Corporate and Institutional FAQs

Continuous Linked Settlement (CLS) began operation in September, 2002. It is a way of reducing the settlement risk in foreign exchange transactions (for example, one leg of the transaction is settled but the other is not).   Currently, CLS operates in seven (7) currencies (USD, EUR, GBP, CAD, CHF, JPY, and AUD). Four more currencies will be added in 2003 (NOK, SEK, DKK and SGD), and further currencies will be considered for inclusion later.

Currently, there are more than 65 banks that are shareholders of CLS, and they have all been involved in the development of the service.   More banks are becoming shareholders every month as new currencies are considered and accepted.  Most shareholders will choose to become "Settlement Members," although some may opt to be "User Members."

Settlement Members have direct links to CLS to input deals on their own and their customers’ behalf.   They effect settlement on the due dates through accounts held at the newly formed CLS Bank.   User Members have the same direct access, but use a Settlement Member to handle their settlement on the due dates.

Third Parties have no direct links to CLS, and their trades must be sent to CLS via a Settlement or User Member. Most banks (as well as major corporates with their own treasury departments), that wish to use CLS, will do so as Third Parties.

When a foreign exchange deal is struck between banks, each counterparty transmits the details to CLS Bank, where they are matched and held until the settlement date.  At the start of day, each Settlement Member’s net position in each currency for that day is calculated.   This includes trades to be settled on behalf of User Members and Third Parties.  The Settlement Member will be long in some currencies (a net receiver) and short in others (a net payer).  For short currency positions a payment schedule is devised by CLS, and, by given times during the CLS day, the Settlement Member must make the payments to CLS Bank.  The Settlement Member pays only net amounts.  CLS Bank actually settles both sides of each trade simultaneously, thereby eliminating the normal settlement risk.  Throughout the day CLS Bank will pay out the net amounts for the long currencies to Settlement Members.

Settlement Members will settle separately with User Members and Third Parties their own net short and long positions.

Foreign Exchange Risk

To what extent do you currently record and manage the settlement risk?   How important is it for you?   If you trade generally with larger banks you may feel that the real risk is small. Conversely, you may want to reduce your risk on smaller banks.

Pressure From Trading Partners

Trading partners may already be committed to CLS and request that you use CLS to trade with them.   Some banks may decide to charge a premium for eligible trades outside CLS.

Regulatory Environment

Central Banks in many countries are seriously concerned about the risks inherent in foreign exchange settlement (amongst other things).   There is pressure from them to reduce the risk, and penalties may be imposed on banks that do not.

Changes To Procedure

Differences will exist in the way deals are struck and settled when using CLS, even as a third party.   A confirmation of the trade will have to be copied to your appointed Settlement Member at the time of the deal.   Your settlement process will be different.  You will now have to settle through the Settlement Member, and you will have to agree upon the method of settling.   It may also be necessary to hold nostro accounts with the Settlement Member, which will require funding.   For non-CLS trades, the existing process must continue, therefore the two will have to operate together.

Costs

Inevitably, changes to systems will incur an expense.   The costs associated with individual payments for each trade will disappear, but your Settlement Bank will still charge for each trade.   Therefore, several questions may arise such as: “What will the overall impact be if new nostro accounts are required?”  and “What will these accounts cost to maintain?”

Benefits

If a significant percentage of your foreign exchange trades can be processed via CLS, you may find that the procedures are simpler and more effective.   Overall costs and settlement risk may be reduced.   Using CLS may avoid the possibility of premium exchange rates or capital charges imposed by Central Banks.

It is difficult to tell whether CLS will be more successful than previous efforts to reduce foreign exchange settlement risk.   The concept appears to be a good one, but critical mass is necessary if the system is to be effective.  As more and more banks are added to the service, the success of CLS becomes a greater probability.

The CLS settlement day is between 7am and 12midday, European Time.