Risk Reduction when Settling Cross Currency Swaps
Currency Swaps settlement can involve very large payments leading to settlement risk – an innovation from Markit and CLS aims to eliminate aspects of this.
Non-banking observers often mistake the notional on a Rate Swap with a loan / deposit and make alarming headlines about the 'exposure' of banks to derivatives. What these non-experts fail to spot is that the their assumption is true for currency swaps – the notional usually indicates the actual size of payments at the front and back of the trade – a real exchange of principal by both parties. Since time began (or a little later) discussions have been held on placing Currency Swaps into a CCP to remove risk throughout the lifetime of the trade, but these discussions have unearthed aspects of the clearing processing chain which don't happily handle very large notional payments, and so far there appears to be no sign of Currency Swaps being accepted for clearing.
An announcement from Markit and CLS has moved the game forward, by linking the trade confirmation process directly to the settlement process. As show in the diagram below the creation of a direct Trade feed from Markit to CLS means there should be no error in instructing the payments required, as only matched instructions can be transferred to CLS. The settlement instructions become part of the daily settlement cycle at CLS, inter-mixed with their FX business and the pay-in pay-out process required by CLS. The benefits of this approach should be to remove the possibility of mis-matched settlements, and provide integrated feedback from CLS and via Markit on the settlement status of these large payments.
More details from CLS here: http://www.cls-group.com/ProdServ/Pages/CCS.aspx and in the PDF attached below.
London and New York, NY – Markit (Nasdaq: MRKT), a leading global provider of financial information services, and CLS Group (CLS), a leading provider of risk mitigation and operational services for the global foreign exchange (FX) market, today announced the launch of a new FX settlement service for the cross currency swaps market.
Cross currency swap trades expose counterparties to significant settlement risk due to the high value of initial and final principal exchanges. The service provides a streamlined process for the payments related to these trades by incorporating them into CLS’s existing unique payment-versus-payment (PvP) settlement service. CLS receives settlement instructions from cross currency swaps electronically confirmed using MarkitSERV, the OTC derivatives trade processing service from Markit.
The new service, developed in consultation with leading financial institutions in the cross currency swaps market, creates greater operational efficiencies and, through multilateral netting, reduces liquidity and payment demands across the industry.
Charles J Bristow, co head of Global Rates Trading and head of Funding for Macro Markets, at JP Morgan, comments: “Settlement remains a critical risk for the market to manage, particularly across products where the exposure to FX settlement can be significant. This new service developed by CLS and Markit to settle cross currency swaps is an important step which will help to mitigate settlement based risks.”
Andrew Hinchliff, executive general manager, Global Markets, IB&M division, at Commonwealth Bank of Australia, comments: “Demand for more effective post-trade clearing and settlement services from regulatory bodies and market participants has never been more acute. The extension of CLS’s settlement service to the growing cross currency swaps market is a welcome addition that will mitigate systemic risk and reduce counterparty exposure across OTC markets.”
David Puth, chief executive officer of CLS, comments: “As part of our ongoing efforts to reduce settlement risk for our members, we are continuously looking to enhance the portfolio of FX products that can be launched on our platform. This new service, developed with Markit and our global community of settlement members is another example of the industry working together to introduce innovative ways to reduce systemic risk in the global FX and OTC derivatives market.”
Brad Levy, managing director and head of Markit’s Processing division, said: “Working with CLS to streamline trade settlement for cross currency swaps demonstrates how service providers can work together to make swaps market operations more efficient. This service brings settlement to the diverse community of market infrastructure providers and OTC derivatives end users connected by the MarkitSERV network.”
CLS enhances financial stability by providing risk mitigation services to the global FX market. It operates the world’s largest multicurrency cash settlement service to mitigate FX settlement risk for its settlement members and their clients globally.
With more than 60 settlement members, comprising the world’s largest financial institutions, and third-party clients, including banks, funds, non-bank financial institutions and multinational corporations, CLS settles FX payment instructions across 18 currencies .
CLS mitigates settlement risk by simultaneously settling the payments on both sides of an FX trade on a real time basis. It does this using its unique payment-versus-payment settlement service which is linked to the real time gross settlement systems of the 18 currencies eligible for CLS settlement. The settlement of these payments and associated funding is final and irrevocable. For further information, please visit the CLS website.