Confirming transactions is a critical control to an investment bank, both to eliminate fraud and to maintain accuracy. The process is particularly important for complex trades, where there can be debate around the exact terminology and counter-parties need certainty about the size and legal security of transactions.

Kamat Aashish, at J.P. Morgan says, ‘Some counter-parties have grown their business beyond their capacity to manage it. Hedge funds sometimes do more business than they are capable of. They didn’t have the right technology and people and as a result we see that they are struggling. Both sides need to sign the confirmation. But if you have your side in order, and your counter-parties are not capable of validating the transaction when you chase them, you are in  trouble.’

The ramifications of a confirmation failure can spread beyond operational risk. Aashish continues, ‘This is an area where operational risk can change to credit risk. The credit risk is where you have a trade-off with counter-parties and the counter-parties don't exist or denies that the trade ever took place. Then you are stuck with a trade that you have to unwind in the market and you will be  a price away. Counter-parties have to find a solution to clearing, netting and settlement issues that they can live with in the long term.’

For example, tighter confirmation procedures would have led to a quicker scrutiny of multi-million dollar frauds at both Barings and at the American branch of Allied Irish Bank.

UBS’s operational risk department say they foresaw the problem in 2003 and approached their business operations management. They were told the confirmation time-lag was an industry-wide problem and their bank are no better and no worse than their peers, therefore they should accept that risk. The OpRisk people questioned this view, choosing to escalate the issue through the risk and governance committee, on to the management committee at the investment bank. The bank’s then chief executive officer decided that the bank should make further investment in human resources and assistance. Nick Bolton says, ‘We improved connectivity between the front office and the back office to  ensure there were no hold-ups in our internal process. We invested in human capital, hiring more experienced confirmation staff. This is a relatively new market and individuals were taking time to get up to speed.’

‘Although we recognised that we could only go so far because it was an industry issue, there were things that we could do to improve the process internally. But also that we should take a more pro-active stance in the industry. As a result, I would say that we are in a relatively strong position on confirmation controls in the credit derivatives market. So that was a specific issue that was escalated.  With the benefit of hindsight, was the correct decision.’

Operational risk insistence on a tightening of confirmation issues has had some very positive effects, say the JP Morgan  managers. For example, The Federal Reserve has acted to improve performance, by holding meeting of key counter-parties, and requiring banks to reduce levels of outstanding confirmations held end of September 2005 by 30% by January 30 2006. The Fed has set another target of 50% by the end April 2006, and of 75% by the end June 2006.