What it means
When someone buys shares or bonds, two things have to happen: the securities move to the buyer and the cash moves to the seller. Without a safeguard, one party could go first and then be left waiting.
DVP links the two movements so that neither happens unless both do. In practice, a central securities depository or a custodian bank runs the process.
The buyer's cash and the seller's securities are checked, and the system swaps them in a single step. If either side lacks what it needs, the trade fails to settle, and nobody loses their asset in the meantime.
The main benefit is the removal of principal risk, which is the danger of losing the full value of the trade because a counterparty defaults after receiving your side. Without DVP, a seller could deliver $5,000,000 of bonds and then find the buyer has gone bust before paying.
With DVP, the exchange is atomic, meaning it happens as a single indivisible event. There are related settlement styles.
Receipt versus payment (RVP) is the same thing seen from the buyer's side, and free of payment (FOP) transfers securities with no cash exchange, which is used for moves between accounts of the same owner. Payment versus payment (PVP) applies the same idea to two currencies in a foreign exchange trade.
Finance and operations teams watch DVP closely because settlement failures cost money. A failed trade can incur penalties, tie up cash and disrupt hedges.
Matching instructions quickly, funding accounts on time and confirming details with counterparties all reduce failures. Timing is a further point.
Some markets settle a trade a day or two after it is agreed, and cash for DVP is often provided through central bank or commercial bank money held at the depository. Treasury teams therefore need to know in advance how much cash a settlement will require, so they do not run short on the day.
In practice
Real-world examples.
Example
A pension fund buys $10,000,000 of government bonds through its custodian bank. The bank instructs settlement on a DVP basis, so the bonds arrive in the fund's account at the very moment the cash leaves it.
Example
A fund manager sells 20,000 shares and the buyer's broker has not funded its account in time. Because the trade settles on a DVP basis, the shares remain with the seller until the cash arrives, and the seller avoids a loss. The trade is then rescheduled or cancelled, depending on the agreement between the parties.
Example
A corporate treasurer moves securities between two of the company's own accounts at different banks. Since the owner is the same on both sides and no cash is exchanged, the treasurer uses a free-of-payment instruction instead. Using DVP in this case would fail because there is no payment to match against the delivery.
Formula
Calculation
Cash due on settlement = (Number of securities x Price per security) + Accrued interest + Fees
Worked example: an investor buys 1,000 shares at $50 each, with brokerage fees of $75 and no accrued interest (which applies only to bonds).
Cash due = (1,000 x $50) + $0 + $75 = $50,075
The seller's 1,000 shares are delivered to the buyer's account at the same moment as $50,000 is credited to the seller. If the buyer's account holds only $40,000, the whole trade fails to settle and the shares stay with the seller.Case study
Seen in the real world.
Meridian Asset Services is a fictional firm that handled trades for several small funds. Before upgrading its processes, it sometimes delivered securities first and received payment later, and a counterparty once failed to pay a $3,500,000 trade for two days.
During that time Meridian had to borrow cash to cover its own obligations and paid about $1,000 in interest. The head of operations realised that the real danger was not the cost but the chance of the counterparty failing altogether.
This illustrative incident led Meridian to insist on delivery versus payment for every trade. Since the change, settlements have either completed in full or failed cleanly, and the firm no longer carries unsecured exposure to counterparties during settlement.
Watch out
Common mistakes.
- Assuming DVP guarantees that every trade will settle, when it only ensures that nothing moves unless both sides can perform.
- Mixing up DVP and RVP, which describe the same exchange from the seller's and buyer's perspective.
- Using free-of-payment instructions for a sale, which sends securities away without the matching cash.
Questions
People also ask.
Does DVP remove all settlement risk?
No, it removes principal risk, but timing, funding and operational problems can still cause delays or failed trades. Firms still need good controls and clear communication with counterparties.
What is the difference between DVP and RVP?
DVP is the seller's instruction to deliver against payment, while RVP is the buyer's instruction to receive against payment.
Who operates DVP?
Central securities depositories, clearing houses and custodian banks run the systems that link securities and cash movements. Most investors use it indirectly through their broker or custodian.
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