The Last Look…
Posted by Colin Lambert. Last updated: August 9, 2022
There are a lot of initiatives underway in the FX payments and settlement space, but the sense is that the time for ideas – and talking – is fast ending, and that both regulators and market participants are keen for working solutions to adopt.
The recent Committee for Payments and Markets infrastructure’s (CPMI) consultation which commenced just over a week ago, served to increase this impression, and it was noticeable that while the very fact that CPMI received 11 “concrete ideas”, suggests that the industry is acting, it also observed that only two are live.
This is not the first time that the FX industry has seen several competing ideas jostling for space, of course, but unlike many other fields – multi-dealer platforms for one – in the post-trade space fragmentation isn’t a benefit. The last thing market participants need is a post-trade infrastructure as complex and as that in the front office.
I am neither in the minority that argues that CLS is vulnerable to disruption, nor do I believe that it has the field to itself, not least because of its regulatory position. There is room for others to provide what could be termed a “competimentary” service that fills in the obvious gaps in currencies, as well as offer support for CLS core currencies, because the fact is, there is undeniably a huge swathe of the market not covered by the mechanism.
While CPMI is the regulatory face of efforts to push ahead on PvP, it should be noted that other regulators have to also play their role. One of the biggest advantages CLS has, is its regulated status under the auspices of the Federal Reserve Bank of New York. This is hard earned (and kept) and means CLS is in a strong position, naturally, and that the competition has many regulatory hoops to jump through. I was told by one person in this space that they didn’t feel regulatory approval and oversight was necessary due to the “trustless” nature of new technological solutions – I respectfully beg to disagree. The FX industry may pride itself on its self-regulatory framework, but in the case of payment and settlements, it wants as many eyes on the process and managers of that process as possible – “trustless” means exactly that in this case.
Trading venues that currently operate outside of MTF regulation in Europe, for example, do not worry participants, because it is merely about the technology – no actual cash beyond market risk (often for no more than a few seconds at most) – is at risk and the market risk is managed at a higher level than the individual platform. It’s the exact opposite in payments and settlements. Regulatory speaking, the playing field has to be level, and this may mean solutions providers having to go the extra mile, as well as regulators being open to new solutions.
If a clear leader emerges from the pack trying to sit with CLS as a key settlement provider for the industry, it could very easily be settling more than CLS in a relatively short period of time
I was talking to someone last week about this, who thought the problem was “confected” in that CLS has the task well in hand and that the risks involved “are not that large”. As it was a friend, I felt able to less-than respectfully disagree, pointing out that while CLS is indeed a crucial element of the FX market ecosystem, the BIS Triennial Survey in 2019 indicated that PvP settled only a substantial minority of flows. If you are wondering why CPMI heard from 11 solutions, the answer can be found in the $9 trillion per day settled without PvP protection in FX markets. If a clear leader emerges from the pack trying to sit with CLS as a key settlement provider for the industry, it could very easily be settling more than CLS in a relatively short period of time.
CLS is, possibly for the first time since it commenced operations 20 years ago, facing competition – not in scale or position terms, but technological. It is, of course, working on its own DLT-founded solution, and it will not sit on its laurels here, but it has to make sure that some of the mistakes of its very early years, prior to launch, are not repeated. Time, unlike either aside of the turn of the century, is not on its side, which may be why I hear whispers that CLS is focusing more on the robustness and expansion of its core services, rather than divert precious resources to new avenues.
Of those firms competing, Baton Systems undoubtedly has a clear advantage in being a working solution with the credibility of an ongoing live operation, but that does not mean another challenger cannot emerge from the field. The only thing I would observe is that reinventing the wheel is not going to cut it in this space, a successful challenger either needs to have a radically different (and better) idea, or operate in specific areas of the world where it can build its ecosystem (and have the money to do so of course).
History suggests, that in areas such as this, there can be a first mover advantage, not least because customers do not earn revenue from FX settlement generally, and therefore want a solution that works, at the right price. Once they have settled (pun intended) on that, getting them to change their provider will be incredibly difficult.
There are still those in FX, primarily heavy users like the major prime brokers, who feel that CLS is too expensive, but I am less convinced this will be an avenue that will bear fruit for challengers. There may be some emphasis on cost in the CPMI report, but it is probably as well to remember that we are talking about a critically vital aspect of the FX industry here – as demonstrated by CLS in the immediate aftermath of the Lehman collapse.
The price is important, but when it comes to something as vitally important as payments and settlement on trillions of dollars per day, the FX industry needs the antithesis of astronaut John Glenn’s famous comment – it doesn’t want the machine built by the lowest bidder!
How ever this sector of the industry plays out in terms of winners and losers, I am confident of one thing – the existing models have a limited shelf life. We have witnessed an (ongoing) argument over the actual uses of new technology like blockchains and DLT, but here, in FX payments and settlement, is an area that will undoubtedly benefit from this technology. That means that while the names above the door of the leading providers may not change, what happens inside those doors must, and will, change – just don’t expect it to happen quickly.