It's not a new idea, but aficionados say it was never more relevant than today. To reduce the gross settlement exposures in the $1.2 trillion a day foreign exchange market a handful of banks and brokers have been working on a new way to trade the rates without having to send over the gross amount. They just settle the difference between the spot rate at the time the transaction was agreed, and the rate at delivery.
One group of banks is particularly interested - the Japanese - since their poor credit standing has reduced the amount of settlement exposure that foreign counterparties are prepared to take on them. The Tokyo foreign exchange committee, which includes the Bank of Japan, the central bank, is standing by to see what an initiative in the London FX market can do to help them.
The proposed instruments are called contracts for differences (CFDs), also known as FXDS. And they are not unlike the non-deliverable forwards used to trade emerging market currencies outside the jurisdiction of the emerging-market regime: the differences are settled in dollars at the end of the contract. As in an interest-rate swap or a forward rate agreement (FRA) no principal changes hands: the loser at the end of each interval, or at the end of the contract, makes a payment.