CPMI Commences FX PvP Settlement Consultation

Just under a year after it called for ideas on the issue, the Committee on Payments and Market Infrastructure (CPMI) has issued a consultative report on increasing adoption of payment-versus-payment (PvP) mechanisms to reduce settlement risk.

In the 2019 Bank for International Settlements (BIS) Triennial Survey of FX Turnover, the high notional volume settled outside of PvP was highlighted, prompted action by the industry as well as the CPMI as part of its G20 commitments. The Global Foreign Exchange Committee updated the FX Global Code in July 2021, including several principles related to FX settlement, while the GFMA’s Global Foreign Exchange Division, earlier this year released a paper containing ideas for reducing settlement risk, which largely reiterated the BIS’s original points.

The issue has bubbled to the surface due to the diminishing percentage of FX trades settled via PvP, thanks largely to a growth in emerging markets volumes – which are not, by and large, CLS currencies, as well as concerns over the cost of using PvP mechanisms. The latest paper says that analysis suggests that the percentage of daily FX volume settled using PvP has fallen from above 50% in 2006, to below 40% in 2019 – a period during which, FX daily volume more than doubled to $6.6 trillion.

Reinforcing the message, the paper also observes, “For any PvP arrangement to be used by counterparties to settle a deliverable FX trade, it first needs to be available (original italics), that is, the arrangement must support the FX product and both currencies of the trade, and both counterparties must have access to the arrangement either directly or indirectly through third parties. The relative decline in PvP settlement can be attributed partly to a lack of availability, driven by growth in the trading of currencies that are unsupported by existing PvP arrangements.”

The paper also notes that any PvP system has to be fit for purpose, including not being too liquidity-intensive, and efficient – specifically that the benefits of the mechanism outweigh the costs and charges associated with using it.

Since settlement risk was first highlighted as a challenge facing the FX industry by the BIS, however, several solutions have emerged, many using distributed ledger technology or blockchain solutions – indeed the CPMI paper studies existing and proposed mechanisms. It studies five existing PvP arrangements in CLS Now and CLS Settlement, as well as Hong Kong’s CHATS system, CCIL in India and B3 in Brazil. The latter two being central counterparties and the other three payments systems that settle on a gross basis.

The relative decline in PvP settlement can be attributed partly to a lack of availability, driven by growth in the trading of currencies that are unsupported by existing PvP arrangements

It also, however, takes a look at new arrangements that emerged from its call for ideas in late 2021. The CPMI says it received 16 responses from a range of interested parties and 11 submissions that provided “concrete solutions”. Of these 11, one, Baton Systems, is live; eight are under development or consideration according to the CPMI, (9th Gear, Buna, CLSAlt, Fnality, FX Shield, IZZI, RTGS.global and Settlement Circle); two provided industry views on ways to expand PvP to a wider range of transactions (AusPayNet and GFMA), two provided conceptual proposals (Citi and Vanini), and one suggested how its service could assist in enabling PvP (Swift).

The paper studies each proposal, and describes how they propose to increase the scope of currencies, products and markets served. Significantly considering how the CPMI has itself explored expanded or overlapping RTGS windows, the paper observes that several proposals adopt a 24/7 operating model, compared to the use of predetermined settlement windows based upon funding aspects, or customised settlement windows.

Overall, based upon the ideas submitted, the CPMI offers some key takeaways:

• While existing PvP arrangements are available for the most traded currency pairs and products, they are not practicable for settling certain trades or they are too costly for some potential users.
• New PvP solutions, which are at varying stages of development, seek to complement the existing arrangements by targeting EME currencies, providing new functionalities such as settlement on demand, offering extended operating hours and expanding their service to retail users.
• Slow uptake of some existing PvP arrangements appears to reflect barriers that would similarly constrain the broad adoption of new solutions. These barriers include weak incentives for users to settle transactions on a PvP basis consistent with the BCBS Guidance and the FX Global Code; technical challenges for PvP providers to access and interoperate with real-time gross settlement (RTGS) systems during operating hours that meet user demands; and complications for PvP providers to reconcile differences in national regulatory requirements (eg, around settlement finality and related protections).

The paper also lays out several ideas for how both public and private sector can adjust their existing business practices or take on new or expanded roles within the workflow to reduce the barriers to PvP further and facilitate increased adoption. It says that the private sector could agree on conventions for value dating, align nostro operating hours, and promote interoperability between legacy and emerging systems. Meanwhile, central banks could assess operational barriers to the use of central bank accounts, money and credit facilities by new PvP providers as well as catalyse continued private sector engagement on reducing FX settlement risk and consider sharpening regulatory incentives for market participants to use PvP services where they are available.