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Polish zloty: one of the |
Fourteen leading institutions have been confirmed as early adopters of CLS Netting, which CLS will deliver in a phased approach starting in 12 to 18 months.
The first phase will deliver a payment netting service for FX spot, forwards, NDFs and swaps for the 18 currencies CLS currently settles, as well as six non-CLS-eligible currencies.
The six additional currencies were identified as relatively liquid, but having high transaction costs: the offshore Chinese renminbi; Russian rouble; Polish zloty; Turkish lira; Thai baht; and Czech koruna.
CLS will net trades nine times throughout the day, with five on value date – or the date when the funds must be exchanged – and four before value date, meaning any date before that settlement date.
“All participants assign a cut-off for each currency,” states the firm. “Some institutions may wish to have their trades’ net amounts calculated on the day before value date. This is more likely for smaller Apac institutions based on their time zone and support model.”
The service will be free to all market participants for two years, and is offered quite separately to its core settlement service, for which it charges per trade.
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Alan Marquard, CLS |
Alan Marquard, head of corporate strategy and development at CLS, says: “The design of the service is substantially complete. We are just working on some final outstanding areas, such as how best to facilitate netting by the buy side.
“We want to make the system as flexible as possible to accommodate the various models used by fund managers.”
Reaching out to the buy side – and other institutions that are not already CLS members – is central to CLS’ thinking in launching the new service, as is expanding its reach into currencies it does not settle.
James Wood-Collins, CEO at Record Currency Management, says: “The service is potentially very welcome if it can increase efficiency for our clients by meaning they will only have to pay or receive the net amount at settlement, rather than the gross amount on both legs of the trade.”
However, he distinguishes this from other forms of netting that fund managers can do, for example at the point of execution. This is nothing to do with what CLS is offering, and must be arranged with the banks that are counterparties to a trade, potentially delivering even greater cost savings, says Wood-Collins.
Netting can deliver substantial cost reductions by reducing the amount of trades institutions put on, but the cost benefit of the CLS service will differ markedly between users. Netting is already a common practice among many of the larger and more sophisticated institutions in the FX market, and some buy-side traders also have access to netting via their banks.
However, other institutions have no access to netting – or have not sought to establish this. According to research by Greenwich Associates, 83% of asset managers surveyed had no transaction cost analysis (TCA) policy or supplier for FX, but this situation is about to change, according to Andy Woolmer, CEO at New Change FX, due to new regulatory burdens being placed on asset managers.
“The regulators have for the first time provided a clear definition of FX TCA, and what they expect from a TCA process,” says Woolmer.
As an audit system, it does not yet fundamentally change the settlement process, and is essentially the same as photocopying - Andy Woolmer
Spending more time thinking about transaction costs is likely to encourage greater interest in things that will minimize those costs – such as netting.
Bartek Zakrzewski, an analyst at Caxton FX, says netting will be particularly lucrative for managers being charged wide spreads by their counterparties.
“Chances are, this will be more relevant to the smaller companies as they’re likely going to be charged a wider spread so netting off will allow them to minimize currency exposure from their FX,” he says.
However, even institutions that already have access to netting at the point of settlement should benefit from CLS Netting, given the process gets more efficient as more people use it. Those that already net down portfolios before trading will also benefit from the standardization that the CLS service will bring to the market.
Currently, some institutions netting outside the CLS system itself net trades by currency, while others do it by currency pair; netting happens at different times of day and with various frequencies.
In many cases, institutions using proprietary systems are forced to intervene manually to complete the process, says CLS, for example if counterparties calculate the sizes of the trades differently. This often results in higher costs and increased intra-day liquidity demands, it says.
One interesting feature of CLS Netting is that it is being built using distributed ledger technology (DLT), and users will have the choice to use the service with or without this functionality.
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David Puth, CLS |
David Puth, CEO of CLS, says: “We wanted to give clients the option to connect using DLT or via existing messaging channels. As adoption and use of DLT increases, we expect to see more clients using this technology as they realize the benefits.”
While CLS opted to develop its netting service with DLT in part to harness the increased resiliency and security it offers, it also felt a responsibility to lead the industry towards greater use of this groundbreaking technology.
Marquard at CLS says: “As a genuinely centralized industry utility, we felt a responsibility to facilitate the greater use of DLT for ourselves and our clients.
“This is a great opportunity to utilize this technology. We are not offering it as part of our core settlement offering yet, but utilizing it as an optional component in this context is, for us, the best way to introduce DLT into the global foreign-exchange market.”
Red herring
New Change FX's Woolmer says: “We have looked at how the blockchain could be used within a netting system and found it to be a bit of a red herring. The real value seems to actually be in terms of marketing for now.
“As an audit system, it does not yet fundamentally change the settlement process, and is essentially the same as photocopying, or other forms of duplication, in order to ensure security and distribution of data. No doubt it will change things – it just hasn't yet.”
However, others believe DLT has much more to offer than being simply a more convenient upgrade on photocopying. The DLT that CLS is using is based on hyperledger fabric – an open-source solution primarily led by IBM.
Tom Zschach, chief information officer at CLS, says: “Working with IBM to deliver CLS Netting using an open-source DLT solution will ensure the appropriate levels of confidentiality, security, standardization, scalability and flexibility required to create a meaningful network effect across the financial industry.”
CLS’ Puth concludes: “CLS Netting is a critical component of our strategy to deliver a comprehensive suite of post-trade and risk-mitigation services for the entire FX market.”