Delivery Versus Payment system – stage III The RBI has paved the way for netting of transactions in government securities. The central bank will roll out the third phase of delivery versus payment (DVP-III) from April 2, 2004. DVP-III is an enhancement to the current DVP-II form of settlement, as it allows netting of transactions in government securities. DVP-III is expected to improve liquidity and flexibility in trading government bonds. DVP-III is likely to allow short-selling of bonds in the narrow sense, since the RBI has allowed sale of bonds, which are contracted for purchase(but not credited to the securities account with RBI called SGL), provided such a purchase is guaranteed by the Clearing Corporation of India (CCIL) or the RBI is a counter-party to the transaction. This means that unlike the equity market, bonds cannot be sold without holding them in the portfolio or buying them, before deciding to offload. However, the new system is likely to enable squaring of bonds and to an extent facilitate reversal of trades, both of which are not possible in the current scenario. The RBI had circulated a notification on DVP-III mode of settlement to market participants in early February. It is only now that it has decided to put implement the DVP-III. The RBI has already allowed participants to roll-over repo (repurchase agreement) contracts, which are guaranteed by the CCIL. The security prices and interest rate on repos need to be re-negotiated on the roll-over. What is DVP-III? There are two parts to a security transaction: the security leg and the funds leg. The current DVP-II system of settlement allows only netting of funds, while securities are still settled on a gross basis, which implies that you need to have bonds in the account with the RBI (SGL balance), before you think of selling them. So, fund obligations among all participants are netted out at the end of the day, while for securities settlement takes place on a gross basis. Say, Bank A buys the 10-year bond and simultaneously sells the same bonds from its inventory. Instead of netting, both buy and sell legs need to be settled separately. There is a significant rider to shorting securities under DVP-III. The settlement cycle of such a sale should be either the same as that of the purchase or a subsequent day, so that the delivery obligation under the sale contract is met by the bonds acquired under the purchase contract.