Counterparty Collateral and Documentation · Forwards Trading Guide
Foreign exchange settlement can expose the full outgoing currency amount. Payment versus payment addresses that principal risk by linking the two transfers.
Recognise the principal at risk
A deliverable currency forward involves two payments. If your dollar payment becomes final before the euro payment arrives, the amount at risk can be the gross dollars paid rather than only the contract’s market value. Time zone differences and payment cutoffs make this an operational as well as a credit problem. A trade that was well hedged can still fail during settlement.
Understand the linked mechanism
In payment versus payment, final transfer of one currency occurs only if final transfer of the other occurs. This removes the principal risk associated with paying one leg without receiving the other within that arrangement. Eligibility, currencies, access and service procedures must be confirmed. Not every bilateral forward automatically uses such a mechanism.
Keep the remaining risks visible
Payment versus payment does not guarantee that a trade settles on schedule. If a counterparty fails to provide funds, the participant can still face replacement cost and a shortage of the currency it expected to receive. Funding arrangements, cutoffs and contingency plans remain necessary. Netting can reduce gross payment amounts but is not identical to making both currency transfers conditional on each other.
Build settlement controls
Independently verify settlement instructions through the approved process, especially after a requested bank account change. Reconcile expected receipts and payments, monitor failed settlements and use escalation contacts that remain available during relevant time zones. Separate trade approval from payment release. A correct exchange rate cannot compensate for sending the required currency to the wrong account.
Try it yourself
A forward has a market value of only $2,000, but requires an outgoing $1 million currency payment before the other leg is final. Is settlement principal risk limited to $2,000?
Show the worked answer
No. The outgoing principal can be exposed during that settlement gap. The small replacement value before settlement does not describe the gross payment risk.
Further reading
- BIS: Managing FX settlement risks
- BIS: FX settlement risk
- Global Foreign Exchange Committee: FX Global Code
Educational material. Numerical examples are hypothetical and exclude costs unless stated. Forward contracts create binding obligations and may require collateral or credit approval. Actual terms, access and risks depend on the agreement and jurisdiction.
