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Global Custody

Page last updated
February 15, 2003



ICLS: What Custodians Need to Know and Do


CLS and "Custody Third Party FX"
Continuous Linked Settlement (CLS) represents a landmark change in the global financial market. For the first time, seven of the world's central banks will be simultaneously linked in real-time to one central multicurrency settlement system known as CLS, operated by CLS Bank International. This will allow for simultaneous settlement of foreign exchange (FX) transactions.

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
A custody third party FX is a transaction done by a fund manager, acting as agent on behalf of a fund. To settle custody third party FX, CLS Bank would ideally match each trade at the fund level, on a unique fund identifier code (fund ID). SWIFT is investigating how to develop a unique fund ID for all funds worldwide. However, before implementing such an ID system, a number of issues must be resolved, such as how to keep the fund identity confidential when it is not being used for matching purposes. It is expected to take 3 to 4 years to develop and implement the SWIFT unique fund ID solution.

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:

Pre-Matching Outside of CLS
To accommodate CLS participants who want to match on more than the custodian's account number for the fund, it might be possible to pre-match on the actual fund ID before the transaction is sent to CLS. This pre-matching could be accomplished using an FX matching utility such as Citigroup's Crossmar Matching ServiceTM (CMS) or SWIFTAccordTM. The use of an FX matching utility gives Settlement Members the option to pre-match on a variety of criteria including the actual fund ID, and may also alleviate the need for SWIFT to develop an alternative solution. Pre-matching brings other benefits such as early identification of unmatched trades and therefore earlier investigation and problem resolution.

Internal and External Pressure to Settle in CLS Sooner Rather than Later

Dual Settlement Processing
When CLS commences operations, participants are likely to feel the pressure of operating in a dual-processing environment to accommodate CLS activity and other activity, such as securities settlement activity, outside of CLS. Eventually the increased inefficiencies and costs resulting from dual processing will present a strong argument for all to use CLS as their primary settlement method. In time, the current settlement methods through in-country settlement systems are likely to become the exception.

Pressure from Clients
Once CLS is live, custodians and fund managers may experience pressure from clients eager to settle transactions using the new industry standard.

Why CLS Has Not Been Top-of-Mind for Global Custodians
Today, custodians are largely preoccupied with other issues such as implementing ISO 15022, the new SWIFT 500 message series, which goes into effect November 2002. The product and operations people who need to participate in decisions regarding CLS are busy with ISO 15022 preparations and have little spare time to consider CLS.

Where We are Today; Where We Need to Be
Despite the immediate pressure created by priorities such as ISO 15022, it behoves global custodians to bring closure to outstanding issues relating to matching in CLS, reach consensus on implementation details, and provide direction to SWIFT and CLS on the requirements needed to make CLS a reality for custody transactions. Custodians need to provide direction to fund managers and deliver a common message regarding CLS to the investment community. Minimally the investment community needs to know:

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.

The Benefits of CLS for Custodians and Fund Managers

CLS, which simultaneously settles both sides of an FX transaction, will soon become the industry standard for mitigating FX settlement risk. For custodians and their clients, CLS brings many operational benefits as well.

Greater Predictability with Quicker, More Certain Settlement Fewer Fails and Fewer Funding Issues

Today, in securities settlement, payments trickle in with no certainty of payment until the payment is received. One typically finds out the day after the settlement date, that funds did not arrive and that the account is overdrawn. CLS provides many benefits:

n With CLS, custodians get information for multiple currencies and trades from one place, rather than from seven different accounts/ banks for seven different currencies. CLS plans to settle four additional currencies in the near future (bringing the total to eleven) and even more currencies are being considered.

n Custodians get one fully reconciled account statement showing all the settlement details for both sides of each transaction.

n CLS offers easy intraday access to real-time settlement information that enables custodians and fund managers to see and fix mistakes ahead of settlement day. With CLS, participants know what has matched and what has not matched and can be proactive and initiate an investigation, when necessary, resulting in fewer fails and fewer funding issues. It also means CLS participants are more likely to receive the cash you were forecasted to receive.

n The CLS process is more predictable than today's process. The delivery of the proceeds can be scheduled to facilitate timely treasury funding to support other business activity later in the day.
l With greater predictability in securities settlement, more transparency in information reporting, streamlined back-office operations and reconcilement of a single account, custodians may eventually be able to offer improved cut-off times to fund managers.


CLS is a trademark of CLS UK Holdings Ltd.
Citibank and Crossmar Matching Service are registered service marks of Citigro
SWIFT and SWIFTAccord are registered trademarks of S.W.I.F.T. SCRL


Conrad Steinmann
Vice President
Citibank e-Business

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
Vice President
Citibank Global Securities Services

Marc Fryburg is Product Manager focused on investor solutions.


Settlement Risk
Background  to CLS
Worth having waited
Global FX
Radical change
3rd Party customers
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