The term failure to deliver refers to a transaction involving the exchange of assets, wherein one party does not deliver their asset. Failure to deliver typically refers to the inability of one party to provide securities to their broker.
When two or more parties agree to trade assets, the agreement will typically include a settlement date. The transaction can only be settled if all parties deliver the assets included in the agreement. If any of the parties does not provide the asset outlined in the agreement by the settlement date, there is a failure to deliver.
The most common failures to deliver scenarios involve a buyer with insufficient funds (cash) to finance a transaction, or a trader shorting an asset and not owning the underlying securities. These scenarios can occur in both the derivatives market as well as the stock market. For example, when shorting a stock, a trader is entering into an agreement to sell shares at a given price, and on a pre-established date. With a naked short, the trader enters into such an agreement; however, they do not own the underlying asset.
Under the Securities and Exchange Commission Regulation SHO, all stocks purchased and sold must be settled in three days or less. If the buyer does not deliver cash, or the seller stock, a failure to deliver occurs.