EODHD Academy
‹ How FX Is Traded Lesson 3 of 16
Contents Lesson 3 of 16

4 min read · professional

What happens if one side pays and the other does not?

Because both legs of an FX trade are cash, and because they settle in two different countries whose banking days may not overlap, there is a window in which one party has paid and the other has not. If the second party fails inside that window, the loss is not a price move. It is the entire principal.

This risk has a name taken from the day it became famous.

Herstatt, 26 June 1974

Bankhaus Herstatt was a mid-sized German bank with a large FX book. On 26 June 1974, German regulators withdrew its licence at the end of the German banking day — around 15:30 Central European Time.

Counterparties had already paid Deutsche Marks to Herstatt in Frankfurt that morning, expecting dollars in New York later the same day, because the New York day starts hours after Frankfurt's ends. The dollars were never paid. The Marks were gone.

The episode gave the industry a permanent piece of vocabulary: Herstatt risk, or more formally FX settlement risk — the risk of paying away one currency and not receiving the other.

Why the number is so large

Compare it with a swap, where only the net difference between two payment streams moves. In FX, the gross amount moves. On the single standard lot from Lesson 1:

  • Mark-to-market exposure of a 1% adverse move: USD 1,080
  • Settlement exposure if the counterparty fails mid-settlement: USD 108,000

A factor of a hundred, on the same trade. Scale that to a market whose daily turnover the BIS Triennial Survey put at roughly USD 7.5 trillion a day in April 2022 and about USD 9.6 trillion a day in April 2025, and the systemic size of the problem is obvious.

The fix — payment versus payment

The industry's answer, built after two decades of official pressure, is CLS: a specialised settlement system launched in 2002 that settles both legs of an FX trade simultaneously or not at all. The principle is called payment versus payment (PvP). If one side's currency does not arrive, the other side's is not released.

CLS covers a fixed list of major currencies (18 at the time of writing) and settles the equivalent of several trillion dollars of instructions on a typical day.

It is not universal, and this is the honest caveat: BIS analysis has estimated that FX payments worth many trillions of dollars a day still settle without PvP protection, because one currency in the pair sits outside the system, or because the counterparties settle bilaterally. Reducing that share is an active piece of official-sector work rather than a solved problem.

What this means for a reader

Three durable takeaways:

  1. FX is a credit market as much as a price market. Who you can trade with, and in what size, is governed by credit lines and settlement arrangements. That is why prime brokerage exists and why the wholesale market is bank-dominated.
  2. Restricted currencies inherit the problem. If a currency cannot be delivered offshore, PvP is irrelevant — the market solves it a different way, with the non-deliverable forward in Unit 2.
  3. A retail account never touches any of this. Your position with a broker never reaches a value date and no currency is ever delivered to you. You have swapped settlement risk for a different exposure entirely: a contractual claim on one firm. Unit 3 is about exactly what that claim is.

Try it now

  1. Read the latest rate off the chart below and compute the full principal on both legs of a 10-lot trade — euros out one door, dollars in the other. That gross figure, not the price move, is what settlement risk measures.
Interactive line chart: EURUSD.FOREX (1M)
  1. Now Measure the largest single-day move in the month. Express it as a fraction of the principal you just computed. The gap between those two numbers is the gap between market risk and settlement risk, and it is a factor of hundreds.
  2. List the two settlement centres your pair depends on and find one date in the next quarter when one is open and the other closed. Both calendars are public: the Federal Reserve publishes the holidays the Federal Reserve System observes, and the ECB publishes the TARGET closing days for the euro. Then write one sentence distinguishing the two risks on the same trade. If the settlement sentence has the bigger number in it, you have understood the lesson.