Settlement risk reduced in this situation is replacement cost risk. As mentioned earlier, replacement cost risk is the cost required to replace the other transaction party’s settlement default when the settlement object is sold at a price lower than the original trading price or when it is bought at a higher price than the original trading price. Accordingly, reducing risk through shortening settlement period decreases the amount of replacement cost by reducing fluctuations of the original contract price caused by the other transaction party’s settlement default and reducing the time elapsed between the transaction day and the settlement default day.

First, by achieving a paperless securities system, securities can be issued using the electronic account book records without the issuance of real securities. This has the effect of improving the safety and efficiency of the securities settlement system by promoting the shortening of the settlement period, the DVP of securities and charges, and the straight through processing (STP) of settlements, etc. The second, is the promotion of STP. STP entails referring to the system to administer all processes from transaction conclusion to clearing and settlement without manual intervention. It reduces errors and attempts to raise efficiency and reduce costs.

Apart from replacement cost risk, the original contract risk exists in the settlement risk that occurs related to the settlement period on X axis. The best measure to evade this original risk is to establish a system that unifies the time difference between the securities delivery and payment of charges or stops one party’s payment when delivery has not been received from the other party. This type of system is called delivery versus payment (DVP) and is a decisive factor in contributing to the resolving of original risk by completely removing the time for the original contract’s exposure to risk.

The Bank for International Settlements classifies DVP into the following three models depending on whether the settlement of securities and charges are to be carried out by gross (per one transaction case) or net (balanced amount). The DVP Model I settlement method settles the securities and charges simultaneously using gross base. DVP Model II processes the delivery and transfer of securities on demand during the day using gross base and calculates the amounts corresponding to settlement charges using net base and then settles them both at the duties conclusion time. Third, DVP Model III administers settlement by paying the calculated balance for securities and charges as well.

The concept of finality must exist for the safe administration of settlements. Although settlement risk occurs with transaction conclusion, finality must exist for the securities and charges paid in order to completely resolve that risk. Finality means that after account exchanges or transfers in the securities exchange system and payment settlement system are administrated, obligation for payment or delivery ceases to exist through the “absolutely no cancellations” form. Simplified, it’s the same as if cash or bearer securities spots are delivered and means that the exchanged/transferred balance may be used immediately.

The argument in question with regard to the settlement size on axis Y is whether to operate the settlement system using the gross base settlement method or the net settlement method. The classification of the gross base settlement and net settlement methods depends on whether the total transaction amount or total transaction quantities is settled per transaction case for settlements based on transactions or if settlement occurs only for the balanced amount or quantity after netting the buying and selling transactions.

Depending on the number of transacting parties participating in netting, netting can be divided into bilateral and multilateral netting. Bilateral netting was founded from the concept of setting-off in civil law and involves netting credit and debt that are to be given and received between both transaction parties. By transferring only netting positions that have calculated those results, all credit and debt relationships are ended. With multilateral netting, a single position is calculated and transferred for securities and for charges respectively of the total selling and buying transactions among multiple parties of 3 or more. In this way, all credit and debt relationships pursuant to securities transactions are ended.

In multilateral netting, credit and debt among transaction participants are all unified without separate legal composition. Accordingly, one method involves the calculation of one single credit and debt. The other method entails placing the central counterparty (CCP) of all transaction participants in the center.

After the materialization of a transaction, the CCP intercede on behalf of both buyers and sellers. On the sellers’ side, the CCP undertakes their debt of securities delivery and credit of receipt of charges. On the buyers’ side, the CCP undertakes their debt of charges payment and credit of securities receipt. Therefore, the CCP becomes the only buyer for all sellers and the only seller for all buyers. When operating multilateral netting coupled with the CCP, to the respective participants, credit and debt between each of them and other participants become unified into credit and debt between each of them and the CCP; therefore, credit and debt relationships between each of them and the original transaction party are dissolved. As a result, multilateral netting coupled with the CCP converts to a bilateral netting structure. Accordingly, credit and debt relationships between each participant are established as a bilateral credit and debt relationships between each of them and the CCP (the other party).

Current international trends involve netting to reduce settlement size on axis Y and decrease the gross base of settlement risk. However, as mentioned before, netting does not always reduce settlement risk. Netting where credit and debt themselves are not reduced such as payment netting may cause yet greater liquidity, replacement cost, and even system risk. Therefore, the most efficient method to reduce settlement size is multilateral netting, which is legally effective, and for obligation netting, which can support this, the introduction of the CCP system is an absolutely essential factor. Thus, the major emphasis for the direction of the improvement of the clearing settlement system on the securities & futures market for the reduction of settlement risk should be placed on the introduction of a unified CCP system regarding spot and futures markets and the exchange and outside the exchange markets through the introduction of the CCP system and the expansion of its services. Consequently, the reduction of settlement size and risk can be planned simultaneously.