Business, Legal & Accounting Glossary
Settlement risk has historically been a problem in foreign exchange markets because each currency must be delivered in its home country. Due to time zone differences, several hours might elapse between a payment being made in one currency and the offsetting payment being made in another currency.
Continuous Linked Settlement (CLS) is a settlement system for foreign exchange trades that eliminates this problem. The system is run by the CLS Bank International, which is a special-purpose bank dedicated to settling foreign exchange trades. The bank and associated companies are owned by (as of 2006) seventy-one of the world’s largest financial institutions, each of which owns an equal share in an overall holding company.
All transactions settle through the CLS Bank during a single 5-hour window each business day. The CLS Bank is based in New York but maintains accounts in the various countries whose currencies it settles trades for. To settle a foreign exchange trade through the system, a firm delivers the currency it owes to the CLS Bank. That payment is not released to the counterparty unless that counterparty deposits the offsetting payment for the transaction. Payments are netted, so each participant in the system only has to make one net payment per currency each day.
Direct participation is limited to the financial institutions that are shareholders of the system. They are called Settlement Members. User Members are institutions that are sponsored by Settlement Members. They can submit settlement instructions for themselves and their clients, but their transactions flow through the accounts of their sponsoring Settlement Members. Other parties may not submit settlement instructions directly to the CLS Bank, but they may indirectly utilize the system as a client of a Settlement Member or User Member.
The process by which a number of the world’s largest banks manage the settlement of foreign exchange amongst themselves (and their customers and other third parties) is known as continuous Linked Settlement. CLS Group Holdings AG and its subsidiary companies manage this process and it includes a settlement bank regulated by the Federal Reserve Board of New York. In 1997 the formation of the Group takes place and since 2002 the settlement system has been operational. As of February 2009, there had been a participation of 73 shareholders and 62 settlement members as well as 4,576 Third-Party participants (411 banks, corporate and non-bank financial institutions, and 4,165 investment funds) in the system.
Since its operations were initiated, between major banks CLS has rapidly become the market-standard for foreign exchange settlement, and as of 17 September 2008, 1,554,166 instructions a day in 17 currencies were settled by it and that represents some 95% of global foreign exchange trading and with a gross value of US$8.6 trillion or about 1,300 U.S. dollars on that day for every person on the Earth. This new record had broken the previous record of about US$ 1,148,000 million, and for the first time in history, the volume of payment instructions settled in one day has exceeded 1.5 million.
The settlement of gross-value instructions with multi-lateral net funding is a key feature of CLS. On average, we can say that the CLS netting efficiency is in the region of 95%; which means that every trillion dollars of gross value settled might require aggregate pay-ins of just $50 billion.
Transactions on Payment versus Payment Basis (PVP)
Transactions are settled down by CLS on a payment versus payment basis, and that is also known as PVP. Whenever there is a settlement of a foreign exchange trade, each of the two parties to the trade pays out (sells) one currency and receives (buys) a different currency; it is ensured by PVP that these payments and receipts occur simultaneously. If there is no PVP then there is a (minor, but with potentially devastating financial consequences) chance that one or more parties could sell away funds to another institution but do not buy any reciprocal funds that are due on them (generally for reasons of credit-related default) this is what we call as settlement risk, or Herstatt risk.
An additional benefit that is provided by the CLS system is the increased straight-through processing capabilities.
CLS currently trades the following currencies:
CLS
Continuous linked settlement (CLS) is a settlement system for foreign exchange trades that eliminates settlement risk. The system is run by the CLS Bank International, which is a special-purpose bank dedicated to settling foreign exchange trades. The bank and associated companies are owned by (as of 2009) seventy-three financial institutions, each of which owns an equal share in an overall holding company.
All transactions settle through the CLS Bank during a single 5-hour window each business day. The CLS Bank is based in New York but maintains accounts in the various countries whose currencies it settles trades for. Transactions are settled on a payment versus payment (PVP) basis. Each party delivers the currency it owes to the CLS Bank. That payment is not released to the counterparty unless that counterparty deposits the offsetting payment for the transaction. Multilateral netted allows each participant in continuous linked settlement to make just one net payment per currency each day.
Direct participation in continuous linked settlement is limited to the financial institutions that are shareholders of the CLS Bank. They are called settlement members. User members are institutions that are sponsored by settlement members. They can submit settlement instructions for themselves and their clients, but their transactions flow through the accounts of their sponsoring settlement members. Other parties may not submit settlement instructions directly to the CLS Bank, but they may indirectly utilize continuous linked settlement as a client of a dettlement member or User Member.
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This glossary post was last updated: 29th December, 2021 | 0 Views.