Rolling Settlement vs. Bilateral Netting: A Comparative Analysis

Rolling settlement and bilateral netting are two distinct methods used to reduce the settlement risk in financial transactions. Rolling settlement involves settling trades on a rolling basis. On the other hand, bilateral netting involves offsetting trades between two counterparties. Let’s explore the difference between these two methods in this post. However, let’s first discuss each method in detail.

What is Rolling Settlement

A trade is settled when the seller receives the money and the buyer receives their shares. Clicking the “Buy” button on your screen does not immediately transfer shares to your Demat account. In the rolling settlement method all the transactions made on a given day are settled on the following days. Trades are not settled on a specified date.  

For the purpose of settling trades, the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) employ the rolling settlement method. In India, the settlement cycle for securities is T+1 days. “T” is the trade execution date. The “+1” indicates that the settlement takes one extra trading day from the date of execution. If you make a trade on Monday, it will settle on Wednesday. Since Saturday and Sunday are not trading days, trades done on a Thursday or a Friday will be resolved the following week.  

What is Bilateral Netting

Bilateral netting refers to the consolidation of swap agreements into a single agreement. The resulting agreement is called a master agreement. It reduces the risk for two parties. The number of transactions reduces in bilateral netting. The volume of accounting work as well as other expenses and charges also reduce. Bilateral netting provides extra protection for both parties in the case of bankruptcy. By netting, all the swaps are completed in the case of bankruptcy. If there was no bilateral netting, the bankrupt firm may collect on all in-the-money swaps. It can claim that bankruptcy prevented it from paying the out-of-the-money swaps. 

Netting allows the bankrupt firm to get payments for in-the-money swaps only when all out-of-the-money swaps are settled. In essence, it implies that the bankrupt firm can receive any payments if the value of in-the-money swaps exceeds the value of out-of-the-money swaps.

Differences between Rolling Settlement and Bilateral Netting

The following are the key differences between Rolling Settlement and Bilateral Netting

based on different parameters.

1. Type of trades:

Rolling settlement is generally used for securities traded on exchanges. However, bilateral netting is typically used for over-the-counter (OTC) trades. This is because securities traded on exchanges are standardised and highly liquid. In contrast, the OTC trades are often customised financial products which are less liquid. So, rolling settlement is a more efficient way to settle transactions in stock exchanges. Bilateral netting is a more efficient way to settle OTC trades.

2. Settlement date:

In rolling settlement, trades are settled on a different date following the execution of transactions. However, in bilateral netting, trades are settled on a net basis. It means that only the net amount is exchanged. This is done by offsetting the trades of the two counterparties involved in a transaction.

3. Cash flow:

Rolling settlement can slightly reduce the amount of cash required to be exchanged on the settlement day. This is because trades are settled on a rolling basis, which spreads out the cash flows over time. However, rolling settlement does not eliminate the risk of default by a counterparty.

Bilateral netting can significantly reduce the amount of cash required to be exchanged. This is because trades are netted against each other. It means that the parties only exchange the net amount. This can also reduce the risk of default by a counterparty, as the net amount is usually much smaller than the gross amount of trades.

4. Settlement risk:

Rolling settlement can lower the settlement risk by spreading out the cash flows over a period of time. This makes it less likely that a counterparty will simultaneously default on a large number of trades. However, rolling settlement does not totally eliminate the risk of default by counterparties.

On the other hand, bilateral netting can highly reduce the settlement risk by netting trades against each other. This reduces the exposure that a certain party has to the other party. It also decreases the chances of simultaneous defaults on a large number of trades. In addition, bilateral netting agreements often include provisions that require counterparties to provide collateral, which can further reduce the settlement risk.

Feature	Rolling settlement	Bilateral netting
Type of trades	Securities	OTC
Settlement date	Rolling	Net
Cash flow	Reduced	Significantly reduced
Settlement risk	Reduced	Significantly reduced

Conclusion

Rolling settlement and bilateral netting are methods for settling trades. Rolling settlements are used in stock exchanges. Transactions are settled on the following dates. Bilateral netting is used to settle over-the-counter trades. Swap agreements are bundled into a single agreement. Although they work differently, both these mechanisms aim to reduce settlement risks. Understanding them is essential for navigating complex settlement systems. Your brokerage firm may provide you with the necessary guidance. Reputed institutions usually help their clients to learn how the transactions are carried out. Investors need assistance, especially with complex rules for intraday trading. Firms like BlinkX provide complete support to their customers. They offer personalised services to assist you in trading conveniently.