Settlement risk elimination to the fore

Despite all the press, the central clearing debate is getting, the largest and most significant risk facing the foreign exchange market remains settlement risk.

Experiences from the collapse of the Icelandic banks last year and, more recently, banks in the Middle East, highlight that the need to eliminate settlement risk is still paramount. In the past 12 months, settlement utility CLS has upped the number of CLS member banks to 59, and doubled the number of participants to 6,043 from 3,336 a year ago. Meanwhile, CLS plans to add the baht, lira, and Chilean peso by the first quarter of 2011 and aims to introduce same-day settlement for USD/CAD next year. Although difficult, same-day settlement between the US and Europe is possible, but would require US payments to be made early US time. Same-day settlement between the US and Asia, however, is nigh on impossible.

To that end though, as reported by FX Week's sister title Risk.net, banks themselves could be making changes. "The operating hours [of CLS] won't change, but the way banks operate could," said one forex banker to Risk. CLS estimates 35% of foreign exchange volumes are internal to banks - either due to trades with their own account-holding customers, or transfers between different subsidiaries of the same bank. The forex banker suggests setting up banks as single legal entities, rather than having multiple bankruptcy-remote subsidiaries in various jurisdictions, would help reduce settlement risk. "Someone with a single legal vehicle strategy has fewer problems than someone with different entities for North America, Asia-Pacific, Europe, the Middle East and Africa," he said.

This would remove the need for banks to shift foreign exchange portfolios within their own organisations from one legal entity to another, but there are limits to how far this approach could be taken. "Some customers might want to have a counterparty operating under the same local laws and some counterparties have legal limits on who they can trade with," said Leigh Meyer, Citi's London-based global head of FX operations.

Some of these challenges, alongside others, will be discussed at a panel discussion at FX Week Europe in London on November 17. For more details see www.fxweekeurope.com.

Saima Farooqi, Editor

Comments? Email saima.farooqi@incisivemedia.com