FX: CLS outlines plans for expansion

Solomon Teague
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CLS, the systemically important FX settlement system, has a number of plans in the pipeline, including an initiative with LCH.Clearnet and a settlement system for currencies outside its proprietary system.

First on the horizon is a partnership with LCH.Clearnet to process payments from cleared FX products on LCH.

Open to all central counterparties, the service will be available for a range of cleared FX products, including OTC and exchange-traded FX options, FX futures and cross-currency swaps, with other physically settled FX products to follow in response to client demand.

John Hagon, CLS
Although CLS is still unable to confirm when the service will be launched, it is expected this year, and will provide payment-versus-payment settlement in all CLS-eligible currencies, operating separately from the group’s flagship settlement service.

Secondly, CLS is looking at ways to simplify business for its clients dealing in currencies outside its proprietary system.

One idea under consideration is a matching and bilateral netting service for such currencies.

This would allow clients to do business with institutions or currencies outside the CLS system without encountering problems such as nostro breaks, where a mismatch occurs between the funds held in a bank’s locally held, local currency account and the amount needed in that account to settle trades, which can entail missed-payment risk.

However, this idea is at an early stage of development.

"The process of matching and confirming, netting and settling non-CLS currencies is very disparate from one currency to another and in many cases, particularly with the buy side, is very manual and complex," says John Hagon, chief operating officer at CLS.

"Payment systems, payment capabilities and liquidity management/collateral mechanisms in certain non-CLS currencies are also immature, fragmented, not particularly robust and unpredictable and can give rise to, for example, nostro breaks where payments are not made on time or at all."

He adds: "Consequently, banks are bearing significant cost and operational risk in settling these currencies."

CLS is also looking to expand on an initiative it has implemented in recent years to increase operational resilience. The original concept, borrowed from practice in the energy sector, saw CLS monitor all traffic among its members to detect deviations from normal behaviour, using a large information panel it installed in the office of the global operations team.

Info wall

Where power-station teams monitor all activity from a single control panel, CLS’s "info wall", unveiled in 2012, ensures operations professionals are able to holistically observe trading, payment and settlement activity in real-time.

This ensures potential problems are identified before payments deadlines are missed or they morph into other, bigger problems. One or two problems are identified per month in this way.

CLS has plans to expand the scope of its info wall in due course to monitor for any form of deviation from normal client behaviour.

"In the context of detecting a cyber-threat or attack, monitoring for unusual activity can be very powerful," says Hagon.

Looking to other sectors has been a useful way of importing innovation from other businesses into financial market utilities where the importance of the core business makes the usual trial-and-error approach problematic, he adds.

"There are many transferable lessons and skills from other industries that the financial services industry is adopting to stay at the forefront of technological and operational excellence," says Hagon.

"Many institutions are taking the lead from industries such as aerospace, air traffic control and the military to gain insight into innovative operational and monitoring models that can be applied to build resilience and manage risk."

Hagon argues these initiatives exemplify the way systemically important financial market utilities (SIFMU), such as CLS, can be market leaders in innovation.

The importance of a SIFMU’s core business makes it vital that products perform as advertised straight away, having been thoroughly tested. Where smaller fintech firms have the flexibility to take a trial-and-error approach, a SIFMU has no such luxury.

CLS was formed as a result of collaboration by a range of institutions to mitigate settlement risk – arguably the most notable risk in the FX market. Today it is among a small number of institutions to be designated as a SIFMU under the Dodd-Frank Act for its role in maintaining stability in global financial markets.

"There are numerous regulatory, risk and operational standards that we need to adhere to and continuously be aware of," says Hagon. "The standards we work towards are higher for CLS due to our place in the market, and the due diligence and rigour we apply ensures that the products and services we offer are both fit for purpose and meet global regulatory standards.