"A small percentage of trades were rescinded and that largely depended on what individual arrangements institutions had within their Isda agreements," Close says. "The vast majority of Lehman trades were processed smoothly and some of these were for very large amounts. Citi was the entity that authorized Lehman’s instructions and it can’t have been an easy decision for it to make, but it stood behind the deals and they went through. CLS worked exactly as it should do. It took settlement risk out of the market. CLS users knew they could leave their trades in it."
Andy Brown, global head of FX at HSBC, agrees that CLS did what it was designed to do. "I think it worked very well," he says. "People are starting to worry more than ever about credit and settlement risk. While CLS doesn’t remove settlement risk completely, it does to a significant degree. It’s a testament to the market’s participants as well that all the trades supposed to go through did. A lot of credit must also go to Citi for successfully getting so many Lehman trades settled."
Not only did CLS ensure the relatively smooth closure of Lehman’s transactions, it did this during a week when it set a new record for the amount and value of business it settled. On September 17, it handled more than 1.5 million payment instructions with a gross value of $8.6 trillion, smashing the previous record of 1.15 million payments set on July 7. The Lehman situation had little impact on the total number of trades settled – the surge was a result of increased market volatility around the same time as Lehman’s demise and because of the quarterly calendar roll – but it certainly added to the complexity of the situation, as well as causing a few sleepless nights for operational risk managers around the world.
Not surprisingly, the events surrounding not just Lehman but other financial institutions, such as AIG, have reignited the discussion about whether the market would be a safer place were it to use a central counterparty. On the surface, it would appear that it does not need one, but the debate is far from redundant.
"This [debate] has two elements," says Close. "Does the FX market want to have an exchange model with a CCP? The vast majority seem still to want FX to remain OTC but the events of last week may cause them to consider whether they want a CCP solution to cover replacement risk on forward contracts."
He adds: "Until last week, the market view had been largely that counterparty or market risk was something it could manage. But the market and regulators now need to be thinking about whether they want a CCP in addition to CLS. If the market decides that’s what it wants, then CLS would expect to be part of the solution."
HSBC’s Brown points out that there are several other issues to consider. "There will be a lot of central bank sensitivities and a CCP would probably only benefit the top end of the market where physical delivery is not required," he says. "A lot of business is still reliant on bilateral credit and while FX is regarded as an asset class in its own right, it is also an ancillary service connected to transactions in other products."
Central bank or even higher national sensitivities would appear to be an obstacle in inserting a successful CCP in such a global market. It is almost totally inconceivable that the Japanese authorities, for instance, would allow the clearing of trades in its currency through a foreign CCP, especially if that CCP was not run as a utility.
CLS had to face and overcome such considerations before it became operational. "CLS Bank is regulated by the New York Fed. The other jurisdictions whose currencies we settle participate in an oversight group, the CPSS – a BIS sponsored group that covers payment and settlement systems," says Close. "The central banks agreed a significant ‘give’ when CLS’s design was finalized in terms of allowing remote access to the local RTGS payment systems for FX settlement. We are allowed to operate remotely, which is not what is generally required to operate as a member of the RTGS. The footprint of the firm is a technology one, rather than physical. If the industry does move towards a CCP, then it should look further towards CLS. For a full exchange model one has to consider whether national jurisdictions would accept the majority of ‘my currency’ trading moving offshore."