The Last Look…
Posted by Colin Lambert. Last updated: December 14, 2021
There is a fair bit of ‘buzz’ around the announcement that HSBC and Wells Fargo are settling FX trades outside of CLS using FX Everywhere, HSBC’s platform, built upon Baton Systems’ Core FX solution, so what does this mean for CLS? More importantly, perhaps, is competition healthy in such an area?
At face value, competition is healthy everywhere (pun intended!), but when it comes to settlement risk we are talking a critical market infrastructure – which means regulation, oversight and all the associated costs and resources. Fintechs can disrupt a lot of areas in our industry, and the crypto/DeFi world is at the forefront of that currently, but the core ‘freedom’ ethos at the core of those markets runs contrary to the wider financial world where some things just have to be regulated as we can’t afford for them to go wrong.
Of course, this should not mean that the incumbents are able to rest on their laurels without fear of disruption, these operations should always be pushing to maintain pace with technology developments. They will not always keep up of course, their sheer size and complexity means inevitably movement is slower, but they should not be inert – something that has been thrown at Swift and CLS, as incumbents, in the past.
I was mildly amused at some of the reaction to the news, not least those arguing this is truly ground-breaking because it extends PvP to non-CLS currencies. It does in theory, but this first settlement process involved four of the G7 currencies, so in terms of reducing settlement risk, nothing has changed. What has changed is the challenge associated with intraday liquidity costs – these have been reduced dramatically.
A working model has been delivered, however, and it is scalable, therefore I believe it should be put to use in those areas where it is needed – non-CLS currencies. This would mean the industry had two mechanisms working to minimise settlement risk in FX (and more at the proof of concept stage) in a complementary fashion, rather than competitive. I am not sure fragmentation in the settlement space is a good idea.
By pushing the use of PvP in non-CLS currencies, the impact on the true settlement risk picture would be more dramatic than in G7, 10 or 18 as well, for I don’t actually buy the $9 trillion number that is often bandied around as being the value of FX settlements outside CLS. A fair chunk of this number is made up on intra-firm trades, where the settlement risk barely exists (HSBC is, incidentally, not necessarily one of those firms, given its highly complex and regional/global structure). By focusing on emerging markets and non-CLS currencies the benefit would be enormous.
Of course, should this eventuate, the next big question is, at what stage does the provider of the PvP need to get regulated? If we have one (or more) service providers who need to be regulated and an equal number who don’t, that looks like an unfair playing field. Of course, the banks are (heavily) regulated entities, but does their oversight actually cover the provision of settlement services?
What has happened this week, is that a major step forward has been taken in reducing intraday liquidity costs, with the alluring prospect of a whole deal more FX volume being settled on a PvP basis.
This week’s announcement highlighted that the firms are using Baton’s rulebook (I searched on the firm’s website for sight of this and couldn’t find it – which might be something for the firm to consider going forward), so there is transparency around the process. Equally, Baton, as the base technology provider, is a signatory to the FX Global Code. It may have to go further, however, which is where it will face the fintech challenge.
In a release announcing the news, it was stated, “The parties hope…to introduce a central Financial Market Infrastructure (FMI) provider to administer the platform rulebook”. This suggests that they recognise that to garner sufficient traction, some form of oversight is necessary, (CLS is on the New York Fed and IOSCO’s radar). For it to be Baton, the firm is going to have to invest in the regulatory aspect of the business, or, as maybe is hinted in the release, find a partner – this may, or may not, involve CLS.
To go back to the basic premise of this column, competition is good, but in certain areas innovation alone won’t be enough. What has happened this week, which is a very good thing, is that a major step forward has been taken in reducing intraday liquidity costs, with the alluring prospect of a whole deal more FX volume being settled on a PvP basis.
Whether this galvanises CLS into faster or more dramatic action, or whether it will seek to partner with what looks like a challenger (but has often been described as anything but), we will have to see. Either way, you suspect this is merely the start of a period of dramatic change in dealing with FX settlement risk.