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 foreign exchange settlement risk or cross-currency settlement risk, sometimes called "Herstatt risk" after the German bank that made a famous example of the risk. On 26th June 1974, the bank's license was withdrawn by German regulators at the end of the banking day (4:30pm local time) due to a lack of income and capital to cover liabilities that were due. But some US banks in foreign exchange transactions had already paid deutschemarks to the bank during the day, believing they would receive US dollars the next day in Germany or later the same day in the US. But after 4:30 pm in Germany and 10:30 am in New York, Herstatt stopped all dollar payments to counterparties, leaving the counterparties unable to collect their payment. The closing of Drexel Burnham Lambert in 1990, Bank of Credit and Commerce International in 1991, and Barings in 1995 resulted in similar losses for counterparties in the foreign exchange market.

Mitigating settlement risk

• Delivery versus payment
• Settlement via clearing houses
• Foreign exchange settlement using continuous linked settlement

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.