01 November 2007 Product Reviews

 

Steady as she goes

David Bannister

Rob Close, chief executive of CLS, says that the FX clearing service isn’t going to change horses in midstream.

CLS Bank had a painful and protracted birth and is still the object of criticism from many quarters of the industry. Set up to eliminate settlement risk through a simultaneous and irrevocable global multi-currency settlement system, the service is supported by 69 of the world’s largest global financial institutions who are shareholders of CLS Group, the ultimate holding company of CLS Bank.

As with similar collaborative ventures, this structure means that there is a steady stream of critics who say that it is too expensive, too limited, only addresses one form of risk, or is the wrong thing doing the wrong job entirely.

Yet since that protracted birth, it can point to a steady growth in volumes and a related fall in costs. It is also expanding its services and moving into non-FX services, such as credit derivatives.

In September, CLS Bank set a record for both the volume and value of payment instructions settled in one day, with 905,478 instructions at a gross value of $8.4 trillion.

Rob Close, chief executive of CLS Group and president and chief executive of CLS Bank, said that the market turbulence of recent months had helped push the numbers up, but added that the growing use of algorithmic trading in foreign exchange had also contributed.

“Algorithmic trading hasn’t been as prevalent in foreign exchange, but it is starting to be, and it is the case that the average value of those trades is smaller.”

This has led to member banks seeing costs fall by as much as 50% during the past year as volumes climbed to record levels.

The continuing growth in volumes and value of trades through CLS, along with the fall in user costs, go some way to answering one of the latest sets of criticism of CLS, contained in a white paper published last month by Wall Street Systems, Optimizing settlement risk management: CLS and beyond.

The paper says the cost of trading though CLS “remains relatively expensive” with “entry fees that are prohibitive for all but the largest bank, while membership fees and settlement costs are also high”.

Rick Schumacher, director of products at Wall Street Systems, said: “The number of transactions to process has gone through the roof, and CLS charges on a per transaction basis. CLS is reluctant to budge on pricing and some banks are upset because they consider that CLS costs are exorbitant. CLS is trying to make advances in this area.”

The paper also says “a strong alternative” to CLS is bilateral netting, in which a bank and counterparty total the net difference in a defined period and settle the amount in a single payment.

“We have been asked by a number of banks to consider accepting trades following bilateral netting, and we have looked at it long and hard,” said Close. “At our board meeting in July we tried to see if there was a business case for doing it, but there really isn’t.”

To change from the current multilateral netting model to a bilateral model would have serious implications for the competitive landscape in FX trading, he said. “Some banks net, some don’t; as an industry utility, we can’t make those choices. It is more important to grow the company and get costs down as volumes grow.”

A limited form of netting will be one of the benefits of the new service for the settlement of non-deliverable forwards that is scheduled to be introduced before the end of the year. This will cover 48 currencies, more than the primary CLS service, which currently handles 15 currency pairs.

This will increase to 17 next year with the addition of the Mexican peso and the Israeli shekel. According to Close, the peso is the last major liquid currency that needed to be added to the CLS system, though CLS is still looking to increase its range of currencies that are covered. Currencies in South America and Asia Pacific are likely candidates for addition in the future, while the decision on some Eastern European currencies will depend on whether or not the countries adopt the euro.

Also to be introduced before the end of the year is the central settlement of payments for over-the-counter derivatives contracts housed in the Depository Trust and Clearing Corporation’s Deriv/Serv Trade Information Warehouse. Initially supporting credit derivatives, the new solution will later be extended to other OTC derivatives products including rates, equities and commodities.