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ICLS: What Custodians Need to Know and Do
CLS and "Custody
Third Party FX"
By simultaneously settling foreign exchange transactions; irrespective of geographies or time zones; CLS will radically reduce FX settlement risk and the exposure created by the possible failure of a major institution participating in FX trading. More than sixty financial institutions representing over forty percent of interbank trading volume plan to participate in CLS within the first six months of operation. As a result, CLS is expected to become the settlement standard for FX transactions within a short period of time.
FX deals executed as part of a securities transaction by fund managers and settled by custodians represent a significant percentage of the interbank FX market. Industry volume analysis suggests that approximately 80,000 FX transactions per day related to custody will be eligible for CLS settlement. Fund managers are required to conduct business in the safest manner as part of their charter and some banks have already decided to require their fund managers to settle through CLS when this option becomes available. Major banks that are both global custodians and CLS participants have formed the CLS Custody Working Group in order to work towards making CLS settlement a reality for FX related to a securities transaction, hereafter called 'custody third party FX.'
The Challenge for Custodians
To facilitate earlier adoption of CLS for custody third party FX, the CLS Custody Working Group is searching for other options. One proposed solution, which has found initial support within the industry, would allow CLS Bank to match trades using the custodian's account number for the fund. FX counterparties and fund managers would populate field 83J/ACCT/ on SWIFT MT300s and 304s with the custodian's account number for the fund.
They would include the fund name or "ANON" (if the fund is not disclosed) in field 83J/NAME/. If consensus were reached on using field 83J to match on the custodian's account number for the fund, CLS would need to enhance their matching system to include field 83J as part of their matching criteria.
The discussion then becomes one of risk v. reward. Many feel that there is no real risk involved in matching on the custodian's account number since there is little chance that there will be two deals, with the same account number and the same fund manager doing a foreign exchange in exactly the same amount on the same day. While some are comfortable matching only on the custodian's account number for the fund, others are not. Ongoing discussion regarding the pros and cons of various options are required in order to reach consensus.
One question being discussed is whether it is necessary to match on the fund/investment manager's account number as well as the custodian's account number for the fund, rather than just the custodian's account number. It may be faster for CLS to replace the investment/fund manager criteria, already built into the CLS system, with the custodian's account number for the fund rather than build a new field to accommodate matching on both criteria.
All Custodians would like their clients to settle their custody third party FX in CLS, sooner rather than later, to reduce their settlement risk. After its launch, CLS Bank will be tasked with managing many high priority projects concurrently, such as getting more currencies on board and integrating with other clearing systems. So finding a way to settle custody third party FX without requiring CLS to make significant changes would benefit all CLS participants.
Estimates are that it will take approximately six months to enhance CLS matching which means CLS would be able to match on the custodian's account number for the fund as early as June 2003. As soon as global custodians reach consensus, CLS can begin to develop and implement a solution.
A Creative Solution:
Internal and External Pressure to Settle in CLS Sooner Rather than Later
Dual Settlement Processing
Pressure from Clients
Why CLS Has Not Been
Top-of-Mind for Global Custodians
Where We are Today; Where
We Need to Be
nCLS is coming and the benefits of using it
nWhy fund managers should use CLS, and
n What identification criteria fund managers need to provide to custodians.
To bring closure to issues relating to CLS, custodians must get involved, review the solutions recommended, and participate in the dialogue. To make processing custody third party FX a reality sooner rather than later, a rapid acceleration of the number of people involved in the discussion is needed.
The ultimate solution will only work if a broad buy-in of CLS is achieved within the industry; if custodians reach consensus on matching and implementing and if they convey a consistent message regarding CLS to the investment community. Doing so would ensure that global custodians collectively are able to settle securities using the best method available for reducing FX settlement risk; and the new industry standard; as soon as possible. The CLS Custody Working Group will continue to be an efficient forum for custodian banks to communicate and resolve issues and to develop the best solutions for including custody third party FX in CLS.
is a trademark of CLS UK Holdings Ltd.
Conrad Steinmann is responsible for CLS services business development. Conrad liaises with Citibank sales and relationship management in key markets around the world to develop third and fourth party product feature and service offerings. Conrad represents Citibank at the North American CLS User Group.
Marc Fryburg is Product Manager focused on investor solutions.
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