Banks worldwide remain uncertain about the impact of continuous linked settlement on foreign exchange trading, with more than a third believing the risk reduction effort will inadvertently add new layers of complexity to back office operations.
The conclusions stem from a survey of banking operations professionals conducted by SunGard ePI, a provider of exception management systems to the financial services industry. While the majority of banks believe the advent of CLS in the forex market will improve current STP rates, a significant minority (36%) contend that it will make the settlement process more complex.
The survey also reveals that the enthusiasm of settlement member banks for offering outsourced services to third parties is not being reciprocated by potential users, who have yet to grasp the full implications of the changes for their back office operations.
Colin Day, of SunGard ePI in Europe, comments: "This latest SunGard ePI survey amongst the global top 500 banks indicates that CLS settlement and user members have to date concentrated on building and promoting the settlement services which they want to offer the inter-bank market, but have not yet made their third party institution customers aware about the terms on which these services will be offered."
He attributes the mixed response to the question of whether the system will make settlement more or less complex to the introduction by CLS of a new matching layer into the settlement process. "On the other hand, respondent who felt that CLS would make FX settlement less complex were mainly thinking of the net payment schedule which CLS introduces with more than half (58%) aware that CLS would reduce their nostro volumes," he says.
CLS is designed to reduce systemic risk in FX settlement, caused by the possibility of an institution failing to honour one leg of an FX transaction and thereby causing a liquidity freeze. To achieve this, CLS introduces a series of four daily net payment schedules for a select group of 60 or so big-ticket settlement members. These payments must be timely or the bank has to pay charges to one of a handful of global liquidity providers.
CLS also introduces an extra layer into the matching process, since the matching routines between banks cannot be replaced with CLS notice matching. In fact, respondents saw the greatest source of CLS exceptions being non-match notices from CLS occurring as a result of banks’ differing confirmation speeds.
"Perhaps the most important point emerging from the survey is a lack of focus, so far, on the increased risk associated with exceptions in the CLS settlement process," says Day. "Most respondents (70%) recognised that volumes of exceptions would fall, but less than half (40%) recognised the need to prioritise CLS exceptions because of the increased value of netted transactions in the payment schedule, and therefore the increased risk when these larger transactions go wrong."
Day believes the global banking infrastructure still has a significant way to go in preparing for CLS, both from an awareness and from a systems point of view. "The object of CLS is reduce systemic risk. That will not reach full effectiveness until consistent standards are introduced throughout all tiers of the FX community," he concludes.