GFXD Publishes Third Paper in FX Settlement Reform Series

The Global FX Division’s Operations Committee has published a third paper in its series looking at managing FX settlement risks, this time investigating the role of payment “shaping” or “splitting”.

Payment shaping or splitting is defined by GFXD as the process where an amount of

currency which is due to be paid is broken down into smaller amounts, equal in total to the original amount. It notes that a large FX payment could attract large intra-day credit and create liquidity challenges between nostro banks when it comes to the actual movement of funds – i.e. the large payment could require incoming funds to be held to build a sufficient balance. “This ‘holding’ of funds could challenge the natural flow of liquidity, itself impacting the settlement of other transactions, further reducing the availability of liquidity,” the paper states. “By splitting/shaping the large FX payment, the costs associated with holding additional reserves on balance sheet against the use of intra-day credit will be reduced, and the circular flow of settlement liquidity will continue, ensuring that other FX transactions settle on time in a normalised manner.”

While acknowledging that compared to the full population of daily FX settlements, the numbers of those being split/shaped remains small, the paper highlights that due to liquidity reasons may be more concentrated in emerging market currencies.

That said, if the FX market moves toward faster settlement timelines, which is likely given the push for T+1 in Europe and increased noises around same-day settlements, GFXD says splitting payments could become more common even in major currencies. “This could increase the number of transactions that must be settled individually rather than being grouped together, which may place additional pressure on liquidity,” the paper observes.

The paper looks at existing workflows, and, inevitably, promotes great automation as the solution to many of the associated risks. Noting that a diverse universe of proprietary automated systems exist currently, the paper states, “Whilst it is unlikely that the whole market adopts a single automated approach, there is an opportunity to harmonise the format of the data being communicated, including those using ISO pacs/pain messages…This change would require users to stop populating the current free format Unstructured Remittance information field and would drive consistency, aid the recipient of the messages and achieve the desired reduction in Settlement Risk, and better capital/liquidity optimisation.

“Consistency would enable market participants to automate processes, improving efficiency and reducing the risks of any funds not being recognised and returned,” it continues. “Such a standardised formatting approach could also be adopted by those using proprietary systems, again driving consistency across the industry.”

The paper concludes, “Our analysis has shown that there are opportunities to improve the FX payment splitting/shaping processes which will result in a reduction of FX settlement risk as well as improving liquidity flows and reducing overall costs, such as those incurred though the provision of intra-day credit or through increased manual interventions. Such opportunities are reliant on i) increased use of and standardisation of automated approaches and ii) improvements in communications between those involved in the settlement of FX transactions.”

The full paper can be accessed here