be classified under market risks, credit/counterparty credit risk, compliance and regulatory risk and operational risk. Refer Annexure 2 to read more on the nature of these risks.

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