Stemming the tide of rising FX settlement risk

10 min read
4 May 2023

As the trading of emerging markets currencies gathers pace and broader uncertainty sweeps across financial markets, CLS is exploring alternative services designed to mitigate settlement risk for the foreign exchange market.

The world is experiencing a period of challenging economic and geopolitical conditions, most recently compounded by market instability and a lack of confidence in certain sectors. As regulation, rising interest rates and shrinking central bank balance sheets further strain the availability of liquidity and increase its cost, market participants naturally seek ways to optimize liquidity and further mitigate market and operational risk.

Created more than two decades ago as a financial market infrastructure to mitigate settlement risk in the foreign exchange market, CLS keeps a close eye on these changing dynamics and continually engages with market participants to adapt its services to their needs.

Demand for its primary settlement solution, CLSSettlement, has risen steadily in the past few years. Average daily settled values are now more than USD6 trillion following recent growth that has outpaced the FX market.

“The majority of the interbank transaction flow through CLSNet is the large deliverable EM currencies, which represent the biggest concern for our members in terms of settlement risk.”

Keith Tippell
Chief Product Officer

Likewise, appetite for the firm’s bilateral payment netting calculation service, CLSNet, continues to grow, and it exceeded the USD200 billion daily notional netted barrier for the first time in September 2022.

Much of this growth in CLSSettlement has come from the asset management community, which accesses the service through CLS member banks. The past three years alone have seen an increase of nearly 25% in legal entities from around the globe settling through CLSSettlement via member banks, representing about 30,000 third parties, including banks, funds, non-bank financial institutions and multinational corporations. It is estimated that approximately 80% of the top 250 investment managers are now settling through CLSSettlement via their custodian banks.1

“Solutions such as CLSSettlement and CLSNet are valuable for market participants as their networks have scale and there is widespread industry adoption.”

Keith Tippell
Chief Product Officer

According to Lisa Danino-Lewis, Chief Growth Officer at CLS, the firm has prioritized raising awareness of settlement risk to a wide array of market participants in order to extend settlement finality benefits to more FX trades.

“CLS and our members go out to the market to educate firms on how to mitigate that risk,” she says. “Over the wider FX industry, market participants are now more aware of settlement risk than ever. With significant growth in third‑party participation in the past few years, that work has paid off.

“Removing the underlying settlement risk over the years has helped the FX market grow and evolve, because the more comfort asset managers and other market participants have in the settlement of their trades, the more activity there will be in FX."

1 Excluding Chinese-based investment managers.

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