Report | Reimagining same-day FX: Exploring the case for additional settlement cycles | ShapingFX series
Exploring the case for additional settlement cycles
CLSSettlement is central to the efficient functioning of the global foreign exchange (FX) market: it provides payment-versus-payment (PvP) settlement for 18 of the world’s most traded currencies1 and settles an average daily value (ADV) of over USD7 trillion of payment instructions for more than 70 settlement members and over 37,000 indirect participants.2
The CLSSettlement system operates a single settlement cycle each day (between 07:00–12:00 CET, 5.5 days a week). It achieves liquidity optimization by multilaterally netting3 gross payments down by 96%, and with additional liquidity saving mechanisms, the total funding required is reduced by 99% on average. This means that settlement in CLS can be completed with only around 1% of the gross settlement value being paid in by CLS settlement members, making considerable liquidity available to the FX market.
Most FX payment instructions in CLSSettlement settle according to the market convention of two days after execution of the underlying trade (T+2), with a smaller portion settling next day (T+1) and only a very small number settling on the same day (T+0). Most of the same-day FX settlement market, estimated to be at least USD500 billion,4 settles bilaterally and without PvP protection outside of CLSSettlement, but discussions around addressing same-day (as well as instant) volumes seem to be intensifying. This is evident in the growth of same-day volumes observed in CLS’s bilateral netting calculation service, CLSNet,5 and the growing number of global experiments in the central bank digital currency (CBDC) space, most of which emphasize the benefits of instant settlement.
However, commentators often neglect the critical trade-off between increasing settlement frequency (which facilitates more same-day or instant settlement) and reducing netting efficiency. For example, conducting multiple settlement cycles in a day lowers the likelihood of finding offsetting flows within a given cycle, and this can significantly increase liquidity requirements. This is a key reason why same-day FX solutions remain niche.
Although the inverse relationship between settlement frequency and netting efficiency is widely acknowledged, there are no public studies that analyze this trade-off using empirical FX market data.
“Public discourse often neglects the critical trade-off between increasing settlement frequency and reducing netting efficiency”
For example, how significantly does netting efficiency decline as the number of daily settlement cycles increases? How much additional liquidity would FX market participants require if they settled multiple times a day?
As a financial market infrastructure (FMI) operating in the largest market in the world (FX), CLS is uniquely positioned to offer insights on these previously unanswered questions. CLS partnered with FNA, a global leader in network analytics and simulation of financial market infrastructures, to study the liquidity implications and potential benefits of introducing additional settlement cycles per day in CLSSettlement.
Authors:
Dirk Bullmann / Managing Director, Public Policy, Strategy and Innovation, CEO Office / CLS
Emanuel Vila / Director, Strategy and Innovation, CEO Office / CLS
Sophie Dalzell / Senior Associate, Strategy and Innovation, CEO Office / CLS
Dr. Carlos Leon / Director, Central Banks and Financial Market Infrastructures Solutions / FNA
Dr. Sam Cook / Chief Data Scientist / FNA
Contributors: Howard Middleton (CLS), Mat Bennetto (CLS), Anthony Winters (CLS), Kimmo Soramaki (FNA), Chloe Wang (FNA).
1CLSSettlement settles Australian dollar (AUD), Canadian dollar (CAD), Danish krone (DKK), Euro (EUR), Hong Kong dollar (HKD), Hungarian forint (HUF), Israeli shekel (ILS), Japanese yen (JPY), Korean won (KRW), Mexican peso (MXN), New Zealand dollar (NZD), Norwegian krone (NOK), Singapore dollar (SGD), South African rand (ZAR), Swedish krona (SEK), Swiss franc (CHF), UK pound sterling (GBP) and US dollar (USD).
2Indirect participants refer to financial institutions that do not have a direct membership in CLS, but still settle trades via CLSSettlement by relying on a direct participant (also known as a CLS settlement member).
3Netting services can be of a multilateral or bilateral nature. CLSSettlement combines FX settlement risk mitigation with multilateral netting, which is achieved by aggregating payment instructions to calculate each participant’s net position across all
counterparties and currencies. This results in a single net payment obligation per currency for each participant. Where multilateral netting is not possible and there is some degree of settlement risk, reducing payment obligations through bilateral netting can still
help substantially reduce settlement risk.
4See Section 2: What are the benefits of implementing additional settlement cycles?
5CLS supports same-day settlement through CLSNet, which is a standardized, automated bilateral payment netting calculation service to support FX trades not settling in CLSSettlement. Participants can submit FX instructions to CLSNet for spot,
tomorrow/next day, forwards, non-deliverable forwards (NDFs), swaps and same-day trades for over 120 currencies.
