FX Markets

CLS on shaky ground with third-party providers

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The weaknesses in the third-party model were exposed this autumn as bank defaults and sharp volatility left service providers with potentially
significant intraday funding and mark-to-market risks. And rumour now has it that JP Morgan has requested some third-party clients to seek out alternative providers.

These risks aren't new though, and in fact have been dealt with by JP Morgan before. In 2005, when its third-party client, futures broker Refco, went bankrupt the bank cancelled all its trades out of CLS and, therefore, all potential replacement risks that it was exposed to through Refco. This may not be the cleanest way of managing risks, and indeed the US bank drew some criticism for taking that action, but it can be done.

Perhaps in the current environment, where credit is still a concern and currency volatility can see EUR/USD collapse from highs of 1.59 in July to 1.25 in November, it's justified for there to be a more active approach to managing these risks. One head of third-party CLS services at a rival bank said, as a third-party CLS service provider, you do have to review who you are taking on. The bank was due to go live with Iceland's now defunct second largest bank Landsbanki as its third-party client but wisely abandoned the on-boarding process.

However, that's not to say there's a pull back from this business. "We've seen quite an influx of new clients," he said. "CLS is back as a hot topic again in the current credit crunch environment, and we see quite a lot of banks that are not on the system yet and didn't feel the need to be, changing opinions."

Meanwhile, CLS seems to be pushing ahead with its aggregation
system that will tackle back-office capacity and ticket processing costs brought on by high volumes of low-value tickets.

The system will see tickets go directly from the front office to be aggregated by CLS with the net position sent back to the bank's back office for processing. It's understood that some members are also looking to have this service rolled out for non-CLS currencies.

JP Morgan did not respond to enquiries.

Saima Farooqi, Editor

Comments? please email

saima.farooqi@incisivemedia.com

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