Settlement

Settlement (of securities/bonds or in FX market) is a business process whereby securities or interests in securities are delivered, usually against (in simultaneous exchange for) payment of money, to fulfill contractual obligations, such as those arising under securities trades.

Nature of Settlement -

There are 2 ways of payment in case of settlement.

1. Delivery versus payment(DVP) in which transfer of security takes place for payment or any other financial asset.

2. Free of payment (FOP) - Here first delivery of securities takes place and later on payment is done. Here 1 party takes risk of not getting anything at all.

Settlement cycles

US and UK have T+3 days for Equities but for bonds they have T+1 days for bonds.

Japan has T+3 days for both bonds and Equities.

Germany T+2 days

Greater the number of business days, greater the risk.

In case of FX market it takes T+2 day mainly.


Settlement date

Transfer of legal ownership of a bond/shares move from the seller to the buyer on the intended settlement date. This should be before value date.

Trade settlement process 

Step 1: Settlement instructions 

Although agreement may have been confirmed on a trade with the client, the actual process of exchanging bonds/cash cannot take place until a settlement instruction has been issued to the custodian. Its better if  standard settlement instructions (SSIs) are used. The settlement instructions are generally transmitted from bank's settlement system via a secure method such as SWIFT.


Step 2:  Settlement process
Upon receipt or ack of settlement instructions, the custodian tries to match the instruction sent by the counterparty to its custodian. It then returns the settlement status.  

Step 3 : Settlement status
Depending on the settlement status, either the settlement is done or there is settlement failure.

In case some problem occurs there is settlement failure due to settlement not done till value date. See here for more on settlement failure.