Volume 2 — Governance and ControlsGovernance and Controls © Copyright 2002, All rights reserved 26 − Ensure that the risk/reward balance of the deal meets corporate guidelines. − Ensure that the necessary approvals for the deal are obtained. • Provide a sound internal control environment with a separation of duties between the creation of a deal by the front office and the verification of a deal by the middle office. Best Practices and Controls • The middle office should perform statistical analysis using stress tests and simulations. • The middle office should ensure that selected models are sound, properly reflect the value of the deal, and are used in accordance with modeling guidelines. • The middle office should validate the calculations, market data, and assumptions used to determine costs of operation and liquidity, market, and swing risks. • The middle office should sign the deal approval sheet, attesting that the risks of the proposed deal structure have been accurately calculated and meet corporate guidelines, as verified by an entity independent of the front office. Key Reports • Deal approval sheet. • Stress-test results. Validation of Deal Entry Process Overview Once a deal has been entered into the system, there are two lines of defense against inaccurate or incomplete deals: a daily front-office deal review and an independent middle-office review. First, the front office should reconcile its individual trade records with the system and sign off on a daily deal summary report indicating that the deals are accurate and complete. The middle office should then review the reports and perform any secondary reconciliation to ensure compliance. If the deal terms are not discovered or corrected at the close of business for the trade day, the error may not be found until the transaction settles. If this occurs, the company will be managing the risks of the business based on inaccurate information. For that reason, this process serves as one of the key trading controls. Objectives • Ensure that the dealmaker quickly and accurately enters all deals and their individual risk components into the deal capture system. • Provide a sound internal control environment with a separation of duties between a deal’s creation by the front office and its verification by the middle office.