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|
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.
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.
“Naturally, this process takes more time, as you would expect.”
Murray Pozmanter, managing director and general manager responsible for all SIFMU businesses at the Depository Trust and Clearing Corporation (DTCC), says SIFMUs have advantages that make them well-placed to innovate.
For example, SIFMUs have a unique breadth of perspective in the area of the market they serve, and have relationships with many market participants that use their services, giving them a particularly good understanding of the challenges they face.
“We are in a good position to conceptualize ways to innovate and deliver on that innovation in order to continue to serve the markets through risk reduction, cost savings or capital efficiency, for example,” says Pozmanter.
If the nature of the challenge means a SIFMU lacks the practical experience to solve it alone, it has the option of partnering with an institution with greater experience in a particular aspect of the market. This is an approach that has been favoured by CLS, for example in its tie-ups with LCH and Markit, as well as by DTCC when it teamed up with NYSE to create New York Portfolio Clearing.
However, while CLS is looking to expand the scope of its business – with its recent initiatives having been delivered while keeping pricing broadly flat – it is also keen to keep building on its core business with the addition of new currencies for settlement.
With the Hungarian forint now on board, all eyes are on Turkey, with the lira set to be the next currency brought into the fold.
In the longer term, the renminbi is the Holy Grail. Both onshore and offshore RMB could theoretically be added.
Although China has shown an interest and has engaged with CLS, it has also shown it sets its own pace for reform, and the timing for its eventual addition to the CLS system will depend on the Chinese government.