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Page last updated
February 15, 2003




The Future of CLS

With Continuous Linked Settlement (CLS) at last on the brink of going live, thoughts are already turning to consider its future possibilities. Plans are progressing at speed to add the additional currencies of Norwegian Krone, Swedish Krona, Danish Kroner and Singapore Dollar, with the Hong Kong and New Zealand Dollars planned to follow on at a later stage.

Based purely on the volumes available from the initial business of FX deals, the direct cost per transaction settled via CLS is expected to be very similar to that experienced pre-CLS, at least initially. However, there are of course significant benefits from using CLS for settling FX deals, notably the elimination of Settlement (or "Herstatt") Risk, the raison detre of creating the system in the first place. In addition, real-time settlement information will become available to institutions for the first time, aiding improvements in liquidity management. Improved STP rates will be realised as banks ensure that their back-office processes and systems are made capable of meeting the demands of CLS, and because of the huge reduction in volumes of FX related payments, with their associated reconciliation issues. Finally, an expansion of business between CLS participants is expected as traders are granted increased limits as a result of the settlement risk impact of CLS and this may well improve the usage of established currency portals in order to find new counterparties.

Does it stop there?
The simple answer is 'no'. Most settlement member banks that are offering a Third Party service have built 24 hour real-time web browser functionality, enabling third party customers to view all the relevant details about the status of trades submitted for settlement in CLS, as well as the positions on their multi-currency CLS Nostro account. Many of these service providers have also built or are in the process of adding functionality enabling third parties to submit new CLS-eligible FX trades, as well as amend and cancellation instructions.

Whilst early experience suggests that it is unlikely many third parties will wish to use such functionality initially, other than as a contingency for SWIFT, clearly there is potential for all CLS participants to cease sending MT300 confirmations over time. CLS Services are working with GBSSI.com in order to establish a database where CLS participants can register whether they send and/or wish to receive MT300 confirmations, as a means of facilitating a smooth transition from SWIFT to web submission as and when participants are ready to switch. The GBSSI database is expected to be on show at SIBOS in Geneva.

Before it can be allowed to move into or develop new spheres of operation there is, quite rightly, a need for CLS to prove itself in a live environment, in terms of successfully reducing FX settlement risk. This 'proving' phase will include the successful take on of new currencies, settlement members and a large number of third party users. Assuming this is all achieved without major hiccups, and that the regulators are kept on board, then attention will begin to refocus on developing new applications for CLS. Considering the very high levels of investment sunk into developing CLS to date, it is important that this does occur following a successful 'proving' phase; this way the direct processing costs levied on CLS settlement members may be reduced to below the barometer level of $1.50 per transaction.

The unprecedented levels of testing involved in getting the CLS system and its settlement members to their present state are proving the robustness of the infrastructure and processes created - this is a key enduring attribute. When coupled with the system's scalability potential it can be seen that there are further significant opportunities for industry level change in the longer term and that CLS has the potential to play a part in improving Straight Through Processing (STP) rates in any arena where there is a settlement component that includes Foreign Exchange. The similarities between "Payment versus Payment" (PVP), which CLS introduces to the world of Foreign Exchange, and "Delivery versus Payment" (DVP) reinforces this point.

Some potential future developments are briefly discussed below.

Managing Intraday Liquidity
Given the values involved, just with regard to the 'first wave' CLS currencies, there are new liquidity challenges to be resolved. These issues have been well documented previously elsewhere and largely revolve around the need for settlement members to pay-in to CLS Bank at prescribed times. The development of a second CLS settlement session could help resolve some of these issues, for instance by enabling settlement members to manage their net positions more fully within CLS; i.e. certain "inside / outside swaps" could become "first session / second session swaps". This method would reduce the small amount of residual settlement risk reintroduced by settling one leg of each I/O swap outside of CLS. However this will need to be considered against operational cost implications.

There are also strong arguments for enhancing CLS in the future such that the main instruments used by banks to manage liquidity can all be settled within CLS. Soon, when CLS goes live, treasury teams will be faced with the prospect of settling FX forwards within CLS but other instruments via their national RTGS system. By integrating money market instruments into the CLS process, not only is liquidity management more efficient but the perennial goal of consolidated real-time balance information can be achieved. A key point to make here is that the benefits attributable to the inclusion of money market instruments within CLS will be widely available, since third party customers would no doubt also be provided with the ability to access a single source of information relating to their real-time positions in CLS across all participating instruments and currencies.

Whilst it remains unclear when, rather than 'if', charging for intraday liquidity will become established, the inclusion of money market instruments in CLS could greatly reduce its cost impact and assist in achieving benefits available from the introduction of intraday credit interest, which would almost certainly have to follow 'hot on the heels' of intraday charging.

SecuritiesSWIFT statistics show that the cross-border securities market has grown substantially in recent years, with growth approaching 50% in some years. This trend is expected to continue.

By capturing cross-border securities traffic, CLS daily volumes could increase by around 25,000 - 50,000 transactions per day initially, an increase of up to 30% over the projected FX trade volumes. Given the amount of consolidation that has occurred in the custody market since the early 1990s, leading to today's position where the majority of business is conducted by literally a handful of players, it appears reasonable to predict that market consensus to utilise CLS will be reached without too much anguish.

In addition to the obvious benefits relating to processing costs, real-time information and improved reconciliation, the use of CLS to fulfil the Payment element of DVP in the securities market would bring significant advantages to investors, who could have complete confidence over settlement when trading across different timezones, exchanges and currencies. The intended move to T+1 settlement for securities within 2-3 years, initially in the US and Japan, demands a T+1 FX settlement capability: CLS fits the bill.

Whilst there are undoubtedly issues to be resolved in order to make this market work within CLS, for instance around the need to use common identifiers for funds, the CLS Custody Working Group is already producing recommended solutions. A further potential implication of this development is the extension of the CLS settlement window, or perhaps the creation of a second window later in the day, which might bring some liquidity management benefits as discussed earlier.

It remains early days for CLS and the system is still to prove itself in a BAU environment before it will achieve critical mass in terms of participants and FX trade volumes, let alone branch out into new applications. Nevertheless, after numerous setbacks it is fully accepted amongst its settlement members that CLS is here to stay, and as such it is now time to embrace the benefits that CLS brings and look enthusiastically to future benefits available. One of the early successes CLS has been the unprecedented levels of co-operation between the first wave settlement members involved in testing, which bodes well for reaching consensus on the future expansion of CLS into other markets.

In short, it is becoming clearer that in the longer term CLS should be able to provide STP benefits in a number of areas and, with incremental development, could theoretically lend itself to any market where there is a settlement component and where physical financial instruments have been or can be 'dematerialised'. Watch this space!


Ian Ellis
Product Manager
CLS Third Party ServicesTransaction
Trade & E-Channels
Barclays Bank PLC


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