FX Less Risk, More Value?

Transcription

1 Links Edition 1, Spring 2000 CLS News from Chase Treasury Solutions FX Less Risk, More Value? In today s environment, a typical settlement of a foreign exchange instruction is made by making separate payments for each currency. Therefore, a party to a trade may make a payment in one currency and not receive the principal payment it was expecting in return from its counterparty at the same time. Payments made in different time zones can add to the problem. Continuous Linked Settlement (CLS) is a new settlement method developed to address foreign exchange settlement risk: the risk of loss of principal associated with the settlement of foreign exchange instructions. Continuous Link Settlement Bank (CLSB) will operate Continuous Linked Settlement by simultaneous paymentversus-payment settlement of both currency legs of a transaction across the books of CLSB. The principal feature of the service is that both sides of the settlement instruction will be settled, or neither side will be settled. In this issue: Frequently asked questions about CLS PAGE 2 A perspective on the liquidity issues surrounding CLS PAGE 3 CLS project status PAGE 4 Key messages from Chase PAGE 5 Cash and information flows in CLS PAGE 6 Next issue: CLS developments Chase products and services Getting ready for CLS more of your questions answered PAGE 1

2 About CLS...frequently asked questions How many shareholders are there in CLS Services Ltd? CLS currently has 62 shareholders from 14 countries, including Chase. What are the drivers and key concerns from a market and regulatory perspective? Major foreign exchange market players are under increasing pressure to take action to reduce FX settlement risk. The report, Settlement Risk in Foreign Exchange Transactions, the Allsopp Report, issued by the Bank for International Settlements (BIS) in March 1996, called for action by the private sector to address these problems, both on an individual and on an industry basis. The follow-up report issued in July 1998 by the BIS, Reducing Foreign Exchange Settlement Risk: A Progress Report, acknowledged that a number of private sector initiatives were either in place or underway. These initiatives include netting and CLS. The BIS report reinforced the message that momentum had to be maintained in order to achieve a marketwide risk reduction. Will CLS focus on FX transactions only? Yes. CLS will address the risk of loss of principal associated with multi-currency settlement payments arising initially from foreign exchange transactions. CLS Bank will settle payments in eligible currencies arising from both a member s own instructions and the instructions of its third party clients. What percentage of global FX transactions will CLS Bank cover? With the initial wave of currencies, assuming all shareholders satisfy appropriate criteria, and ramp up is completed, CLS expects to cover over 30% of the globally eligible FX interbank trades. We expect this number to grow as usage and the number of eligible currencies expand. What are the currency eligibility criteria? Any currency included in CLSB s settlement service must satisfy specific criteria: having the equivalent of a Real Time Gross Settlement system ( ) as the basis for transferring funds to and from the CLSB; overlapping operating hours; acceptable liquidity within the local market and clearing system; and the ability for CLSB to have an account at the applicable central bank. Other considerations may include: the value and volume of instructions among CLS members must warrant inclusion; there must be at least two Liquidity Providers that are committed to provide liquidity support to CLSB by selling and buying the currency up to specific committed amounts; the potential volatility in the value of the currency relative to other CLS Bank eligible currencies must be within specified CLSB margins; and adequate nostro bank services must be available to CLSB members to allow timely funding of pay-in obligations. Which currencies are to be included for the start of CLSB? Work is proceeding for the inclusion of the following currencies in the first phase of CLSB: US Dollar (USD), Canadian Dollar (CAD), Sterling (GBP), Euro (EUR), Swiss Franc (CHF), Japanese Yen (JPY) and Australian Dollar (AUD). Which other currencies are considered for inclusion at a later stage? The exact process to include a currency within the services of CLSB is currently being finalised. Once this process is in place, it will start validating the current plan of introducing seven currencies as well as producing a programme and timetable for adding new currencies into the service. It is intended to include as many currencies as possible for settlement within CLSB, subject to each currency meeting the eligibility criteria and there being FX industry demand for its inclusion. Does CLS intend to offer additional services, currencies, etc? CLS highest priority is to launch CLSB with all essential service components. CLSB will then concentrate on Ramp-Up an intensive go live schedule for its members. This is planned to achieve as much benefit as possible as soon as possible. CLS is currently planning enhancements, additional currencies and additional services. This process has already begun, but no plans are yet approved. Participation in CLSB services How can we participate in the services offered by CLSB? An institution may participate by applying to become either a Settlement or User of CLSB. It can also receive the benefits of CLSB through a CLS Settlement or User who is willing to offer its services. This indirect participation is referred to as a Third Party transaction. What is the difference between a Settlement and a User? The main difference is that settlement members will have an account with CLSB. CLSB does not allow User s to have an account. User s can input their instructions directly to CLSB, but must have their transactions settled via an account of a Settlement. Each Settlement will establish its own limits for its sponsored User s. User membership is being offered to encourage as wide a participation in CLSB as possible for institutions that do not want to be Settlement s, or are unable to meet all the criteria of Settlement ship. What is the difference between a User and Third Party business? User s submit their instructions directly to the CLSB whereas Third Party instructions need to be introduced by either a User or Settlement. It is also intended that each User will have the appropriate systems provided to them by CLSB so that they can effectively perform their daily cash management processes with their designated Settlement. CLSB will not provide this information directly to third parties. It should be noted that User and Third Party instructions are consolidated into the settlement positions of the Settlement. The way in which a member provides settlement services for its customers, whether Third Party or User, is a commercial matter between the member and user. P A GE 2

3 Liquidity issues Foreign Exchange Market Practice Chase seeks to work with other banks to optimise liquidity during strategic working hours. Chase has foreseen that as markets open around the globe there is a need for liquidity to be available to facilitate initial payments into CLSB. This means that co-ordination will be needed by CLS members in order to handle large volumes at key times globally. Current practice in the foreign exchange market is for banks to provide cash settlement of trades in regular clearing on the value date. The timing of settlement delivery is therefore only constrained by local guidelines such as those set by APACS or the European Banking Federation. In general, banks are able to manage the routing and timing of their own and their correspondents settlements as part of their regular daily traffic. However, within CLS, members will be obliged to cover their short positions in accordance with a frontend biased pay-in schedule, through a realtime gross settlement system. This change of practice has caused trading banks to review their liquidity requirements very carefully, taking into consideration not only their expected peak traffic, but also the peak requirements of their correspondents and other large customers active in the FX market. It is already evident that the front-end bias of the pay-in schedule will mean that a short CLS position held by a nostro provider will not be greatly mitigated by long positions held by its customers. Chase has therefore begun dialogue with other CLS member banks to seek common ground in alleviating the concentrated liquidity strain. SETTLEMENT MEMBER PAY-IN SCHEDULE CLS Bank Operational Timeline CET Funding requirements calculated on a net basis. Pay-ins are spread over the CLS window* to minimise Liquidity impact on the domestic markets. They are effected on a TIMED basis. Initial Pay-in schedule calculated and sent to Settlement s via S.W.I.F.T. Net at 24:00 CET. Designed to allow all transactions to settle by CET next day. Revised Pay-in schedule at 06:30 CET, calculated when funding requirements change following: Same-day trades Bi-lateral Rescinds Matching items that were unmatched as at 24:00 previous day Authorisation User member Transaction Initial Pay-in Schedule & URD Match Deadline Revised Pay in Schedule & BRD Settlement Completion Target Time JPY AUD European North American * to CET time (01.00 to EST, to Tokyo time) Pay-in deadlines 8am to midday 1st 2nd 3rd 4th 5th P A GE 3

4 CLS Project status The CLS project is managed through four threads : Operational Readiness: Help members prepare to operate in the CLS environment. Bring as many members, and member transactions, into CLS as soon as possible. Ensure member system architecture and organisational processes meet CLS performance standards. CLS Business Processes: Ensure CLS has all of the capabilities in place to operate the CLS Bank System in a safe, sound and efficient manner. System Development: Deploy the CLS Bank system with all of the required (day-one) functionality. Manage costs and vendor deliverables. Legal & Regulatory: Co-ordinate the legal and regulatory process. Gain approval from regulators to operate CLS Bank in advance of the go-live date. Regulatory approval requires CLS Bank to have a sound legal basis in all relevant jurisdictions. Each of these threads must be successfully completed before CLS can go-live and CLS has established a Project Management Office to manage all aspects of the CLS Bank implementation across each of the threads. In addition, the industry has identified a number of CLS related Best Practices that should ideally be resolved for CLS to be successful. These issues include treasury/liquidity management, processing of unsettled trades, compensation, phasing of legacy trades for submission to CLS, timeliness of instruction input and third party trading standards. Operational Readiness is the responsibility of Participant Management within CLS. This organisation takes each CLS participant through a comprehensive process leading up to their go live. This process begins with an orientation and includes a technical review of each participant s plan, a comprehensive test process leading to technical certification, completion of legal documentation, final approval and rollout onto the CLS Bank system. The first group of banks to go live in CLS Bank will be the Beta and Operational Trialing and Acceptance (OTA) Banks. These 16 institutions include: Chase, HSBC, JP Morgan, Barclays, United Bank of Switzerland, ABN Amro, Bank of America, Bank of New York, Bank of Tokyo Mitsubishi, Canadian Imperial Banking Corporation, Citibank, Deutsche Bank, Hypo Vereinsbank, Morgan Stanley and Paribas. Eleven millennium banks are due to go live soon after the Beta and OTA. CLS will then implement the remaining 35 members. CLS is in the midst of organisation transformation as it becomes an operating company which can deliver against the business processes that need to be in place for CLS Bank to go live. These processes include day-to-day operation of the CLS Bank system, management of abnormal settlement situations, regulatory reporting and vendor management. The CLS Bank system must be deployed and thoroughly tested before the start of operations. IBM serves as both the facility provider and system developer. IBM will deploy a pre-production member test service, followed by a production member test service. s will undergo acceptance testing on the member test service, leading to technical certification. The IBM build is in three major phases: build 1 is focused on member connectivity and was deployed in April 1999, build 2 is focused on participant functionality and has only recently been delivered, build 3 completes the build and is focused on the functionality for CLS Bank. S.W.I.F.T. is providing the network communications infrastructure and this connectivity is already being tested by the Beta banks. CLS is working with each of the central banks for its initial seven currencies: CAD, USD, EUR, CHF, GBP, JPY and AUD. Accounts will be opened with these central banks starting this spring. CLS Bank will have a real-time interface either directly to the System or to the central bank as its correspondent. Currently the expectation is that CLS live date will be September However, the final date has not yet been ratified by the Board of CLS Services Ltd, and therefore may be subject to change. Legal and regulatory activities are well underway. CLS rules are now in their second revision. The CLS Bank has received its initial charter (which is required to open accounts with central banks) and legal opinions are being obtained in the 14 jurisdictions of the head offices of the current CLS shareholders. The member handbook, which is integral to operationalising the rules is also in its second revision. P A GE 4

5 Information Flows CLS Bank CLS s Settlement 5 6 User Non-CLS s Third Party Third Party CLS: Chase s Key Messages Chase believes that CLS is an important industry initiative that represents a significant change in the FX and Payment environments. Noted for our leadership in industry and regulatory issues, Chase has a close relationship and dialogue with CLS. Chase offers a complete array of end-to-end solutions for our clients CLS-related products and services will play a core role in our future product set. Chase continues to evaluate the development of this new process to deliver the products and services our clients will need once CLS is live. Chase takes a thoughtful, comprehensive approach to initiatives, such as CLS, that have wide-reaching implications. This approach is characterised by our ability to provide creative and value-added solutions to our clients, such as our centralised euro clearing hub architecture. We are actively engaging with our clients to understand their CLS-related requirements, and to partner with them to deliver the solutions they need. As CLS evolves, Chase will share information and discuss the issues at hand through a variety of media: round table discussions, one-on-one client meetings, open forums and newsletters. Please contact your Chase Treasury Solutions Relationship Manager to discuss your specific requirements. P A GE 5

6 The cash and information flows between CLS parties Information flows are described in the diagram opposite and cross-referenced to numbers in this chart. Settlement Type Trade Submission Cash Flows Information Reporting 1 Settlement to CLS Bank Individual Trade Details (incorporating 3rd Party trades) Amend and Rescind instructions Funds to cover Short Position as dictated by Pay-In Schedule Additional Pay-Ins (in any currency) when instructed by CLS Bank (see below) None 2 CLS Bank to Settlement N/A Pay-Outs of long positions Pay-In Schedules (including notification of Pay-Out totals for Long Positions) Status updates for individual trades Intra-Day MT900/910 Reporting of settled trades (may be viewed via Gateway) Overnight MT950 reporting of individual currency accounts 3 User to CLS Bank Direct submission of individual trade details Direct submission of amend and rescind instructions User s have no accounts at CLS Bank; therefore there are no cash flows either to or from CLS Bank None 4 CLS Bank to User N/A User s have no accounts at CLS Bank; therefore there are no cash flows either to or from CLS Bank Status updates on individual trades (via Gateway) Projected positions by Value Date and by Designated Settlement 5 User to Settlement User s submit trades direct to CLS Bank Funding of currency accounts held with Settlement i.e. covering Short Positions Pre-value date notification of circumstances leading to Chase limits being breached for a given value date. NOTE: this assumes that the User is advised of their limits (not mandatory) and would result in a request to have the limits increased on a one-off basis 6 Settlement to User * N/A Credits to currency accounts held with Settlement i.e. to reflect Long Positions Intra-Day MT900/910 reporting of settled trades Overnight MT950 reporting of individual currency accounts (from relevant account holding branch) Overnight reporting of projected positions for forward value dates Overnight reporting of submitted future trades that have caused a Mark to Market exception Intra Day and Overnight reporting of trades causing Risk Control limits to be exceeded for future value dates. Such trades would need to be manually authorised during the authorisation period prior to day of value 7 3rd Party to Settlement Submission of trade details following independent execution of trade with counterparty Net funding to cover all currency short positions None 8 Settlement to 3rd Party * N/A * Net payout of all currency long positions. Dependent upon successful settlement of all 3rd Party trades Pre-value date reporting of: projected positions for next n days trades causing Mark to Market exceptions trades held on exception queue due to Risk Control limits being exceeded Value date reporting of: individual status updates of trades intra-day MT900/910 (or proprietary equivalent) reporting of settled trades overnight MT950 (or proprietary equivalent) reporting of currency accounts 9 3rd Party to User & 10 User to 3rd Party It is assumed that the relationship between a 3rd Party and a User will be similar to that of a 3rd Party to a Settlement. However, there may be differences in the Cash Management of the 3rd Party s accounts depending on the nature of the User s business. P A GE 6