CLS Sees Growing Buy-Side Demand for FX Settlement Risk Solutions

Foreign exchange (FX) settlement, processing and data solutions provider CLS anticipates that buy-side interest in FX settlement risk mitigation tools will continue to grow. 

Margaret Law, head of client management for Asia-Pacific (APAC) at CLS points to evidence that between 2017 and 2018, the average daily gross value settled by third parties—including banks, funds, non-bank financials and corporates—grew 18 percent.

Settlement of FX transactions requires counterparties to exchange the principal, or the value of the trade, in two currencies. “Settlement risk is the risk that one party to an FX transaction delivers the currency it sold but does not receive the currency it bought from its counterparty, resulting in a loss of principal,” says Law. 

CLS aims to reduce settlement risk by simultaneously settling the payments on both sides of an FX trade through CLSSettlement—its payment-versus-payment (PvP) settlement service. 

Asset managers, asset owners, banks, non-bank financial institutions and multinational corporations can participate in and submit FX trades to CLSSettlement through a CLS third-party service provider that is also responsible for handling all of the payment instructions and funding to CLS in relation to the trades.

Law adds that interest in settlement risk mitigation is driven by the asset management community in Japan, as well as from the larger APAC region. 

According to the Bank for International Settlements Triennial Central Bank Survey in 2016, Japan is one of the world’s largest centers for currency trading and a crucial hub for the Asia FX community. The country accounts for 6.1 percent of global over-the-counter FX turnover.

CLS recently signed Nomura Asset Management (NAM) as the first asset manager in Japan to provide access to CLSSettlement for Japan-domiciled funds. 

NAM is working with The Nomura Trust & Banking Co., Japan Trustee Services Bank and The Master Trust Bank of Japan to offer CLSSettlement a total of 21 investment trust funds. NAM, along with the three trust banks, is supported by global custodian banks including Brown Brothers Harriman, Citibank, and Sumitomo Mitsui Trust Bank. 

According to CLS, while large banks and securities companies in Japan have been using CLSSettlement to settle FX trades, it is only recently that asset managers and pension funds are starting to do so. This is because Japan-domiciled fund FX transactions involve many stakeholders, such as trust banks, asset managers, global custodians and counterparty brokers. 

However, following guidance by the Basel Committee on Banking Supervision to use PvP settlement and netting where appropriate, the Financial Services Agency of Japan and the Bank of Japan have promoted the use of PvP settlement to Japanese wholesale FX market participants. 

Buy-side firms are also increasingly aware of the risks associated with FX settlement, and as a result they are getting more involved in how those risks are managed, Law adds. 

“In addition to risk mitigation, firms are able to benefit from streamlined trading operations, and enhanced liquidity from netting that lowers transaction costs. They are also able to boost trading and counterparty limit management efficiencies that support business growth opportunities. For these firms, reducing risk through efficient post-trade processing has a direct impact on the performance of their investment portfolios—every marginal saving delivers to the bottom line,” she says.

On top of that, the creation of the FX Global Code—a set of global principles developed to provide a common set of guidelines promoting integrity and effective functioning in the wholesale FX market—encourages more market participants to focus on best practice in the post-trade area, including the need to mitigate FX settlement risk. 

The code was developed by a partnership between central banks and market participants from 16 jurisdictions. While it does not impose legal or regulatory obligations on market participants, the code is intended to serve as a supplement to local laws, rules and regulations by identifying good practice and processes. 

Law says many of CLS’s products aid compliance with the principles set out in the FX Global Code. 

“Additionally, CLS has developed new solutions with the buy-side’s needs in mind, such as CLSTradeMonitor, which allows non-settlement members, or those without direct access to CLSSettlement, to see the matching and settlement status of their own trades. Previously, they had to rely on an intermediary for this information,” she says.