Settlement currency

The settlement currency is the money in which a trade is actually completed. The buyer's funds are debited from a cash account in this currency, and the seller's proceeds are credited to an account in it. It is stated in the specifications of the instrument or the contract. That is why it determines whether an investor can buy a security at all: there may be enough money in the account in total, but it may be held in a different currency.

How the obligation is settled

The security is exchanged for cash on the settlement date. By then the buyer must have the required amount available in the settlement currency specifically. If it is not there, the broker will either reject the order or convert the funds under the rules of its terms of service and for its own fee.

The currency of denomination and the settlement currency may differ. In that case the terms of the issue set out a conversion rule: the exchange rate and the date at which the amount is converted. The choice of date determines who bears the currency risk in the interval between the trade being agreed and being settled.

In derivatives contracts that provide for cash settlement, the settlement currency determines the currency in which margin is accrued or the difference on a non-deliverable forward is paid. The underlying asset may be oil or the dollar, while the money changes hands in roubles.

An example with a currency pair

On the exchange's currency market, the settlement currency is visible directly in the instrument's name. A currency pair is written as two codes. The first is the base currency, the one being bought or sold. The second is the currency used to pay for it. When buying dollars against roubles, an investor receives dollars and pays in roubles. The exchange displays the day's most actively traded pairs like this:

In every row of this table, money changes hands in the second currency of the pair, while the first is delivered.

Where the concept gets confused

The settlement currency is often mistaken for the currency of risk. A share may trade and settle in roubles while the company's revenue depends on exports. Settlement in roubles does not protect against exchange-rate swings. It merely fixes the money in which the trade goes through.

The reverse confusion also happens. A security denominated in a foreign currency but settled in roubles does not put foreign currency into the holder's account. Coupons and the redemption amount arrive in roubles at the conversion rate. This is typically how a replacement bond works.

Nor is the settlement currency the final word for tax purposes. Income for personal income tax is calculated in roubles, and the exchange-rate difference between purchase and sale itself becomes part of the tax base. This is covered in the entry on currency revaluation for tax purposes.