PvP is a settlement mechanism that ensures that the final transfer of a payment in one currency occurs if and only if the final transfer of a payment in another currency takes place. PvP arrangements are primarily designed to reduce settlement risk in foreign exchange transactions.
Depending on the way they are constructed they can substantially reduce funding costs and some PvP arrangements have design features that may also mitigate additional frictions in cross-border payments such as long transaction chains, limited operating hours and weak competition. However, the problem is that many deliverable FX trades are still not settled using PvP and in fact the proportion of non-PvP settlement has been increasing since the early 2000s.
There are a number of factors responsible for this including a lack of availability, driven by growth in the trading of currencies that are unsupported by existing PvP arrangements.
Earlier this year in an effort to address this situation and gather industry views, The Bank for International Settlements’ Committee on Payments and Market Infrastructures (CPMI), released a consultative report – issued as part of the G20 crossborder payments programme – which focused on ways to facilitate increased adoption of payment versus payment (PvP) to reduce foreign exchange settlement risk and improve cross-border payments.
1 Graph 1.A: Adjusted for local but not cross-border inter-dealer double-counting, ie “net-gross” basis; daily averages in April; on-us settlement is where both legs of a trade are settled across the books of a single institution; respondents in 2013 and 2019 did not report whether on-us settlement was with or without loss protection.
Graph 1.B: Adjusted for local but not cross-border inter-dealer double-counting, ie “net-gross”; daily averages in April; a few countries reported greater settled turnover than deliverable turnover in which case we use settled turnover as the denominator. 2 Turnover settled with multiple payments between counterparties (eg spot trades, outright forwards, FX swaps and currency swaps). 3 Each circle represents a country, and circle area is proportional to the deliverable turnover reported by that country.
Sources: CPSS (2008); Kos and Levich (2016); BIS Triennial Central Bank Survey; authors’ calculations.
The report analysed the causes of non-PvP settlement, highlighted existing and proposed new PvP solutions and suggested roles for the private and public sectors to facilitate PvP adoption. It did not set out to provide a view on which of the solutions might be most viable to achieve this, but instead looked to identify practical actions that would facilitate and encourage increased adoption of PvP settlement over the medium term.
As part of the report the CPMI conducted a survey of five existing PvP arrangements and issued a call for ideas on new proposals for PvP settlement. These yielded many promising ideas for new solutions that may be capable of processing FX transactions that currently settle on a non-PvP basis. These would of course need to achieve a critical mass of users to be effective but they could complement existing PvP arrangements by supporting a wider range of EME currencies, reaching less sophisticated market participants and providing features such as real-time and same-day PvP settlement to further control bilateral exposures and improve liquidity management.
We have published this special e-Forex supplement to explore some of these issues in more detail and we hope you will find it of interest.