Settlement risk reduction creates market growth and stability
Settlement Optimisation that results in Payment versus Payment (PvP) settlement has a number of tangible benefits:
automation of matching, netting, settlement and reconciliation reduces operational overheads and applies best practice to the settlement lifecycle
reduction in settlement risk exposure from PvP and netting reduces risk capital requirements
trading desks can access liquidity and potentially better pricing from counterparties with which they have no or limited credit appetite
sales desks can trade more with the same customer and gain a larger wallet-share, or access new customers currently out of reach
real-time visibility of liquidity improves cash and liquidity management.
The hidden benefit
A benefit that is less obvious, but nonetheless demonstrable, is the achievement of above-average FX volume growth by currencies that gain access to PvP settlement.
The Bank for International Settlements (BIS) Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets indicates the amount of FX traded, based on a daily average of market turnover measured in April of each survey year.
The long term CAGR of the Global FX market (as measured by the survey – see Part 1 of this series) is around 5%. However, currencies that joined the CLS Payment versus Payment service in more recent years have consistently exceeded this level.
The Mexican Peso joined CLS in 2008 and had a CAGR of 22% in FX turnover over the first 5 years of operation, before volume growth flattened out. The Hungarian Forint has shown a 18% CAGR between the 2016 and 2019 surveys – it joined CLS at the very end of 2015.
There are currencies that are achieving these growth rates without PvP, but it is generally due to a shift in the balance of trade and economic power, such as the Renminbi.
However, there are many more currencies that lack any growth, but could flourish from an elimination of settlement risk by having access to PvP services. The Russian Rouble, Turkish Lira and Polish Zloty have shown flat or negative volume growth since 2013, and the large number of non-reporting countries that are missed by the Triennial Survey (including most of LATAM, MENA, CEE and Africa) are also strong candidates to capitalise on these organic growth opportunities
Policy makers should include PvP in their toolkit
Central Banks, regulators and policymakers should look at the potential growth and stability impact on their markets from accessing PvP services. Development of market confidence from security of settlement encourages investor inflows, reduces liquidity bottlenecks and drives operational best practice.
Stimulation and stability of the financial system has wider benefits for the entire economy.
Settlement Circle’s Settlement Optimisation Service (SOS) is available to all market participants and across all currencies. We look forward to engaging with Central Banks and regulators to ensure markets reach their potential.
By Declan Clements, November 2021
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