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Page last updated
February 15, 2003

 

 

I

Settlement Risk: Here comes CLS

CLS will be a major way of settling foreign exchange trades in the near future. On the suggestion of the Bank for International Settlement it is being developed by CLS Bank in order to eliminate the settlement risk which can occur when FX trades are settled. As a payment versus payment system with its initial currencies USD, CAD, GBP, EUR, CHF, shortly followed by JPY and AUD, CLS offers settlement for gross transactions of both legs of trades simultaneously- with immediate finality.

Although bank failures are relatively rare events, the losses can be enormous when an institution fails, possibly even causing a so-called domino effect in financial markets. At any point of time, the amount at risk to even a single counterparty could exceed a bankís capital. The dimension of risk potential is illustrated by the huge growth in financial market activity. It is for instance estimated that the value of FX trades settled each day world-wide is over USD 3.500 billion before netting. Furthermore, the daily message traffic over SWIFT per 1998 has averaged 4 million messages.

Regulators and central banks are very concerned about these risks- this is one of the reasons which led to the CLS concept in 1995. It was the result of an analysis by a major group of FX trading banks (G20) which considered how the private sector might develop a solution to the problem of settlement risk, which can pose a threat to financial stability not only to counterparties involved but also to other market participants and the financial system as a whole. In 1997 CLS Services Ltd. (CLSS) was formed as a holding company to integrate ECHO (Exchange Clearing House) and MIB (Multinet International Bank), who offer netting services, and to develop and build the CLS Bank (CLSB), headquartered in New York, providing the future CLS service.

Apart from settlement members which must be shareholders of CLS Services Ltd. and meet the criteria for settlement membership of the CLS Bank (currently CLSS has 62 shareholders in 14 countries- one of them is Bayerische Landesbank) each other bank can submit its transactions to CLS either as a 3 rd party or a user member. Settlement members will hold accounts with the CLS bank. User members (their role has not yet been fully defined) can submit trades directly to the CLS Bank, but their trades will be settled through the account of a settlement member. Both settlement and user members can submit their own or their customers trades. The so called third parties will have no direct access to CLS, their trades can easily be submitted via their respective settlement member- for CLSB this means that it will not be able to distinguish between a settlement memberís or a 3rd partyís deal.

CLS Funding and Settlement
The CLS Bank will know before the start of the daily settlement activity which trades are due to settle and will calculate memberís net positions in each CLS currency. Settlement members will fund their settlement obligations according to their individual CLS pay-in schedules at fixed times by paying the required amounts of the currencies in which they are short to CLS Bank via their respective RTGS systems. The CLS Bank will settle the dayís transactions across its books followed by the pay out of the long positions. The settlement period will be set so as to make best use of the overlapping opening hours of payment systems in the different time zones. The national RTGS systems will extend their operating hours accordingly. The CLS Bank will hold accounts for its settlement members in each of the currencies in which it settles, and will itself hold accounts at each relevant central bank. By this procedure the settlement risk will be eliminated and the backing of FX Trades with equity, as considered by regulators, can be avoided by processing them via CLS. At the same time a multilateral netting of FX transactions will be achieved.

The planned roll out schedule by CLS :

May 1999 to February 2000: integration testing

March to September 2000: Operational Trials

October 2nd 2000: CLS goes live with the initial currencies USD, CAD, GBP, EUR, CHF followed shortly by JPY & AUD in the 1st quarter 2001

End of 2000: Start of 3rd Party-business Bayerische Landesbank and CLS

Bayerische Landesbank, typically at the forefront and prepared to take the new challenges, is a shareholder of CLS Services Ltd. since July 1998.

Through us and our 3rd party service, you will also be able to enjoy the obvious benefits of Continuous Linked Settlement- the most important one certainly being the already mentioned elimination of FX settlement risks by payment versus payment . Equally important is the fact that CLS trades will not have to be backed with equity, as considered by regulators for FX settlement risks, what consequently will lead to a market concentration on activities processed via CLS. This also means that on the one hand you will be provided with better quotations by your counterparties, on the other hand that you will be in a position to offer your customer more competitive rates. Due to reduced exposures CLS participants will also be able to expand their FX activities. Furthermore, we will see a substantial reduction in traditional treasury clearing activities. Through the multilateral processing of fx deals the liquidity needs of CLS participants will be reduced to a net short position. Last but not least, given its innovative and revolutionary character, CLS is a possibility for you, to gain enhanced prestige amongst your customers.

Enjoy the benefits of CLS as a third party of BayerischeLandesbank
Given our long, vast experience as a provider of treasury clearing services and due to our function as central clearer (Girozentrale) to the Bavarian savings banks, AAA rated Bayerische Landesbank, located in the center of the CLS time zone, is ideally situated to offer you the advantages of CLS as a 3rd party.

According to independent findings the outstanding service quality of Bayerische Landesbank, with which you, of course, would automatically be provided for CLS transactions, is second to none. Amongst others, our service includes highest flexibility, competitive pricing, attractive conditions, sophisticated technology and detailed reporting, tailored to your needs. For us, you are more than just an “account number” and Bayerische Landesbank, being a global niche player, knows exactly your needs as a 3rd party.

A summary
Continuous Linked Settlement which until now is a unique system for FX settlement risk reduction and for producing efficiencies in operations, expenses and funding will revolutionize FX business and its market structures today. In Bayerische Landesbank and its CLS 3rd party service you will find the ideal partner for both your todayís and future needs.

 

Prepared by Bayerische Landesbank
Financial Institutions Division

 


Settlement Risk
Background  to CLS
Custodians
Complex?
Worth having waited
Global FX
Radical change
3rd Party customers
The Future

 

 
 

 

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