Why Trades Fail & the Consequences of Failed Trades | Gresham

Trade failures can disrupt the financial ecosystem, causing a plethora of issues that include financial losses, operational inefficiencies and reputational damage. When settlements don't go as planned, anything can happen from simple delays to serious risks of systemic market instability and loss of counterparty confidence.

We look at why trades fail, along with their consequences and how firms can take the right measures to prevent and manage these failures. From automated reconciliation to understanding the role of T+2 settlement cycles, here’s how to reduce risks and ensure smoother, more reliable trade settlements.

Why trades fail

Trade failures typically occur when one party fails to meet their obligations, whether that’s delivering securities or paying cash by the settlement date. These failures can happen for a number of reasons and often stem from issues that could have been prevented with better processes in place.

Issues with funding

Funding issues are a common reason. For instance, a buyer might not have enough cash in their account to settle the trade, or they may lack a credit line to cover a shortfall. Alternatively, a seller might not have the securities available for delivery, especially if they’re involved in securities lending programs. Scenarios like these can cause serious delays and risk a domino effect on the trade lifecycle.

Inefficient manual processes

Another factor contributing to failed trades is inefficient manual processes. Many firms still rely on outdated systems, which can lead to errors in confirming or matching trades before the settlement date. Errors can snowball, leaving settlement instructions incomplete or inaccurate and creating discrepancies that delay or prevent settlement.

Automated systems

While intended to streamline the process, automated systems aren’t always foolproof. Sometimes, data quality is compromised or the system fails to integrate with reconciliation processes. As a result, you get gaps that might go unnoticed until it's too late.

Getting a handle on these failures and addressing them early is important. One factor to consider is the T+2 settlement cycle, which mandates that trades be settled within two business days. Failing to meet this timeline can lead to fines and operational penalties, adding to the already heavy costs of a failed trade. These timelines are only going to become shorter and shorter as firms move towards the goal of same-day settlement cycles.

The serious impacts of failed trades

When a trade fails, the immediate consequences can be financial, operational, and reputational. At the heart of it all is the risk of financial loss. If the buyer or seller doesn’t meet their obligations, they could face compensation claims from the other party, who may have missed out on potential gains. Missed opportunities can impact a firm’s bottom line. Unsettled trades can also create unexpected market exposure, which can increase overall risk.

In addition to direct financial losses, failed trades can tarnish a company’s reputation. Repeated trade failures signal operational inefficiencies and may lead to reduced confidence from clients and counterparties. Over time, this can damage relationships and even hinder a firm’s ability to secure better deals or establish new partnerships.

On top of these tangible impacts, there are hidden costs that often go unnoticed. These include the resources spent on investigating failed trades, reconciling discrepancies and negotiating compensation. Firms that don’t streamline their post-trade processes or fail to implement automation may find these costs spiralling out of control, further weighing on operational efficiency.

Failed trades also carry significant regulatory risks. Penalties for missed settlements under the T+2 settlement rule, for example, can be steep (typically calculated as a percentage of the transaction value or as a daily rate), and ongoing non-compliance can attract more severe scrutiny from regulators.

The Settlement Discipline Regime (SDR)

The SDR is a set of rules under the Central Securities Depositories Regulation (CSDR) in the European Union, designed to reduce trade settlement failures and improve market efficiency. These rules naturally link to the underlying reasons as to why trades fail, such as those that have been outlined above. However, the impact of SDR on failed trades can be felt by firms in a multitude of other ways, such as:

• Higher compliance costs - Firms will need to invest in more automation, better reconciliation tools that enable them to identify breaks quicker and more efficiently, and sometimes even reshaping their settlement infrastructure.
• Increased operational risk - Aside from the increased risk from failed trades and the market exposure that can result, firms that fail to settle trades on time under SDR are charged a daily penalty. The size of the penalty is based on the type of security traded and its market volatility. These cash penalties could result in reduced market liquidity, as firms may become more cautious about trading until tighter internal systems and processes are put in place to mitigate the risk.

The Role of Reconciliation

Reconciliation is at the heart of resolving trade failures and preventing them from happening in the first place. With the growing complexity of financial transactions and the increasing speed of trade settlements, it's more important than ever to have a system in place that guarantees accuracy and timeliness.

One of the most effective ways to prevent trade failures is by automating the reconciliation process. By doing so, firms can spot discrepancies early on, often before they result in failed trades. Automating reconciliation leads to real-time tracking of:

• Securities
• Cash balances
• Short-term investments
  
  

With these three items in check, firms can manage their positions more efficiently and avoid settlement delays.

Creating a Well-Designed Reconciliation System

A well-designed reconciliation system can also provide firms with an overview of their assets and liabilities. Making sure that data across custodians and brokers is matched correctly means firms can avoid costly errors and reduce operational risks. Taking this approach leads to smoother trade settlements and better overall risk management.

Moreover, the integration of high-quality data is non-negotiable here. A reconciliation system that pulls accurate, up-to-date information from multiple sources means errors due to outdated or inaccurate data are kept to a minimum. Integration is central to aligning the trade lifecycle and making it more efficient.

While automation is incredibly effective, it’s equally important to combine it with well-trained teams who can oversee the process and act on exceptions when necessary. The goal is to create a system that reduces errors while enhancing decision-making and operational efficiency.

Reducing Exposure to Failed Trades

Risk management is at the centre of preventing trade failures. A strong framework can help firms identify potential risks early, take proactive steps to mitigate them and recover quickly when issues arise.

Establish clear operational controls

One of the most effective ways to manage risk is by establishing clear operational controls. It includes real-time monitoring of cash and securities positions, ensuring adequate funding, and validating trade details before settlement. Firms that adopt these measures are better positioned to detect mismatches or liquidity gaps before they become a problem.

Automated risk assessment tools

Automated risk assessment tools also play a role. These systems can flag potential settlement failures based on historical patterns, allowing firms to adjust their positions or take corrective action in advance. The ability to anticipate risks rather than react to them helps reduce financial losses and operational disruptions.

Team collaboration

Another critical aspect of risk management is collaboration between teams. Trading desks, operations teams and compliance departments all need to work in sync to ensure smooth settlements. A breakdown in communication between these teams can lead to overlooked discrepancies, which in turn increases the likelihood of a failed trade.

For firms looking to further strengthen their risk management strategies, stop-loss orders and risk limits can be valuable. These mechanisms help prevent excessive exposure by triggering actions if certain thresholds are breached. While they are commonly associated with trading strategies, they also serve as safeguards in mitigating failed trade risks.

At a broader level, staying informed about regulatory requirements and market trends is essential. With settlement cycles tightening and penalties for trade failures increasing, firms need to ensure their processes align with industry expectations to avoid unnecessary fines or reputational damage.

Recovery Strategies for Failed Trades

Trade failures demand swift recovery action to minimise operational and financial impact. Knowing what went wrong leads to better prevention strategies.

Root cause analysis comes first:

• Was it a funding shortfall?
• Did manual processes break down?
• Did systems fail to catch the issue?
• Where did communication break down?
  
  

Having this analysis helps prevent repeat failures while highlighting process improvements. It also guides immediate recovery steps.

A quick resolution requires working closely with all affected parties. Keep communication open with counterparties, custodians and brokers throughout the recovery process. Fast action limits both financial losses and relationship damage.

Recurring failures signal deeper issues needing attention. Firms may need to:

• Adjust trading strategies
• Strengthen controls
• Enhance staff training
• Upgrade systems
  
  

This is why post-failure reviews matter. Documenting what happened, what worked in recovery, and what needs changing, are all crucial components to realigning your workflows. Using these insights will help your firm build stronger processes and prevent future failures.

Recovery success relies on addressing both the immediate problem and its underlying causes. This balanced approach helps firms emerge stronger after each incident.

The role of automation and reconciliation 

Automation is necessary to prevent and manage failed trades. The complexity and speed of modern financial markets demand a solution that can keep up with the sheer volume of transactions, whilst adhering to accuracy and efficiency.

The key to this is automated reconciliation. It speeds up the reconciliation process and also improves its accuracy. By matching trade data from custodians, brokers and internal systems in real-time, firms can spot discrepancies immediately. In turn, this reduces the likelihood of errors going unnoticed until it’s too late and provides an up-to-date, accurate view of positions.

Integrating high-quality data is also important. Automation systems that rely on accurate, real-time data can reduce the chances of mismatches and failures. When automated systems are linked to reconciliation processes, firms gain the ability to spot discrepancies before they escalate into full-blown failures. 

They help:

• Save time – since automation speeds up reconciliation and reduces manual effort, thus reducing operational risk.
• Save resources – as it reduces the need for manual intervention and lowers operational burdens.
• Save money – by minimising costly trade failures, fines, and inefficiencies.
  
  

Moreover, automation can integrate with other processes, such as trade entry and settlement tracking to provide a unified approach to managing the entire trade lifecycle. This integration plays a central role in streamlining operations and reducing the manual effort involved while keeping compliance within settlement rules like T+2.

While automation is key, technology is only one part of the equation. A well-trained team that can oversee automated systems, spot exceptions and take corrective actions when needed is just as necessary.

Enhancing trade success rates with Gresham’s solutions

Trade failures are a growing challenge, and with regulatory frameworks like ESMA’s CSDR Settlement Discipline Regime (SDR) tightening settlement requirements, firms that don’t adapt could face rising penalties and operational risks. Staying ahead means using automated reconciliation tools to reduce settlement failures and improve overall efficiency.

A shift in approach is already happening. Around 30% of the top 200 global investment managers now use reconciliation solutions to prevent failed trades and strengthen their post-trade processes. Gresham’s reconciliation software helps firms manage risk, resolve discrepancies early and keep up with evolving settlement rules.

With penalties increasing and market scrutiny rising, firms that invest in automation and reconciliation will be better prepared for the future of trade settlements.

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