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The devil is in the detail:<br />
shining a light on FX<br />
Settlement Risk and what<br />
still remains to be done to<br />
address the issues<br />
Keith Tippell, Chief Product Officer at CLS Group outlines some of the work being done by<br />
CLS and steps it is taking to meet the challenges of FX Settlement Risk.<br />
RISK MANAGEMENT<br />
Keith Tippell<br />
Has CLS been able to offer further<br />
insight on concerns regarding<br />
rising settlement risk in the FX<br />
market?<br />
International regulators have<br />
expressed concern over rising FX<br />
settlement risk, especially in emerging<br />
market (EM) currencies and other<br />
growing segments of the market that<br />
lack payment-versus-payment (PvP)<br />
arrangements. Despite these concerns,<br />
volumes in CLSSettlement have grown<br />
steadily, with average daily values<br />
settled exceeding USD6.0 trillion. The<br />
asset management community, which<br />
accesses CLSSettlement indirectly<br />
through settlement members, has<br />
been a significant contributor to this<br />
growth.<br />
To better understand settlement<br />
risk, we worked with a subset of<br />
our settlement member banks and<br />
analyzed their trades to determine<br />
how they were settled. This provided<br />
a good indication of the market’s<br />
management of settlement risk and<br />
the range of mechanisms used to<br />
settle FX flows.<br />
Our analysis showed that of the FX<br />
transactions eligible for CLSSettlement<br />
(which comprise 80% of all FX<br />
transactions according to the 2022<br />
BIS Survey 1 ), on average 51%<br />
of the traded notional is settled<br />
through CLSSettlement. Much of the<br />
remainder comprises inter-branch<br />
and inter-affiliate trades (35%) or<br />
trades where settlement occurs via<br />
a single currency cashflow or over<br />
accounts within the banks’ direct<br />
control (together, 8%). This leaves<br />
around 6% of trades exposed to<br />
settlement risk that could be settled<br />
via payment versus-payment (PvP) in<br />
CLSSettlement, primarily comprising<br />
trades across large numbers of<br />
corporates and funds that do not<br />
trade in high volume.<br />
How is CLS addressing policy<br />
makers’ concerns over settlement<br />
risk?<br />
We fully support wider adoption of<br />
PvP and applaud the efforts of the<br />
Global Foreign Exchange Committee,<br />
whose FX Global Code encourages<br />
its use, and of the Financial Stability<br />
Board, whose Cross-Border Payments<br />
Roadmap has a dedicated building<br />
block to further PvP adoption.<br />
With regards to CLS-eligible<br />
currencies, the 6% of trades<br />
that could be settled via PvP in<br />
CLSSettlement is the target of<br />
ongoing efforts to increase adoption<br />
of CLSSettlement.<br />
Addressing settlement risk beyond<br />
CLS-eligible currencies may<br />
require an alternative solution. As<br />
a systemically important financial<br />
market infrastructure, adding new<br />
currencies to CLSSettlement is an<br />
44 MAY 20<strong>23</strong> e-FOREX