The Last Look…
Posted by Colin Lambert. Last updated: February 27, 2024
The approaching T+1 switchover is grabbing most of the attention in the FX industry – rightly so, it is the most pressing issue it faces – but it is just part of what should be a broader push to reform the FX market when it comes to payments and settlement.
It is noticeable that multiple regulatory/advisory bodies in the FX world have rarely mentioned the T+1 switch, but have maintained the volume of noise when it comes to settlement reform – thus suggests they see it is very much more than a one-time problem to be solved. The safer settlement push mainly targets the swathe of currencies that are currently settled outside of Payment vs Payment (PvP) – and essentially, the world’s regulators are saying to the FX (and other) industries, “sort out your settlement processes to make them safer”.
Recent data offers a mixed picture in terms of the growth of PvP settlement mechanisms, the Australian FX Committee’s semi-annual turnover survey reported that just 13.4% of gross notional was settled without risk mitigation in October 2023, a sharp drop from over 43% in October 2022 (when reporting was in its infancy). This looks good on paper – and any improvement is indeed good, but it should also be noted that less than 10% of gross notional in Australia was in CLS currencies.
Likewise in Japan, 29.6% of payments were PvP (and to stress this is the number of payments rather than gross notional), down from 34.2% in October 2022. The amount of CLS-eligible pairs traded was down to 91.7% of volume, from 95%, therefore some drop off should be expected, but in both cases, it is clear there are still gaps, which one can presume, are replicated in bigger markets.
While those numbers are probably going in the right direction, I suspect the continued noise around, and a big driver of, the push for reform from the authorities has been the advance in technology and while a cautious approach is acceptable in certain circumstances, my sense, talking to one or two people closely involved with the push for change, is that the authorities are running out of patience. They see technology solutions coming to market, but little being done to adopt them.
This is not, I should stress, a “why doesn’t CLS change” issue, my understanding is that the real frustration is the lack of take up of other solutions that are available that can fill the gaps left by the settlement behemoth – namely those non-CLS currencies. Talking to someone recently, their point was succinct, “[institutions] can actually operate with more than one solution” when it comes to its payment and settlement unit, “the question is, why aren’t they?”
I accept that change doesn’t happen overnight (it’s not even happening overnight in North America thanks to their inability to coordinate a day for the switch!) but it feels as though the authorities want to see some progress
A common retort to demands for change is that a lot of participants don’t want it, but this is disingenuous. The fact is, those players who want to settle net at the end of the day, or in a designated window, can – this issue is not about forcing everyone down one corridor, when it comes to FX settlement, one size does not fit all.
Two reasons often given for what is seen in some quarters as the slow adoption of other ‘safe’ settlement mechanisms are the continued hangover from Covid and banks’ drive to cut costs. These have left development teams under-staffed and with a very long, and growing, ‘to-do’ list, and this is why I think the noise from the authorities is being maintained, and will not go away. Essentially, they are saying that the potential problem is too big to be brushed off on cost and resources grounds – the money, and people, have to be found.
I accept that change doesn’t happen overnight (it’s not even happening overnight in North America thanks to their inability to coordinate a day for the switch!) but it feels as though the authorities want to see some progress. This can be provided, but at the moment it seems everyone is looking at CLS, which is not necessarily the right direction.
CLS continues to provide a crucial service for the FX industry, but it is limited by its structure from randomly adding currencies. It takes – literally – years for CLS to add a new currency, so maybe the authorities are telling us to look in a different direction?
We seem to be stuck in a situation where institutions want the comfort of a provider with scale behind them (CLS), because they don’t want to back a losing horse in the race amongst the fintechs. This is probably what has to change and it will require a degree of proactiveness and decisiveness on the part of banks in particular (not a characteristic they are renowned for in the modern era, where everything has to be decided by committee).
Someone, somewhere, however, has to make the decision to back an alternative solution for non-CLS currencies that embraces modern technology. It is not about dumping CLS, or even moving a small portion of business away from it – rather it is about adding another service to it.
The FX industry is generally pretty good at facing reality and self-regulating, therefore we need to acknowledge in stronger terms that technology has moved on, and has largely been proven, which means it’s time to implement it as and where necessary. I have previously written that spot should probably be T+1in FX soon, a big impetus for this move would the adoption of more settlement risk mitigation technologies. The technology is there, we should use it.