Herstatt risk

Herstatt risk

The risk of loss in foreign exchange trading that one party will deliver foreign exchange but the counterparty financial_institution will fail to complete its end of the contract. This is also referred to as settlement risk.

Herstatt Risk

The risk that a foreign exchange trade will not settle. For example, a buyer may not receive delivery of the currency he/she bought by the settlement date, or the seller may not receive payment. This may occur because of the negligence or deliberate withholding by one party or the other. If a party does not receive the securities or payment, he/she is not obligated fulfill his/her end of the bargain until delivery or payment is made, but this can render him/her unable to conduct other activities that would advance his/her investment goals. Herstatt risk takes its name from the Herstatt bank, which notoriously failed to settle currency transactions and went into bankruptcy in 1974.
References in periodicals archive ?
After that this risk was named the Herstatt risk. With direct yen-renminbi exchange the Herstatt risk almost disappeared.These two factors - the low-cost issue and the time-zone risk - are the main substance of point 2.Start of Direct Yen-Renminbi TradingInterbank currency trading in China must utilize the China Foreign Exchange Trading System (CFETS) in Shanghai.
CLS means Continuous Linked Settlement and it is designed to do away with the Herstatt risk of default assumed by one party in a foreign currency deal.
(14) Such arrangements lead to exposures because there is no direct link between the payment of the two currency legs; thus, there is a risk (called Herstatt risk) of paying the currency sold but not receiving the currency bought.
(6) Foreign exchange settlement risk (or Herstatt risk) may include both credit and liquidity risk, and arises because of the time lag between the settlement of the two legs of the transaction.
Indeed, Herstatt risk has become a generic term to describe cross-border settlement risk for banks.
They are typically categorized as credit or solvency risk, liquidity risk, market risk, Herstatt risk, fraud risk, operational risk, legal risk, and systemic risk.
* systemic risk -- associated with payment systems, market transaction settlement practices and the inter-connectedness of market participants (sometimes called knock-on risk; there is a form of settlement risk known as Herstatt risk dealing with cross-border transactions);
For example, most Asian financial markets are connected to the two largest International Central Securities Depositories--Euroclear and Cedel--which clear Asian paper in European time and give rise to Herstatt risk. In addition, ECHO and Multinet activities would mean that most netting of foreign exchange trading in Asia would be carried out on New York or London time.
Since then, this risk has often been referred to as "Herstatt risk." Herstatt was a small German bank that was involved in many foreign exchange transactions when it failed.
credit/systemic risk has come to be known as Herstatt risk
Indeed, finding a safe and efficient delivery-versus-payment mechanism that ensures the simultaneous settlement of payments in two or more currencies and virtually eliminates Herstatt risk remains both a goal and a challenge for market participants.
Payments netting reduces the so-called Herstatt Risk that one party will make a payment and the other party default before the offsetting payment is made.