Delivery Versus Payment

Thackston Meridian Pension Trust opens an institutional account at Corvale Fenn Securities and instructs that it be operated on a DELIVERY VERSUS PAYMENT basis. Its custodian bank, not the broker-dealer, will hold the assets. A new operations clerk asks what practical difference this makes to how the trust's purchases settle.

1. A.The broker-dealer extends credit to the trust, which pays for the securities after they have been delivered.No credit is involved. Payment and delivery occur simultaneously, which is the entire point of the arrangement.
2. B.Securities and payment are exchanged simultaneously between the broker-dealer and the trust's custodian bank.Correct. The custodian pays only against receipt of the securities, eliminating the risk that one side performs and the other does not.
3. C.The custodian bank gains discretionary authority to approve each purchase before it settles.DVP is a settlement mechanism and confers no investment discretion on the custodian.
4. D.Settlement is deferred until the end of the month, when all of the trust's trades are netted and settled together.There is no monthly netting. Each trade settles individually on its settlement date, against payment.

Why: In a delivery versus payment arrangement, the broker-dealer executes the trade but the securities and the money move between the broker-dealer and the customer's own CUSTODIAN BANK, simultaneously and against each other, rather than into an account the broker-dealer maintains for the customer. On a purchase the custodian pays only upon receiving the securities; on a sale, the mirror image, receive versus payment, means the custodian releases the securities only upon receiving the money. The point of the arrangement is to eliminate the risk that one side performs and the other does not, and it lets an institution keep all of its assets consolidated at a single custodian while trading through many brokers. It is an institutional settlement mechanism, not a form of margin or discretion.

A pension fund trades through Wexford Trading but holds all of its assets at an unaffiliated custodian bank and settles every trade delivery versus payment. Wexford executes a purchase for the fund. Which institution takes in the securities and pays for them?

1. A.Wexford pays for the securities on settlement date and then collects the funds from the custodian bank.Wrong. That would put the capital of the executing firm at risk on an account whose whole design avoids it.
2. B.The custodian bank pays on trade date and takes delivery whenever the securities become available.Wrong. Splitting the two legs in time is the exact exposure the arrangement is built to prevent.
3. C.Wexford holds the securities in its possession and control until the payment of the fund clears, then releases them.Wrong. The firm never takes the position onto its books, so there is nothing for it to hold.
4. D.The custodian bank takes in the securities and releases payment simultaneously, on instruction from the fund.Correct. Simultaneous exchange at the customer own bank is what makes the settlement delivery versus payment.

Why: In a delivery-versus-payment arrangement the executing broker-dealer arranges the trade but does not stand in the middle of settlement. The customer custodian bank receives the securities and releases the cash in the same movement, so neither leg can complete without the other and the customer is never exposed to having paid without receiving. The role of the executing firm at settlement is to instruct and to see that the two sides agree, not to fund the purchase. Had the fund instead held the position in a cash account at Wexford, Wexford would receive the securities and would owe possession-and-control treatment for them.

The Wexmoor Manufacturing pension plan instructs Halloran Securities that every purchase made for the plan is to be settled by delivering the securities to the plan bank custodian against simultaneous payment by that custodian. This instruction describes:

1. A.Delivery versus payment, with confirmations sent to both the plan and its custodianCorrect. Securities move only against simultaneous payment, and the firm needs the custodian identity and account number, with confirmations to both parties.
2. B.An omnibus arrangement, under which the custodian becomes the shareholder of record for many plans at onceAn omnibus account pools many owners into one position. Here there is one plan settling its own trades through its custodian.
3. C.A networked arrangement between Halloran and the fund transfer agentNetworking describes how customer-level records are carried at a fund transfer agent. It is not a settlement instruction.
4. D.A free delivery, since no money changes hands between Halloran and the custodianA free delivery is precisely the opposite: securities move without a simultaneous payment. Here payment is simultaneous.

Why: This is delivery versus payment, the standard institutional settlement instruction. Securities move only against payment and payment moves only against securities, so the plan is never exposed to having paid without receiving or having delivered without being paid. The customer must give the firm the custodian name and the account number at the custodian, and confirmations go to both the customer and the custodian.