Forex settlement methods
Forex operates at a different level than other market and business entities. Starting from the basic fundamentals to the final settlement aspect, it varies. Once a transaction is completed it demands that it be settled at the earliest. Forex settlement is unique in the sense as it is a settlement between the economies of two different countries through a common individual. Since the economy of the United States is the strongest and most widely sought after, most of the forex transactions are done in the form of dollars, making it the most used currency in foreign exchange markets.
There are many accepted methods of forex settlement. These include:
- Electronic fund transfer
- Automated clearing houses
Cash and checks are the most common mode of funds settlement. But, the bulk of the settlement is done through electronic fund transfer, which transfers trillions of dollars in the form of foreign exchange on any given day.
Electronic fund transfer
There are two ways through which electronic funds transfer is done in the US.
- CHIPS. It's an abbreviation for Clearing House Inter-Bank Payment System. It is a private system operated by the New York clearing house.
- Fedwire. It is the system operated by the Federal Reserve Bank.
There are two major differences that can be seen in the operation of both systems. Firstly, CHIPS depends on Fedwire for its transaction. So even though it's a private entity, the private settlement is done through the federal bank.
Secondly, fedwire transfers the money in real time. This means that as soon as the settlement has been arrived upon, the money is transferred to your account. CHIPS do not immediately clear the settlements. It is done only at the end of the day when all the transactions have been completed.
However, United State's CHIPS and Fedwire are the most frequently used methods of transferring payments, but many other countries also have similar methods of their own for the movement of currency from one account to another. For e.g., CHAPS, which stands for Clearing House Association Payments System is responsible for settlement in the Forex market in U. K. where transactions are done via Bank of England, whereas in E. U. an operating organization known as Target which entails various banks of the member states does all the settlement in the market.
This is a term which you must be aware of when dealing in forex. Since the transaction involves the banks of two different countries and economies, there is always a settlement risk during the various transactions. For example, it's highly possible that the currency amount that you traded has been debited from your account, but the amount that has to be credited from the other bank has not yet reached you! This is how settlement risk is defined.
This has been reduced to a much extent now with the use of the latest technologies and high speed internet connections. Also with the use of real time transfer systems by banks the risk has been reduced to a bare minimum.