Best settlement initiative: CLS

Created 20 years ago to mitigate FX settlement risk, CLS continues to lead the settlement sphere with new solutions designed to meet the challenges of an ever-evolving FX market

Amid challenging economic and geopolitical conditions not seen for more than a decade, market participants naturally seek solutions to mitigate their market and operational risks. Many are turning to market infrastructure provider CLS, much as they did when it was first created in 2002.

CLS’s launch was a turning point for market participants, as the public-private initiative brought order to an FX market in which settlement risk had been ubiquitous. For the asset management community, which accesses the service via third-party providers, the certainty of settlement allows them to trade with a larger pool of banks and market participants in a safer and more secure way.

Consequently, asset managers have been major contributors to CLS’s growth throughout its lifetime. In the past three years alone, they have largely been responsible for the 25% increase in the use of CLSSettlement by third-party participants, which also includes corporates, banks and non-bank financial institutions. It is estimated that 80% of the top 250 asset managers – excluding China-based investment managers – are now settling through the service.

“Twenty years ago, the asset manager landscape looked very different,” points out Lisa Danino‑Lewis, chief growth officer at CLS. “At the time, asset managers executed FX primarily with their main custodian because the risk of trading outside that sphere was too great. The introduction of CLSSettlement gave the asset management community more options when trading FX because it mitigates settlement risk.

“Consequently, CLSSettlement has seen a massive increase in asset manager participation since its launch in 2002.”

The safety CLS provides has significantly contributed to the fivefold expansion of the FX market between 2002 and 2022, Danino‑Lewis points out. During that time, CLS itself has grown significantly and now settles an average of $6.5 trillion of payment instructions every day in 18 of the most actively traded currencies.

However, as the trading of emerging market currencies has gathered pace in recent years, a rising fraction of FX volumes involve a non‑CLS currency and are therefore ineligible for CLSSettlement. Integrating a new currency into CLS’s settlement service is a complex and protracted regulatory and legislative process that can be impacted by macroeconomic policy. As a result, CLS is focusing its efforts on enhancing the CLSNet platform – a standardised, automated bilateral payment netting calculation service – across 120 currencies.

CLSNet supports market participants in significantly netting down their overall positions, thereby reducing their funding requirements and, consequently, their number of outgoing payments. The automation of the netting calculation process offers significant operational efficiencies and enables marked improvements in market participants’ liquidity positions.

The service experienced a 400% year‑on‑year increase in average daily volume of net calculations in the first half of 2023 alone, and with the recent addition of Deutsche Bank, CLSNet now comprises eight of the top 12 global banks. The middle of June 2023 saw a record daily notional of $306 billion of net calculations in the service.

CLSNet should be especially useful for asset managers when, starting in late May 2024, US and Canadian securities transactions will need to be settled within a T+1 timeframe. Given the limited time that market participants will have to reconcile the ensuing FX transactions from those securities trades, using a service that calculates the net FX positions, such as CLSNet, could help improve intraday liquidity.

“A large number of market participants already mitigate risk and increase operational efficiency using our netting calculation service. For those that don’t, it would make sense for them to start using CLSNet,” says Danino-Lewis. “With this move to T+1, market participants will likely want to settle those transactions gross if they can fund them on a net basis. But, because they have a condensed time period for post-trade operational processes, the challenge for the asset management community is to automate that process front to back. CLSNet can help them fully automate and straight-through-process the procedure so they can achieve the most efficient outcome.”

Another CLS post-trade service that can help asset managers is CLSTradeMonitor, which provides a view of the status of CLSSettlement payment instructions across multiple custodians in one place. 

 

CLS was named Best settlement initiative at the 2023 FX Markets e-FX Awards.

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