A long sought after goal is now becoming a reality, clearing Cross-Currency Swaps

Some of you may know I worked at LCH on SwapClear many years ago, and that during that time we did look at clearing currency swaps, and LCH did look at partnering for settlement. Currency swaps often trade in large notional sizes, being used to take advantage of beneficial interest rates globally, and enable the move of a loan from one currency to another. The stumbling block has always been the large exchanges of principal at the front and back of the trade, where covering those flows with margin is not cost effective.

Also in my career I worked at DTCC and was responsible for delivering the link between the Trade Information Warehouse for CDS / CD Index trades to provide the world's first end-to-end processing platform for OTC products, from confirmation throught to settlement This goal was achieved by a partnership with CLS, whereby DTCC delivered the bilateral net cashflows to CLS for settlement within their daily processing cycle.

So now these two ideas have come together in a new platform at CLS, segregated from their mainstream daily FX settlement service, but dedicated to processing cleared business from LCH.C, but open to other CCPs.  The CLS press release says:

CLS, the leading provider of settlement services for the global foreign exchange (FX) market, today announced that it is working with LCH.Clearnet, a leading global multi-asset clearing house, to develop a service to facilitate the settlement of cleared foreign exchange products.

 

The new service is consistent with goals set out by the G20 to promote clearing of standardized derivatives. It will be open to all central counterparties (CCPs) and apply to a range of cleared FX products, including OTC and exchange-traded FX options, FX futures and cross-currency swaps. The service will provide a specialized payment-versus-payment (PvP) settlement in all CLS-eligible currencies and will operate separately from CLS's main PvP settlement service. CLS settles an average of USD5 trillion a day for the world’s largest financial institutions.

 

The service will deliver a number of risk benefits to industry participants. In the event of a clearing member failure, payment netting will substantially reduce the size of the participating CCP’s potential liquidity shortfall, mitigating systemic liquidity disruption. The service is designed to work on an all-or-nothing settlement basis, which minimizes the risk arising from partial or incomplete settlement. CCPs using the service also will benefit from CLS’s expertise in monitoring and processing payment activity.

 

David Puth, CEO of CLS, comments: 
“This is an important milestone in the continued development and safeguarding of the global foreign exchange market. We look forward to working in partnership with LCH.Clearnet, which is ideally placed to develop this service.
We have been working with the CCP community and other industry stakeholders to design and model the most effective way to mitigate settlement risk for cleared FX products. Settlement risk is one of the most significant risks in FX. Our priority is to mitigate this risk, while increasing operational efficiency through our technology and connectivity.”

 

Gavin Wells, Global Head of ForexClear, at LCH.Clearnet, comments:
“We are delighted to be working with CLS on this initiative. We continue to see increased demand from the market for FX clearing, as firms are keen to benefit from the associated capital efficiencies and improved risk management associated with clearing. The new CLS settlement service is integral to our plans to broaden our service offering by adding products involving physical FX settlement.”

 

CLS aims to launch the new service in 2016, subject to regulatory approval.

This is the first time CLS has worked with a CCP to become the underlying settlement platform for the cash movements. CLS provides a multi-lateral net settlement service which operates with a daily cycle, where participants must pre-fund their inward payments, before receiving their outward payments. Given the multi-lateral nature of the service, either the whole daily cycle settles, or not at all. The failure of one participant to fund their pay-ins could potentially stop the daily cycle, and from a clearing perspective trigger a default.

CLS very successfully settles a vast amount of FX business each day and has been operating for many years – there is no other service equivalent to CLS in the world. Does this bring in another single point of failure to the markets? Maybe in theory, but the FX market by comparison is vast in size – $5trn per day, compared to the expected flows of cleared business which when netted will be much smaller – and run on a new processing cycle too.