Questions on Counterparty Risk with Trade / Settlement

[Spaghetti Code]

Hi again, and sorry for possibly obvious question: When a trade is made, there is a trade date and a settlement date. On the settlement date, the securities have to be delivered, as well as the money to the other party. If one of the parties is nearing the point of insolvency, and is unable to deliver the shares or the money to the other party, what happens? Does the broker take on the risk for delivering the shares? Also, when a trade is made, my broker seems to let me trade with the cash/securities immediately. This means I could sell the security or spend the cash to someone else, and the risk when then be split across two people. Reverting the transaction doesn't seem like it would be possible.


A followup question: The settlement procedures seem like they can be expressed as very short term debt, almost like a 2 day forward. If I agree to sell shares, and the next day the price plummets, it seems like the buyer could try to back out of the trade some how, depending on how much the price moves. What prevents this from happening?

 

[OptionsOptionsOptions]

When you sell you do not have access to the funds right away.

 

[Spaghetti Code]

When you sell you do not have access to the funds right away.

It's true that I can't take the funds out right away, but after selling shares, the broker does let me buy into a new position immediately.

 

[OptionsOptionsOptions]

It's true that I can't take the funds out right away, but after selling shares, the broker does let me buy into a new position immediately.

No they don't .......your buying power isn't updated until the next day.

• When you open a position the buying power is updated immediately.
• When you close a position the buying power is updated the next day.

 

[Spaghetti Code]

The core of the question wasn't really about buying power, but counterparty risk. I was hoping to learn more about how that is mitigated.

 

[OptionsOptionsOptions]

The core of the question wasn't really about buying power, but counterparty risk. I was hoping to learn more about how that is mitigated.

OK.... I was responding to this portion of your OP. Which is buying power related.

...... Also, when a trade is made, my broker seems to let me trade with the cash/securities immediately......

 

[ctheo1]

• The entity that clears the trades will step in. If your broker doesn't clear trades, then the entity they clear through will step in. This is almost never a problem. Your counterparty/broker risk pertains more to what happens to your money when your broker goes bust. This should be your concern as it may not be obvious how broker money and client money is segregated etc.
• This is not an issue. The trade date price is the valid price and the one recorded with the exchange and the clearing house. Only the exchange can "bust" the price.....like they did in the 2010 flash crash.

 

[Spaghetti Code]

The entity that clears the trades will step in.

Coming back to this, it took a while for this to sink in. For the future: the Clearinghouse for the trade becomes the counterparty for both sides of the trade.