OSTTRA tackles FX risk with new settlement orchestration and expanded optimisation tools

OSTTRA has added settlement orchestration to its suite of FX services to help clients optimise their derivatives portfolios and tackle critical challenges in the market

Long known as a leader in post-trade processing and optimising portfolios across multiple asset classes, OSTTRA has partnered with Baton Systems to launch an FX payment-versus-payment (PvP) service that offers settlement risk mitigation for riskier currencies. The partnership, announced in March 2024, aims to address the growing risk of FX transactions traded in the market that are not eligible to settle within established settlement services, with offshore renminbi (CNH) at the forefront.

Under the terms of the partnership, OSTTRA now operates the rule book and technology governing the end-to-end process and orchestration of funds. As such, the rule book defines the ownership of funds at each stage of the PvP workflow as recorded on the distributed ledger, thus ensuring ownership of funds is only transferred when both counterparties have fully funded settlement accounts. Given that OSTTRA has been providing the matching capability for Core-FX since 2018, this effective collaboration between the two firms provided an ideal environment for a smooth operational transition.

With billions of dollars settled daily through Core-FX – and more than $8.1 trillion since its inception – Baton’s distributed-ledger technology (DLT) has already left its mark on the FX settlement landscape. To scale the service, Baton sought a partner with a sizeable network, while OSTTRA – whose links extend to the world’s largest banks and buy-side market participants – was looking to develop its own settlement orchestration offering or collaborate closely with an existing service.

“After an extensive market review and due diligence process, OSTTRA concluded that Baton Systems was a very good fit for what we were looking to do,” says Steve French, head of FX and securities product strategy at OSTTRA. “Baton Systems has a proven DLT PvP solution that we look forward to bringing to the wider market to address FX settlement risk concerns.”

The launch of the PvP service is one step in OSTTRA’s broader strategy to improve the post-trade market structure of over-the-counter markets. It follows on from a strong push by the Bank for International Settlements (BIS) for the FX industry to reduce FX settlement risk – commonly known as Herstatt risk – by building a robust PvP framework for FX transactions. BIS’s concerns revolve around the growing potential of settlement failures in the $2.1 trillion of daily deliverable FX turnover that sits outside existing PvP platforms.

Already processing more than 80 million bilateral post-trade FX transactions a month, OSTTRA is well placed to offer on-demand PvP netting and settlement on a bilateral basis across its sizeable network. However, as part of its mission to optimise and de-risk the portfolios of its clients, particularly market-maker banks, investment managers and large corporates, OSTTRA intends to evolve the service to include settle-to-market (STM) functionality – where the variation margin transferred between counterparties is recorded as a legal settlement of a derivative contract – thereby significantly reducing derivative regulatory capital required under the standardised approach to counterparty credit risk (SA-CCR).

“The initial focus of the new settlement service is on the finality of PvP to reduce settlement risk in certain currencies that stand outside the established settlement networks, with CNH being the most obvious one,” says French. “But our greater mission is to reduce overall risk through compression and optimisation – in addition to improving settlement opportunities – to bring down exposures as much as possible.

“The Holy Grail really is to process STM along with PvP settlement – an approach that is much more efficient because it involves linking variation margin with settlement risk, for which there is a massive appetite in the FX industry.”

 

Broadening portfolio optimisation

Since its inception, OSTTRA’s focus has been to provide innovative solutions to ensure participants can optimise their portfolios in the prevailing regulatory framework, and interact with any new initiatives in the most efficient way.

The introduction of uncleared margin rules in 2016, and SA-CCR most recently, has added a layer of complexity to market participants’ post-trade FX workflows since they are now compelled to closely monitor their exposure to each counterparty to minimise the amount of initial margin they are liable to post and the amount of regulatory capital they have to hold.

 

OSTTRA offers clients a multitude of options to help reduce the regulatory capital they need to hold and decrease the funding costs of their derivatives portfolios. The choice depends, to a large extent, on whether they want to minimise their cleared and non-cleared initial margin exposures, their leverage ratios, and risk-weighted assets under the internal models method and standardised approach, or gross notionals, among others. However, for most participants, it is highly relevant to consider all of these aspects at the same time to avoid negatively impacting one metric when optimising something else. Therefore, the key objective in OSTTRA’s optimisation solution is to consider all the relevant metrics concurrently, rather than taking a piecemeal approach.

“We recognised early on that focusing on one risk factor in isolation can negatively impact other key issues elsewhere and actually increase the cost of maintaining a portfolio,” says Mattias Palm, head of triReduce FX and commodities at OSTTRA. “Unlike other vendors, we are able to optimise simultaneously across multiple risk factors to ensure maximum efficiency while diminishing potential unwanted side effects.”

With links to clearing houses and efficient optimisation choices, OSTTRA’s clients can now minimise their risk exposures even further and more efficiently. Participants can optimise their bilateral and cleared exposures under SA-CCR, alongside their STM exposures. In a similar vein, OSTTRA collaborated with LCH’s ForexClear to develop a mechanism for clearing FX forwards without negatively impacting cleared initial margin.

Alongside the addition of PvP settlement to its optimisation options, OSTTRA has sought to extend the compression of trades in deliverable currencies not included in existing settlement services. The encouraging results achieved with compression of deliverable Russian rubles mean the same concept is now being applied to other non-Continuous Linked Settlement currencies, with particularly promising results to date with CNH. A key concept is that, during such a compression run, specifically targeted transactions are terminated to reduce settlement risk and gross notional at the same time.

“With all of these different tools at their disposal, it has become easier for our clients to optimise their portfolios because they can do more with less,” concludes Palm. “But the overall idea is that, for optimisation to be truly efficient and competitive, it needs to include all cleared and uncleared margining options, as well as capital and gross notional optimisation, compression, PvP settlement orchestration and STM – all of which should be available at the same time to ensure the most optimal results.”

Since the risk factors that are optimised during a weekly run depend on the needs of clients taking part at that time, OSTTRA is working to increase the scope of every run so that all market participants can optimise their portfolio most efficiently in the shortest timeframe possible.

OSTTRA was named Best settlement orchestration initiative and Best compression/optimisation service for FX at the FX Markets e-FX Awards 2024.

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