CLS

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The Benefits
of CLS to Asset
Managers
Following its successful introduction in September 2002, the Continuous
Linked Settlement (CLS) service looks set to become a permanent feature
of the FX settlement landscape for the foreseeable future. Since its
launch, CLS has been effectively used by banks to mitigate settlement
risk in their FX trades and more recently has seen uptake by corporates
and non-bank financial institutions via CLS third party providers.
Article: Brian Wedge & Justine Deery

LS has always planned to make should be considering as preparation

C its service available to Asset

Managers and attention is now
being focused more closely on this
for CLS settlement in the future.

The CLS Community

aspect as CLS seeks to extend the The initial users of CLS were the major
service to a broader customer base. In inter-bank FX players who are also
this article we look at what CLS means shareholders and settlement members
to Asset Managers and what steps they of CLS bank. To settle via CLS, non-

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members need to access the service via
settlement members. These
participants are referred to as Third
Parties and have predominantly been
inter-bank FX banks, but there is a
growing interest from some of the
non-banks and also from some
...CLS Bank recognised some time ago that Asset Managers would
also benefit from trading via CLS...
corporates. At JPMorgan, for example,
we provide third party services for
Refco Capital Markets and the New
York Clearing House as well as a
number of banks worldwide.
Third parties choose a single
settlement member for all their trades
– usually an institution which has
extensive experience in global clearing.
Although the CLS service was
62 JANUARY 2004
originally designed for inter-bank
trading, CLS Bank recognised some
time ago that Asset Managers would
also benefit from trading via CLS and
set up the CLS Custody Working
Group (CWG), with representation
from 23 institutions, to help design a
solution to this problem. As a result, a
recent technical enhancement was
made to CLS and it is now in a
position to settle trades from Asset
Managers.
However, the Asset Manager
solution is somewhat different from
the inter-bank. Unlike the model for
third parties, who appoint a single
settlement member to handle all their
trades, the solution devised by the
CWG means generally that Asset
Managers will have as many settlement
members as custodians. For Asset
Managers the CLS settlement can be
viewed simply as an extension of the
custody services already provided by
players like JPMorgan Investor
Services, and will be used to settle any
trades not transacted with the
custodian.
Good News for Asset
Managers
Asset Managers can expect to achieve
the same benefits from CLS as all
existing participants, but may well find
that they attach a different value to
them than the inter-bank players.
The most significant benefit from
CLS – and the reason for its inception
– is the reduction of settlement risk.
Since all Asset Manager trades will
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settle just like all other trades, this
will, of course, be achieved. There is
some debate in the industry about the
degree to which it is the fund, the fund
manager or the custodian, who will
benefit from the risk reduction, but
regardless of who currently bears the
settlement risk – it will be reduced
by CLS.
Although it was not designed
specifically to improve Straight
Through Processing (STP), CLS has
already been shown to provide
significant operational benefits to some
of the participants. Further
developments are now in progress
under the guidance of CLS’ “STP for
FX” Working Group.
Since settlement of CLS positions is
normally by single payment or receipt
in each currency settled, use of CLS
also brings the benefit of reducing the
number of gross payments. This
netting effect can also be beneficial in
reducing the size of intra-day credit
lines required.
Clearly, the enhanced information
flows and visibility brought about by
CLS, will facilitate the resolution of
any problems in advance of settlement
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rather than the cumbersome post-
settlement resolution of today.
There are, however, several
considerations for Asset Managers
wanting to trade through CLS. The
most obvious one is how they can
...Further developments are now in progress under the guidance of
CLS’ “STP for FX” Working Group....
comply with the current industry best
practise for CLS settlement which
requires participants to notify CLS of
eligible trades within two hours of
execution. Another consideration is
that for Asset Managers who deal with
custodians on a regional (or currency)
basis, CLS settlement will not be
possible as a single settlement member
must be used for all CLS trades.
How will it Work?
There is a general understanding of
how the process should work for Asset
Managers. However, as with any new
initiative it is important to maintain a
dialogue with all the players and
ensure that their views are heard. To
CLS
facilitate this process the CWG has
created a Fund Manager subgroup as a
forum for proposals and discussions
on this topic. Larger custodians are
doing their own research and inviting
their asset management clients to
discuss their positions as well as
educate clients on the current CLS
initiatives for extending its services to
Asset Managers. Like all industry
initiatives it is vital that there is
agreement across all providers to
ensure that the full benefits are
achieved.
In general, it is expected that Asset
Managers will appoint their custodian
banks to be their CLS provider. If the
custodian bank is already a settlement
member they will provide the service
directly, and non-settlement member
custodian banks will be able to provide
CLS services to their asset
management clients via third party
providers like JPMorgan.
JANUARY 2004 63
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With various players in the mix,
Asset Managers need to make
themselves aware of the types of
services on offer from their CLS
providers and the level of detail that
they’ll have access to on the status of
their CLS-settled trades. Depending on
the CLS provider selected, the Asset
Manager may or may not have the
visibility of access to in-depth, real-
time information on their trades.
However it works, it is unlikely that
the uptake of CLS by the Asset
Manager community will be a “big
bang” approach. CLS settlement
...Asset Managers should
initiate the planning process for
CLS as soon as possible...
requires bilateral agreement between
the parties involved enabling a gradual
approach to be taken with the
implementation. This gradual
approach to introducing new members
and currencies has worked well and
will most likely be used again for Asset
Managers with the details being
worked out in the coming year. CLS
expects uptake of the service by Asset
Managers to begin in 2004.
The Road Ahead
The timing of implementation for any
given Asset Manager will also vary
depending on a number of factors.
However, while many details remain to
be finalised, it is clear that Asset
Managers should initiate the planning
process for CLS as soon as possible.
The first step is to get a good
understanding of the benefits of
introducing CLS and the availability of
64 JANUARY 2004
solutions offered by custodians. Fund
managers should consult with the
funds they manage for their input on
the value and urgency of eliminating
settlement risk by settling in CLS.
Asset Managers should engage in open
dialogue with their custody providers
about the services and service options
available to support CLS settlement
and also about the internal expertise
on hand.
In addition, FX counterparties
should also be canvassed. When CLS
was first proposed there was
speculation on whether a dual pricing
regime would evolve, where deals
would be priced differently depending
on whether they were to be settled in
CLS or not. So far this has not been
evident in the inter-bank market, but
there are an increasing number of
instances where counterparties are
being told that they must be able to
settle in CLS if they wish to continue
trading with some banks.
When an organisation understands
the implications of CLS, it is also
prudent to have early discussions with
their operations and technology
groups to ensure that any required
changes are well planned.
Armed with the above information
the business case for CLS
implementation can be clearly
established and the implementation
timescale can easily be prioritised.
While many details remain to be
finalised, it is clear that Asset
Managers should initiate the planning
process for CLS as asoon as possible.
The future of settlement risk-free
FX trading in the Asset Manager
market is CLS. By getting involved
with the CWG, Asset Managers can
play an active role in shaping the
future and better understand the
benefits of settling through CLS.◗
CLS - Key Facts
CLS is a service specifically for
clearing FX payments in a Payment
versus Payment (PvP) basis.
Designed to eliminate the
“temporal” exposure that exists
through settling
payments independently and
through completely separate
channels and legal frameworks, CLS
is an industry initiative for
mitigating that settlement risk.
CLS began operating in
September 2002, and has now
settled more than 20 million trades.
The daily value now settled averages
the equivalent of more than USD 1
trillion. Currently there are over 50
(direct) settlement members and
over 90 third party members who
access the service via the small
number of settlement members who
also offer third party services. Direct
members connect to CLS via the
SWIFT network, and indirect
members can connect to their
chosen settlement member via
SWIFT or the settlement member’s
proprietary client access
mechanisms.
CLS is a real-time system with
connectivity to the Real Time Gross
Settlement (RTGS) systems of the
currencies it settles.
Trades to be settled in CLS are
matched in advance of value date,
eliminating most causes of error, and
then settled individually between
07:00 and 09:00 on the day of value.
Funding is on a multilaterally netted
basis, resulting in a significant
reduction of payment instructions
and corresponding reduction in the
need for intraday credit lines.
Brian Wedge
CLS Product Manager, JPMorgan
Treasury Services
Justine Deery
Product Manager, JPMorgan Investor
Services.
Brian Wedge serves on the CLS STP Working
Group.
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