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Banks warned on FX settlement risk

15 May 2008  |  8645 views  |  0 globes - map of earth

Bank-backed settlement body CLS has responded to a repeated call from the Bank for International Settlements for the industry to do more to crack down on FX settlement risk by outlining new measures and initiatives for eliminating exposures. These include investigating industry support for implementing multiple settlement sessions, which would include the settlement of same day trades.

The report from BIS' Committee on Payment and Settlement Systems (CPSS) - which is based on a global survey of 109 institutions - says although there has been a major reduction in aggregate FX settlement exposures, more needs to be done.

The study found that 55% of all FX obligations are now settled through CLS Bank. However most of the remaining 45% use traditional correspondent banking arrangements that are subject to temporal and systemic risk relating to counterparty failure.

The BIS has called on individual institutions to ensure risk controls and incentives that are in place are compatible with settlement services. Industry groups should continue to develop services for settling FX trades that will reduce risks, particularly services for settling same day and certain next day trades.

The BIS also recommends that central banks work more closely with banking and non-bank regulators to support improvements in local payments law and the operations of large-value payment systems and to encourage appropriate risk management procedures for FX settlement exposures.

"The financial services industry has made significant progress in dealing with foreign exchange settlement risk. However, more can and should be done to tackle remaining exposures and to guard against the risk of reversing the progress that has already been achieved," says Timothy Geithner, president of the Federal Reserve Bank of New York and CPSS chairman. "Recent market conditions emphasise how important it is that the settlement infrastructure supporting financial markets is robust and reliable, so that markets have the confidence to function normally even in adverse circumstances."

Responding to the report, CLS Bank says it supports efforts to further eliminate settlement risk and has modified its eligibility criteria for currencies and membership in a bid to extend its influence.

The settlement body says it is also investigating the industry support for implementing multiple settlement sessions which would include the settlement of same day trades.

CLS says it also welcomes the CPSS's call for legally sound netting arrangements and the effective calculation of bilateral exposures.

"One of the community's agreed operating rules is that netted input of FX instructions cannot
be submitted to CLS for settlement," says the statement. "CLS is also working with major banks to assess alternative work flows to address the underlying drivers for netting: cost and capacity issues."

Read the BIS report here:

» Download the document now 667.5 kb (PDF File)

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