There is widespread agreement that CLS – the continuous linked settlement system – has performed an admirable job since it started operations in September 2002. Its effective removal of settlement or Herstatt risk for the majority of foreign exchange transactions is often cited as one of the catalysts for the recent growth in the market. However, as it approaches its fifth anniversary, CLS is frequently seen in some quarters as acting as a brake on further market expansion because its business model has become anachronistic.
The main issue is that CLS does not allow pre-netted trades to be submitted for settlement. As it charges on a per-ticket basis, its users have had to pay more as the number of deals they put through CLS rises.
CLS has reduces its tariffs as volumes have increased, but this has not totally silenced the chorus of complaints from some quarters.
CLS’ model reflects how the market used to be, not what it has become. The FX market has changed radically since CLS’ conception. In particular, the growing use of electronic trading has resulted in a whole new range of participants flocking to the market, such as high-frequency traders that trade smaller amounts far more frequently than used to be the case a decade ago. Another issue is that the acceptance of FX as an asset class has led to the more active management of currency exposure by real money accounts and when they trade, they frequently want to have deals allocated to multiple different accounts.
The result is that the growth in ticket volumes has outpaced the increase in volumes and at times some banks have struggled to process the vast number of deals they are doing with their counterparties. With volumes predicted to increase yet further, CLS is becoming seen as a burden – described by some as a bad tax on the industry – both in terms of cost and the stresses it imposes on back offices. Given its ownership structure, CLS itself is naturally aware of this issue.