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CLS hits back at critics

05 October 2007  |  9055 views  |  0 foreign exchange rates on screen

Bank-backed settlement body Continuous Linked Settlement (CLS) has responded to industry concerns over the spiraling costs of settling FX trades, insisting that it intends to reduce transaction costs by roughly half as volumes rise.

CLS also intends to reconsider its current position on bilateral netting, where payments between two banks are netted off on a daily basis, a practice currently prohibited within the CLS multilateral operating model.

Massive growth in FX transaction volumes, fuelled by the emergence of high-frequency algorithmic trading had sparked fears that the old pricing structure used by CLS would prove crippling for firms that had increased their trading volumes by as much as tenfold and has led to them seeking alternative methods of settlement.

A white paper released by FX vendor Wall Street Systems states that a number of its FX clients had voiced such fears and were increasingly looking to bilateral netting as a means of settling trades.

The white paper concludes that "banks cannot continue to rely exclusively on CLS for their FX settlement and risk needs" and that many are "already investigating lower cost alternatives to CLS".

"Some CLS shareholders are already using CLS purely to mitigate settlement risk and choosing bilateral netting to produce payment instructions. Other banks will follow suit, which may have an impact on CLS in the future."

The Wall Street Systems' white paper was released on the back of a report issued in July 2007 by the BIS Committee on Payment and Settlement Systems which called for a greater reduction of settlement risk by FX participants, citing that, as of April 2006, only 55% of the total FX settlement obligations had been settled through CLS with 32% still settled through the traditional and highly exposed correspondent banking arrangements.

Rick Schumacher, product manager of Wall Street Systems suggests that a possible reason for the limited adoption rates of CLS is the concern over cost and a perceived lack of benefits of scale, an issue made all the more pressing by the predominance of high-volume algorithmic trading. "When CLS first started, banks were doing 10,000 trades a day. But now that has increased to 150,000 in many instances," says Schumacher.

As regards Wall Street Systems' motive for the white paper, Schumacher insisted that "it was not a dig at CLS" and that it is agnostic in terms of how FX trades are settled. "We are just trying to track the industry issues and provide some suggestions to further the debate."

CLS has responded to the white paper by dismissing the claims over the rising cost of its service insisting that, on the contrary, current costs are expected to decrease by half as transaction volumes rise following the introduction of a sliding scale for pricing.

According to Jonathan Butterfield, executive vice president, marketing and communication at CLS, the average cost of settlement in August was 53p per transaction. Should volumes reach 1 million sides, settlement costs will be no more than 25p, says Butterfield.

As regards bilateral netting, Butterfield adds that a decision was taken in July by CLS members not to adjust the current position which prohibits the practice due to the fact that CLS cannot provide a full audit trail for trades. However Butterfield says that he expects that this decision should and will be revisited in the near future.

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