Settlement risk: BIS issues consultative report on settlement risk

BIS reports on settlement risk

In a consultative report, BIS says: "The central bank strategy to reduce systemic risk arising from settling foreign exchange trades has achieved significant success. However, a market-wide survey has identified areas where individual institutions, industry groups and central banks need to take further action to reduce and control remaining large and long-lasting exposures and to guard against a risk of reversing progress already made."

Risk reduction

BIS says that the major reduction in risk very much reflects the impact CLS has had since its creation. The industry-owned utility now settles 55% of FX market transactions. As of April 2006, 550 institutions were using CLS to settle trades in 15 currencies. But BIS has suggested that institutions should consider using bilateral netting to reduce exposures, provided that the necessary robust legal framework is in place. For industry groups such as CLS, BIS says that it "should continue to develop services for settling FX trades that contribute to the risk-reducing efforts of individual institutions. Particular emphasis should be placed on possibilities for settling same-day and certain-next-day trades, as well as trades involving additional currencies and counterparties."

Commenting on the report, Rob Close, chief executive of CLS Group, says that he supports BIS’s call for action. "CLS notes from the report that more than half of institutions surveyed expect to settle more of their own trades through CLS... CLS is working with its members to meet their changing needs, including extending coverage to include fund FX and additional currencies, and extending its working day if the impetus comes from the industry to settle same-day trades."

Netting controversy

Netting remains a controversial topic for many in FX and, so far, CLS has refused to accept pre-netted trades for settlement. "The report recognizes that netting can reduce risk but correctly expects that netted amounts can be settled effectively. CLS continues to work with the industry around the utilization of netting as a partial solution to capacity and cost issues to determine whether it should accept netted input as well as gross, while listening to the majority of industry voices who prefer the gross-only settlement approach of CLS," adds Close. "CLS Bank has also offered a solution that enables fast-growing banks to deal with potential capacity problems with its warehouse solution."