How CLS is supporting the FSB’s roadmap for enhancing cross-border payments

In October 2020, the Financial Stability Board (FSB) published its Enhancing Cross-border Payments Stage 3 roadmap. The roadmap seeks to address the current challenges (e.g., high costs, low speed, insufficient transparency and limited access) and frictions inherent in crossborder payments today. It consists of 19 building blocks, of which CLS is focusing its main efforts on building block 9 – facilitating increased adoption of payment-versus-payment (PvP) – as well as monitoring developments in others. CLS has long advocated for greater PvP adoption to mitigate FX settlement risk and fully supports the roadmap’s efforts in this area. Marc Bayle de Jessé, CLS’s CEO, answers some of the key questions about the initiative and CLS’s involvement.

Cross-border payments by their very nature involve the settlement of an FX transaction, which requires payment of one currency for receipt of another. CLS’s PvP settlement system helps ensure that the final transfer of a payment occurs if and only if the final transfer of a payment in the other currency takes place. Without PvP, there is a risk that one party to an FX transaction pays the currency it sold but does not receive the currency it bought.

Currently, there are a large number of jurisdictions whose currencies are not eligible for PvP settlement in CLSSettlement because they are unable to meet our currency onboarding standards. These standards derive from the Committee on Payments and Market Infrastructure’s (CPMI) and IOSCO’s Principles for Financial Market Infrastructures (PFMI) and other applicable regulations. Hence the focus of building block 9 is to take stock of existing and in-development PvP arrangements, and to develop proposals for increased adoption of PvP.

As a financial market infrastructure (FMI) that operates the predominant settlement system for FX transactions (CLSSettlement), we have responded to certain questions set out in the CPMI’s call for industry expert responses on the topic of cross-border payments.

We have long been a proponent of PvP adoption in order to mitigate FX settlement risk and have worked closely with both the public and private sectors to highlight its importance. Our most recent activities have included publishing a whitepaper on the issue of rising FX settlement risk as well as encouraging dialogue, speaking at industry events, and presenting at the Global Foreign Exchange Committee and several regional FX committees in order to raise awareness of the issue.

We are also partnering with our settlement members to develop a PvP solution for transactions with currencies that are currently ineligible for CLSSettlement. This work is being planned with the roadmap’s timelines in mind to ensure we are well placed to provide input as it progresses, specifically when the CPMI begins developing proposals for increased PvP adoption. This work is scheduled to commence in June 2021.

CLS is a systemically important FMI and is subject to CPMI and IOSCO’s PFMI. Our own ability to expand PvP protection to new currencies and improve direct access to CLSSettlement is therefore limited, as few remaining currencies can meet our currency onboarding standards which derive from the PFMI and other applicable regulations. Specifically, Principle 1, legal basis, and Principle 8, settlement finality, have presented the largest obstacles to onboarding new currencies to CLSSettlement.

CLS will continue to engage with countries that can meet the necessary standards and aim to bring those currencies into CLSSettlement. We have been working with Chile, which enacted key legislative amendments in recent years, and are aiming to bring the Chilean peso into CLSSettlement. This would be our first currency from South America.

With regards to a new, separate PvP solution for non-CLS currencies, a fundamental consideration is whether such a solution, with the appropriate risk management standards, is better than the outright risk taken today by financial market participants in trading currency pairs not eligible for CLSSettlement. Furthermore, the market should consider trade-offs and choices in design elements to achieve an operating model that can be implemented, while ensuring appropriate risk mitigation.

Lastly, the industry must continue to develop standards, particularly ISO2022, among others, that will enable cross-border payments to advance effectively and make interoperability between payment systems possible.

In Q4 2020, we created a working group of over ten settlement members with global operations to evaluate market demand and explore potential PvP solutions for currencies ineligible for CLSSettlement.

This working group’s initial feedback showed a strong interest in a new PvP solution, and as a result, an industry pilot is now underway. This pilot will evaluate the liquidity and settlement risk of potential models and consider the benefits of the solution against certain factors such as account structure, entity and rulebook jurisdiction, and local market practices and regulations.

Improvements to cross-border payments cannot be realized without private sector involvement. We strongly support public-private collaboration in developing solutions to industry challenges and applaud the CPMI’s request for industry responses on the cross-border payments topic as a good example of this approach.

Indeed, CLS itself was established in 2002 as a result of unprecedented cooperation between the industry and central bank community. Twenty major financial institutions formed a group which, with support from central banks, refined the PvP concept that remains at the heart of CLS’s settlement system today.

In order to create successful solutions, policymakers together with the private sector should, and are, engaging with the industry during the early stages of new market infrastructure initiatives to identify and develop the optimal model for PvP. This approach is crucial to ensure that the market’s needs are truly understood and that the preferred solution obtains sufficient investment and support from the industry.

Specific to CLS, the 18 central banks whose currencies are settled in CLSSettlement, plus five other Eurosystem central banks, have established the CLS Oversight Committee – a formal cooperative oversight arrangement coordinated by the Federal Reserve Bank of New York. The CLS Oversight Committee is used to: 1) avoid duplication of effort by the central banks; 2) foster consistent, transparent communication between the central banks and CLS; and 3) enhance transparency regarding applicable regulatory policies in CLS jurisdictions. This type of arrangement could be well-suited as an initial starting point for cooperative oversight of new global payment arrangements.

Our membership criteria have been designed to permit fair and open access, while also balancing the integrity of the settlement system that we operate. As our rules are governed by English law, settlement members must meet the requirements outlined by the UK’s Settlement Finality Regulations (SFRegs). Further, our rules stipulate a wide range of membership requirements, such as contingency plans, capital ratios and minimum long-term credit ratings. Any expansion of direct access to a broader range of institutions would require changes to the SFRegs.

That being said, we believe certain low-risk, non-bank participants should have the ability to directly participate in CLSSettlement. This includes supranational institutions, multilateral development banks, foreign systemically important institutions and their operators, and sovereign wealth funds.

In addition, for market participants that do not fit our membership criteria or for those that do not wish to fulfil the requirements for direct access, third-party participation can still provide access to the risk mitigation and operational and liquidity efficiencies of CLSSettlement. Our third-party growth figures are testament to this model – we have seen an annual 10% increase in third-party activity since 2018.

The roadmap’s implementation is a vast and broad piece of work spanning multiple stakeholders, and a timeline is specified in the roadmap itself. We continue to monitor developments closely, remain engaged in discussions with key policy makers and stakeholders, and stand ready to support any initiative and its future implementation.

As I mentioned earlier, the CLS working group looking at the alternative PvP model is planning its work with the roadmap’s timelines in mind to ensure we are well placed to provide input during the course of roadmap implementation.

We applaud the work that the FSB and CPMI are undertaking to address the challenges of cross-border payments, and welcome future dialogue on the roadmap and its implementation. In order to progress, a strong public-private partnership – similar to the one that created CLS in 2002 – is required to build a successful cross-border solution to remove FX settlement risk from global financial markets.

1The UK’s Financial Markets and Insolvency (Settlement Finality) Regulations 1999 (SFRegs).

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