Part I of our CLS review showed that there are now over 50 large MNCs connected to CLS. This has been much lower than expected because settlement risk has not been a priority for corporate treasury departments for many reasons, including:

• if a corporate is a mono-bank user, large banks can provide a complete FX service for trading, price-discovery, confirmation, and integration into cash flow forecasting system and TMS, so settlement is just debiting the bank account 
• corporates net internally across the group before they go to the FX market with the residual FX required, so minimising FX settlement exposure (However, it could still be a huge risk exposure.)
• corporates who use the FX trading platforms which have a settlement centre, match and upload the transaction details to TMS, and catch bad trades, SSI errors feel that covers their immediate risks
• most corporate treasury departments have had other more pressing problems than solving settlement risk
• there were many more urgent risks and compliance problems to solve first.

Unfortunately, this has resulted in FX settlement risk becoming, for many corporate treasury departments, the single largest uncovered risk in corporate treasury today.

For many of the corporates who have taken CLS the primary reason for adoption was because they needed to de-risk their overall treasury operations and flows, and settlement risk was the biggest remaining risk, e.g. at the month or quarter end the settlement risk of a mismatched deal can be huge. The other reason for moving to CLS has been to improve the overall efficiency of their FX processes and business continuity processes. 

Bank CLS services and charges

Banks normally offer CLS as part of their FX services. No bank is providing CLS as a stand-alone service, it is always part of their overall FX services. In fact, most banks will only provide CLS to those corporates that they have a long-term relationship with, AND if there are adequate trading volumes are for the bank to warrant the investment and the impact on their liquidity.

The banks’ CLS services are very similar, as it is such a basic simple service. There are slight variations, e.g. offering a GUI showing how deals are progressing: how many matched and what cash needed.

Settlement member banks charge corporates for the CLS not CLS Inc. The CLS settlement member bank charges vary: some make a % charge, others charge per transaction, and some bundle CLS charge in the other FX services.

CLS implementation

Most corporates have consolidated their overall FX trading and processing before implementing CLS, so that as much as possible of their FX settlement risk is included. CLS implementation is normally carried in the low FX trading periods. 

Most CLS corporate users carry out the bulk of their FX through a trading platform. In the platform there is typically a filter to determine whether the trade qualifies for CLS settlement process or not. If it does qualify, then it is routed to the CLS settlement bank, if not it is routed to the TMS and a confirmation matching platform to be settled manually

Implementation is “pretty seamless” according to corporate treasury project leaders of CLS implementation projects. The most complicated part is coordinating and managing the numerous groups who have to be involved:

• the bank where FX accounts are held and the third party provider to implement CLS 
• FX trading platform provider
• the internal IT group and TMS provider to develop the links and integration of the IT systems, FX trading platform and CLS
• cash management and banking relationship team
• internal accounting team.

The other main issue for many corporates implementing CLS has been setting up the accounts at their counterparty banks to accept trades via CLS. This is because each bank has its own rules, processes, and forms, and also because the banks have varying degrees of familiarity with setting up corporates on CLS, as well as having very different back office departments. In setting up the counter-party banks companies need to ensure that each bank understands: 1) which CLS settlement member they are using and their SWIFT code, 2) the SWIFT code of the counter-party, 3) when testing is to be carried out, and 4) the live date. Banks vary as to how long this setup takes: some banks do it same day, while others take longer.

Today most corporates use CLS for all 17 currencies because it actually makes it more complicated to exclude some of the CLS currencies. Although there are still some corporates who do not use all the CLS currencies. 

CLS Benefits

For corporates there are two main benefits from settling through CLS - minimising settlement risk and improved FX processing efficiency as the following quotes show:

• GSK: “As all settlements are automated after matching, CLS forms an integral part of GSK Treasury’s Business Continuity plan. In the event that our Business Continuity plan has to be invoked, we can rest assured that all our matched CLS trades will settle without the need for our interaction, freeing up essential resources which we can focus elsewhere.”
• Nike: With no increase in day-to-day system costs we have freed up to 70% of the resources that used to be tied up dealing with FX settlement. Elimination of settlement risk and a much higher level of control are important benefits, but it is the improvements in operating efficiency and the level of automation that are providing the big gains for us.
• Hewlett Packard, “CLS is a natural fit with our straight through processing objectives. It gives HP greater control through the streamlined operational processing. HP now has quicker access to information and CitiBank handles the net settlement of CLS trades to and from HP’s FX bank accounts. The operations team at HP simply have to monitor trade confirmations and net settlement by currency.”

Other comments have a common theme: ‘it is a simple process that just works’ including:

• all CLS trades are confirmed by the TMS CLS module with no further interaction required during the settlement 
• once a trade is matched it will automatically settle.

The reduction in overall payment volumes varies between corporates. It really depends on how much trading is in non-CLS currencies which still have to be covered by the old processes, e.g. one corporate now settles 93% by value through CLS while 50% of trades are still in non-CLS currencies, so cash team has only had a 20% reduction in workload.

Future CLS development

The published strategic priorities that CLS have set themselves, over the next couple of years, are:

• participation expansion including: increase number of settlement members and in new jurisdictions; increase third party participation - custodians to investment firms, banks to corporates; and increase member participation - additional branches, subsidiaries and affiliates
• adding new currencies: CLS are actively engaged in Hungary, Poland, Russia and Turkey amongst others
• Americas Same-Day Settlement (SDS) session: the USD/CAD SDS went live in 2013 with 16 members active (one remaining bank targeted for second half of 2014)
• expanding the Americas SDS session beyond USD/CAD: under consideration are Mexican peso, European currencies and South African rand

Mid-sized to large corporates can expect the usage of CLS to become more common as the number of settlement members increase and the number of CLS currencies expands. However, this will not happen quickly as adopting CLS at a currency level or bank level is a major decision with many people involved, e.g. accepting rouble into CLS. But the risk reduction and operational improvements are so great, that it will happen….. eventually.

Key CLS questions for corporates

Generally, corporate treasury departments need to have centralised all FX trading for CLS to be appropriate. When evaluating possible use of CLS, questions that corporate treasury departments could ask include:

• what is our settlement risk at peak FX trading points? can we afford for a major FX trade to be mismatched over a weekend?
• do we want to centralise all their FX settlement just through a single bank?
• do our FX clearing banks offer CLS settlement?
• what improvements in our FX systems and processes are needed?
• what operational efficiencies can be achieved through using CLS and what operational administration and resources will be saved?
• does the volume of CLS compliant trades warrant the cost of implementing and operating a CLS link?

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CTMfile take: Although there are important operational improvements and savings, the raison d’etre for using CLS is the elimination of FX settlement risk. In 2000, Peter Alsop and his committee who drove the development of CLS, were right to conclude that FX settlement risk was the biggest single risk in the financial system. Today, for many corporate treasury departments, it is the single largest unmanaged risk. Yet, they can, as Nike put it, “With no increase in day-to-day system costs we have freed up to 70% of the resources that used to be tied up dealing with FX settlement and eliminated settlement risk.” Although, the operational improvements are important, it is the removal of settlement risk that is vital.