Delivery versus payment
|
Brokerage Anatomy™
|
Delivery versus payment — commonly abbreviated to (“DVP”) — is a common form of principal settlement for securities transactions within a settlement or clearing system, and is commonly contrasted with delivery free of payment (or “FOP”).
Delivery versus payment
DVP involves the simultaneous exchange of the securities (or their title documents, if different) with the agreed cash consideration. Title to the securities and cash transfers by delivery at the moment of exchange. This is the safest form of settlement: prisoners’ dilemma risk is minimised: if one side does not hand over what it owes, the other side also stops, so the parties have no credit exposure to each other, though they still run market risk between trade and settlement.
Free of payment
FOP, obviously enough, involves handing over securities without the cash — though commonly it just means simultaneously crediting the seller with cash in a different system, or discharging the debt some other way — so technically, FOP means not settling securities and cash in the same system at the same time.
Example
In a repackaging settlement, the arranger may sell a security to the SPV free of payment against delivery of the issued note, also free of payment. Settling the issued note and the collateral security delivery versus payment would create an unnecessary set of cashflows between the party acting as underwriter, asset seller and swap counterparty and the issuing vehicle.
Securities settlement and custody
Where a broker settles with its client free of payment — particularly where the customer pre-funds the purchase price — the question arises as to what is the arrangement between the dealer and the customer after payment has been made, but before the securities have been transferred. Is the customer a beneficial owner, or merely the broker’s creditor?
Unless agreed otherwise, we should assume it is a creditor/debtor relationship. A trust arrangement creates all kinds of unwanted regulatory hurdles: questions of custody, for example. Custody regulations such as the FCA’s CASS rules can be unwieldy and are best avoided if you are not actually in the business of holding assets in custody long term.
The so-called “DVP exemption”
Confusingly, the CASS rules have a “DVP exemption” from their application for certain transactions which, as between the client and the broker, are not DVP transactions but rather agency arrangements whereby the broker buys or sells assets that it holds for its customer in the market without ever itself owning those assets. This is a rare circumstance, and confuses the hell out of compliance officers who assume (naturally) that it applies to all DVP trades between broker and customer — being the vast majority of all brokerage transactions — when it doesn’t.