Standardized Netting of FX Payments Moves Closer to Reality

The CEO of CLS, David Puth weighs in on standardized netting of FX payments


David Puth, CLS
CEO of CLS, David Puth

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The following article is written by the Chief Executive Officer at CLS, David Puth.

While some areas of financial markets and technology have undergone significant development over a number of years, there is clearly an opportunity for post-trade partners to do more – including in foreign exchange (FX). CLS sits at the heart of this market and sees approximately $5 trillion of payment instructions settle through our core service every day.

In the search for ever more ways to improve liquidity and efficiency, we are focused on innovation centering on the payment efficiency of our clients’ underlying supporting infrastructure. For traders in a market of such size and scale, efficient netting of payments can have a significant impact on intra-day liquidity demands and an institution’s overall ability to effectively manage risk.

The inception of CLS in 2002 addressed many of these issues for institutions that use our services. Our role is to protect our settlement members, 66 of the world’s leading financial institutions, and 21,000 of their clients, from the most significant risk in the FX market – settlement risk.

Time for innovation

However, not all currencies or market participants access our core settlement service. And while some participants are currently capable of bilateral payment netting for trades not settled in CLS, this practice is not universally adopted. Various bespoke approaches to payment netting lack standardization, scalability, and efficiency, which in turn increase operational risk. Therefore, many institutions limit their payment netting activities to their larger counterparties.

In addition, many FX market participants across the buy-side and sell-side do not use bilateral payment netting and instead settle a significant portion of their non-CLS trades on a gross basis. Gross settlement without netting requires access to deep liquidity, which requires institutions to allocate more collateral and capital.

To address this gap in the market, we are working closely with the global FX market community to develop CLS Netting, a standardized, bilateral payment netting solution for all market participants, regardless of whether or not they currently have access to CLS.

Netting already forms a crucial part of our settlement offering and the facilitation of standardized netting for a wider group of institutions will significantly improve the way currency payments are netted across the globe, with tangible benefits for clients.

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Participants will be able to submit FX instructions for six products and 24 currencies. In addition to the 18 currencies CLS currently settles, we will offer payment netting for the Chinese renminbi (offshore), Czech koruna, Polish zloty, Russian ruble, Thai baht and Turkish lira.

CLS Netting will standardize bilateral matching and payment netting in these currencies, manage payment netting positions through a single interface and enable automated reconciliation. This will decrease the volume of payments manually initiated, resulting in fewer late or failed payments.*

The strong appetite for a globally standardized netting service is demonstrated by the desire of leading international financial institutions to become early adopters. So far, 14 have committed to work with CLS, including: Banco Actinver, Bank of America, Bank of China – Hong Kong, Bank of Tokyo-Mitsubishi UFJ, Citibank, FirstRand, Goldman Sachs, Goldman Sachs Asset Management, HSBC, Intesa Sanpaolo, JPMorgan Chase, Morgan Stanley, Neuberger Berman, Northern Trust – with others joining this group in due course.

Use of distributed ledger technology

The speed at which technological innovations are developing leads us to focus our efforts on those post-trade processes where change is possible. Our goal is to continue to expand and develop the service with new currencies, products, and technologies, and the adoption of distributed ledger technology (DLT) will be central to this.

In addition to submitting FX instructions over existing SWIFT-based channels, participants will have the option of connecting directly to CLS Netting via a highly secure, permissioned distributed ledger, administered by CLS.

As a founding member of the Linux Foundation’s Hyperledger Project, we have long acknowledged the benefits of distributed ledger technology and have worked diligently over the past 12 months to explore how DLT can be used to improve efficiencies, security, and resilience in the global FX community.

It is crucial that the basic fabric of any distributed ledger technology we use for the CLS Netting platform adheres to high standards and resilience. We will incorporate DLT capabilities in a way that is meaningful to our members and participants, and we believe it has enormous potential.

To facilitate broad adoption amongst industry participants, we will collaborate with IBM to develop the underlying technology, which will be based on the Hyperledger fabric rather than a proprietary solution. IBM is a key member of the Hyperledger Project and has been a partner of CLS since our inception. Our partnership creates the foundation for new technology that can be applied not only to CLS, but more broadly across the financial industry.

By bringing our expertise and connectivity across post-trade FX, our never-ending focus to improve security and resilience and the innovation of DLT together, CLS is well-positioned to be part of the next wave of technological innovation taking place across financial services.

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