What’s the difference between a Correspondent Bank, Clearing House and Settlement Bank? Are they all involved in the transfer of funds one country to another?
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What's the difference between a Correspondent Bank, Clearing House and Settlement Bank?
I am based in London, I sell 1m of a USD denominated bond, and ultimately want the USD cash to turn up in my USD account of a New York bank which will hopefully pay me fractionally higher interest than a USD account in, say, London.
Typically one clears down trading accounts to Correspondent Accounts, which are in the country of the currency, about once a day.
For Eurobonds typically Euroclear or Clearstream, these entities hold paper securities and swap them between client accounts and shunt the cash in the opposite direction. They may charge a bomb if you go overdrawn , and pay lousy interest if you are in credit - which is why you rapidly shunt actual cash into or out of your appropriate Correspondent Bank in a process called ‘Funding’.
Basically you keep your cash in Correspondent Accounts and your paper securities at Clearing Houses. You can keep cash in Clearing Houses, but that is (was in my time) regarded as moronic behaviour.
Settlement Bank - beats me, sounds like a bank operating as a Clearing House.
They can be involved in the transfer of funds from one country to another, but it could just as well be the transfer of funds within the same country. Also it is possible to just transfer paper in the Clearing House with the corresponding cash being shunted around elsewhere.
Securities transactions take place in three stages: Trading, clearing, and settlement.
Trading is the conclusion of mutually binding contracts for sale. It’s essentially about striking a deal such as: Market participant A sells 100 shares in company so-and-so for $3.78 each to market participant B. No delivery at this stage, just the contract, obliging one party to deliver the securities and the other party to fork over the money. This stage takes place either on a regulated market such as a stock exchange, or an online trading platform, or “over-the-counter”, i.e. on the basis of bilateral negotiations between the market participants.
Clearing refers to the determination of mutual delivery obligations. It’s essentially a netting thing: Transactions between market participants in the same security, but in opposite directions, are netted against each other. So if market participant A sells 100 shares in company so-and-so to B, and on the same day B sells 120 shares in the same company to A, the result is a net delivery obligation of 20 shares from B to A. This may sound nonsensical (why would B buy from A and then sell back to A on the same day?), but you have to remember that major market participants, such as large banks, conduct thousands of transactions each day - some on their own behalf, some on behalf of clients, some on behalf of investment funds, trusts, or other masses they administer. So it’s well possible that in this pile of transactions there are opposing transactions in the same security. On top of that, there is currently a trend towards using central counterparties - entities which act as an intermediary between buyer and seller, so that a sale of 100 shares in company so-and-so from A to B would be conducted as a sale from A to the central counterparty and then onwards from the central counterparty to B. There are various reasons for doing it that way, most of which involve risk management and collateral, but the result is that there are plenty of netting opportunities. A clearinghouse is a bank which does that netting and determines net delivery obligations, but at this stage, no security is actually changing hands (contrary to what FRDE said).
Settlement is the actual delivery. Usually not physically, by hauling paper from one market participant to another; it’s mostly done analogous to cashless payments: Various market participants, or the banks performing these business for them, hold accounts with the settlement bank, and the bank will transfer sharees from A’s account to B’s account by making corresponding entries in its ledger, based on the results of the clearing process.
I should probably add that the boundaries between clearing and settlement are somewhat blurred, and many companies offer services in both areas. Clearstream, for instance, is a large international clearinghouse, but in some markets - notably Germany and Luxembourg - it is also active as a central securities depository, which I suppose is what you mean by “settlement bank”: The bank that keeps the accounts for transferring securities on the settlement stage. In some transactions, Clearstream will do both clearing and settlement, in other transactions it will do only one of them. On top of that, Clearstream is a subsidiary of Deutsche Börse, the company running the Frankfurt stock exchange, so you can, in effect, get all three stages - trading, clearing, and settlement - from one supplier. This is, incidentally, the reason why the planned (but failed) merger of the New York and Frankfurt stock exchanges which was discussed last year would actually have involved the Frankfurt stock exchange as the bigger player of the two merging entities, even though New York is by far the bigger trading site: Contrary to NYSE, the company running the New York stock exchange, Deutsche Börse operates lucrative post-trading activities in the areas of clearing and settlement as well, so Deutsche Börse is the more profitable company of the two in spite of being the smaller market.
Thank you all. Very helpful. Can someone please explain when using SWIFT service when transferring personal funds to a beneficiary overseas, if the bank is using a nostrum or vostrum account. What is the difference?
SWIFT is not a payments system, it’s essentially just a very elaborate and secure e-mail system. If bank A wants to make a payment to bank B, it can (and typically will) communicate with B through the SWIFT network. Each bank has one or more codes in this network, the bank identifier code (BIC), which essentially acts as its e-mail address (if you want to look up a particular bank’s BIC, here’s an online directory). Through SWIFT, banks can exchange highly secured electronic messages containing information about a particular payment (such as amount, currency, branch, purpose, etc) in a standardised format which the IT systems of both banks can process. But SWIFT does not actually clear and settle the transaction itself. This occurs through an actual payment system, which may be a vostro/nostro account, a payment system operated by a central bank such as the Fed’s Fedwire in the U.S., or a payment system linking different banks and operated by a private company, such as CHIPS in the U.S. SWIFT merely acts as a communication network carrying the electronic messages.
For all practical purposes, btw, there is no difference between nostro and vostro accounts. “Nostro” means “ours”, “vostro” means “yours”, so if bank A makes a payment to bank B of $100 and the thing is handled through nostro and vostro accounts, the amount of $100 would be on a vostro for A (bank A keeping an account for bank B with a credit of $100 in it) and a nostro for bank B (bank B keeping in its ledgers an entry which says that it has a credit of $100 with bank A). But since many transactions occur this day and this account may switch from credit to debit and back all the time, it does not really make much of a difference to distinguish between nostro and vostro.
Very helpful Schnitte. Thank you.