What Is DVP – Delivery Versus Payment?
DVP – Delivery versus payment is a method of settlement for securities. It guarantees the transfer of securities only after payment is made. It requires that the buyer fulfills their payment obligations Payment must occur before or immediately at the time of the delivery of the purchased securities.
DVP stipulates that the buyer’s cash payment for securities must be made prior to or at the same time as the delivery of the security. Delivery versus payment is the settlement process from the buyer’s perspective. Receive versus payment (RVP) is from the seller’s perspective. DVP/RVP requirements emerged in the aftermath of 1987. Thereafter, institutions were not required to pay money for securities before the securities were held in negotiable form. There are other terms that have the same essential meaning as DVP. Terms include delivery against payment (DAP), delivery against cash (DAC), and cash on delivery COD).
DVP – How it Works
A significant source of credit risk in securities settlement is the principal risk associated with the settlement date. The idea behind the RVP/DVP system is that part of that risk can be removed. Specifically, when the settlement procedure requires that delivery occurs only if payment occurs. In other words, securities are not delivered prior to the exchange of payment for the securities. The system helps to ensure that payments accompany deliveries. As a result, a number of stresses are mitigated. For example, reducing principal risk, reducing liquidity risk, and limiting the chance that deliveries or payments would be withheld. This can become particularly problematic during periods of stress in the financial markets.
By law, institutions are required to demand assets of equal value in exchange for the delivery of securities. The delivery of the securities is typically made to the bank of the buying customer. The payment is made simultaneously by bank wire transfer, check, or direct credit to an account.
DVP – Origins and Purpose
The DVP method 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 to eliminate as much risk as possible. Central to this effort was the intent to eliminate the risk that a security delivery could be made without payment. Or, conversely that a payment could be made without delivery. This is also known as principal risk. The DVP procedures were proposed to reduce or eliminate the counterparty exposure when trading securities.
The result was the introduction of the DVP method of security settlement. It is a system-wide risk prevention measure for trading securities. The delivery versus payment (DVP) method helps to avoid many different types of trading risks. Below are a few of the risks trading parties are exposed to:
Eliminating the Risks
- Credit risk – Credit risk is the possibility that the buyer cannot settle their obligation in full value. This failure to perform can occur on the due date or any time thereafter.
- 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. Conversely, the buyer is exposed to a replacement cost loss if the market price is above the contract price.
- 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 the delivery. And, the seller is at risk if it is possible to complete delivery but not receive payment.
- Liquidity risk – Liquidity risk refers to the risk that the party involved will not settle an obligation. This can either be for the full value when due or on some unspecified date thereafter.
- Systemic risk – Systemic risk can be broadly defined as the possibility of one institution not meeting its obligations when due. As a result, this failure causes other institutions to fail to meet their obligations when due.
The delivery versus payment system avoids principal risk because it is structured so that principal is never at risk. When following the DVP protocols, the delivery of securities occurs only when payment is made. Therefore, the principal risk is eliminated. Since DVP eliminates principal risk, the probability of not meeting delivery or payment obligations also decreases. The result is a reduction in the possibility of liquidity risk as well. (Source: corporatefinanceinstitute)
DVP and FOP
Securities Settlement Systems (SSS) are managed by Central Securities Depositories (CSDs). The operation of a securities settlement system is one of the core services a CSD provides. Transfers of securities between SSS participants can take place in two main ways. Namely, delivery versus payment (DVP) and free of payment (FOP).
- DVP-Delivery versus payment transactions includes a securities leg and a funds leg. Securities are not transferred until the funding obligation has been settled.
- FOP-Free of payment is a settlement method for a securities transaction in which the delivery or reception of the securities is not linked to a corresponding transfer of funds. Funds may either be remitted by other, mutually agreed means, or payment may not be made at all.
What is a Non-DVP settlement?
What does DVP – RVP mean?
The delivery versus payment method is also known as receive versus payment (RVP).
- DVP is basically from the buyer’s perspective since the name describes the delivery of purchased securities.
- RVP is from the seller’s perspective. The name describes receipt of payment for the delivery of purchased 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.
Up Next: What Is the Fisher Effect?
The Fisher Effect is an economic theory that describes the relationship between nominal interest rates, inflation expectations, and real interest rates.
It is an economic theory introduced by economist Irving Fisher in the 1930s. It consistently describes the relationship between inflation and both real and nominal interest rates. According to the Fisher Effect, the real interest rate is equal to the nominal interest rate minus the expected rate of inflation. In this equation, all rates used should be compounded. The result, in practice, is that as inflation rates go up, real interest rates go down, when nominal rates don’t increase at rates equal to those of inflation.
This effect is not always immediately visible, but over time, it is a consistent economic pattern. The Fisher effect formula not only plays an important role in economics and business. Also, it has applications that can benefit individuals and investors.