The Continuous Linked Settlement Bank (CLS) has garnered tremendous coverage within the financial services industry since its launch in 2002 as the market infrastructure created to eliminate FX settlement risk for participating members. Over the past five years, CLS has grown through a combination of new participants including banks, fund managers and custodians, increased usage from participating members and the introduction of new currencies.
With 30+% average yearly growth, approximately 65% of the global spot market and an average daily value settled of US$3.8 trillion, CLS has become the FX settlement market standard. However, despite all of its success, CLS’s offering for corporates – CLS third party services – has received little attention in the market, which is surprising to many given the range of benefits it provides to treasurers.
Currencies and Instruments Eligible for CLS Settlement
Fifteen currencies are currently eligible for CLS settlement: US dollar, euro, UK sterling, Japanese yen, Swiss franc, Canadian dollar, Australian dollar, Swedish krona, Danish krone, Norwegian krone, the Singapore dollar, the Hong Kong dollar, the New Zealand dollar, the Korean won and the South African rand.
CLS settlement currently covers payment instructions related to trades executed in four main instruments – spot, forward, option exercises and FX swaps.
The Benefits of CLS
Elimination of settlement risk
Since the settlement is accomplished in a payment versus payment (PVP) environment with settlement finality instead of the traditional delivery versus payment (DVP) with delayed finality, participants are protected against any loss of principal. With the elimination of settlement risk, companies are then in a position to expand their FX counterparties and realign their operational limits at their banks.
Improved operational efficiencies
Due to pre-settlement matching and multilateral netting, participants improve their straight through processing (STP) rates and reduce their volume of settlement transactions, which translates to the elimination of failed trades (and the corresponding costs of resolution and compensation), lower bank costs, faster reconciliation and reduced errors. Some participants refer to this benefit as the ‘fire and forget’ benefit because of the robustness of the system and the zero fail rates.
Improved liquidity management
Funding requirements are reduced substantially by the multilateral netting process and same day receipt and funding.
Utilisation of best practice
Through the use of CLS, participants are involved with the industry’s best practice for FX settlement, supporting their compliance with various regulatory authorities.
Reasons Behind Slow Uptake
Given these compelling benefits, why haven’t more corporates embraced the offering and why haven’t more multinationals heard about it? Some suspect that following early success with corporates there has been less subsequent effort directed at educating this segment with numerous other cash management opportunities. Others feel CLS is suffering from the same challenge as another market infrastructure trying to target corporates, SWIFT. Both of these institutions rely on their members/owners (i.e. financial institutions) to promote and sell their corporate offerings. The fact is both theories are directionally correct but incomplete.
CLS has seen healthy growth in other third party segments, such as banks, fund managers and non-bank financials, but that has not been at the expense of corporate prospects. CLS engaged in an initiative to better understand how large multinational corporate treasurers in the US and Europe viewed the benefits of CLS through a series of interviews. The findings were quite interesting:
- Very few of the corporates interviewed were aware of CLS or its third party service.
- The majority of those who were aware of the service learned about CLS through industry forums or publications and not from their banks.
- Most companies indicated an interest in the service in the near to mid term.
- The prioritisation of perceived benefits varied widely among corporates.
- Credit profile and corporate strategy appeared to be determining factors in the ranking of benefits and value to the corporates interviewed, and not industry or geography.
Based on these findings, it was clear that the buying behavior of corporates was quite different from other markets and CLS has been successful in adjusting its marketing efforts accordingly. Consequently, several corporates have joined including GlaxoSmithKline, Nike, Unilever and Volvo.
But what about the second theory – the member/owner sales model? This arrangement has proven to be a challenge since the banks don’t always articulate the sales message as frequently or effectively as identified in the feedback from the corporate treasurer interviews. But the real issues are much more fundamental.
Management of the CLS relationship typically resides in the financial institutions segment within the treasury services group of the member/owner bank. Although these groups have robust sales teams with experienced relationship managers, they are not responsible for the corporate segment. The relationship managers that are responsible for corporate sales activity are much better versed at discussing payments issues, such as SEPA and IBAN, than FX settlement services and CLS. So, despite their desire to differentiate themselves from the competition by acting as a trusted advisor to corporate treasurers, they are ill equipped to address CLS oriented questions. In addition, although the benefits of CLS have a direct impact on the primary contacts of a corporate treasury risk management, these same contacts do not necessarily have responsibility for FX settlement. These misalignments are the main reason it is difficult for CLS and its member/owners to create traction in the corporate market. Unless these issues are addressed, the ‘CLS secret’ will remain buried.
Don’t Want to Wait?
What can treasurers do who want to understand and assess the merits of CLS for their company? They should ask their cash management banks about the service. Although banks must always balance resources – financial and physical – against perceived market opportunities and demand, nothing gets a bank more focused on a product than a couple of large multinational clients asking about it. Since banks view operational services as an attractive annuity revenue stream with a zero sum game characteristic – what one bank loses in revenue, another one gains – and they are very sensitive to their portion of their clients’ share of wallet, banks are remarkably agile in mobilising if a few key corporates indicate an interest in a new concept. The last thing they want to do is give their clients an opportunity to use a competitor and open the door for further revenue erosion. Some would point to the banking community’s recent support of SWIFT corporate access, which was driven in part by GE and Microsoft’s interest in the service, as an example of this phenomenon.
Currently, 23 banks provide CLS third party services. Some of these institutions are regionally focused while a few have a true global offering. The factors one should consider in choosing a provider vary in degree by company but include:
- Experience – How many third party clients do they have and are any of a similar profile? The chances are for the next 12-24 months few banks will be able to offer many corporate references, but they should have numerous third party banks and funds.
- Functionality – How intuitive is the customer interface, how robust and flexible are their reporting capabilities? Don’t expect huge variances in this category.
- Credit and liquidity – What are the pay-in and payout requirements/deadlines for participants? This varies widely by providers and can be a key factor for many corporates.
- Staffing – Does the bank have a dedicated CLS staff for implementation and customer support? Where are they located and who do they report to? In general, a dedicated support group located ‘in region’ is better than a non-product specific global customer service center desk.
- Cost – What are the direct and indirect costs of the service and how are they calculated? Unlike traditional bank services, which are easy to compare across providers because of similar pricing structures, there is no pricing standard for CLS services and what may look like an inexpensive service may actually be the most costly due to embedded indirect costs.
- Contracts – Who is responsible for the various parts of the process, what is the recourse and what is the liability?Like pricing, this can vary dramatically and can be a key factor in selecting a provider.
- Overall relationship – Is the provider a major provider of FX, treasury management and/or credit services to the company? This issue is more about leverage for negotiating pricing, contracts, etc. It should not drive the assessment but influence a close decision in favour of the relationship bank.
What’s Next?
CLS for corporates will continue to grow at a modest rate while banks monitor the market interest, however the tipping point for broader adoption could move quite quickly if a few more well-placed multinationals influence their banks to take a more aggressive position in the market. Although the service is not suited to every multinational, treasurers should be aware of the concept so they can make an informed decision, and their banks should assist in this effort, or risk losing some coveted revenue.