The FX market has long grappled with settlement inefficiencies in post-trade processes, a challenge that continues to impact market participants and operational workflows. These inefficiencies stem from the complex nature of FX transactions and the intricate web of relationships between trading platforms, clearing houses, settlement systems, and market participants. As the global FX market evolves, addressing these settlement issues has become increasingly crucial for enhancing overall market efficiency and reducing systemic risks.
Loic Moreau, Head of Risk and Operations at LCH ForexClear, sheds light on the current state of FX settlement. “Today, all cleared deliverable FX is settled in CLSClearedFX, a dedicated LCH session in CLS,” he says. This settlement structure introduces challenges.
“The problem with having separate settlement sessions, one for bilateral and one for cleared, means there is a double funding obligation from members to CLS where the payments flowing in do not net with the payouts,” Moreau explains. This situation creates additional liquidity and operational complexities for market participants, highlighting the need for more efficient settlement mechanisms in the FX market.
Kah Yang Chong, Head of Business Development at TradeNeXus, offers further insights into these inefficiencies. “Compared to other financial instruments, OTC FX is fast-paced and complex with its wide array of market participants, trading rationale, and varied workflows,” he explains. “It’s difficult to find a one-size-fits-all solution, which may be why regulations are broad and often carve out FX to some degree.”
So is there anything that can be done operationally and technologically to solve this problem?
Where inefficiencies originate and efforts to solve them
Steven French, Head of FX & Securities Product Strategy at OSTTRA, echoes both points about fragmentation. “The fragmented nature of the FX markets means that execution takes place across a diverse range of trading platforms with multiple paradigms supported including bi-lateral, tri-party, and centrally cleared,” he says. French also notes that while processes and services exist to improve settlement efficiencies, inconsistent adoption across market participants leads to a continued reliance on manual processes, resulting in trade breaks.
Chong adds that while most FX settlements are processed straight-through, the niche scenarios that do encounter issues can have significant impacts with higher operational burden and associated risk.
Data quality is a critical factor in settlement efficiency. “In some cases, systems may not be able to transform or interpret data correctly, requiring manual intervention to input, send, or consume data,” Chong says. “This can lead to manual errors, incorrect interpretation of data or lack of visibility into the process.”
Furthermore, as the industry moves towards shorter settlement cycles, these inefficiencies become even more pronounced. Chong warns, “For example, as currency settlement cut-off approaches, this increases the chances of settlement issues as parties may need to switch settlement methods and rebook trades.”
Are there any solutions to these issues? Moreau details efforts at LCH ForexClear to solve some of them.
“We aim to be the first CCP to send all settlement instructions for physically settled FX into CLS’s main session. And that will be netted with the bilateral settlement,” he says. This integration, slated for later this year, subject to regulatory approval, is expected to address several key issues, including the operational, funding, and liquidity challenges outlined earlier.
The strategy stems from a collaborative effort with CLS and major market participants. “We partnered with CLS to find a solution to address these inefficiencies. And we didn’t set a limit because we had all these problems we identified in mind. And rather than trying to address one and then another, we tried to find a global solution for the CLS-eligible currencies,” Moreau explains.
Chong emphasises the importance of a holistic approach in tackling these challenges. “At TradeNeXus, we continually engage with our clients to identify market challenges and work with our network of counterparties to find a common solution that we can implement to reduce manual workarounds and upstream hardcoding,” he says. This collaborative strategy aims to create a stronger ecosystem for market participants, improving overall marketplace efficiency.
French points to the critical role of post-trade vendors in all of this. “Post-trade vendors have a vital role to play in addressing fragmentation and inefficiencies throughout the trade lifecycle. Settlement risk can be significantly reduced by adopting solutions that are closely integrated with execution, providing transparency into trade breaks and messaging failures,” he explains.
French also underscores the importance of self-service capabilities in gaining real-time oversight and control over settlement risk causes. The question is, should these capabilities come entirely from a technological angle, or are there operational changes firms can make instead?
Technological and operational solutions
While acknowledging that technology will play a role, Moreau warns against piecemeal solutions that might create new problems while solving others. “You may create new issues. So you resolve one and you create another one,” he says. This shines a light on the need for operational efficiency, no matter the level of technological investment.
Chong believes closer collaboration within a firm is part of the solution. “Bringing the front office and operations closer together through closer coordination, transparency of data, and common understanding of the challenges and issues in each area,” Chong says, can lead to a better risk culture and improved outcomes.
He cites recent T+1 securities market changes as an example where such coordination proved crucial. “Our clients shared that they facilitated closer coordination between the teams because of the common need to ensure timely settlement of the shorter-dated trades by working with the front office to address potential pitfalls with shorter timeframes,” he says.
French broadens the scope of the discussion, highlighting the need for improvements in pre-trade processes as well. “While post-trade processes receive much more attention now, pre-trade activities like onboarding firms, counterparties, funds, and accounts also require an overhaul,” he says.
French also points out historical blind spots in post-trade processing. “Historically, post-trade processing has suffered from some blind spots as trades move from system to system, making it difficult to track confirmations,” he explains. This lack of visibility often leads to uncertainty and inefficient communication methods to resolve issues.
Addressing these inefficiencies requires a multi-faceted approach. As Moreau puts it, there’s a need for “better coordination in the industry between the settlement providers, and also better coordination and communication on the technology that is used.”
“Now we know we have new technologies,” he continues, but cautions, “Are they really game changers for the industry? I do not think so. They are providing additional value, but there are already services in place that provide what people need.”
Moreau instead stresses the importance of focusing on fundamental issues. “What matters the most to me is the efficiency of the processes and the ability of banks to recycle payments to avoid having to provide additional funding,” he explains.
Chong believes data and transparency are critical parts of the picture. “Availability of good data (input and output) together with closer linking of front office and operations can solve many of the challenges highlighted above, and this may largely be addressed by technology,” he says.
“TradeNeXus has integrated with State Street’s LINK platform which is an interoperable interface bringing together platforms like FX Connect on the trade execution side together with TradeNeXus post-trade to provide insights into execution audits, trade breaks and settlement status.” On a more granular scale, TradeNeXus has recently partnered with buy-side clients and banks to launch a new feature that allows upfront identification of CNH vs CNY onshore trades at trade matching Chong continues, illustrating how technology can offer solutions where market standards are lacking.
“Technology absolutely has a role to play in solving these problems,” French asserts. He outlines Osttra’s Onboarding, Connectivity, and Operations (OCO) initiative, explaining how it “helps firms address settlement inefficiencies by providing enhanced self-service onboarding and connectivity.”
French also highlights the importance of proactive issue management and transparency. “Advanced monitoring and exception management tools can help clients proactively identify and address issues before they impact settlement,” he says, adding that “improved reporting capabilities offers greater transparency and gives firms the clarity they need to understand and resolve any bottlenecks in the trade lifecycle.”
Technology is solving long standing issues in FX settlement
As the industry moves towards shorter settlement cycles, these technological solutions are becoming increasingly crucial. “With shorter settlement cycles, this may require further optimization of processes with compressed timeframes,” Chong notes. “Technology will play a key part in the solution by taking exceptions management to the next level.”
However, technology is not a silver bullet. The path forward appears to lie in a balanced approach that leverages both new and existing technologies, improved data quality and processes, and maintains a focus on the fundamental goals of efficient and risk-minimised settlement.