When you buy or sell a security in a market, the transaction is not complete until it has settled. During the settlement process, the clearing agency takes the funds supplied by the buyers and the securities supplied by the sellers and swaps them.
Typical users are exchanges and clearing houses.
Problem: When a buyer is not able to pay for the securities he/she agreed to purchase by the time of settlement, this can lead to a tidal wave of problems for the market as a whole. If the seller of one security needs the cash to settle a different transaction, and does not get it because the first buyer failed to deliver, then that can continue to ripple through the system. This was the case when Lehman Brother’s went bankrupt over the course of a weekend.
Solution: Trade Netting helps exchanges and clearing corporations to pool all the pending trades and settle them simultaneously. This has an enormous advantage of settling transactions individually. In the case of Indeval in Mexico, this reduced liquidity requirements by requiring 52% less cash and 26% fewer securities to settle the same trading volume. This solution allows global exchanges to allow their customers to gain an economy of scale by allowing their customers to tap their global liquidity to help settle transactions in multiple markets.
Resources on Trade Netting:
Safe, Secure Securities Settlement
Modeling, simulation and analysis of a securities settlement system: The case of Central Securities Depository of Mexico