Policy makers are paying closer attention to settlement risk – but an increasing share of FX transactions are settled without payment-versus-payment (PvP) protection.
With different initiatives seeking to address this, collaboration and industry engagement have an important role to play in shaping future solutions and driving adoption. Nasir Ahmed, Head of Swift UK and Ireland, explains why industry engagement is crucial, and discusses how FX market participants of all sizes can be encouraged to engage with PvP services.
Why does the issue of PvP need to be addressed from a global perspective?
With greater scrutiny from policy makers and international bodies, there’s more pressure than ever for the FX wholesale industry to eliminate settlement and counterparty risks. And while a large portion of the most actively traded currencies are currently settled PvP in CLS, there is still a significant proportion of FX transactions that are not being settled PvP, especially in emerging market currencies.
There are a number of reasons for this. For one, the volume of trades in emerging markets continues to grow, leading to more FX transactions against emerging market currencies. Some of these flows are not under PvP protection, because there is no available PvP arrangement that covers many of these currencies.
Other reasons worth mentioning are the disparate operating hours of local RTGSs or inconsistencies across jurisdiction about the legal definition of settlement finality, that have been captured in the recent report issued by the Committee on Payments and Market Infrastructures (CPMI) on the causes of non PvP settlement. In short, the market structure we have today simply doesn’t facilitate PvP protection across all currencies.
How can this issue be addressed?
There are a number of things that we can leverage. One is the greater use of CLS, which has PvP in place: in 2022, we have seen double-digit growth on the Swift network, driven by CLSSettlement, the service that settles FX transactions on a PvP-basis for 18 eligible currencies. The CLSNet service, meanwhile, offers an optimised bilateral netting calculation service and is open to 120 currencies, providing another way to mitigate the risk on those non-CLS currencies. In 2022, new key players including Deutsche Bank and UBS have onboarded the service.
On another note, innovative fintech solutions are arriving in the market, such as Baton, which supports PvP between two counterparties on the blockchain. The industry should continue exploring the different ways that new technology can help solve these longstanding problems, while being mindful of the scale, business conduct rules and reach needed for any solution to be beneficial.
A further opportunity lies in driving greater adoption of initiatives like Swift gpi and gpi for Financial Institution Transfers that offer more transparency over the MT 103 and MT 202 flows processed through the correspondent banking network. It’s important to continue this work and make sure that as many players as possible are embracing those solutions.
Where does collaboration and industry engagement fit in?
The financial industry has a long-standing tradition of market dialogue and collaboration. Associations and working groups, supported by market infrastructures and policy makers, frequently work together towards shared goals of financial stability, security and resiliency. As such, industry engagement and collaboration have an important role to play in tackling issues like the lack of PvP protection for certain FX transactions. Different bodies and organisations can help to foster this engagement, including cooperatives like Swift, central infrastructures like CLS, industry associations like GFXD, and policy makers like the Committee on Payments and Market Infrastructures (CPMI).
CPMI, in particular, has been doing some important work to build a dialogue in the market about how to increase the adoption of PvP – and there’s a significant opportunity for the industry to collectively contribute to this dialogue.
So far, the parties taking part are mainly larger institutions and fintechs, with less engagement from
the smaller players. These typically lack the resources needed when it comes to listening to regulators and policymakers, or working with the community to solve a common challenge.
How can broader engagement be encouraged among smaller FX market participants?
It’s important to engage all participants in the chain in order to reduce ecosystem risks and make the discussion open to all. Ultimately, it’s important to tackle the issue in a way that is practical and reasonable, and that can at some point be adopted by the entire ecosystem. If you don’t have adoption, people won’t come onto your platform or use your service, which means you’ve failed in your effort to solve the problem.
When it comes to meeting the needs of smaller players, a key focus should be on circumventing barriers such as high entry costs, while still ensuring stringent levels of security and resiliency. A good example is Swift CLS third party service, which has seen increased adoption: around 30,000 indirect participants are now benefiting from CLSSettlements’ operational excellence, liquidity optimisation and risk management framework for their FX transactions via direct settlement members. Also key is enabling users to leverage the investments they have already made in RTGS connectivity, standardised messages and existing infrastructures, such as Swift’s single window to more than 235 market infrastructures globally.
At this stage, the industry is still searching for a solution – but there are still plenty of opportunities that can be leveraged today. As development continues, the focus should be on inclusiveness, particularly when it comes to the needs of intermediaries and local or smaller players. There is a clear need for solutions that are cost-effective and easy to adopt – whether that means building on existing capabilities, or making sure that any new solutions are interoperable and future-proof.