Accessible Version
The Systemic Nature of Settlement Fails, Accessible
Figure 1: Example of Settlement Fails
Figure 1 depicts a chain of settlement fails, also known as daisy chain. The first row shows the opening trades, where a hedge fund exchanges cash for securities with Dealer A, which in turn exchanges cash for securities with Dealer B. Specifically, the hedge fund borrows a security from Dealer A, and Dealer A provides such security by borrowing it from another dealer, Dealer B. In other words, Dealer A simultaneously enters into a repo and a reverse repo with the same security as collateral, an example of matched-book activity. The hedge fund proceeds to sell the security, having in mind to buy it back at the end of the week (hopefully at a lower price) to deliver it back to Dealer A, as the term repo expires.
The last row portraits a situation in which the closing trades fail to settle. In particular, the hedge fund is unable to find the security to deliver back to Dealer A, who records a fail to receive starting that day. If Dealer A is then unable or unwilling to buy that security outright or to borrow it in the bilateral repo market, then Dealer A is also going to fail to deliver the same security to Dealer B, as part of the end leg of the reverse repo.