What Fund Managers Need to Know about CLS

CLS Bank International (CLS Bank), the only global settlement system, is a bankers’ bank for FX settlement. A total of 55 member banks from 150 locations are settling via CLS Bank, and a further 165 third parties are also live on the service with many more due to go live over the coming year.

Initially CLS was seen very much as a service for banks, but over the past few months, the number of non-bank financial institutions, corporates and now fund managers using CLS as a third party is beginning to grow.

Foreign exchange activity from cross border investment represents a significant proportion of total daily values, and fund managers will benefit significantly from the introduction of Enhanced Fund FX. Following a joint project with settlement member banks that are major custodians, CLS has introduced this unique solution that makes CLS settlement benefits available to the fund management community. This next community of CLS participants will be fund managers, including pension funds, the asset management divisions of banks and insurance companies, as well as investment managers. One fund manager has described this solution as providing “DvP for forex”.

Beyond Settlement Risk

CLS participants are telling us that they are realising various benefits from CLS settlement that go beyond settlement risk elimination and into areas that are relevant to fund managers. These include the virtual elimination of errors in FX settlement, improved STP leading to greater efficiency, improved liquidity management, and expanded trading lines.

Participants have real time status reporting on each trade and daily net cash position reporting in each currency. This increases the transparency of the settlement process and provides real operational oversight and control. These aspects of the service provide an answer for foreign exchange processing to the growing pressures to improve oversight and control of all financial processes.

Recent independent research by TowerGroup examined the impact of CLS on 77 member banks and third parties and the results show that CLS is beginning to have an impact on the front office.

Seventy-seven per cent of member respondents reported changes to the credit approval process for CLS counterparties, with 59 per cent reducing use of credit limits, and 15 per cent eliminating settlement limits for CLS counterparties. Twenty-four per cent of member respondents report changed trading practices with counterparties, of which 80 per cent indicate that they tend to favour CLS counterparties. Thirty-nine per cent of member respondents also cited that they had improved access to counterparties in CLS.

New Trading Patterns

CLS participation with the associated elimination of settlement risk has led to third parties changing their trading patterns, leading to more trading opportunities with a wider range of banks than was possible before. The TowerGroup research reports that among third-party respondents, 54 per cent report changed trading practices with counterparties, of which 68 per cent indicate that they tend to favour CLS counterparties and 47 per cent received larger trading lines. To quote one US brokerage firm: “The reduction of settlement risk has allowed participating trading partners to reconsider and calculate credit worthiness differently today than prior to CLS.”

A European bank adds: “From a business perspective we are already seeing benefits with regards to the reduced exposure to those counterparts clearing via CLS and its introduction has opened doors to those participants who we might not normally have traded with but now can due to the elimination of settlement risk.”

Existing participants also report other significant benefits. A common example is a marked improvement in liquidity management as the netting function within CLS reduces the value of payments required for settlement by 95 per cent – considerably reducing intra-day funding requirements. Another is the reduction of settlement costs, both directly via reduction in clearing volumes and Swift charges and indirectly from cleaner reconciliations and fewer fails.

Other impacts revealed by the TowerGroup research included reduced settlement risk, improved STP, reduction of errors, increased nostro charges and a positive regulatory impact.

Benefits of Broader Participation

Ultimately, the very real attraction of CLS services lies in the reduction of risk and the inherent cost savings that are being accrued due to the service’s design. The reduction in credit facilities required to support FX settlement is significant and these facilities are being redeployed by the “front office” of existing members.

2004 will see the addition of the Hong Kong dollar, New Zealand dollar, Korean won and the South African rand, which have all been endorsed in principle to become CLS Bank eligible currencies once the full CLS Bank and regulatory approval processes have been satisfied and the technical implementation is completed.

CLS is rapidly achieving industry standard status, and the benefits are increasingly being recognised by member banks and participants. The challenge remains to broaden CLS participation beyond the banking sector and into non-banking financial institutions and corporations. CLS is establishing itself as the FX global settlement standard, and fund managers should seriously consider the potential benefits of participation.