Issue #55: The 1974 Failure of Bankhaus Herstatt and the Rise of Real-Time Gross Settlement (RTGS)
On a daily basis, trillions of dollars flow between financial market participants in securities, derivatives, and foreign exchange contracts. Moreover, most of these payments occur largely without the knowledge of most people, thanks to a collection of institutions known as financial market utilities (FMUs). These financial market utilities collectively compose the “plumbing” of the modern financial system, performing critical post-trade functions, such as matching the transfer of financial assets and corresponding payments between buyers and sellers. Once a trade has been negotiated, someone or something has to arrange for and assure the safe transfer of financial assets and corresponding payments to the proper accounts.
These financial market utilities also mitigate settlement risk, the risk that trades might not be settled and completed as anticipated. Of key importance is counterparty credit risk, the risk that a party involved in a trade might fail to deliver financial assets and funds as promised. These financial market utilities mitigate settlement risk through more or less the same mechanism – precisely targeted liquidity that requires these financial market utilities and their participants to deliver financial assets and funds according to a tight within-day timetable.1