Pre-trade Compliance

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Pre-trade compliance is an exercise to ensure that all the trades generated adhere to the restriction imposes by the Investment Management Agreement (IMA) or the regulatory authorities.

As the penalties for non-compliance is high, it is very important that all violation are detected before trading.

Most of the time, such an exercise is done by the system, although there are some pre-trade compliance stuff that handles exceptions.

Examples of Investment Restrictions:

• Cash level must not be above 3% and no negative cash (overdrawn)
• There must be no more than 10% of a single stock in the entire portfolio
• No investment for Singapore market
• Investment of Samsung must not exceed 3% of the portfolio
• No tobacco stocks

Computation of Pre-Trade Compliance

Computation of pre-trade compliance is usually done during order generation. Most systems perform pre-trade compliance after orders are generated, whereas some other systems perform during order generation. Some systems perform another round of pre-trade compliance check before the front office system sends all the trade to the trading desk.

Remember that due to a tight market; sometimes we need to hold all the buy orders when sell orders execution is slow. This could potentially trigger the cash level violation. However, if the fund managers instruct traders to hold buy order at the trading desk, such violation will not be detected before post trade compliance. One way to avoid such violation is to instruct traders to buy whatever they could sell. Another way is to request for temporary violation during portfolio implementation period.

Please note that pre-trade compliance uses last traded price as a means of computation. If the price of a particular stock fluctuates greatly, it will affect the outcome of post trade compliance. For example, if you need to sell a stock worth $100 in your portfolio. However, after the trade you manage to sell at $300. Additional cash will be generated and trigger the cash level violation during post trade compliance. Such price fluctuation cannot be detected by pre-trade compliance checks.

As system computation is very precise, fund manager may require the system to perform some rounding off because 3.000000001% is still a violation if you have a 3% cash restriction.

Another problem relating to the computation is the exchange rate. For example if the exchange rate rounding is different between the front office, trading desk and the back office; the compliance report will be different when violation is near. The front office system may issue a violation warning whereas the back office system may show an actual violation.

Most investment systems allow warning to be issue at a certain percentage level before violation. For example, you can allow the system to trigger a warning if the cash level reached 2.8%.

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