What industry issues will the alternative PvP model address?
Settlement risk, the predominant threat currently facing the foreign exchange market, is the risk that one party delivers the currency it sold but does not receive the currency it bought from its counterparty, resulting in a loss of principal. Recently, there has been a rise in settlement risk due to an increase in global trading of currencies that are not eligible for CLSSettlement, our PvP settlement service.
This is why CLS, which is uniquely placed at the heart of the FX ecosystem, is collaborating with the public and private side to address rising settlement risk by developing an alternative PvP solution for a broader range of currencies and market participants. In addition to settlement risk mitigation, the service will also deliver liquidity optimization and enhanced operational processes.
Why is there such an imperative to solve for the increase in settlement risk now?
Policymakers and market participants alike are calling for greater adoption of PvP within the FX market to further enhance financial stability. There are two public policy initiatives underway to respond to this industry challenge, including the work done by the Committee on Payments and Market Infrastructures, which led to a recent initiative to encourage PvP adoption across the FX market through building block 9 of the Financial Stability Board’s (FSB) “Enhancing Cross-Border Payments Stage 3” roadmap.
The recent update to the FX Global Code by the Global Foreign Exchange Committee (GFXC), also places greater emphasis on the use of PvP settlement mechanisms where available and provides more detailed guidance on the management of settlement risk where PvP settlement is not available.
With which organizations is CLS collaborating for the initiative?
As a financial market infrastructure (FMI) that operates the leading settlement system for FX transactions (CLSSettlement), we are uniquely positioned to work closely with both the public and private side to highlight the importance of settlement risk. We have been raising awareness of the issue by presenting to the GFXC and several regional FX committees, responding to public policy consultations, publishing whitepapers and facilitating industry dialog. In parallel, we are conducting an industry pilot with 12 of our global settlement members to evaluate potential alternative PvP solutions. This includes a detailed data analysis of the settlement members’ trade data to better understand settlement risk for currencies that are not currently eligible for CLSSettlement and the settlement mechanisms for FX trades settled in those currencies. This work will enable us to contribute the combined findings and conclusions towards a range of key policy initiatives.
Will the alternative PvP model be built from scratch?
As part of the industry pilot, we are exploring the feasibility of multiple alternative PvP designs with a view to broadening access to currencies and market participants. We recognize that there needs to be a significant degree of flexibility in the operating model and other aspects of the service design for any alternative solution to be successful in mitigating settlement risk and optimizing liquidity. In parallel, we are expanding access to CLSNet, our automated and standardized bilateral FX payment netting calculation service, to further facilitate settlement risk mitigation and liquidity efficiencies for a broader range of market participants.
An example of how we are diversifying connectivity options to CLSNet is in our collaboration with Finastra, one of the world’s largest fintechs, where we are diversifying CLSNet’s connectivity options by providing Finastra customers with direct access.
As an FMI at the center of the FX ecosystem, we have the experience and expertise of managing operations at scale to the highest of industry standards, and we are confident we can develop an alternative PvP solution that meets the needs of the industry.