Central Bank and Multilateral Agency Publication | September 01, 1998

Managing Cross-Border Settlement Risk: The Case of Mexican ADRs

By: Bob Chakravorti

Technological advances and a global securities market enable individuals to buy shares of foreign companies with a click of the computer mouse. Such investors rarely ponder the underlying intricacies involved because these cross-border transactions usually occur without problems. This article analyzes the international transfer of funds and securities and one financial market’s commitment to improving the process.

Deregulation of financial markets around the world, together with new technology, has led to rapid increases in the value and volume of cross-border transactions and capital flows, especially to emerging markets. Daily foreign exchange turnover rose from $717 billion in 1989 to $1,572 billion in 1995. From 1990 to 1996, annual private capital flows to emerging markets increased dramatically, rising from $45.7 billion to $235.2 billion (Folkerts-Landau, Mathieson, and Schinasi 1997).

With the increase in cross-border transactions, risks in financial markets have also increased. In the global marketplace, the failure of a participant in one part of the world may have dire consequences for participants elsewhere. Such a crisis occurred in the foreign exchange market when the authorities closed Bankhaus Herstatt in 1974. At the time it was closed, the German bank was involved in foreign exchange transactions that had not been completely settled. The bank had received Deutsche mark payments from foreign exchange transactions but was closed before it could deliver U.S. dollars to its counterparties. The Herstatt case highlighted the potential for problems caused by different parts of foreign exchange transactions settling at different times in different countries. This type of risk has become known as Herstatt risk, or foreign exchange settlement risk.

Differences in settlement times are also common in the settlement of cross-border securities transactions. Various components of a transaction may settle in different countries on different days. This article focuses on the difference in the Mexican and U.S. settlement periods. In Mexico, securities transactions are settled two business days after a trade, whereas in the United States these transactions are settled three business days after a trade. This difference in settlement periods can increase the risk of settlement fails in Mexico.

This article analyzes steps taken by Bolsa Mexicana de Valores (BMV)—the Mexican stock exchange—and S.D. Indeval to reduce settlement fails resulting from cross-border securities transactions. Indeval is responsible for clearing and settling securities transactions. It does so by operating Sistema Interactivo para el Depósito de Valores (SIDV), the Mexican securities transfer system, and is the central securities depository. The BMV and Indeval impose penalties on participants that do not settle on time, and they have created an electronic securities lending facility. To further improve the efficiency and liquidity of the settlement process, Indeval has proposed that a clearinghouse be established. These initiatives help ensure the timely settlement of securities in Mexico and reduce both general and cross-border settlement risk.

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