FX settlement risk on the rise, finds BIS triennial survey
5th December 2022 – Daily FX turnover subject to settlement risk has risen to $2.2 trillion from an estimated $1.9 trillion in April 2019, the BIS triennial survey 2022 has revealed.
Other findings include that FX trading in Emerging Market Economy (EME) currencies has become increasingly internationalised, meaning that most trades involve a counterparty that resides outside the country that issued the currency. Further, the report laid out that the structure of FX trading in many EME currencies increasingly resembles that in AE currencies, notably in terms of its internationalisation but also in terms of the range of instruments traded and the diversity of participants who trade them. However, settlement risk remains in many currencies, especially those not settled via CLS.
Jerome Kemp, President of Baton Systems, commented: “These BIS findings shine a much-needed spotlight on the increasing importance of EMEs in the overall global FX landscape, as well as the dearth of options available for risk reduction relative to settlement. This presents a major challenge, particularly for those banks who do not have direct access to safe settlement mechanisms such as Payment versus Payment (PvP) settlement.”
The report lists several barriers to safe settlement, including that non-PvP settlement “may be the only option for some counterparties, currencies, or timezones”.
There is a recognition, however, that private sector stakeholders are working to reduce FX settlement risk for a broader range of currencies and market participants. The report notes that private companies are also developing new services that complement existing PvP arrangements by targeting additional currencies and by providing more options for users to manage intraday liquidity.
Kemp echoed this, pointing to Chinese renminbi as an example: “Take the growing significance of Chinese renminbi on the international stage as an example – this report shows that it represented 7% of all trades in 2022 making it the 5th most traded currency. The continued growth of the offshore renminbi (CNH) suggests that the currency is now being seen as a major across central limit order books (CLOBs). But while the electronic trading platforms may be up to speed with the execution of offshore CNH, the reality is that across the market, settlement processes have not kept up – they’re slow, expensive and rife with settlement risk.”
“The facts are that incumbent payment vs payment (PvP) settlement process only applies to 18 currencies, and it’s a list that hasn’t been extended in the past seven years. The need to efficiently reconcile, net, and safely settle bilateral CNH FX transactions on a PvP basis must now come into sharp focus off the back of this BIS report. Using DLT, banks can now go a long way to not only eradicating CNH settlement risk, but also increasing market access and opening up extensive offshore renminbi trading opportunities for a significantly broader range of wholesale market participants, whilst simultaneously expediting the entire post-trade process and cutting out unnecessary cost.”
In addition to settlement risk, the findings showed shows FX trading continuing to shift away from multilateral platforms, where price information is available to all participants, towards “less visible” venues. Less visibility hinders policymakers from appropriately monitoring FX markets.
“The return of meaningful volatility to the FX markets, perhaps for the first time in over a decade, has made it much harder for firms to obtain optimal pricing”, added Vikas Srivastava, ex- head of currency trading and risk management at Barclays Global now Chief Revenue Officer (CRO) at FX technology firm Integral.