CLS places FX industry at the crossroads

saimafarooqi

Despite steady progress by CLS to eliminate settlement risk for the foreign exchange markets, dealers still have to contend with how to manage settlement risk on the 45% of forex trades that fall outside of the industry utility's remit.

Since last autumn in particular the expectation has become that, if a bank wants to be an FX bank, it needs to join CLS to settle trades because the risks are not fully priced in.

However, according to one forex dealer, concerns over settlement risks falling outside CLS were recently highlighted when a Middle Eastern bank received payments without having made any. "CLS was designed to get around the whole conflict of settlement risk but it is limited in the number of participants and on currencies," said the dealer.

The dealer thinks two things are going to have to happen. "Either the regulators are going to have to force the banks that want to participate in foreign exchange into CLS, so you go the prescribed regulatory route and therefore mitigate risk that way. Or, the banks are going to have to price CLS-settled currencies versus non-CLS-settled currencies differently. But right now the industry as a whole does not look at that risk," he said.

Initiatives such as the CLS-Traiana joint venture will come some way towards managing some of that concern as it will aggregate all currencies, not just CLS currencies. "It's a step forward in reducing settlement and operational risk," said another dealer. "It's not the end goal but it's probably a step in the right direction."

So far four banks have signed on: RBS, Citi, Deutsche Bank and JP Morgan, and a further four are in ongoing discussions to join.

The price change by CLS is another step to more accurately reflect settlement risk, even if it is an increase. "I had to say to my guys internally that you have to look at CLS as an insurance premium and that is reflected much more in the new pricing," said one head of operations. He added, however, that the price rise would be passed on to customers.

For those currencies and customers not part of CLS, there is a rumour that some clients are being told by the front office at banks that they can't trade with them unless they can settle through CLS.

As the forex dealer predicts, either people are going to get onto CLS or they're going to get priced differently. "It's as simple as that. The industry is going to bifurcate."


Comments? Email saima.farooqi@incisivemedia.com

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