Settlement risk

Settlement risk is the risk that a counterparty does not deliver a security or its value in cash as per agreement when the security was traded after the other counterparty or counterparties have already delivered security or cash value as per the trade agreement.

One form of settlement risk is so-called Herstatt risk, which is the settlement risk resulting from different legs of a transaction settling in different time zones (or more generally, in different settlement systems where netting is not possible). Herstatt risk exists primarily (but not exclusively) in foreign exchange transactions and cross-currency swap transaction.

The term Herstatt risk follows from a famous incident on June 26, 1974, in which the German Herstatt bank was closed due to insolvency during German banking hours, but before the start of US banking hours. As a result, the bank failed to make payment on the US dollar legs of foreign exchange transactions even where it had already received the deutschmark payments on such transactions.

For More Information

• Overview of Settlement Risks across Europe (26 countries)
• Bank for International Settlements: Committee on Payment and Settlement Systems Forum for central banks to monitor and analyse developments in domestic payment, settlement and clearing systems as well as in cross-border and multicurrency settlement schemes. Excellent publications and research showing various forms of settlement risk and mitigation strategies.
• Overview: Settlement Risk is a more in-depth article.