The Continued Rise of CLSNet: A New Chapter in FX Market Efficiency
Posted by Colin Lambert. Last updated: December 13, 2023
By Lisa Danino-Lewis, Chief Growth Officer, CLS
As we approach 2024 amid uncertain market conditions and an ever-changing geopolitical and economic landscape, the FX market faces substantial challenges. To navigate this period of potential market volatility, financial market infrastructures (FMIs) like CLS have a vital role to play.
CLS’s primary objective is to mitigate settlement risk in the FX market. Its multicurrency cash settlement system, CLSSettlement, was specifically designed to address this by offering payment-versus-payment (PvP) settlement, ensuring that the final transfer of one currency payment occurs if, and only if, the final transfer of another currency (or currencies) takes place. Additionally, CLSNet, CLS’s automated bilateral payment netting calculation service for over 120 currencies, streamlines post-trade matching and netting processes and thereby mitigates risk, reduces operational costs and optimizes liquidity for FX market participants.
Recent efforts by policymakers emphasise the importance of mitigating settlement risk, with the Financial Stability Board (FSB) underscoring the adoption of PvP settlement mechanisms in its G20 Roadmap for Enhancing Cross-border Payments. Moreover, the FX Global Code, overseen by the Global Foreign Exchange Committee, includes key principles concerning settlement risk (principles 35 and 50) that recommend the use of PvP settlement mechanisms where available and advocate bilateral netting in cases where PvP settlement is not.
Additionally, the European Central Bank published guidance around how banks should mitigate and reduce settlement risk in FX markets. This was based on its assessment of the settlement risk management practices of a sample of banks.
While CLS effectively mitigates settlement risk for CLS-eligible currencies, a challenge remains for currencies ineligible for PvP settlement, particularly emerging market currencies, and certain same-day FX trades resulting from the move to T+1 settlement for securities in North America in May 2024. In response, CLS is focusing on growing adoption of CLSNet to reduce risk and enhance efficiencies for these currencies and transactions.
With the implementation of T+1 settlement for securities in North America in May 2024, market participants face potential new challenges in the FX post-trade lifecycle
CLSNet supports adherence to principles 35 and 50 of the FX Global Code, as trade instructions sent to CLSNet are validated and matched to pre-determined timeframes between counterparties for selected currency pairs. This ensures that only matched trade details are included in the automated net calculations and that there is a single common record of net payment obligations. By automating the netting calculation process through a centralized platform, participants benefit from greater operational efficiency and enhanced risk mitigation for currencies not supported by CLSSettlement.
Recent growth statistics illustrate the scale of industry support for CLSNet. The average daily notional value of net calculations in CLSNet has consistently exceeded $105 billion in the last 12 months, and in September 2023 it reached a record daily notional of $367 billion netted. The growing CLSNet community includes eight of the top 10 global banks, and CLS is focusing on further expansion to include banks, funds, corporates and non-bank financial institutions.
CLSNet’s tangible benefits are expected to drive further adoption over time. It enhances operational efficiency through standardisation, automating the reconciliation of FX trade details between counterparties and net payment amounts, thereby eliminating reconciliation discrepancies, and reducing the need for extensive communication between counterparties.
CLSNet’s netting calculations also facilitate bilateral netting, which optimises liquidity management by reducing the funding required to handle bilateral payment options, freeing up capital for other activities such as trading.
With the implementation of T+1 settlement for securities in North America in May 2024, market participants face potential new challenges in the FX post-trade lifecycle, including time constraints that may limit the use of CLSSettlement. CLSNet helps participants to reduce funding requirements and payment obligations, particularly for FX trade instructions that may not meet CLS’s 00:00 CET deadline for settlement.
As the growth in emerging market currency trading continues, the remaining challenge lies in mitigating risk for currencies ineligible for PvP settlement. For now, CLSNet can help market participants benefit from greater operational efficiency and enhanced risk mitigation for currencies not supported by CLSSettlement.
 Principle 35 provides that market participants should reduce their settlement risk as much as practicable and encourages the use of automated settlement netting systems. Principle 50 provides that market participants should properly measure, monitor and control their settlement risk and includes recommendations concerning the confirmation of bilateral net amounts and the agreement of predetermined cut-off points.