The risk (settlement risk) that a market participant, though having delivered a currency it sold, may fail to receive the currency it bought. For example, a company in need of a certain amount of euro may have already paid for it in terms of a local currency (e.g., baht), but have not yet received the euro amount.

FX settlement risk is a bilateral credit exposure to a counterparty often referred to as principal risk (Herstatt risk). This type of risk can be eliminated by means of a payment-versus payment (PVP) settlement, whereby the sold currency will be paid if and only if the bought currency is received. Without PVP coverage or protection, a counterparty failing to deliver or settle between trade and settlement date, the other counterparty could lose the full principal value of the transaction.

Settlement protection mechanism (such as PVP, netting, etc.) help also prevent a situation where the principal value substantially divers from the replacement cost of the transaction.

However, settlement risk may still in existence due to unavailability of PVP (PvP) arrangements, or lack of suitable or cost-effective PVP mechanism for specific trades.