Financial Markets Operations Management

CHAPTER 8 Settlement and Fails Management

8.1 INTRODUCTION

In the previous chapter we followed a typical transaction from the Front Office through to clearing. In this chapter we will cover the final phase in the transaction lifecycle, in which the liabilities of both the buyer and the seller are completed. We refer to this as settlement.

The term “settlement” can be defined as:

“The completion of a transaction, wherein the seller transfers delivery versus payment (DVP) securities or financial instruments to the buyer and the buyer transfers money to the seller.”¹

This¹ definition is valid for securities and other cash market financial instruments, but what about derivatives? “Open” derivatives contracts can be open for months, if not years, and the concept of settlement is only truly valid when derivatives contracts are exercised, i.e. in instances where the underlying asset is delivered or received. You will recall from the previous chapter that open derivatives contracts are either margined (for open exchange-traded and cleared OTC derivatives transactions) or collateralised (for non-cleared OTC derivatives).

In this chapter you will learn about the following topics:

• The different types of settlement;
• The concept of delivery versus payment and the three BIS DVP models;
• The locations in which settlement takes place;
• The reasons why transactions fail to settle;
• The ways in which settlement fails are managed.

8.2 THE DIFFERENT TYPES OF SETTLEMENT

In the BIS/CPSS definition ...