Definition
A “Fail to Deliver” (FTD) situation arises when a broker-dealer who has sold securities fails to deliver them to the purchasing broker-dealer on the settlement date. This can occur for several reasons, but it is usually because the broker-dealer did not receive the securities from its selling customer in time. An FTD may have significant ramifications in the financial markets, including trading restrictions, financial penalties, and market disruptions.
Examples
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Late Transfer of Shares:
For example, if Broker A sells 100 shares of Company XYZ to Broker B but fails to ensure that the shares are transferred from the seller’s account to Broker A in time for settlement, Broker A will fail to deliver the shares to Broker B.
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Margin Call Situations:
Another example could be a trader who sells securities they own on margin. If their broker fails to obtain the securities sold, perhaps due to a margin call or other financial impediment, this results in a fail to deliver.
Frequently Asked Questions (FAQs)
What happens if there is a fail to deliver?
In the event of a fail to deliver, the situation must be rectified quickly, usually by acquiring the required securities and delivering them to the buyer. Financial penalties might apply, and the broker-dealer might face regulatory scrutiny.
How is a fail to deliver different from a fail to receive?
A fail to receive (FTR) is the counterpart situation where a broker-dealer does not receive the securities they were expecting from a counterparty. Both FTD and FTR can create settlement issues in the market.
Why do fail to deliver situations occur?
Fail to deliver situations can arise due to clerical errors, insufficient securities in the seller’s account, or operational inefficiencies in the transferring process. Other causes include financial distress of the selling party or regulatory interventions.
How are fail to deliver situations resolved?
These situations are typically resolved by purchasing the securities in the open market and delivering them to fulfill the contract or executing a “buy-in” where the purchasing broker-dealer forcibly buys the securities to cover the short.
Fail to Receive
A fail to receive happens when a broker-dealer does not receive the securities that were supposed to be delivered to them. This situation often involves the same set of securities as a fail to deliver.
Buy-In
A buy-in is a procedure used by the purchasing broker-dealer to obtain securities in the open market when the selling broker-dealer has failed to deliver on time.
Settlement Date
The settlement date is the date on which the transfer of cash or securities must be completed between parties.
Margin Call
A margin call occurs when a broker demands additional funds or securities from a client to cover potential losses.
Online References
Suggested Books for Further Studies
- “Securities Operations: A Guide to Trade and Position Management” by Michael Simmons and George Handjinicolaou
- “Settlement and Custody: The Core Functions and Responsibilities” by Gianluca Corradi and Sara Gazzano
- “Market Risk Management for Hedge Funds: Foundations of the Style and Implications for Performance” by Francois Ducķevoy
Fundamentals of Fail to Deliver: Financial Markets Basics Quiz
### What is 'fail to deliver'?
- [x] A situation where the broker-dealer on the sell side of a contract has not delivered securities to the broker-dealer on the buy side.
- [ ] A situation where the broker-dealer on the buy side refuses to accept the securities.
- [ ] A situation where the market liquidity is temporarily impaired.
- [ ] An occurrence when stock prices drop below a critical baseline.
> **Explanation:** 'Fail to deliver' is specifically related to the non-delivery of securities from the seller’s broker-dealer to the buyer’s broker-dealer on the settlement date.
### What is typically the root cause of a 'fail to deliver'?
- [x] The broker not receiving delivery from its selling customer.
- [ ] A sudden increase in market volatility.
- [ ] A drop in the stock prices on the settlement date.
- [ ] Legal disputes between trading parties.
> **Explanation:** Fail to deliver generally occurs because the selling broker-dealer has not received the necessary securities from their customer.
### What financial mechanism can resolve a fail to deliver?
- [ ] Hedging
- [ ] Initial Margin Deposits
- [ ] Sell Short Strategy
- [x] Buy-In
> **Explanation:** A buy-in allows the purchasing broker-dealer to buy the securities in the open market if the selling broker-dealer fails to deliver.
### How does a fail to deliver differ from a fail to receive?
- [ ] FTD occurs due to market fluctuations while FTR occurs due to documentation issues.
- [x] FTD is a non-delivery by the selling broker-dealer, while FTR is a non-receipt by the buying broker-dealer.
- [ ] FTD impacts the buying broker-dealer, whereas FTR impacts the market regulator.
- [ ] There is no practical difference, both terms could be used interchangeably.
> **Explanation:** A fail to deliver is when the selling broker-dealer does not deliver securities, and a fail to receive is when the buying broker-dealer does not receive the expected securities.
### What action might a broker-dealer face if they frequently fail to deliver?
- [ ] Increased broker commissions
- [ ] Permanent market ban
- [x] Regulatory scrutiny
- [ ] Reduction in trade volumes
> **Explanation:** Broker-dealers that frequently fail to deliver can face regulatory scrutiny and financial penalties to ensure market integrity.
### What should be done to rectify a fail to deliver?
- [ ] Wait until the next settlement period
- [x] Purchase the required securities in the open market and deliver them
- [ ] File an official complaint with the SEC
- [ ] Close the brokerage account
> **Explanation:** The most immediate remedy is to purchase the required securities in the open market and deliver them to fulfill the trade obligations.
### If a fail to deliver is due to financial distress, what market action is expected?
- [ ] Immediate suspension of trade by the exchange
- [ ] Freezing of broker-dealer’s assets
- [x] Forced buying by the purchasing broker-dealer (buy-in)
- [ ] Loan offering to the distressed broker-dealer
> **Explanation:** The purchasing broker-dealer will execute a forced buy (buy-in) to fulfill the contractual obligations and minimize disruption.
### What does the settlement date signify?
- [x] The date on which the transfer of cash or securities between parties must be completed.
- [ ] The date on which securities transactions are declared.
- [ ] The date for the annual meeting of shareholders.
- [ ] A forecasted timeline for market evaluation.
> **Explanation:** The settlement date is the crucial deadline for completing the transfer of securities and corresponding cash between buyers and sellers.
### In terms of penalties, what might result if a broker-dealer cannot resolve a fail to deliver?
- [ ] Higher trading limits
- [x] Financial penalties and loss of reputation
- [ ] Lower brokerage fees
- [ ] Preferential regulatory treatment
> **Explanation:** Unresolved fails to deliver can lead to financial penalties and regulatory actions which can damage the firm’s reputation and restrict future operations.
### What is a margin call?
- [x] A demand from a broker that a trader deposit additional money or securities to cover potential losses.
- [ ] A monthly billing contract from the brokerage firm.
- [ ] A conference call between brokers to negotiate terms of a deal.
- [ ] A public announcement by a company regarding dividends.
> **Explanation:** A margin call is a demand from a broker to the client to add more funds or securities to the account to cover potential losses due to leveraged positions.
Thank you for taking this journey through the comprehensive understanding of “Fail to Deliver” situations and tackling our sample quiz questions. Keep striving for excellence in your financial market knowledge!
