With T+1 looming, buy-side firms are worried they won't meet CLS netting deadlines for FX.
Gary Gensler, chair of the U.S. Securities and Exchange Commission (SEC) descended upon a European Commission workshop on T+1 settlement last week to urge regulators to include foreign exchange (FX) in their efforts to reduce settlement times in coordination with central banks, the Bank for International Settlements (BIS), and CLS Bank.
R.J. Rondini
One trade association in attendance was the Investment Company Institute (ICI). According to R.J. Rondini, securities operations director at ICI, the main operational challenge reported by ICI’s buy-side members when it comes to FX is the CLS timeframe.
CLS Bank is integral to FX transaction netting and has a critical role in ensuring timely settlements. With the shift to T+1 settlement, Rondini says, firms are concerned about meeting CLS netting deadlines, especially when dealing with a high volume of end-of-day trades.
In the U.S., for example, the market closes at 4 p.m. EST, while the deadline for submitting FX transactions to the CLS netting process is 6 p.m. EST. In addition, buy-side firms access the CLS window via their custodian, which has a processing time of its own ahead of the 6 p.m. deadline.
“Let’s just say, arbitrarily, my custodian has a 5 p.m. processing window for CLS, for them to get it in at 6 p.m. That gives me only an hour after the close of market to affirm and match my trades, then execute foreign exchange and communicate it to my custodian,” Rondini says.
As of now, CLS Bank officials are not extending their timescales. Marc Bayle de Jessé, chief executive of CLS Group, said shortening foreign exchange settlement times was something CLS “on its own cannot change.”
Chip Lowry
Chip Lowry, an advisor at the Foreign Exchange Professionals Association (FXPA) notes that altering the cut-off timeline by even an hour or two could entail a substantial change in CLS’s architecture — a transition that is likely to require significant funding and time.
“For them to say they can’t do it alone, I understand what they mean. But I think what Gensler is really talking to with moving FX to T+1, is making sure that CLS can expand its submission windows to accommodate it. What kind of technology changes are required on the CLS side is the real unknown question,” Lowry says.
There are several operational workarounds that buy-side firms are exploring.
Firstly, executing bilateral FX directly with their custodian, bypassing the CLS process entirely.
Secondly, pre-funding their U.S. dollar accounts to eliminate FX concerns at that specific point in the day.
Thirdly, create an estimated FX forecast earlier in the day, execute the foreign exchange accordingly, and later, after market closure, make adjustments if their initial estimates prove inaccurate.
Investors based in Asia bear the brunt of the reduced FX settlement cycles due to time-zone differences.
Reports from ICI members in Asia indicate a rising trend of pre-funding their U.S. dollar accounts. FXPA’s Lowry, meanwhile, suggests firms are looking at alternative solutions, such as establishing a 24-hour desk in Asia, opening an office in a more accommodating time zone, or enlisting the assistance of custodians.
Basu Choudhury, head of partnerships and strategic initiatives at post-trade service provider OSTTRA, anticipates the buy-side firms are likely to be attracted to the latter solution, enlisting custodians to settle FX trades for them. However, he warns pricing might deteriorate over time.
“As a bank, I have to make sure I have enough dollars to be able to facilitate your settlement. So for me, it means I’ve got to warehouse and lock up dollars,” Choudhury says.
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