Introduction to Settlement
Settlement refers to the process of transferring funds to the seller and securities to the buyer.
This process involves series of communication between different players and hence settlement date is later than the trade date. The settlement period i.e days between the trade date and date when settlement should take place, will differ based on the exchange and type of security being traded. For example it is 3 days in the US market, referred to as T+3.
However, due to various reasons, the actual settlement of securities and funds can happen beyond the settlement date. Most banks have a policy to settle their customers on the settlement date, regardless of whether the settlement has actually occurred. The customer’s cash account is credited with funds on a sale and debited on a purchase on the due settlement date. This is also referred to as Contractual settlement.
In contrast, in Actual settlement, the banks settle customers only once the counterparty actually settles their leg.
This feature explains how the system should be configured to support Securities settlement and how the process works in Temenos Transact.
The Securities (SC) module supports both contractual and actual settlements. In a contractual settlement environment, the customer’s cash account is credited with funds on a sale and debited on a purchase on the due settlement date, regardless whether the settlement has actually occurred. In an actual settlement configuration, the accounting happens only when the settlement actually occurs.
Central Securities Depositories Regulation
Central Securities Depositories Regulation (CSDR) lays down uniform requirements and rules for settlement of financial instruments in the European Union (EU) and conduct of central securities depositories (CSDs) to promote safe, efficient and smooth settlement. Settlement across borders presents higher risks and costs for investors within one country. The EU has adopted CSDR to harmonise rules in that region.
The regulation mandates the use of CSDs for securities issuance and for the settlement of securities transactions that are executed on recognised trading venues. The regulation requires that CSDs be authorised to provide services and sets out high prudential and conduct of business requirements for CSDs. It also sets out rules aimed at reducing settlement failure rates and improving settlement discipline.
In cooperation with the regulation on Over the Counter (OTC) derivatives, central counterparties and trade repositories (European Market Infrastructure Regulation or EMIR), and the Markets in Financial Instruments Directive (MiFID), CSDR provides a framework in which securities infrastructures (trading venues, central counterparties and central securities depositories) are subject to common rules on a European level.
The main objective of the regulation is to increase the safety and efficiency of securities settlement and settlement infrastructures in the EU by introducing:
- Shorter settlement periods
- Cash penalties and other deterrents for settlement fails
- Strict organisational, conduct of business and prudential requirements for CSDs
- Passport system allowing authorised CSDs to provide their services across the EU
- Increased prudential and supervisory requirements for CSDs and other institutions providing banking services that support securities settlement
The focus of this feature is on clauses around securities settlement.
Settlement Tolerance
The system needs to account for the settlement difference when the settlement amount is different from the anticipated settlement amount if the difference is within tolerance.
- EUR 2 for settlement amount up to EUR 100,000
- EUR 25 for settlement amount over EUR 100,000
In case of settlement in currencies other than EUR, the EUR equivalent (settlement amount and tolerance) is derived using the official exchange rate for applying the tolerance checks. If the difference in amount is less than or equal to the tolerance specified, the system processes the settlement (no STP break) and posts the difference to a designated account.
Bilateral Cancelation
Under the regulation, matched instructions cannot be settled unilaterally. This means that matched instructions can only be cancelled if both counterparties request a cancellation of their instructions. Until the cancellation confirmation is received from the market, the instruction remains eligible for settlement.
When the counterparty has requested a cancellation of a matched transaction, the CSD informs the bank of the pending cancellation request. In case of cancellation initiated by the counterparty, the account owner can accept (send MT54X cancellation) or ignore the request. When the bank has requested a cancellation of a matched transaction, the CSD informs the bank of:
- The status of the cancellation request
- Acceptance of cancellation by the counterparty once received
Upon receipt of the cancellation request, an MT548 is triggered (from the custodian) in the following format.
:23G::INST
:25D::IPRC//CANP
:24B::CANP//CONF
It denotes ‘The cancellation request that has been sent has not been executed yet. It is pending. Your counterparty must also cancel their trade and we are waiting for the confirmation it is done’. Simultaneously, another MT548 is triggered to the counterparty acknowledging the cancellation request.
:23G::INST
:25D::IPRC//CPRC
It denotes ‘A cancellation request from your counterparty for this instruction is pending waiting for your cancellation request.’ Once both counterparties have sent cancellation messages, the instruction is immediately cancelled and reported accordingly through MT548 in the Tag IPRC//CAND.
Hold and Release
The system allows a user to put an instruction on hold and release it again later at any stage in the instruction life cycle before the transaction has settled.
By setting an instruction to ‘on hold’, the system undergoes a matching process but is not eligible for settlement until both parties have released their respective settlement instructions. Such ‘On hold instructions’ that fail to settle on the intended settlement date are subject to penalties.
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