06 JulIntraday Liquidity. What to do with the FX that is not PvP / in CLS?
CLS settlement is a great thing. With the new rules on FX settlement coming into effect on Jan 1 2015, its value is higher than ever. But, not every FX trade can make use of CLS. What are the alternatives?
This is the fifteenth in a series of posts on how banks and FI’s might adapt. The previous posts are available on the 3C Advisory website, click here.
The options here are really rather limited. Clearly, the regulators and the market participants are very happy with the security that settling PVP in FX via CLS brings, and rightly so. Somewhat ironically, when CLS was first set up, it was quite difficult to persuade some market participants to use it. “It costs more than just doing a payment; no incentive,” was the objection. There was no obligation and no deadline. The banking community is not at all good at dealing with that sort of challenge; it marches best when there are firm deadlines.
There is a risk that an unholy trinity of events could create the perfect storm. Each of the options we have discussed immediately above are valid ones; Nostros could and maybe should reduce some limits, some FIs could and maybe should demand lower limits and some FIs might use the just-in-time approach to payments, although in this case I would hesitate to use the word “should”. Now, if all three of those are practiced extensively, this will have the same effect as a series of roadworks in and around the same neurological point. If you were in New York, imagine that three different departments decided to close the Holland and Lincoln tunnels as well as the George Washington Bridge, on a Friday afternoon in July. Or, if you are in Switzerland in the winter, both the St. Gotthard and San Bernardino tunnels. You get the picture.
PvP vs. non-PVP Settlement
The only available PVP settlement mechanism is via CLS Bank. The latest figures show that CLS settles some 64% of the world’s FX flows. The missing 36% is made up of a number of components: 1) currencies that are not eligible, in particular, Chinese Remnimbi, Turkish Lira and Russian Roubles, and 2) trades that would be eligible, but one or both of the parties do not use CLS.
The former, group 1, make up some 6% of the missing 36%, but they are growing, so adding new currencies is a good thing if it can be done. CLS is working hard to add new currencies; it has cleverly opted to add the Rouble, but without allowing short positions in the settlement cycle. This avoids a lot of tricky issues. Kudos to CLS.
Group 2, the trades that could be inside CLS, can be influenced. This too is not easy. The typical case is a bank from a country whose currency is not in CLS. Let’s use Turkey as an example, and for simplicity, assume that the typical Turkish bank trades three pairs: TRL/USD, TRL/EUR and EUR/USD. Only the last pair could be in CLS. So the Turkish bank decides not to use CLS. For its own purposes, this makes the cash management easier, as it does not need to deal with CLS flows separate from its other flows.
Lessons Learned: The BCBS directives are a good thing. They will force a lot of discipline into the FX settlement. Kudos too to CLS for allowing currencies onto the platform with slightly different payment rules.
There is still work to do on the liquidity front to manage the exposures. More on bi-lateral netting and the new BCBS regulations at the end of July; vacation coming up.
A personal request: Finally. I have ventured into self-publishing. The not so creatively titled, but practical guide: “Cash & Liquidity Management: Mastering the Challenges of New Regulations and a Changing Marketplace” is now available in print and on Kindle. All the bits form the Blog are there, together with a lot of detail on current challenges. Many of those challenges will take effect on Jan 1 2015. Time to be well informed! As too is the book on more general operations issues.
Book #1: The Bankers’ Plumber’s Handbook
How to do Operations in an Investment Bank, or Not! Includes all the Blog Posts, with the benefit of context and detailed explanations of the issues. True stories about where things go wrong in the world of banking. Available in hard copy only.
Book #2: Cash & Liquidity Management
An up to date view of the latest issues and how BCBS guidance that comes into force from Jan 1 2015 will affect this area of banking. Kindle and hard copy.
Hard Copy via Create Space: Click here
Amazon UK: Click here
Amazon US: Click Here
Thanks for your support and thanks to the numerous contributors.