GFXD Publishes Second Paper on FX Settlement Risk

GFMA’s Global FX Division (GFXD) has published its second paper on FX settlement risk, this one focusing on processes and opportunity to better manage payment errors.

The paper, produced by GFXD’s Operations Committee, observes that the proportion of payment errors within wholesale FX markets remains small, however it also says that the nature of the market – notably sizeable notional values – means that payment errors attract significant internal and external focus. With this in mind GFXD says its Operations Committee is “keen to explore how the industry can better manage those instances when an FX payment is made in error”.

The paper stresses that while payment-vs-payment (PvP) can mitigate the risk of payment errors, other methods such as netting and gross bilateral still present a risk. As such the paper also considers the processes around the return of erroneously paid funds. “Analysis has shown that there are varying different approaches taken across the market, which tend to lead to unwanted delays and increased risk and cost,” it states.

The committee responsible for the paper has identified six main causes of payment errors:

Execution, specifically late or incorrect allocations, trade or payment shaping, booking errors (including bookings after currency-cut-offs), cancel & rebooks; incorrect settlement instructions; an ad-hoc change from net/gross, or manual processes in netting; rescinds from PvP settlement mechanisms; payment formatting errors; and funds paid to the wrong entity within the same organisational structure. On the latter, the paper notes that often it is not possible to move funds internally. “It is critical that those engaged in the execution and settlement of FX transactions understand the front to back processes/mechanics/timings as well as how automation and standardisation are key factors in mitigating payment errors,” it states.

The paper highlights – and reiterates – the guidance available in the FX Global Code, and also stresses that late payments can often trigger the concerns from oversight as incorrect payments. Late payments can impact funding models, and trigger internal escalations as well as late payments to other market participants, it states.

One of the challenges around incorrect payments is, the paper states, “the lack of guidelines and standardisation – process, communication methods and timelines, across the global industry”.

This is dealt with in Principle 55 of the FX Global Code, but to complement that, GFXD’s Operations Committee says it has identified the inconsistent nature of the time taken to recover and return incorrect payments – mainly due to the very manual nature of the process. This is exacerbated if multiple nostros and custodians are part of the chain.

To meet this, the paper recommends the use of automated and authenticated messages such as Swift, including new ISO20022 formats, as these can be expected to expedite the issuance of a recall notice and subsequent kickback of funds. “The inclusion of new and structured data attributes within ISO20022 will standardise the exchange of information, reducing any manual intervention and improving efficiency – therefore reducing risk exposure,” the paper states.

GFXD also says that feedback suggests that smaller payments tend to be ‘de-prioritised’ and often inefficiently require more engagement to rectify promptly. In addition to the processes involved to ensure the return of payments made in error, additional reporting is often required as such errors could require reporting as a ‘loss with or pending recovery’ dependent on the duration.

If there is a related interest compensation claim, the paper says market participants should follow GFXD and ISDA guidance and clearly state the compensation rate used such as i) overdraft / account funding charges, ii) use of funds (loss of interest) charges or iii) back valuation of the original payment.

In conclusion, the paper says that payments made in error should be identified and returned as soon as possible and no later than five business days.