Contractual settlement
 Homey da Custodian, yesterday.
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Of a custodian, to recognise settlement of a securities trade on the day it is due to settle, without regard — immediately — to whether it actually does happen. One debits/credits the cash and custody accounts on the scheduled settlement date rather than when the trade actually settles.
When would they be different? Surprisingly often. “Settlement fails” in the cash equities markets are quite common, and have a domino effect, as often the guy who has sold a stock one one day is relying on someone else delivering it to him the day before. So one settlement fail can bugger up the whole chain.
Now don’t for a minute think the custodian is underwriting any — well, much — risk associated with that failed settlement. Oh, no: Homey don’t play that. It will promptly reverse any settlement if the fail stays outstanding for longer than a day or so. But you could look at contractual settlement as a form of overnight credit facility to save a client’s blushes and allow the rest of the settlement chain to carry on.
CASS shortfalls
This “informal credit facility” isn’t just untrammeled largess on the custodian’s part. Homey don’t play dat, either. For one thing, it will be girdled around with all manner of amulets, spells, indemnities, wooden stakes, garlic cloves and hold harmless undertakings to protect the custodian from all evil. For another, where the custodian maintains an omnibus account holding fungible assets on behalf of lots of clients — and pretty much every one does — it will not usually be the custodian’s own assets it uses to cover outgoing deliveries unmatched by failing receipts, but those of other clients.
Thus, where in inbound trade fails and a custodian offers contractual settlement, there may be a time where the custody record is a couple of coupons short of a toaster. Should (heaven forbid!) the custodian fail at this point, you might have some unhappy bunnies among its omnibus custody clients.[1] for this reason the FCA introduced the shortfall regime under its CASS rules, requiring custodians to fund any pending shortfall with cash or its own assets on any day. For more about that ...
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References
- ↑ Though, actually the client to whom the inbound fail was attributed would wind up wearing most of that.