Introduction

Settlement is the expression of a deal in financial terms be it a transfer of assets or securities or a payment from one party to another. With increasingly diverse and complex global trade and investment activities mechanisms have developed in reaction. Thus split settlement is a mechanism wherein the financial parts of a transaction are split into more than one component sometimes settled by different channels or currencies or dates.

This now extended concept makes it possible to handle complex transactions especially international or multiparty deals. Split settlements have gained worldwide popularity in finance especially in cross border transactions securities trading and complicated contractual agreements. This article provides an informed reading on the concept of split settlement in finance including how it works its types of benefits risks and implications to different stakeholders in the financial ecosystem.

What is Financial Settlement?

A financial settlement is the process by which the transaction is carried out. So while the buyer takes possession of the asset or security purchased the seller gets remitted payment. An important characteristic of most financial markets is that procedures related to settlement are standardised following rules laid down by specific clearinghouses exchanges or regulators to see that the market runs smoothly. A settlement can happen at any time.

Settlement Risk

Settlement risk also known as delivery risk happens when one of the counterparties fails to deliver his end of the transaction. There needs to be a catalyst in terms of managing this kind of risk in financial markets and more so in cases where transactions accommodate a variety of jurisdictions currencies and intermediaries. Established settlement systems have immensely played an important role in reducing the risks and impacts of asset and fund transfer delays for financial institutions brokers and traders.

However not all settlements are easy to work with. It is sometimes even necessary to split a settlement into parts. This may be for currency considerations jurisdiction reasons or because the parties have differing timing demands on the settlements among other reasons.

What is Split Settlement?

Split settlement refers to the practice of splitting a single transaction into different settlements and such settlements are made either in different currencies across jurisdictions or over different time frames. Split settlements are very common in cross border transactions and high value financial contracts for which parties need to settle portions of the transaction differently.

For example an international firm may entertain a merger where payoffs are received in both U.S. dollars and euros. In that case the transaction would settle in two currencies being paid at different timelines through two different financial institutions.

The primary rationale of split settlements is to balance the financial requirements and arrangements of the parties involved. Given that businesses and other financial institutions are expanding in every direction around the world split settlements offer a solution to some of the problems created by multi currency and complex financial deals.

Mechanics of Split Settlement

Split settlements are as formal as traditional settlements but settled partly often in other peoples financial systems. The general mechanisms involved in a split settlement include

Split Terms Agreement

The parties ought to agree on the splitting terms as a way of advancing payment division currency settlement and the agreed on channels and timelines. All these need to be placed into a lawfully binding contract.

Multiple Currencies

The most traditional argument in favour of splitting the settlement is if there are likely to be several different currencies involved that must be accommodated. Consider a U.S. based corporation that buys a company in Europe. Then the settlement could be in USD and partially in euros. The banks would convert between the currencies and make sure that the appropriate payments were made.

Multi Jurisdictional Compliance

Here it is the area where split settlements are most likely to incur a much greater amount of work. As a general rule split settlements are bound by different legal and regulatory requirements prevailing in different jurisdictions. In such a transaction parties may have to adhere to local laws concerning taxation reporting and anti money laundering regulations depending on the location of the transaction.

Multiple Settlement Agents

In a complex transaction the various parts of the settlement may be settled through different banks clearing houses or even through multiple settlement agents. For example one bank would settle the settlement of the USD component while another bank would settle the EUR component.

Technology and Systems

Typically fintech platforms are usually engaged to execute split settlements. Platforms for such purposes can automatically track multiple payments provide currency conversion capabilities and religiously observe all settlement deadlines.

Categories of Split Settlements

Split settlements can be categorised into various categories based on the character of the transaction or the type of asset being transferred. The most common types of split settlements are

Split Settlements in Securities

Split settlements can take place in securities markets where there are dual classes of assets such as stocks and bonds or even when a transaction cuts across several borders and currencies. For instance a multinational company may have issued bonds in various currencies and therefore settle them separately.

Split Settlements in Commodities

In commodity trading split settlement occurs when the physical commodity is traded across borders and therefore payment has to be made in multiple currencies or using different bank systems. For example if an oil shipment has been sold to a buyer in another country the price quoted might be in U.S. dollars but a part of the settlement may be in a currency that is local to the buyer.

Real Estate Split Settlements

Split settlements are also very common in all areas of commercial or international real estate transactions. In such a transaction there could be a buyer who pays the down payment in one currency and finances the rest of the purchase by way of a loan offered in another currency. The final settlement would often be done in parts with payments to various parties like sellers lenders and maybe government agencies all being made from different jurisdictions.

Split Settlements in Cross Border Transactions

One of the major applications of split settlements is in cross border transactions. These are either the sale or purchase of goods or services between two countries with two different currencies and the price will have to be paid in both currencies. A split settlement can make all these complexities less of a pain while dealing with currency conversion payment timelines and regulatory compliance across borders.

Split Settlements Benefits

The advantages of split settlements in dealing with complex financial transactions especially in globalised markets include the following

Accommodating Terms of Payment Settlement

Split settlements provide flexibility in the settlement of financial needs between the selling and purchasing parties. For example a buyer may need to pay in the local currency while a seller would prefer to receive payment in a stronger foreign currency. The split settlement accommodates the preferences of such parties on favourable terms of payment.

Currency Risk Management

Multilateral netting allows transactions to be settled in multiple currencies allowing parties to manage currency risk. Suppose that a multinational company is concerned about volatile exchange rate fluctuations. It might settle a certain portion of the payment in a stable currency such as the U.S. dollar and the rest of it in the much more volatile local currency. This would provide some protection from adverse currency movements across the entire transaction.

Compliance with Local Laws

In most international trades local laws are likely to require one to make payments in the currency of the jurisdiction where the transaction is being made. Therefore split settlements will help a firm comply with local laws and yet achieve its financial goals.

Efficient Management of Cash Flows

Large multi party transactions have cash flow management through split settlements. This is because parties split the payment into various tranches so that payments line up with the paying parties cash flows thus minimising liquidity risk.

Risks of Split Settlement

Split settlements are beneficial but with risks that should be correctly managed such as

Exchange Rate Risk

If two or more currencies are part of a contract then the currency is exposed to exchange rate risk. Between contracting and settlement one currency may fluctuate in value relative to another. In this circumstance one party might pay more or receive fewer currency units than anticipated. To protect against this kind of risk from arising parties often turn to hedging instruments one of the most common forms of which is the forward contract or option.

Settlement Delays

This may introduce excessive time lags in the settlement of the transaction with multiple channels and timelines. It may be very difficult in volatile markets as short delays may shift the values of assets or currencies dramatically.

Increase in Transaction Costs

Managing larger settlements generally entails increased transaction costs including payment banking fees conversion costs and compliance expenses. These costs will therefore reduce the margins of the transaction if the parties are not careful to optimise their settlement processes.

Legal and Regulatory Risks

Split settlements particularly in cross border transactions expose parties to multiple jurisdictions legal and regulatory risks. Failure to comply with local laws tax regulations or reporting requirements can result in fines court cases and another blow to the reputation of the parties involved.

Real World Applications of Split Settlements

Cross Border Mergers and Acquisitions (M&A)

Cross Border M&A transactions usually involve settlement in several currencies and jurisdictions. For example for the acquisition of a European firm by a U.S. company part of the payment is settled in U.S. dollars to pay the liabilities in the United States. Another part is settled in euros to pay the European shareholders. Split settlements ensure that all parties have received the appropriate levels of compensation in their preferred currency.

International Trade Transactions

In international trade split settlements usually occur when the buyer and seller are from different countries employing different currencies. The exchange could be an American firm purchasing products from a supplier in China where half of the payment is made in U.S. dollars and the rest in Chinese yuan. The split settlement allows risk to be controlled when exchanging currencies while also complying with local regulations.

Role of Technology in Facilitating Split Settlements

Increased globalisation and interconnectedness of financial markets mean that therefore technology’s role in facilitating split settlements has become extremely important. Most specifically the use of fintech platforms and blockchain technology has been profound in streamlining the whole process.

Blockchain and Distributed Ledger Technology (DLT)

Blockchain technology would help to make split settlements more secure and decentralised. Smart contracts could be made to structure and execute automatically several events of settlement when predetermined conditions are met. Such an approach would reduce the need for intermediaries and speed up transaction settlement.

Fintech Platforms for Multi Currency Transaction

It has become easier for businesses to handle multiple split settlements in different currencies using international payments fintech platforms. Platforms have improved through such systems by allowing the actual purchase system to attract real time exchange rates automated currency conversion and compliance checks with the aim of reducing errors and delays possibility.

Automation and AI

Artificial intelligence and automation allow for the development of smarter algorithms to optimise split settlements by keeping tabs on market conditions recommending the best time to settle and automatically adjusting the payments so that proper reduction of risk and increase in efficiency are realised.

Regulatory Framework and Compliance

There are many regulations associated with settlements through splits especially for crossborder and multi currency transactions. It is important to comply with these in order to avoid legal implications and financial costs.

AntiMoney Laundering (AML) and KYC

Financial institutions engaged in partial settlements must abide by AML and KYC across all jurisdictions involved. In many cases this means they have to establish the identities of the parties involved track the flow of funds and report suspicious activities accordingly.

Tax Reporting

Split settlements can commonly create tax issues in more than one jurisdiction when applied in cross border transactions. The parties should ensure all relevant tax reporting requirements are met and that double taxation does not nibble away at the profitability of the transaction.

Central Bank Regulations

In other nations central banks prohibit the usage of foreign currencies for domestic settlements. Emerging market countries may need to have their use of more than one currency for split settlement approved by a central bank.

Guidelines on Split Settlement Management

Hedging Instruments

In the split settlement the parties involved would often use hedging instruments such as forward contracts options or swaps to manage the foreign exchange risk. These instruments can lock in the exchange rates and protect against adverse currency movements.

Careful Contract Drafting

In a split settlement settlement terms should be part of the contract outlining how payments currency and timeline portions should be settled between an individual party’s responsibilities ensuring that there will be no confusion and hardly any legal disputes later in the process.

Selection of Reliable Financial Institutions

Those who carry out split settlements should have relations with trusted banks and payment processors to ensure that such settlements will be carried out appropriately and efficiently. Institutions that have such expertise and systems can handle complicated transactions involving several currencies and jurisdictions.

Recent Trends for Split Settlement in Finance

Split settlements must evolve in response to the new demands and technologies in the evermore interconnected and digitalized world financial framework. Changes they introduce affect the structure processing and settlement of cross border transactions and multiple currencies. The next generation split settlements differ from previous ones as they abandon traditional approaches and adopt advanced technologies and new regulations that bring about efficiency transparency and security.

Digital Assets and Cryptocurrencies

Digital assets particularly cryptocurrencies such as Bitcoin and Ethereum have had a huge impact on split settlements. There is now a mix of fiat currency and cryptocurrency split settlements in the picture. A company for example settles half the transaction in U.S. dollars and the other half in Bitcoin. For instance in international deals where cryptocurrency is more accepted or preferred.

This implies that blockchain technology which the cryptocurrencies are founded upon can also make fractured settlements less complicated because of its security and instant and clear nature when making a deal. Smart contracts in blockchain entail the availability of numerous channels that will automatically be provided for programmable settlements.

For instance parties can pre programme the payment conditions and the transfer will be subject to particular automated conditions. This reduces the demand for intermediaries with lesser costs and accelerates settlement times.

Integration of CBDCs and Blockchain Technology

Yet another trend modifying split settlements is Central Bank Digital Currencies or CBDCs. Many governments and central banks are researching and developing CBDCs a form of digital fiat currency. CBDCs promise to be more efficient than traditional fiat currencies for cross border and multi currency transactions. As regards split settlements CBDCs would enable parties to settle portions of their transactions using those same secure government backed digital currencies reducing currency exchange costs and risks.

Decentralised Finance (DeFi)

Decentralised finance or DeFi has the opportunity to change the way split settlements are made in the near future. DeFi stands for decentralised finance and is a way of carrying out peer to peer financial services without the use of traditional banks or clearinghouses. By using blockchain technology smart contracts allow split settlements to be made directly between parties instead of relying on third party institutions.

ESG and Sustainability in Split Settlements

ESG factors increasingly influence financial transactions including settlements. Companies become increasingly bound to the expectations of sustainability and social responsibility and these developments also manifest in financial markets. One of the newest trends is indeed the one connected to socalled ESG linked split settlement when a part of the transaction is tied with any type and all kinds of sustainability or social goals.

For instance in a cross border merger a share of the settlement could be attributed to ESG related activities like investments in renewable energy or sustainable business practices. The trend is synchronised with the increasing priority accorded towards sustainable finance where parties are incentivized to link financial performance to social and environmental impact.

Conclusion

Split settlements have become a must have in the handling of the intricacies of finances in a globalised world. Split settlements happen where a transaction can be broken up into different parts and settled into different currencies jurisdictions or timelines so that the flexibility and efficiency required in handling cross border multi currency transactions are brought to full play.

However split settlements have disadvantages besides these benefits some of which include volatility in exchange rates costly transactions and keeping up with the regulatory compliance aspects. Technology is increasingly playing a significant role in facilitating split settlements as financial markets continue to develop. Such financial transactions would become faster more secure and more efficient as they sort out complex transactions in a new financial environment.