Effective Product Control

CHAPTER 15Independent Price Verification

In Chapter 8 we learnt that a bank can source their end of day rates (or pricing inputs) from both independent providers and the trading desk. When a rate is sourced from the trading desk, valuation control need to ensure that the rate is aligned to the market. This validation process is known as independent price verification or IPV.

IPV of all fair valued assets and liabilities is performed at every month end and a smaller version of IPV is also usually run mid month. Pricing variances can arise due to genuine differences of opinions regarding the fair value of a position and they can also arise due to deliberate mismarking by a trader.

Traders can mismark their prices to manipulate the value of their portfolio, which has a direct impact on their P&L performance. A trader may choose to inflate the value of their trading portfolio (and P&L) to earn a higher bonus and guarantee future employment, which can occur when they are behind on their budget and want to conceal their true trading performance. This type of pricing is known as an aggressive marking.

Mismarking can also be used to deflate the value of a trading portfolio (and P&L), which may occur in the lead up to year end when the trader has made their budget for the year and wants to roll forward some of their unrealized profits into the next financial year. This type of pricing is known as a conservative marking.

Mismarking can often be used for a trader to achieve a smoothed ...