Foreign Exchange Operations: Master Trading Agreements, Settlement, and Collateral

CHAPTER 4

Foreign Exchange Settlement

The topic of this chapter is settlement of foreign exchange transactions. For our purpose, settlement is the process of transferring funds to discharge the obligations of a foreign exchange transaction.

I begin with the settlement instructions for the spot foreign exchange deal that was illustrated in the previous chapter. Then I shift attention to how banks accomplish foreign exchange settlements. I also discuss the historical development of the current arrangements for foreign exchange settlement, leading to the development of payment systems that operate on real-time gross settlements principles. After reviewing some of the most important payment systems, I turn attention to CLS Bank.

SETTLEMENT INSTRUCTIONS FOR AN INDIVIDUAL SPOT FOREIGN EXCHANGE DEAL

In the example of a spot trade in the previous chapter, Bantamweight Bank sold 50 million euros against dollars to Heavyweight Bank, a foreign exchange dealer:

Trade date: 01 August

Value date: 03 August

Party A: Bantamweight Bank

Party B: Heavyweight Bank

Face in EUR: EUR 50,000,000

Face in USD: USD 61,750,000

Exchange rate: 1.2350

Buyer of EUR: Party B

Buyer of USD: Party A

Receiving agent (USD): Allstar Bank NY

Receiving agent (EUR): Striker Bank London

Refer back to Exhibit 3.14 (types of SWIFT messages) to examine the flow of messages shown in Exhibit 4.1.

Exhibit 4.1 SWIFT Messaging Diagram

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