Brian Charlick

FX has important choices to make

September 2021 in Supplements

By Brian Charlick, Principal Consultant at CGI

Settlement risk within the forex market is beginning to rise once again. According to BIS, the reason is attributable to the rise in Non CLS settled currency trading as a percentage of the entire forex market. Indeed the size of the non settled forex market has increased from 50% to 60% of the Market since 2013; the total value of that 60% is estimated by BIS to be $8.9Tn. Much of this growth is due to the rise of the Chinese Renminbi, and to a lesser extent the Russian Rouble. The risk of settlement failure is therefore growing with the rise in these and other minor, non CLS, currencies and can be assumed, will continue to grow for the foreseeable future.

One way in which settlement, or Herstatt, risk could be removed is using real time settlement. This is a capability being introduced for cash settlement within some countries, such as the UK with Open Banking, but that has not spread to many of the CLS settling currencies, and certainly not for Forex payments.

Indeed, the growth of FX transaction volumes does not look like it is slowing and the demand for real-time settlement is not disappearing anytime soon either. In the near future, we may see some sporadic attempts, but the FX market in general is still some way off. The payment technology is driving forward but the market does not seem ready to adopt it until the path seems clearer and more joined up rather than fragmented by a range of alternative solutions. Perhaps it will take the group of global FX banks to move in a unified direction to sway the market. The alternatives being developed and promoted are growing, leading to a wider spread of use and less cohesion among the market player

We have SWIFT, CLS and ISO 20022 from the established market infrastructure all making advances, but we also have new entrants such as Google, Apple, Amazon and PayPal all offering a new model of clearing currencies for smaller amounts and individuals.

We are seeing DLT and the Central Banks also looking at new models for settlement. The utilisation of tokens could be a new way for CLS to settle, it may also be something to be used by the likes of Visa and MasterCard, thus becoming an even bigger disruption to the market. Indeed, the use of Tokens could be the way to mitigate, although not eliminate, Herstatt risk more than ever and could reduce the demand and need for real time payment v payment, certainly from a settlement risk point of view.

These alternatives for the future will not only require the market to move in a coherent way, but in order to get ahead of these challenges, market participants need to start reviewing their internal operating models and controls, embracing and leveraging new technologies; collaborating with others to ensure a consistent industry approach.

Ensuring the technologies support a process that can adapt and adopt altering market models will be a key to success; being able to control the activity and position a necessity.

One thing is certain; we are in for an interesting period for FX settlements.