A method of settlement in the securities market that guarantees the transfer of securities only after payment is made
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Delivery versus payment (DVP) is a method of settlement for specifically the securities market. It basically guarantees the transfer of securities only after payment is made. It requires the buyer to fulfill their payment obligations before or immediately at the time of the delivery of the purchased security/securities.
The delivery versus payment method is also known as receive versus payment (RVP). DVP is basically from the buyer’s perspective since the name entails the “delivery” of purchased securities. In contrast, RVP is from the seller’s perspective, as the name entails “receipt” of payment for the delivery of bought securities.
The DVP method is typically settled via banks. The delivery of securities is made to the buyer via their bank once a payment is received from the buyer.
Delivery Versus Payment (DVP) is a method of settlement for specifically the securities market.
The DVP method basically guarantees the transfer of securities only after payment is made. It requires the buyer to fulfill their payment obligations before or immediately at the time of the delivery of the purchased security/securities.
The purpose of the delivery versus payment method is to avoid a few different types of risks.
Origin of DVP
The DVP method essentially gained popularity after the global market crash of October 1987. The event led the central banks of the G-10 countries to work out a security settlement method that ensured the maximum possible elimination of risk. It resulted in the introduction of the DVP method of security settlement as a risk prevention measure while trading securities.
Purpose of DVP
The delivery versus payment (DVP) method’s purpose is to avoid a few different types of risks. The following are the different kinds of risks a trading party may be exposed to when entering into a transaction in the securities market.
1. Credit risk
Credit risk is the possible inability of the buyer to settle their obligation in full value, either when due or any time thereafter.
2. Replacement cost risk
Replacement cost risk is the risk of loss of unrealized gains. Unrealized gain is determined by comparing the security’s market price at the time of default with the contract price.
The seller is exposed to replacement cost loss if the market price is below the contract price, whereas the buyer is exposed to a replacement cost loss if the market price is above the contract price.
3. Principal risk
Principal risk is the risk of loss of the full value of securities or funds that the non-defaulting counterparty’s transferred to the defaulting counterparty. The buyer is at risk if it is possible to complete payment but not receive delivery, and the seller is at risk if it is possible to complete delivery but not receive payment.
4. Liquidity risk
Liquidity risk refers to the risk that the party involved will not settle an obligation for the full value when due but will do on some unspecified date thereafter.
5. Systemic risk
Systemic risk can be broadly explained as when the possible inability of one institution involved to meet its obligations when due will cause other institutions to fail to meet their obligations when due.
Eliminating the Risks
The DVP method essentially sees the elimination of the risks above as follows:
The delivery versus payment system easily avoids principal risk because it is essentially structured to avoid such events. When following the DVP method, the delivery of securities is only, and only, once payment is made. It eliminates principal risk.
Since DVP eliminates principal risk, the probability of not meeting delivery and/or payment obligations also decreases, reducing the possibility of liquidity risk.
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