Pioneering Spirit Needed to Avert CLS Complacency
While there has been increasingly sound progress on Continuous Linked Settlement (CLS) some members of the community are now asking themselves – what next?
Clearly CLS’ mission: “To be the premier means for FX settlement”, has yet to be realised. If the community is to benefit from low-cost processing for the long-term, CLS must move well above current activity levels. Indeed, as a user community we must not leave loose ends around the core product. The community must seize the chance to direct and accelerate CLS’ development.
According to Credit Suisse’s study of 36,000 trades during October and November 2004, October 2004 was CLS’ most active month, with an average of 143,000 sides per day (each trade consists of two sides i.e. Deutsche Bank Vs Credit Suisse is one side, Credit Suisse vs. Deutsche Bank is the other side of that trade). From this study Credit Suisse found that overall trades match in about 38 minutes and three quarters (75%) of all trades match in just 5 minutes. The study found that the netting effect had also become more pronounced, with the average net funding requirement trending towards 2%.
There are now over 330 market participants actively using the system. The CLS Board has approved a new recommended best practice that will help eliminate the use of MT300 confirmations for trades settling through CLS. This could save the industry up to €17 million per year. Daily operations run with a level of certainty and stability that is “reassuringly boring.” All together, this represents very good news.
But should “more of the same, business as usual” be the order of the day? Absolutely not! Building a communal processing vehicle and firmly establishing a market standard is not a sprint. It is a marathon and we have really just completed the first few miles. In that sense, CLS has similarities to the work put into building SWIFT. It will take an extended period of evangelizing to spread the use of the system in the financial community, as well as extensions in scope and functionality to deliver the wide range of benefits from which every market participant can sufficiently profit.
The politics of today’s market environment means that there are always more projects on the radar screen than there are resources to realize them. CLS is a discretionary project, even if there is increasing evidence of cases where not being CLS-enabled might be a barrier to day-to-day operating.
There are steps that CLS and the community can take to promote and expand the current offering in such a way that there is a compelling business case for all possible market participants to take part.
The regulators – who were unanimous in articulating their expectations that the banks work together to reduce settlement risk – have not been so forthright in suggesting penalties for those who avoid using CLS. In fact, the wherewithal to impose penalties is already in place; it is provided for in the Supervisory Guidance paper issued in September 2000 by the Bank for International Settlements. The entire marketplace would be well served if the regulators reminded everybody that this facility is here and the regulators should use it themselves.
In the financial services industry, research and development is not an explicit function in the same way it is in many other industries. Nonetheless, new developments are essential for CLS. At its April 2004 strategy session, the CLS Board looked at various topics that are important for the future. If these products can be brought into the CLS fold, then for all Third Parties, both sell and buy-side alike, FX settlement will become a single process and they will be able to buy on a one-stop-shop basis. This too would be a major selling point to encourage usage of CLS as the standard for FX settlement.
Liquidity is an important aspect of CLS. In its current set-up, CLS’ processing cycle physically separates the majority of FX trades from same-day trades, overnight swaps and money market deposits. In-Out swaps have enabled participants to manage commitments up to a point. Adding a further one or two CLS settlement sessions would enable later settlement in important currency pairs, such as Cable and EUR/USD, as well as USD/CAD, for which the original second session idea was conceived.
Perseverance is important. Many of those involved in CLS have been working on this topic since the earliest days of its inception and we need another round of enthusiastic support and effort from these people. There is still ample opportunity to expand CLS’ activity, as well as to optimize liquidity and funding for all participants. There is also the need to add volume. As a financial community, we need to resist the temptation to switch the cruise control on. We must strive to move up a gear and push to create a more certain future for CLS.