More is more: How do you improve coverage of PvP settlement in the FX market?

10 min read
29 June 2022
Marc Bayle de Jessé
Chief Executive Officer

CEO Marc Bayle de Jessé delivered a keynote speech on ways that the industry can improve payment-versus-payment (PvP) coverage in the FX industry at the Central Bank Payments Conference in Athens. In it he outlined the status of current PvP protection, why there is a need to increase it and how CLS is tackling this.


What is PvP and why do we need it?

Before I start, let me give a brief overview of why we need PvP. Cross-border payments sit at the heart of international trade and economic activity and typically involve the settlement of an FX transaction requiring payment of one currency for receipt of another. Crucially, PvP mitigates the risk that one party delivers the currency it sold but does not receive the currency it bought from its counterparty, resulting in a loss of principal. Because many currencies are paid at different times of the day, there could be a big timing gap between the payment of one currency and receipt of the counter-currency. Such a loss of principal may be manageable if the amount is small. However, if it is large, a single failure could lead to a domino effect where an institution not receiving funds is unable to make payments to other banks – leading to a chain reaction that spreads losses throughout the financial system.

CLS mitigates principal risk through PvP – you get paid only if you pay. On settlement day, a counterparty’s payment instruction in one currency is not settled unless the counterparty’s payment instruction in the other currency is also settled.

Given the projected growth in cross border transactions, PvP will be even more of a priority for market participants going forward.


Given the crucial role that PvP plays in the FX market, what is the current status of PvP coverage?

Through CLS, the volume of PvP settlement and its coverage is already significant. CLSSettlement currently settles on average USD6 trillion daily across 18 of the most actively traded currencies, accounting for a large proportion of FX trades in the market. The CLS community has also continued to grow – more than 70 of the world’s leading financial institutions are settlement members that participate directly in CLSSettlement. Recently, we conducted an analysis with some of our settlement members of their settlement data and found that approximately 90% of the settlement risk exposure associated with their trades in those 18 currencies is settled in CLSSettlement with full PvP.

CLS’s PvP coverage is also growing as the community of users in our ecosystem increases. In addition to our settlement members, CLS has more than 30,000 third-party participants around the world accessing its services indirectly through CLSSettlement members. These include banks, funds, non-bank financial institutions and multinational corporations. CLS is actively engaged with these third-party participants, including the buy side, which continues to drive growth in CLSSettlement. Over the past year, the number of third parties using CLSSettlement has increased 25%, and we have seen nearly 10% growth in third-party settled values in the last year.

Asset managers contributed the most to these increases. In particular, pension funds increasingly invest internationally, leading to more FX activity. As a result, they recognize the need for a strong infrastructure that can mitigate risk that arises from FX trading, as well as provide them with liquidity and cost benefits. In addition, many other firms are moving to a multi-dealer model and are not always trading FX with their custodian bank where settlement risk is eliminated – hence the need for a settlement platform offering risk mitigation and efficiencies. With asset managers taking FX settlement risk more seriously and looking to identify cost savings, many are now rethinking their traditional approaches towards FX settlement. As part of this shift, we are working with custodians to explore ways to expedite the onboarding of new participants. We expect the growth of third-party volumes on CLSSettlement to continue.

In addition to asset managers, multinational corporations are also increasingly adopting PvP settlement, particularly those that conduct a significant number of cross-border transactions. Corporate treasurers in these types of organizations are facing a range of challenges, including pressures to reduce risk, maximize operational efficiencies and comply with an increasing number of regulatory requirements. PvP settlement helps to address a number of these issues.

There is also growth in PvP coverage via the expansion of CLS’s PvP settlement services. We have enhanced our offering to include CLSNow, which is a bilateral PvP gross settlement service offering same day settlement in CAD, CHF, EUR, GBP and USD. CLSNow enables counterparties to optimize the use of available liquidity in the same day market while also mitigating risk.


With these levels of growth amongst wider market participants and the expansion of PvP settlement services, why is there a need to increase PvP coverage, now?

Both regulators and industry participants have become increasingly concerned that, given the rise in some key emerging market currencies that are not settled using PvP systems, FX settlement risk is beginning to rise once again. CLS settlement members confirm that a primary driver of this increase in settlement risk is high turnover of non-PvP settled trades in currencies not eligible for CLSSettlement.

The trend is reflected in the 2019 BIS survey, which indicated that FX trades involving a non-CLS currency totaled approximately USD1.25 trillion – an increase of 35% over the USD930 billion reported in the 2016 survey.1 USD and EUR are on one side of the vast majority of these trades, but without PvP settlement, both sides carry FX settlement risk for CLS settlement members and other market participants. This has heightened the focus on overall risk management in cross-border payments, with both the public sector and market participants calling for greater adoption of PvP mechanisms to mitigate rising settlement risk.
In October 2020, the Financial Stability Board (FSB) published the G20 Roadmap for Enhancing Cross-Border Payments – an initiative targeted at addressing the challenges of cost, speed, transparency, and access in cross-border payments.2 The Roadmap comprises a set of 19 building blocks developed by the FSB in partnership with the Committee on Payments and Market Infrastructures (CPMI) and other relevant international organizations and standard-setting bodies. In October 2021, the FSB’s First Consolidated Progress Report of the G20 Roadmap for Enhancing Cross Border Payments reported that many milestones for 2021 had been successfully completed or were close to being finalized.

The FSB Roadmap’s building block 9 focuses on the recommended mitigation of settlement risk for cross-border payments. In its latest update, the FSB stated that the CPMI is exploring how to increase adoption of PvP in the market either through enhancements to existing services or the development of new public/private sector solutions.

In addition to the CPMI’s efforts to tackle settlement risk, the Global Foreign Exchange Committee also called for the industry to adopt PvP more widely in its three-year review of the FX Global Code (the Code), a set of global principles of good practice for the FX market.3 The updated version of the Code amended the key settlement risk principles – principles 35 and 50 – regarding PvP and netting.

The specific changes to the Code relating to the mitigation of FX settlement risk and best practices in post-trade processing are shown in Figure 1.

Figure 1: FX Global Code – settlement risk principles (35 and 50) 

These changes to the Code encourage FX market participants to explore ways to further mitigate risk and reduce operational costs by adopting a best practice approach to FX settlement risk management and netting.

1 Bank for International Settlements (BIS): Triennial Central Bank Surveys of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets.
2 FSB’s Enhancing Cross-border Payments: Stage 3 roadmap (October 2021). 
3 FX Global Code


If settlement risk is rising because trading in non-CLS eligible currencies is increasing, why can’t CLS simply tackle this problem by adding more currencies into CLSSettlement, thereby improving PvP coverage?

CLS is a systemically important financial market infrastructure and is subject to the Principles for Financial Market Infrastructures (PFMI) published by the Committee on Payments and Market Infrastructures and the Technical Committee of the International Organization of Securities Commissions in 2012.

The PFMI standards are designed to ensure that the infrastructure supporting global financial markets is robust and able to withstand financial shocks. Therefore, adding new currencies to CLS is an extended effort subject to several complex factors, particularly the necessity of verifying that crucial legal, risk and liquidity standards are met in the jurisdiction whose currency is onboarded. Local authorities – and not CLS – determine the timing and pace to implement the agreed onboarding process. CLS is currently working with Chilean authorities to bring the Chilean peso into CLS in the coming years. That said, we are looking for ways to bring risk mitigation to currencies that are unlikely to be able to join CLS in the medium term.


How does CLS intend to improve PvP coverage?

In response to policymakers and market participants calling for greater adoption of PvP in the FX market, CLS has been actively engaged with the FX industry to develop alternative PvP mechanisms. These efforts have received strong support. However, recent geopolitical events have led CLS to reassess the pace at which this project moves forward.

This highlights one of the most significant points when it comes to expanding PvP coverage. Progress in this area will not necessarily result from strong industry cooperation and technology advancements. As a trusted financial market infrastructure, we already have the requisite technology, oversight, governance, credibility and support of our members. Instead, progress will be made by overcoming regulatory and geopolitical challenges, which currently present the biggest obstacles to expanding PvP coverage.

Accordingly, we made a strategic decision to allocate further resources to functional enhancements to CLSNet, our bilateral netting calculation solution that standardizes and automates post-trade matching and netting processes for over 120 currencies. The enhancements will provide further risk mitigation for trades not settling in CLSSettlement and support Principles 35 and 50 of the updated Code. 

We believe CLSNet enhancements can deliver more immediate benefits in terms of mitigating risk, optimizing liquidity and creating operational efficiencies for currency flows outside of CLSSettlement. It is our intention to expand the CLSNet network each year, and in doing so, broaden the risk mitigation that bilateral netting calculations and confirmations can bring to the wider FX market.

In addition to existing CLS settlement members, CLSNet can be used directly by non-CLS banks and buy-side firms. This enables a wider group of market participants to benefit from the operational cost reduction and risk mitigation the service delivers.


What happens next?

For those currencies eligible for CLSSettlement, our settled volumes are at an all-time high. This is because our settlement members are settling increasing volumes of trades using CLSSettlement, and our third-party community of asset managers, corporates and regional banks is growing.

That said, rising settlement risk needs to be tackled. This is a need recognized by the public and private sectors. CLS is working with its clients to direct trades in those emerging markets currencies that are not currently eligible for PvP settlement into our CLSNet service, which in our view is the most effective near-term way to address rising settlement risk in the FX market.

I hope this explains why we need PvP settlement, what is the current status of PvP coverage and how CLS is increasing PvP coverage through expanding the community of direct and indirect participants in CLSSettlement – and finally, how CLS aims to address risk associated with non-CLS eligible currencies through CLSNet.