Introduction to Clearing and Settlement

Introduction to Clearing and Settlement

Peter Eisenhardt

30 years: Capital markets & investment banking

Clearing and settlement directly follows a trade. Clearing is what comes immediately after the trade, where all the terms of the deal are double-checked. Settlement is the final stage, in which the transfer of securities and money takes place. In this video, Peter briefly explains how these key processes in a securities transaction are achieved.

Clearing and settlement directly follows a trade. Clearing is what comes immediately after the trade, where all the terms of the deal are double-checked. Settlement is the final stage, in which the transfer of securities and money takes place. In this video, Peter briefly explains how these key processes in a securities transaction are achieved.

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Introduction to Clearing and Settlement

3 mins 2 secs

Overview

The clearing and settlement of securities takes place after a trade. Ideally, all the terms of the deal are verified without error in the clearing stage and settlement takes place via delivery versus payment (DVP), so that payment and delivery of the security occurs simultaneously.

Key learning objectives:

  • Explain clearing and settlement

  • Describe the terms of a deal that are reviewed at the clearing stage

  • Define DVP and explain when this takes place

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Summary

What is clearing and settlement?

What follows a trade is called clearing and settlement. Clearing is what comes immediately after the trade.  All the terms of the deal are double checked, reconciled, and confirmed.

Settlement is the final fulfilment of a securities transaction - the actual transfer of securities and money.  Ownership of the securities is transferred and the buyer takes delivery against payment to the seller.

What are the terms of a trade that are double checked in clearing?

These terms includes:
  • The exact identity and trading entity of both the buyer and seller
  • The exact security
  • The quantity
  • The price amount of cash to be transferred
  • The date intended for settlement
  • The accounts and instructions for both the delivery of the securities and the cash

How is the clearing process made to be more efficient?

  1. Netting 
    • Efficiency can be achieved by “netting” if counterparties have more than one trade in the same security.  Instead of sending payments and securities for each transaction, trades and payments can be aggregated and settled by transferring the net difference in securities and funds.
  2. Accuracy
    • It is important to avoid any errors in the clearing process.  If any one of the terms is not agreed properly and don’t match, the trade will not settle.

What is “Delivery versus payment”?

“Delivery versus payment” (DVP) is an important concept in settlement.  DVP stipulates that cash payment and delivery of the security occur simultaneously, so that both buyer and seller are protected against default. Trades not settling DVP are subject to what is called “Herstatt Risk”, named after a small German bank that failed in 1974.

When does settlement take place?

Settlement takes place on a “T plus” basis - that is, trade date + a given number of days.  For example, a T+ 2 trade settles two days after the trade.

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Peter Eisenhardt

Peter Eisenhardt

Peter has over 30 years experience working in banking. He has held several senior positions in international investment banks. Peter is now the Secretary General of the International Council of Securities Associations

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