FX: CLS netting service expanded to cover all tradable currencies

CLSNet, the bilateral netting service due to be unveiled in the first half of 2018, has been expanded to cover more than 140 global currencies, instead of the 24 originally planned, according to CLS.

The service, which will be standardized and automated, and open to institutions that do not settle on CLS, will enable netting of trades in all currencies not associated with jurisdictions on official sanctions or black lists.

CLS had always intended to include the gamut of currencies, but had planned to limit it to a smaller number in the early stages to get clients comfortable with the service.

However, having liaised with clients, it found a high level of demand for peripheral currencies and so decided not to hold them back.

David Clark, chairman of the Wholesale Markets Brokers’ Association (WMBA), says: “The BIS [Bank for International Settlements] figures show that there are more currency pairs traded and there is an element of chicken and egg about meeting this demand.”

One example is the growth of the renminbi, which generates more interest among traders as liquidity increases, which in turn generates greater liquidity.

As an increasing amount of China’s trade with smaller Asian and other countries is priced in RMB, it will be increasingly important for businesses to have better hedging instruments for a range of RMB pairs.

“The entry of the RMB into the [World Bank’s special drawing rights currency basket] last October has played a role in this,” explains Clark.

So far, 21 participants have committed to the service, according to Adam Levine, executive director for corporate strategy and development at CLS.

“The service has garnered interest from both large and small institutions, buy side and sell side, and institutions inside and outside existing CLS jurisdictions,” he says.

WMBA’s Clark says there has long been demand for this kind of netting service, adding: “Many market operators have been waiting for a while for this development and it will enhance liquidity because it will assist risk management.”

Although the launch date remains some time away, the platform has been largely built. CLS is leaving a long period for testing, first internally and then with member working groups. 

CLS has also been working hard on its compression service, triReduce CLS FX Forward Compression, which is yet another way for institutions to manage their operational risk.

However, netting is notably different from compression, says Levine at CLS. Compression only impacts forward-dated trades, such as forwards and swaps, allowing participants to reduce their notional exposure to their counterparties, by replacing the underlying trades.

CLSNet will cover different types of trades, says Levine, including spot, tom/next, same-day and non-deliverable forwards, as well as swaps and forwards.

“The benefit is also different as CLSNet will calculate the net exposure by currency and counterparty, on the value-date or the day before,” says Levine. “There is no reduction in the notional exposure and no change to the underlying trades or legal obligations.”

Clark agrees netting and compression are notably different services, which – while they are both designed to manage operational risk – are complementary, rather than in competition.

“This is an alternative, not a replacement,” he says. “The cost/benefit analysis in respect of capital employed will eventually be a key factor in which way the market goes.”

Compression might be the route of choice for trades where it is available, but netting is likely to be far more widely available.

Compression is difficult to achieve in less liquid emerging market (EM) currencies, says Clark. It is therefore even more significant that the netting service has been expanded to cover more currencies.

As well as helping traders manage risk, CLSNet will be of interest to many institutions as a way of getting some hands-on experience in using distributed ledger technology (DLT). For some it might be their first opportunity using DLT, giving them an opportunity to better understand how it works and can improve their efficiency.

CLSNet was built using Hyperledger, the open source distributed ledger platform developed by IBM, that describes itself as “an operating system for marketplaces, data-sharing networks, micro-currencies and decentralized digital communities”.

Clients will be able to connect to the system either through the traditional Swift channel, or directly using the distributed ledger, though there will be no inherent difference to the service either way.

IBM argues that the blockchain is the most revolutionary technology since the web itself.

“Only an open source, collaborative software development approach can ensure the transparency, longevity, interoperability and support required to bring blockchain technologies forward to mainstream commercial adoption,” it says.

Tom Zschach, chief information officer at CLS, supports this goal, adding: “We have been an important contributor to the Hyperledger project and we are keen to drive adoption within our industry.”