In banking, the settlement is a mechanism for banks and financial institutions, members of the clearing house to settle the amounts due and receive the corresponding assets transactions they have carried out on the markets.
A settlement shall be made by the aggregate of all positions (purchases and sales) by product type or assets held by each account holder, and is materialized by a net payable or receivable as well as net securities flow delivered or received vis-à-vis the clearing.
Thus, for financial flows and securities operations that are offset through the clearing house, counterparty risk is assumed by the clearing house (principle of novation). A clearing house is a national or international organization which calculates net payables and execute payments.
There is a distinction between settlement in the financial markets and interbank clearing. The first focuses on securities, futures, or forex market. The second focuses on the checks and transfers between banks and involves a payment system.
In the case of securities and futures markets, clearing also calculates the net quantity (sum subtracted from the sum of purchase sales) of financial deliverables. A clearing house consists of clearing members, it guarantees the successful completion of clearing operations.
To ensure the successful completion of operations, the clearing house uses two mechanisms, innovation and multilateral netting of flows (netting). Novation is for clearing, only on the derivatives markets, to replace one of the two counterparties on a transaction counter. Thus, the clearing house receives all cash flows, Labuan Forex License and financial products.
It may do so at the multilateral netting of flows (netting) and determine the balance to deliver or receive from each associate member, in cash, and financial products. In both cases, only the net balances are subject to delivery, reducing systemic risk.
The clearing house is the guarantor of the performance of the operation: if a participant fails, it replaces it, leaving it to the participant to return to the trader who placed the order, turning against his client. The clearing house will instruct the curator to settle or deliver when it is satisfied that clearing members have good cash, and titles (or products).
To ensure its role as guarantor of the markets and reduce the risk of failure, the clearing, in addition to strict control the quality of its members, implements two mechanisms to ensure that the operators will not fail at closing. This applies to forward transactions (futures market, swaptions).
From the start of the transaction, it requires a Labuan Forex License and a deposit, also known as initial margin, which is, in general, the maximum tolerated variation in one day on the market. This is used to guarantee the residual risk borne by the clearing house in the event that there are outstanding (unsettled) transactions.