On June 26, 1974, the regulator controlling the German banking system decided to liquidate Herstatt Bank, which at that time was quite active in conducting currency transactions. It is difficult to say what the regulator was guided by in their actions, but at the time of stopping his work (and this was done instantly), the bank had no transactions worth about $ 200 million. United States.
The bank’s failure to fulfill its obligations caused an appropriate chain of bankruptcies and deferments of payments, which reached the United States 3 days later. Only in New York at that time non-cash turnover in payment systems fell by 60%. Since then, the risk associated with the counterparty’s failure to fulfill its obligations in the foreign exchange interbank market has been called herstatt.
Settlement risks and Forex trading
Forex is an over-the-counter foreign exchange market in which participants (including liquidity providers) are banks. Having at their disposal free currency resources, they can invest them in one or another currency. It is worth adding that investment banks also take part in exchange rate manipulations due to the fact that large capital is in their hands.
A regular trader sitting at a trading terminal hardly thinks about how his deals are made. If, according to the broker, they are brought to the interbank market, this is already good, then the broker is not a “kitchen”. True, not everything is so simple, because a trader works in Forex not with a real currency, but with a CFD, and therefore the herstatt risk is not dangerous for him.
Another thing – the relationship between banks. Here, currency transactions are conducted with real currency and the delay in transactions is allowed up to 2 days due to the difference in time zones and technical issues. Concluding a series of transactions, the bank can count on the fact that a certain amount of money will go through it within 2 days, which means it is possible to enter into contracts further. Accordingly, if the bank does not receive its money, it will not be able to fulfill its reciprocal obligations.
Hergerstadt settlement risk has two component parts:
- Liquidity risk. Since transactions are concluded with a larger amount of money supply than is available, there remains a risk that the counterparty will not be able to fulfill its obligations. For example, Bank A buys an asset from Bank B, then hoping to sell this asset to Bank C. If Bank B cannot provide an asset to Bank A in time, Bank B will violate its obligations to Bank C. A domino effect will occur due to lack of liquidity. Li >
- Credit risk. The counterparty simply refuses to fulfill the obligations after 2 days.
To solve the problem of herstatt risk, the idea of using the CLS system, an international system of conversion transactions, was proposed. It provides that the settlement of the first transaction occurs simultaneously with the calculation of the second. That is, payment of the acquired currency occurs only after receipt of the realized currency. True, for example, the Central Bank of the Russian Federation’s system that has been operating since 2002 is not included.
How can this information be useful to a trader? The fact that it is important to understand how this or that operation occurs in order to be able to assess risks. If this risk is not terrible for CFD trading, then this information will be useful for investors working through broker-banks with a real asset.