CLS eyes EM FX growth, new products

By:
Solomon Teague
Published on:

CLS, the provider of settlement services for FX, is inching closer to bringing the Hungarian forint into the fold of currencies it settles. This is just one of a catalogue of projects the group is working on, as it extends its settlement reach further across the FX world.

CLS is a vital piece of global financial architecture. Settling more than half of all FX transactions in the market – approximately $5 trillion per day – its core function is to eliminate settlement risk among its members in the FX market.

It has operated without any interruptions since launching in September 2002, allowing counterparties to trade without taking on credit exposure to each other.

The Bank for International Settlements’ committee on payment and settlement systems embraced FX settlement as one of its initial, defining projects, and describes the work of CLS since 2002 as "one of its major, enduring successes".

And the US Financial Stability Oversight Council classes it as a systemically important financial market utility. Only eight institutions have this designation, including the Chicago Mercantile Exchange and several subsidiaries of the Depository Trust & Clearing Corporation, such as the Depository Trust Company.

Hungarian forint

When the forint is added to the CLS system, expected in November, institutions will be able to trade the forint without having to worry about the credit risk of the institutions with which it trades. This should also encourage other institutions to trade in the currency, increasing liquidity.

Russell Dinnage, senior consultant at GreySpark Partners, says: "Settlement risk is the primary risk in the FX market, and by mitigating this risk CLS will enable increased trading in forint, which could even feed through to increased imports and exports.

"It will also make the forint a more tangible asset and reduce the need for positions to be hedged, which should increase liquidity."

The more currencies that come on board, the more effective the system will be. Adding new currencies is a time-consuming process, but having worked with the Hungarian central bank Magyar Nemzeti Bank (MNB) for around 18 months, the date for the forint’s accession onto the system is fast approaching.

David Puth, CEO at CLS, says: "Central-bank support is an essential component of adding a new currency. A certain amount of foreign-exchange activity is also necessary to make the addition of a currency commercially viable for CLS and our shareholders."

Diligence

MNB says its preparations for including the HUF in the CLS system are progressing according to plan, the diligence phase having been completed at the end of 2014.

"The tasks ahead include the clarification of legislation, the harmonization of IT systems and the modification of the central bank’s account management policy and business terms," it says.

However, it is not just the central bank that has work to do to prepare for the change. Financial institutions, both Hungarian and international, must also adapt their systems in preparation.

"The foreign participants of the system must find a forint account manager through which they can execute their settlements," says the MNB in a statement to Euromoney. "In addition, Hungarian credit institutions must also build up their own access to the system."

Some reservations have been expressed that this process can be completed ahead of the November deadline.

It is quite surprising we will be the first currency in the region to be added onto the CLS system
György Éder, Raiffeisen Bank

György Éder, head of trading at Raiffeisen Bank in Budapest, says some local banks in Hungary that would provide nostro accounts to CLS clearing members do not have sufficient collateral – mainly Hungarian government bonds – to pledge to provide intra-day liquidity in extreme market situations.

"At a time when many banks, especially Anglo-Saxon banks, are reducing their balance sheets, Hungarian banks may need to increase theirs in order to have the necessary collateral," says Éder.

"Since some clearing members are still searching for HUF nostro partners with CLS service in Hungary, local banks looking for settlement availability are turned down by these CLS members. There is some concern about whether this can be resolved before the November 16 go-live date."

However, this problem should ultimately be resolved, and MNB says the addition of the forint onto the CLS system, ensuring Hungarian banks settle their own foreign exchange turnover using the CLS service, is a priority.

"There is a sufficient amount of liquidity in Viber [Hungary’s real-time gross settlement system] for the processing of morning settlements," it says. However, it hopes the redistribution of liquidity will enhance the role of the Hungarian interbank market after the launch of the system.