Payment versus Payment (PvP)

Payment versus payment (PvP) describes a method of settling foreign exchange deals in which each side's payment becomes final only when the counterparty's payment in the second currency becomes final at the same moment. By linking the two legs of a trade, PvP removes the principal risk that a party pays away the currency it sold but never receives the currency it bought.

PvP is the foreign exchange counterpart of delivery versus payment in securities settlement. The best-known PvP arrangement is Continuous Linked Settlement (CLS), which has settled a large share of global FX trades in major currencies since 2002.

Every foreign exchange trade, whether a spot deal at the spot rate, a forward or an FX swap, involves two payments in two different currencies. Without PvP, each leg is paid separately through the domestic payment system of its currency, often through nostro accounts at correspondent banks, and the systems operate in different time zones. One party typically pays hours before it receives. If its counterparty fails in between, the full value of the trade can be lost.

This danger is known as Herstatt risk, after the German bank closed by regulators in June 1974 after it had received Deutsche marks from counterparties but before it had paid the dollars it owed. It is the foreign exchange form of settlement risk.

A PvP system makes the two transfers conditional on each other. The general approach is:

1. Both counterparties submit matching instructions for the trade to the PvP arrangement.
2. Each party funds its sold currency, usually by paying into accounts the system holds at the relevant central banks, often on a net basis across many trades.
3. The system checks that both legs can be completed and then settles them simultaneously on its books.
4. If one side's funds are missing, neither leg settles, and the funds already paid are returned or held.

In CLS, settlement takes place during a window when the real-time gross settlement systems of all participating currencies are open, and settlement occurs in central bank money, which gives strong payment finality. Multilateral netting of funding obligations means members pay in only a small fraction of the gross value of their trades.

Bank A sells EUR 10 million to Bank B for USD 11 million. Without PvP, Bank A might pay the euros in the morning European time and receive the dollars only later in the US day. If Bank B fails in between, Bank A has lost EUR 10 million. Under PvP, Bank A's euros are released to Bank B only at the moment Bank B's dollars are credited to Bank A, so neither bank can lose the principal; the remaining risk is replacement-cost risk, the cost of redoing the trade at a new rate.

Central banks have pushed for PvP since the 1990s, when work by the Committee on Payment and Settlement Systems, now the Committee on Payments and Market Infrastructures (CPMI) at the Bank for International Settlements, set out a strategy to reduce FX settlement risk. The Basel Committee on Banking Supervision issued supervisory guidance in 2013 expecting banks to use PvP wherever practicable. BIS surveys nonetheless show that a substantial share of FX turnover still settles without PvP protection, particularly in emerging-market currencies not covered by CLS and in trades settled bilaterally.

PvP requires each currency to have a connection to the arrangement, so currencies outside CLS, or subject to capital controls, are harder to cover. Same-day and intraday trades may also fall outside the settlement window. Central banks and the private sector have explored linking national payment systems directly and using tokenized money or atomic swaps on shared ledgers to provide PvP for more currency pairs.