The true cost of pre-settlement netting

In its July communiqué, the CLS board said it would reject netted trades, for the time being, due to its unequal impact for all. As a not-for-profit fixed-cost business, CLS pricing is based on a volume model, so the more volume the market settles through CLS, the lower the price. This business model, CLS claims, has worked - the average price of all instructions for members was down to 54p in August, and down to 38p for one customer, as volumes surged.

But for some banks that hasn't been enough. Burdened with a growing proportion of low-value tickets from algorithmic traders, the cost pressure of processing these trades has become critical. This is notwithstanding the stress this type of flow is putting on banks' back-office systems.

As such, these banks - a small but significant group of CLS members - are now beginning to net trades pre-settlement, and will now have to settle them outside CLS. It's no secret that alternative settlement systems are being developed in the market that meet the very real need for these banks to net.

However, as Rick Schumacher, director of products at Wall Street Systems, correctly points out, in the end it will be the banks that drive development in this area (see page 9). The costs of doing this will centre on the $5 million they paid to become CLS shareholders, and the assumption that the alternatives are cheaper.

Costs for the smaller member banks on CLS could, however, be more significant, as less volume from the major member banks will drive up the price of settling over CLS. Some argue that, if the top 10 foreign exchange banks choose to withdraw their volume from CLS altogether, smaller banks could be forced out of the market. As dramatic as that might sound, it is something to think about.

Meanwhile, from January 1, 2008, the other industry-owned utility, Swift, will enable high-volume customers to use a three-year fixed-fee contract, equivalent to 95% of the messaging charges paid by the customer for the past 12 months. It also includes an entitlement to increase messaging use by 50% in value at no additional cost. High-volume customers account for almost 80% of all messaging traffic exchanged over Swift. A 15% rebate and a 5% reduction will also apply to all Swift customers for FIN messaging. This comes on top of the 10% price reduction granted in 2007.