Treasury Middle Office

The treasury middle office is the control function that measures, monitors and reports the risks and financial results arising from a treasury's dealing activity. It stands between the dealers who take positions and the operations staff who settle them. Its work includes checking positions against limits, valuing them independently, calculating profit and loss, and reporting to senior management and risk committees. It is found in banks and in the larger corporate treasury departments.

The middle office is one of three parts of the traditional treasury structure. The front office, located in the treasury dealing room, executes transactions, and the treasury back office confirms and settles them. The middle office neither trades nor pays. In terms of the Three Lines Model it carries out second line work, and it usually reports to the chief risk officer or the chief financial officer and not to the head of dealing.

• Limit monitoring. Positions are compared each day, and for some limits during the day, with the limits approved by the board: open currency positions, interest rate sensitivity, value at risk, stop-loss levels and exposure to each counterparty through credit limit management. Breaches are reported and escalated.
• Independent valuation. Positions are revalued using prices and rates obtained from sources independent of the dealers. This mark-to-market process, and the checking of any prices supplied by dealers, guards against mismarking.
• Profit and loss. Daily results are calculated, explained in terms of market movements and new deals, and reconciled with the dealers' own estimates and with the accounting records. In banks this work is often called product control.
• Risk measurement. The middle office runs sensitivity analysis, scenario tests and stress tests on market risk, and contributes to the measurement of liquidity and interest rate risk on the balance sheet.
• Deal review. Deals are checked for off-market rates, unusual counterparties, late entry, amendments and cancellations, any of which may indicate error or concealment.
• Reporting. Regular reports go to senior management and to committees such as the asset and liability committee, supporting asset liability management.

Beyond daily monitoring, the middle office maintains the treasury policy and limit framework, proposes changes to limits for approval, and checks that dealers trade only in authorised products and with approved counterparties. It typically coordinates the approval process for new products, making sure that systems, valuation methods, accounting treatment and legal documents are ready before the first deal. It also oversees the models used for valuation and risk, including the testing of their results against actual outcomes. In companies that apply hedge accounting, the middle office often prepares the hedge documentation and effectiveness tests.

Dealers are rewarded on the results they report, which creates an incentive to understate risk or overstate profit. An independent middle office removes control of valuations, limits and reported results from those with that incentive. Its independence has three elements: a separate reporting line, its own access to market data and systems, and pay that does not depend on dealing profits.

Losses from unauthorised trading illustrate what happens when the function is weak. In the Barings case of 1995, reported profits from supposedly low-risk arbitrage were not challenged although they were implausibly large. At Société Générale in 2008, a trader with previous experience in control functions concealed very large positions with fictitious offsetting trades, and repeated warning signs, including cancelled trades and queries from an exchange, were not followed through. Reviews of both cases stressed the need for control staff with the authority and the knowledge to question dealers.

In a bank, middle office tasks are spread across specialised teams for market risk, product control, valuation control and treasury risk, and are subject to regulatory requirements on market risk capital, interest rate risk in the banking book and liquidity. The term is also used in asset management, where the middle office covers trade support, performance measurement and data, a somewhat different set of tasks.

In a non-financial company, the middle office may be one or two people, or a role combined with treasury accounting. Its focus is compliance with the treasury policy: that hedges match the underlying exposures, that counterparty limits are respected and that the board receives accurate reports on exposures and hedge cover.

A middle office is only as effective as its data, its staff and its standing. If positions are booked late or in systems it cannot see, its reports are incomplete. Complex products may be valued with models that few outside the dealing room understand, leaving control staff dependent on the people they oversee. Where the function is treated as an administrative cost, it may lack the seniority to challenge profitable dealers. Organisations address these weaknesses through investment in a treasury management system, rotation and training of control staff, and periodic review by internal audit.