Settlement process

Contents

Settlement process.......................................................................................... 1
 Nostro account :..................................................................................... 1
 Vostro Account :..................................................................................... 1
 Nostro vs Vostro:.................................................................................... 1
 Trade Capture:........................................................................................ 2
 Confirmation:.......................................................................................... 2
 Fixing Date:............................................................................................. 2
 Settlement:............................................................................................. 2
 Netting:................................................................................................ 3
 Nostro Settlement:..............................................................................3
 Settlement Risk:................................................................................... 3
 Operational Process :........................................................................... 4
 Netting Accuracy:................................................................................. 4
 Settlement Instruction:........................................................................5
 Third party Payments:.......................................................................... 5
 Account reconciliation:........................................................................6

 Nostro account : A nostro account refers to an account that a bank holds

in a foreign currency in another bank. Nostros, a term derived from the
Latin word for “ours,” are frequently used to facilitate foreign exchange
 and trade transactions1. A Nostro account is a mechanism that banks use
to keep track of all funds being held in other banks in the currency of the
country where the funds are held. The Nostro account is maintained in a
foreign currency that can be converted for use in foreign exchange and
foreign trades
 Vostro Account : A Vostro account is part of correspondent banking
where a foreign bank holds the funds and acts as an intermediary to
those funds. The account is held on behalf of a domestic bank that
manages and supervises the funds. The domestic bank will approach the
international correspondent bank to open an account on behalf of their
client1. A vostro account is established to enable a foreign correspondent
bank to act as an agent or provide services as an intermediary for a
domestic bank. These services include executing wire transfers,
withdrawals, and deposits for customers in countries where the
domestic bank does not have a physical presence2.
 Nostro vs Vostro: Nostro and vostro accounts are used when one bank
opens and maintains an account with another bank. These two
“accounts” actually refer to two sets of accounting records maintained
for the same account. Nostro refers to the records held by the account
opener, while vostro refers to the records held by the account provider 1.
Nostro and vostro are used to differentiate between the two sets of
accounting records kept by each bank. Nostro comes from the Latin
word for “ours,” as in “our money that is on deposit at your bank.”
Vostro comes from the Latin word for “yours,” as in "your money that is
on deposit at our bank."2
Nostro and vostro are same and different perspective
 Trade Capture: The trade execution and capture function is the second
phase of the FX processing flow. Deals may be transacted directly over
are recorded phone line or through Internet based systems (for example,
proprietary trading systems or multi dealer trading platforms).Trade
information captured typically includes trade date, time of execution,

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 settlement date, counterparty, financial instrument traded, amount
transacted, price or rate, and may also include settlement instructions.
 Confirmation: Data included in the confirmation should contain the
following: the counterparty to the FX transaction, the office through
which it is acting, the transaction date (or trade date), the value date (or
settlement date), the amounts of the currencies being bought and sold,
the buying and selling parties, and settlement instructions. Amended
confirmations should be sent promptly when necessary. Settlement
instructions for forward transactions should be reconfirmed two days
before the settlement date. Confirmations should be reviewed on the
trade date to determine the fixing source, and transactions should be
reviewed daily thereafter to ensure that fixings are obtained as required
in the confirmation language.
 Fixing Date: In finance and banking, a fixing date is the date that a rate is
determined. It is calculated backwards from the value date (settlement
date) using the same rules as for calculating the spot date. For example,
if the value date is a Thursday and the currency pair has a T+1 spot date,
then the fixing date will be the Wednesday1.
 Settlement: Settlement is the exchange of payments between
counterparties on the value date of the transaction. Bilateral settlement
netting is the practice of combining all trades between two
counterparties due on a particular settlement date and calculating a
single net payment in each currency. For example, if an institution
executes twenty-five dollar-yen trades with the same counterparty, all of
which settle on the same day, bilateral settlement netting will enable the
institution to make only one or two netted payments.7 These netted
payments will generally be much smaller than the gross settlement
amount due. The establishment of settlement netting agreements
between counterparties can thus reduce settlement risk, operational risk,
and clearing costs.

 Netting: Various market utilities support multilateral settlement

netting, which involves combining all trades between multiple

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 counterparties and calculating a single net payment in each
currency. Settlement on a gross basis not only increases the actual
number of settlements that are necessary but also increases the
probability of settlement errors. An enforceable settlement netting
agreement has the benefit of entitling parties to reduce the
number and size of payments between themselves.
 1. Currency should be same
 2. Counterparty should be same
 3. Settlement Date should be same

 Nostro Settlement: For counterparties that do not settle on a

net basis, payment instructions are sent to nostro banks for all the
amounts owed—as well as for expected receipts. Settlement
instructions are sent one day before settlement, or on the
settlement date, depending on the currency’s settlement
requirements. If a settlement error occurs in the process, it is
typically quite costly. If a company fails to make a payment, it must
compensate its counterparty, thus generating additional expense.
Settlement errors may also cause an institution’s cash position to
be different than expected.
 Continuous Linked Settlements:

A settlement system for the FX market that eliminates the

settlement risk by Following a payment- Vs-payment process
All transaction are settled on daily basis across various currencies

Until a counterparty pays their side of amounts, they will not

receive the amount due to them.
1. 18 currencies are settled in CLS

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 2. CLS has an account with the regulators of each of the 18
currencies which include AUS, JPY, Yen, etc.
3. It settles more than half of FX transactions worldwide
4. It needs to maintain net position per currency per counterparty

 Settlement Risk: the risk that a company makes its

payment but does not receive the payment it expects
—can cause a large, even catastrophic, loss. This risk
arises in FX trading because payment and receipt of
payment often do not occur simultaneously. A
properly managed settlement function reduces this
risk. Settlement risk is measured as the full amount of
the currency purchased and is present from the time a
payment instruction for the currency sold becomes
irrevocable until the time the final receipt of the
currency purchased is confirmed.8 Sources of this risk
include internal procedures, intra market payment
patterns, finality rules of local payments systems, and
operating hours of the local payments systems when a
counterparty defaults.

 Operational Process : The operational process of settlement

netting should be supported by a legal agreement. Such an
agreement may be a brief document that only supports settlement
netting or a settlement netting provision that is included in a
master agreement. The following master agreements have been
developed as industry standard forms. Each form includes
provisions for settlement netting (included as an optional term) and
close-out netting:
 International Swaps and Derivatives Association (ISDA)
Master Agreement,

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  International Foreign Exchange Master Agreement (IFEMA)
covering spot and forward currency transactions,
 International Currency Options Market Master Agreement
(ICOM) covering currency options, and
 International Foreign Exchange and Options Master
Agreement (FEOMA) covering spot and forward currency
transactions and currency options.

 Netting Accuracy: Correct calculations of netted payments

are important to ensure accurate settlement amounts and enhance
the efficiency of operations. All market participants are encouraged
to automate the actual netting calculation so that errors introduced
by manual calculation are reduced. To protect against an improper
settlement of a net amount, counterparties should confirm the net
payment amount with each other at some predetermined cutoff
time before settlement. Parties should establish the latest possible
cutoff time for confirming bilateral netted amounts. Such a
deadline will ensure that the parties agree on the transactions
included in the net amounts. This should be part of Affirmation
process possibly. As affirmation is pre settlement step.

 Settlement Instruction: Settlement instructions should

clearly reference the following information:
 the recipient’s account name, account address, and account
number;
 the name of the receiving bank, a SWIFT/ ISO address, and a
branch identifier; and
 the identity of any intermediary bank used by the recipient.
 Incomplete or inaccurate settlement instructions
heighten the risk of a disrupted settlement
process, thus inflating processing and
compensation costs. Failed FX settlements may

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 also disrupt completion of an underlying
transaction.
 Standard settlement means SSIs are pre populated and
validated pre or post trade. This flag should be part of Trade
execution as Y or N.
 Non Standard settlement Although SSIs are preferred,
they are not always available and may not be
appropriate for all trades. When SSIs are not
used, the settlement instructions may be
recorded at the time of trade execution. These
exception settlement instructions should be
delivered by the close of business on the trade
date (if spot) or at least one day before
settlement (if forward).

 Third party Payments: Third-party payments are the transfer

of settlement funds for an FX transaction to the account of an
entity other than the counterparty to the transaction. Third-party
payments raise important issues that should be considered
carefully by a firm requesting such a practice.
 Participants should recognize that third-party payments may
significantly increase operational risk and potentially expose
all involved to money laundering or other fraudulent activity.
The practice also heightens the risk of financial loss; if the
third-party payment is directed to an incorrect beneficiary,
the payment may be delayed or even lost.
 Third-party payments may also create potential legal liability
to the dealer making the payment. Both nondealers and
dealers should be aware of the risks involved with these
transactions and should establish clear procedures
beforehand for validating both the authenticity and
correctness of such requests.

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  In addition, nondealer participants should provide dealers
with any written information required to screen, internally
review and approve, and accurately make the third-party
payment. For example, written information may include the
third party’s receiving bank name and address; the third
party’s account name, address, and number; and the nature
of the third party’s affiliation with the nondealer participant.
Also, third-party payment instructions should be provided via
authenticated means. Instructions otherwise provided—for
example, by phone or fax—should be reconfirmed by staff
independent of those providing such instructions.

 Account reconciliation:the process of comparing expected

and actual cash movements—should be performed as early as
possible.The main objective of the account reconciliation function is
to ensure that expected cash movements agree with the actual
cash movements in a firm’s currency accounts. All market
participants are encouraged to reconcile expected cash flows
against actual cash flows in a timely manner

 Conduct Daily Position Valuation Using independent price

sources, staff independent of the trading function should revalue
outstanding positions to market daily. This is particularly important for
market participants that are active in less liquid forward markets or in
exotic options markets. Both trading and operations staff should be
familiar with the procedures used for position valuation.
 Mark to Market: Marking to market reflects the current value of
FX cash flows to be managed and provides information about
market risk. Senior management will be able to better manage and
evaluate market positions when it knows positions are accurately
valued on a daily basis.

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