Volume Leakages Holding Back CLS Benefits
There is now some real evidence of just what a difference using CLS makes. In this article, we’ll give you some real examples of how CLS really adds value.
Recently CLS teamed up with Z/Yen, an independent research firm, to look at the impact of CLS on the operations of the settlement member and third party community. Z/Yen has several years’ experience in doing multi-company comparisons in the financial services industry. Various strands of good news, as well as a bit of bad news emerged from this. The good news is that operations people began to see the benefits, but the bad news was that the benefits have not yet translated to obvious cost reductions, indeed the nostro funding costs have gone up. I validated the results with one of Credit Suisse First Boston’s FX operations managers. His comment on CLS’s value was simple and heartening: “The value of CLS is not an obvious one in terms of we need fewer heads. The real value is actually that putting lots of trades into CLS has meant we had lots of capacity. Once we had the trades in CLS, life was easier. We were able to complete lots of projects and change related work that we could not otherwise get to.” Capacity is what we are really talking about. That is something that makes a real difference. At International Payments Week, in London (April 2005), there was a panel discussion involving live third parties. One of Credit Suisse’ third parties, Corner Banca, a Swiss private bank, was joined by a representative from Alfa Bank, a Russian bank that uses UBS for CLS settlement. The Russian bank is a major player in an area of the world with more than the usual risk profile, the Swiss bank is very conservative and, being private, is not officially rated by one of the major credit agencies. Not really two banks destined to do lots of FX business together. The big deal is that these two clients of Credit Suisse and UBS recently started trading FX with each other and settling via, you guessed it, CLS. Both of them told the audience that without access to CLS, these trades would never have been possible. This is not a Credit Suisse or an UBS story; rather it is a CLS success story. CLS is a new business enabler and that is something that makes a real difference.
As much euphoria as these stories generate, there are some other issues to consider. We recently reviewed Credit Suisse’s CLS related costs for the first quarter of 2005. The cost of our CLS related funding, which is what we pay to get all these timed payments made, keeps going up. Now, this is not driven by whether we self-clear or don’t, rather it is a function of the net positions we have to fund. The increase in cost made it clear that we are still suffering from the fact that there are plenty of market counterparts with plenty of trades that are still not settling in CLS. Basically, this lot of counterparts complicate life for everybody else and push our costs up. This ‘long tail’ of missing volume is something that needs a community-wide clean-up programme to fix. We all have these weak spots. At Credit Suisse we audit our non-CLS activity about every two months. Last time we did it, we found a local counterpart doing some 170 trades per month with us that were CLS eligible yet we had not yet – ‘matched up’. This bank is probably doing that many trades per day in total. We used our contacts and cleaned this up quickly. Getting the job done does take discipline. However, this is not CLS’s problem, it is not a particular person’s problem; it is our problem as a community. So how might we attack this issue of the ‘long tail’ or so-called leakage? We have some ideas:
The overall subject of volume leakage is something that we think can be divided up into six obvious pots together with a seventh ‘opportunity pot’. Figure 1 shows this in graphical form. Below it we describe the issues and offer a recommendation for how we as a community can move this volume in to CLS.
The major players still have a noticeable number of trading locations that are not yet CLS eligible. Reasons vary and include IT change projects, switches to single-booking names. CLS knows the names and the timings. The rest of us have some but not all the information.
The simplest method to move a heterogeneous community that is widely dispersed is something known as the ‘Name and Shame’ or ‘Hall of Fame Game’. CLS should publish the list of the names and current status of their projects. We all know that public attention moves certain things faster than internal projects. In addition, some degree of formal communication at the most senior management levels might also help overcome any internal obstacles. The other weapon, which CLS has so far lacked, is a hard deadline. We could as a community go a long way towards this by trying to influence the rules in the marketplace. If EBS were to announce that from, say 1 Jan 2006, there would be a new best practice of CLS settlement, this too would hurry matters along.
These are less important in volume terms and more challenging in political terms, as they tend to be units that fiercely guard their independence and push back on any diktat from head office. Here, the same remedies as with the branches of settlement members would be the best approach.
There are three participating already, with about as many considering the issue. The requirement to be a shareholder was once a stumbling block; however CLS has already offered alternatives. The other stumbling block, which in isolation is a valid one, is simply that in per ticket terms the investment in IT changes and operating costs is punitive and off-putting. The central banks are really low volume and currency intervention is a rare species. An attempt to have the BIS act as a settlement member has so far not produced an acceptable solution. The central banks are really important opinion leaders.
CLS can only continue to encourage the thought process. The fastest result would be obtained if the Fed/the Bank of England and the ECB all signalled positive intentions in unison and quickly.
There are perhaps some 100 banks that are important in volume terms that have committed to join but not completed their projects and perhaps another 100 banks that are important and should make a decision. Here, the same remedies as with the branches of settlement members would be the best approach.
Settlement for funds in CLS is a little more complex than for regular inter-bank trades. CLS has the means to do this. The key here is to get the fund manager to ask the custodian to set this up. Fund managers are notorious for their general indifference to STP and single-minded focus on ‘performance’. There is perhaps some hope that the recent spate of regulatory incidents will change this mindset and the buy-side will see STP related issues as ones that drive capacity and thus ultimately performance. We have seen cases where the sell-side firms are writing to their buy-side clients to ask them to consider using CLS.
We need to build on this momentum and have one of the CLS working groups define some standard language and then ask every CLS settlement member to send it to their clients. Again, some degree of formal communication at the most senior management levels may help too.
The anecdote we provided above proves that there are cases where two parties might not realize that the other is CLS eligible or simply not realize they are trading with one another.
Ideally, any active CLS participant should review its own non-CLS activity. This could be made easier if either on CLS’s website or within the SSI Search directory a BIC lookup was provided. CLS could also bring potential gaps to users attention. This is straightforward to spot, simply using the giant CLS data warehouse to see “who is trading with whom” and by implication who is not. If 80 per cent of the market participants are settling trades with a particular counterpart in CLS and the others are not, it is worth providing the data in a way that lets the 20 per cent not doing so check whether this is an omission or deliberate.
There is new business to be done. Simply raising the awareness of who is CLS eligible could help this. The second suggestion in regards to the previous item, above, would help CLS users identify both errors of omission as well as opportunities
Driving further volume into CLS is not a matter of dealing with nice juicy ‘low-hanging fruit’. It is about disciplined administration in chasing down the causes of the volume leakage to help move us all step-by-step to an ubiquitous standard. In part, we each have the wherewithal to help ourselves. To make real progress we need CLS to measure and report. Why? Because we all know that what gets measured gets managed.