Goldman Sachs and Morgan Stanley are the first institutions to use the new standardized, automated bilateral payment netting service for foreign exchange created by FX settlement service provider CLS.
CLSNet will match, provide confirmation and calculate net payments for FX trades, standardizing payments netting to reduce costs and increase liquidity.
It will also help users comply with certain principles of the FX global code of conduct, which calls for a greater level of standardization in FX trading.
According to CLS, FX trades that settle on a gross basis are exposed to higher settlement risk and are required to hold higher levels of capital against trades than those that have been netted.
CLSNet brings the benefits of netting to institutions that do not use CLS settlement services, including buy-side institutions. It can be used in conjunction with any trading platform, unlike some other netting services.
Six additional participants have committed to joining the service, one of which is known to be Bank of China.
CLS declined to provide any more names of prospective customers, but said one is a Central American bank that is not a CLS settlement member. The company promised more market participants are expected to join the service in the coming months, with a “robust pipeline” in place for 2019.
Adam Levine, CLS
Adam Levine, head of product management at CLS, says standardization is what sets CLSNet apart from other netting services.
“While a large number of participants currently net with each other on a regular basis, they experience different challenges,” he says. “For example, institutions have their own cut-off times for payments because they work with different custodians and in different time zones.”
CLSNet tackles this problem by providing users with the choice of 11 different cut-off times – five the day before value date and six on value date. Institutions can pick the one that best suits their needs.
Counterparties do not have to pick the same or negotiate cut-off times, as CLSNet will issue the netting report at the earlier of the two cut-off times for those counterparties.
Levine admits the CLS service does not offer as much flexibility on cut-off times as other providers, but insists this is a feature, not a bug.
“Our clients advised us that a greater level of flexibility only increases uncertainty and operational risk,” he says.
CLSNet brings those benefits to trades involving more than 120 currencies, making it essentially currency agnostic. It had originally intended to go live with just 24, but the breadth of the offering was expanded to include all actively traded currencies not included on any sanctions lists at launch.
This increased its appeal on day one, given the network effect that the inclusion of more trades will make the system more efficient. The benefits of netting are also more pronounced with less-liquid emerging-market currencies because of their high settlement costs.
David Clark, chairman of the European Venues and Intermediaries Association, says the launch of this netting service comes at an ideal time for FX market participants.
“Of particular importance is the contribution made by this initiative to improving operational risk management at a time of increasing uncertainty,” he says. “This will certainly encourage more use of different, and especially emerging market, currency pairs.”
In a similar vein, Barry Lo, general manager for the bank-wide operation department at Bank of China (Hong Kong), says that CLSNet will “enhance operational efficiency in trade matching and payment netting for non-CLS settled currencies such as CNH, and strengthen our risk management.”
CLSNet uses the Linux Foundation’s Hyperledger Fabric distributed-ledger technology (DLT) framework, though clients will not necessarily notice that, given they will submit and receive orders for netting via Swift.
The platform is the first post-trade production deployment of blockchain technology in a global market utility, according to CLS and IBM, which helped build the system.
However, CLS insists the use of DLT is not a gimmick: it looked at other technologies when developing its netting service, but felt DLT offered functionality that other technology could not.
“The development of the CLSNet service was an evolutionary process which required industry-wide testing and leveraging innovative technology,” says Levine. “Those that wish to will be able to adopt DLT-based interfaces with the system in the future.”
The service has been a long time coming, having first been announced more than two years ago, at which point CLS said the service was essentially built. A planned launch in the first half of 2018 was postponed to allow CLS and prospective customers to conduct more testing.