SEC allows DVP to stop payment risks
The Securities and Exchange Commission (SEC), in a bid to reduce risk and increase efficiency in settlement arrangement at the Colombo Stock Exchange (CSE), has given stock broking houses the nod for the Delivery Versus Payment (DVP) process.
DVP settlement system ensures that securities delivery will occur only if a payment occurs.
The system acts as a link between a funds transfer system and a securities transfer system. By far the largest financial risks in securities clearance and settlement occur during the settlement process, that is, the process through which the transaction is completed by final (unconditional) transfer of securities from the seller to the buyer (delivery) and final transfer of funds from the buyer to the seller (payment).
Without such a mechanism (delivery versus payment) counterparties are exposed to principal risk, that is, the risk that the seller of a security could deliver but not receive payment or that the buyer of a security could make payment but not receive delivery. “The intent of the recommendation to grant this is to reduce or eliminate principal risk in securities settlements, that is, the risk that the seller of a security could deliver the security but not receive payment or that the buyer of a security could make payment but not receive delivery of the security,” a SEC official told the Business Times.
Principal risk in securities clearance and settlement systems is generally recognised to be the largest potential source of systemic risk. In terms of risk management, the CSE is in the process of introducing a Central Counterparty (CCP), which interposes itself between counterparties to contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer and thereby ensuring the performance of open contracts. CCP is imperative for short selling as this makes it possible to sell what one does not own.
The short seller achieves this by borrowing the stock from a broker, and immediately selling the stock at its current market prices, with the sale proceeds credited to the short seller’s margin account. CCP will see implementation of a Clearing and Settlement System along with demutualisation and dematerialisation (the process through which a member-owned company becomes shareholder-owned) of the CSE, the official said. Clearing is the counterparty for all trades and provides end to end anonymity. The clearing house, which will be owned by the CSE, will guarantee cash and securities delivery and allow CSE to achiever true DVP. “We’ll be engaging with the CSE on the models in which this will be implemented,” the official said adding that it’ll be about a year before it’ll be ready to be used.