The Last Look…
Posted by Colin Lambert. Last updated: July 23, 2024
The subject of wholesale central bank digital currencies has gained new momentum this year and like so much in the world, opinion is divided – they are either the next big thing, or something that will destroy. The reality is, naturally, in between, and while CBDCs may well be a big part of the future of money, in their current form they are not, but a version of them, or at least a new system of payments, will emerge, of which, they will be part.
Perhaps my biggest issue with wholesale CBDCs is that they are the latest iteration of a solution looking for a problem. I absolutely understand they can improve the speed of settlement, but in the FX market in particular, it is questionable how many participants actually want that. While I am fond of reminding everyone that the real reason the FX market exists is to oil the wheels of the global economy and other markets, the fact is that the majority of trading probably takes place with the intention of making money – and that ability is diminished if all trades are settled instantly. Netting is a big part of our market, and as such should be maintained as a core function of any payments and settlement system.
This is not to say that we should ignore the benefits of instant settlement and a more digital process, rather that we need to develop a framework in which market participants have choice. Yet again, one size does not fit all in the FX market.
The development of wCBDCs should continue, and if they do deliver the ability to settle on an atomic basis, then those players that want that will be well-served. At the same time, however, surely CBDCs can be developed in such a way that those that want netting can use it ahead of timed settlement?
I continue to be bemused by the polarised views on wCBDC, because if we look at trading, the FX industry offers multiple methods to do the same thing – buy or sell. Why can’t the settlement process also offer a diverse choice?
Some argue that a sticking point is the FX market’s reliance upon CLS and point to that service’s challenges when initiating significant change. There is no doubt that CLS has higher hurdles to overcome when changing its operations, for example adding new currencies, but given the wCDBCs will effectively replace currencies already supported by CLS, would it be such a heavy lift? CLS sits in a tricky position in the FX industry, because it is too important for it to be able to casually make changes, but the industry around it is evolving fast, and other solutions, and demand for flexibility and speed, will continue to increase. Rather than being an industry-wide issue, however, it is more one for CLS, which needs to ensure that it is fit for purpose and meets the evolving needs of a broader college of participants.
There are already challengers in the settlement space, but clearly they lack traction at this time (and the world is probably waiting to see what Osttra does with the Baton piece), but I suspect a successful development of wCBDCs will see the world fragment with the emergence of two or three services. A good outcome for the industry would be having these different services linked by one framework, post-trade is often seen as a burden and an area ripe for collaboration, perhaps the next stage will be more collaboration in settlement? Certainly, if we are to retain the benefits of netting, whilst also offering atomic settlement there is likely to be more than one firm providing the service, but it would be very helpful if these providers are linked in some fashion. Hoe this looks is anyone’s guess, but one idea could be for CLS sits above a network of other settlement engines that provide instant gratification, perhaps even be the ultimate owner of multiple systems if its constitution allows.
If, and it remains an ‘if’, wCBDCs do take off, the FX post-trade world will look different, not least because of a widespread change in how many settle and pay. This is an outcome that CLS should be prepared for, because the FX industry – and more importantly, the central banks – will not wait for it to catch up. Any major wCBDC launches will not happen soon, but the chances are eventually one will be launched in a significant market. This could be good news for the end-users that rely upon quick payments, bad news for those firms still charging the earth for payment services due to liquidity charges, and interesting news for the FX market. After all, with spreads continuing to be tightened, revenues have to be maintained somehow, and making settlement and payments more efficient would be one way.
