Since 1992 the The Committee on Payment and Settlement Systems (CPSS) of the BIS (www.bis.org) has produced studies which cover various aspects of derivatives clearing and settlement. This include in 1997 a text entitled Clearing arrangements for exchange–traded derivatives which sets out some guidelines which have become industry standards. This was followed in 1999 by some guideline on Securities lending transactions: market development and implications and in 2006 by Cross-border collateral arrangements.
In the United States clearing and settlement is modern with consistent rule for market participants. In Europe the trend is towards consolidation especially in the context of an integrated European financial market. But there still cases of exclusive arrangements between markets participants. This may involve an obligation for a user of a trading platform to use a specific clearing and settlement infrastructure. The source of the obligation may be legal or regulatory, or may lie in the rules of the trading platform.
Despite the advantages of modern technology and the increasing sophistication of clearing and settlement, they remains a high risk operations. Clearing and Settlement are knows as "Herstatt Risk" (see background and definition by Gabriele Galati) and generally legal, technical, financial and operational.
Legal Risk stem from discrepancies between national securities laws (Different laws about dealings in securities) and conflicting tax rules for example domestic withholding tax regulations creating disadvantage to foreign intermediaries.
The lack of harmonization in operating hours/settlement deadlines (e.g. timing of intra–day settlement cannot guarantee that a transactions will be concluded on time for all parties. There are still variations in standard settlement periods. In addition, where the IT system is not up to date with modern technology human errors, poor staff training on new and complex derivatives/lack of product knowledge and also communication failure remain a high risk.
Bilateral clearing and settlement trades are transactions executed in non-CCP securities or securities specifically excluded from CCP settlement are settled directly between the two trading parties or their agents. A settlement system in which participants’ bilateral net settlement positions are settled between every bilateral combination of participants. See also net credit (or debit) position. Bilateral netting an arrangement between two parties to net their bilateral obligations. The obligations covered by the arrangement may arise from financial contracts, transfers or both. See also multilateral netting, netting, net settlement. Bilateral settlement is very much a feature of the OTC (See the BIS OTC derivatives).
Under CCP, bilateral trades may be "novated" to the clearing house for clearing and settlement. This involves the clearing house assuming any counter party risks by entering into separate contractual arrangements with both counter parties in effect, becoming buyer to one and seller to the other. The user benefits of CCPs may include the transfer of credit risk to a high quality counter party and cost savings associated with straight through processing and the consolidation of margining and settlement functions. The CCP provides netting through a single legal set off that can be supported by any given size of balance sheet/regulatory capital requirement. It improves counter party risks but is not a replacement for bilateral OTC.
Securities lending and securities borrowing is any transaction in which an institution or its counter party transfers securities against appropriate collateral subject to a commitment that the borrower will return equivalent securities at some future date or when requested to do so by the transferor, being securities lending for the institution transferring the securities and securities borrowing for the institution to which they are transferred.