In common trading terms, if a seller does not deliver securities or a buyer does not pay owed funds by the settlement date, then the transaction fails. In a stock exchange, this occurs if a stockbroker does not deliver or receive securities, within a specified time after a security sale or a security purchase. When a seller cannot deliver the contracted securities, this is called a short fail. If a buyer is unable to pay for the securities, this is called a long fail.
Whenever a trade is made, both parties in the transaction are contractually obligated to transfer either cash or assets before the settlement date. Subsequently, if the transaction is not settled, one side of the transaction has failed to deliver. Failure to deliver can also occur if there is a technical problem in the settlement process carried out by the respective clearing house.
Presently, firms have one to three days after the date of a trade to settle transactions, depending on the market. Within this time frame, securities and cash must be delivered to the clearing house for settlement. If firms are unable to meet this deadline, a fail will occur. Settlement requirements for stock, options, futures contracts, forwards and fixed-income securities differ.
Fail is also used as a bank term when a bank is unable to pay its debt to other banks. The inability of one bank to pay its debt to other banks in interbank fund transfer systems, can potentially lead to a domino effect, causing several banks to become insolvent.
The cause of a failed trade could be one of three main reasons.
Failing to pay for purchases creates a risk to the buyer's reputation that may impact its ability to trade in the future.
Failing to deliver securities, especially in a short sale, could create a situation where the buy holds securities that do not actually exist. Further, it could create a chain reaction. During the financial crisis of 2008, failures to deliver increased. Much the same as check kiting, where someone writes a check but has not yet secured the funds to cover it, sellers did not surrender securities sold on time. They delayed the process to buy securities at a lower price for delivery. Regulators still need to address this practice.