**3. Risk management in settlement of stock transactions**

#### **3.1. Clearing and settlement of stock market transactions**

The risks managed by Institutions such as market operators, clearing houses and central depositories are not less important, but are maybe less visible to the public.

It is known that stock market transactions are followed by a mutual transfer of ownership from seller to buyer, and the amount of money equivalent, from buyer to seller. Clearing

and settlement take into account that transfers of financial instruments and financial funds between parties are to be performed safely and with little cost.

Risk Management on the Romanian Capital Market 343

delivery versus payment (Delivery Versus Payment - DVP). By using mechanisms that ensure DVP, one eliminates the most important component of all financial risks that accompany the

As presented before, between the moment a transaction with financial instruments is closed and the ownership transfer certain stages are to be completed in a given time frame. The

**CREDIT RISK**, implies the possibility that one side of a transaction might not honor its

 **Principal risk**: is a consequence of time the difference between payment and delivery of securities as part of an exchange transaction. In case bankruptcy occurs between the two moments or insolvency of one parties involved in the settlement of that transaction, it is possible for one party to incur a loss equal to the transaction left unsettled. If such a risk occurs, the buyer might find itself in the position of having the financial securities acquired through market transactions paid, while the counterparty is no longer able to deliver those securities. The risk of the principal, from the perspective of the seller is described by the situation in which financial instruments have been delivered, but the

 **Replacement Cost Risk:** refers to a situation where before a final settlement between the parties involved in securities transaction may not be able to complete the initial negotiated market transaction settlement, thus requiring a replacement of that transaction. Thus, parties' involved in a transaction are equally exposed to loss due to the price change of the security that was object of the original transaction, the time interval between the time the original transaction (but not settled) and the transaction time for the replacing one. The buyer involved in a transaction takes over the risk associated with the replacement cost if the initial price of the transaction performed with a particular security is below the market price of that financial instrument once the transaction shall take place. Looking at the situation from the seller's point of view, the same type of risk occurs when the transaction replacement loss is concluded at a price lower than that of the original transaction. The size of the losses due to the risk associated with the replacement of a stock transaction is directly proportional to the volatility of the securities that were part of the original transaction and with the time between the date of completion of the transaction and the time of the final settlement. The shorter this time frame is, the lower the probability for the risk to materialize. **LIQUIDITY RISK** refers to the situation where the seller of certain financial securities does not receive on the settlement date the amount from the buyer and thus he finds himself in a position to borrow or sell other financial assets to honor at its turn various other obligations assumed in view of collecting amounts from the original sale of securities. Liquidity risk arises in the case of the buyer as well if upon settlement it does not receive the securities purchased that were possibly involved in a transaction following the initial sale. The size of

settlement of transactions with financial instruments**: principal risk.**

obligations, or after maturity, in whole or in part. Types of credit risk:

buyer no longer has the opportunity to order the payment to the seller.

**3.2. Risks in clearing and settlement systems** 

following risks are present and occur:

To prevent and to reduce the risks specific to the settlement of financial instruments transactions, direct access to clearing and settlement system is limited to those participants who meet a set of capitalization criteria, operational capacity and professional experience, which means that the settlement of an exchange transaction involves a given number of financial intermediaries. The more financial intermediaries are involved in the settlement of financial instruments transactions, the more complex is the settlement process.

### *3.1.1. Clearing and settlement stages*

Clearing and settlement process begins immediately after a transaction with financial instruments is closed and goes through the following main steps:

	- **obligation to deliver securities:** falls to the seller that is part of a transaction or to the participant in the settlement that is in the position of a net debtor for a particular security;
	- **obligation to pay an equivalent amount:** falls to the buyer that is part of transaction or to the participant in the settlement with a debtor net quality in respect to financial funds.

The last stages of the settlement imply the highest financial risk throughout the process of finalizing exchange transactions, one of the main criteria that measures the performance of a clearing system and securities settlement transactions refers to the method the connection between the mechanism of transfer of securities (obligation to deliver) and transfer mechanism of funds (payment required) is made. The systems within which the permanent transfer of securities are to take place, subject to an exchange transaction, only if the final and irrevocable payment of amounts is made, fulfilling one of the main conditions to measure performance: delivery versus payment (Delivery Versus Payment - DVP). By using mechanisms that ensure DVP, one eliminates the most important component of all financial risks that accompany the settlement of transactions with financial instruments**: principal risk.**
