Settlement currency

Table of Contents

Settlement currency
What is settlement currency?
Understanding settlement currency
Working of settlement currency
Risk of settlement currency
Example of settlement currency
Frequently Asked Questions

Settlement currency

Settlement currency plays a very important role in global trade and finance as it enables seamless transactions and reduces currency risks in the market. Settlement currency is essential in international trade and finance, allowing smooth transactions and avoiding currency risks. It assures that transaction parties agree on a common currency for payment, resulting in increased efficiency and cutting out uncertainties.

What is settlement currency?

The currency in which funds are transferred to the vendor’s bank account, as well as the currency in which the vendor demands payment, is known as the settlement currency. Your payment processor’s features and the accessibility of accounts will determine whether you can have one settlement currency or more.

Understanding settlement currency

Understanding settlement currency matters for both businesses and investors because it significantly affects the stability, cost, and timeliness of foreign trade in today’s interlinked global economy.

Liquidity, stability, and acceptance in global markets are usually taken into consideration when selecting settlement currency. It streamlines the procedure for all parties involved by ensuring consistency and transparency in international transactions.

It is crucial to have a processor that provides the necessary currencies for clients in countries where you currently operate and will be selling to when it involves settlement currencies. In order to limit foreign exchange charges, you should also search for a system that incorporates a large number of comparable currencies. Reducing fees eventually translates into more profitability.

Working of settlement currency

Settlement currency serves as the preferred method for exchanging financial assets after a trade. When undertaking global trade or investments, the parties agree on a specific currency for settlement, which is often stable and widely accepted.

Consider a US company, XYZ, selling to a Singaporean client. Consider a US-based corporation selling to a Singaporean customer. They agree that the settlement currency will be US dollars (US$). Once the transaction is completed in US$, the Singaporean buyer transfers Singapore dollars (SGX) into US$ in order to settle the payment. Using a similar settlement currency saves both parties from the challenges that come with fluctuating exchange rates and different currency denominations.

Let’s say an investor seeks to buy 1,000 EUR in US$. The conversion rate between these two currencies is 1 EUR = 1.08 US$. Euros will serve as the transaction or trade currency, with the US dollar serving as the settlement currency.

Therefore, the settlement currency (yen) is calculated as 1,000 EUR x 1.08 US$ = 1080 US$.

Risk of settlement currency

Despite the fact that it streamlines international trade, settlement money involves certain risks, which are as follows:

Fluctuating exchange rate

Due to fluctuating exchange rates between the settlement currency and other currencies that might impact the trade’s value, foreign exchange risk is a significant source of concern. For example, there may be financial consequences if the settlement currency depreciates in relation to the trade partners’ currencies.

Counterparty risks

Relying on sole settlement currency may increase losses if one party experiences financial difficulties or fails on the transaction, particularly if the currency depreciates considerably.

Liquidity risks

One way to add liquidity risk and maybe cause delays or issues in the transaction process is to use a less stable or liquid currency as the settlement currency.

Currency risk

Parties who rely only on a single settlement currency are subject to all of the risks that come with it, such as inflation, unstable economies, and changes in the central bank’s or government’s policies.

Example of settlement currency

For example, a Singaporean company is importing products from the US. The US dollar is the mutually agreed-upon settlement currency for their trading transactions. The Singaporean company pays the US exporter in US dollars after completing a purchase order.

Due to the US dollar’s widespread acceptance and stability, both parties can reduce their exposure to foreign exchange risk and expedite the transaction process by utilising it as the settlement currency. Additionally, this choice assists in eliminating possible currency fluctuations that can affect the transaction’s value.

Frequently Asked Questions

What are the advantages and disadvantages of settlement currency?

Settlement currency has several benefits, including reduced currency risk for all parties, streamlining financial planning, optimising transactions by standardising currency for settlement, and boosting efficiency in international trading.

If the settlement currency is different from the trade currency, it may be vulnerable to exchange rate volatility. In addition, there are sovereign risks, such as reliance on the stability and regulations of the country issuing the settlement currency, as well as currency conversion expenses.

What is the time of currency settlement?

The actual currency exchange takes place two business days after the transactions in the United States, where the typical time of currency settlement is T+2. Similar rules apply in Singapore regarding the timing of currency settlement; the actual exchange of currencies occurs within two business days after the trade date, and the standard settlement period is T+2. All necessary logistical and administrative procedures related to currency transactions can be completed within this settlement period.

What is the difference between settlement currency and payment currency?

The currency that is used for transferring funds to satisfy the financial obligations resulting from a trade is known as the payment currency, whereas the settlement currency is the currency in which you can receive payments based on the charge type and appropriate currency conversion.

Payment currency relates to the transfer of funds needed to wrap up the transaction, whereas settlement currency deals with the actual exchange of securities.

What is presentment currency?

Presentment currency represents the currency used to issue and present a negotiable instrument for payment, such as promissory notes or cheque. The currency that the payee is expected to get payment in is the one indicated on the instrument.

In order to guarantee that the payee receives the precise currency as specified by the negotiable instrument, the presentment currency is essential for figuring out the quantity and currency in which the payment must be delivered.

What is the difference between settlement currency and trade currency?

The currency used when financial assets are delivered as part of a trade is referred to as the settlement currency. Conversely, the currency used to initiate a trade is known as the trade currency. While settlement currency refers to the genuine exchange of securities, trade currency is the currency whereby the transaction value is initially negotiated.