Foreign exchange settlement risk arises when the two payment legs of a currency trade are completed at different times or through separate systems. A party may have transferred the currency it sold before the counterparty's payment has been received. If the counterparty defaults during this interval, the first party may lose the full amount transferred, rather than merely facing a change in the trade's value. The risk is also termed cross-currency settlement risk and is a form of principal risk.
Source: European Central Bank (ECB) (source). This glossary entry is an independently worded adaptation of the cited information.