What is Delivery Versus Payment (DVP)?

Delivery versus payment (DVP) is a payment settlement app designed for the sale of securities. It guarantees that the payment will only be made to the seller of securities, after the transfer of securities. The buyer is required to prepay or immediately pay upon the purchase of securities or when the securities are delivered.

Usually, a financial institution such as a bank offers delivery versus payment DVP. The major benefit of using DVP gives buyers and sellers the peace of mind that they cannot be defrauded. It reduces the risk of not being able to receive the securities for buyers and risk of not getting paid for sellers.

The bank holds onto the money received by the buyer in escrow. Once the seller transfers the securities to the buyer and the bank has proof of delivery, the payment is released to the seller. The process can also be immediate, depending on the service that you are using.

DVP is also known as delivery against payment DAP and cash on delivery COD.

The opposite of a DVP is the receive versus payment RVP, in which securities and payment must be exchanged at the same time simultaneously.

Why is DVP important?

Both deliveries versus payment DVP or the receive versus payment RVP methods are payments that effectively reduce risks during the exchange of securities for a cash payment.

The DVP method became popular after the global market crash in 1987 to reduce the level of risk in such transactions. The central banks in Canada, the United States, the United Kingdom, France, Germany, and other European countries introduced the DVP for safe buying and selling of securities.

What Risks can DVP reduce?

While trading, an investor or trader takes on a variety of risks. Here is a brief discussion on how these risks can be minimized using DVP.

1. Credit risk

Credit risk in a purchase of securities is the risk that the buyer will not make the payment as obligated in full at the agreed time or later. This can be avoided when the bank ensures seamless payment to the seller.

2. Unrealized capital gains loss or replacement cost risk

Replacement cost risk is the risk of losing unrealized gains. Unrealized gains are capital gains due to increase in the market price of an asset after it has been in your possession.

An example of unrealized gains is let’s say you bought securities for a total of $500. After 2 days, the price of those securities went up to $550. You have unrealized gains of $50.

Now, while trading securities, there is a risk of losing these unrealized gains. Both buyers and sellers are at risk of losing unrealized capital gains. If the contract price is less than the market price of the security, the seller suffers a loss. And when the contract price of the securities is higher than its market price, the buyer suffers a loss.

If the seller of the securities was to replace the asset after selling it. They will have to pay higher to buy the same securities if the market price goes up, this is known as replacement cost risk.

Replacement cost risk can be reduced when the payment is delivered on a pre-agreed time and there are no unnecessary delays.

3. Principal risk

The principal risk is the risk of complete loss of the securities or the payment in exchange for securities if the other party defaults. Principal risk does not exist in a DVP, because the bank holds on to the funds and they are only sent to the seller after the delivery of securities is ensured.

4. Liquidity risk

Liquidity risk is the risk of one party not fulfilling their obligation. Like principal risk, the liquidity risk is also low as the bank holds the payment in escrow.