More than a third of FX trades from European asset managers would have to settle outside CLS following the US shift to T+1 and therefore carry increased risk, a leading association has found through new research.
The European Fund and Asset Management Association (EFAMA) said that due to the inability to meet internal custodian deadlines – based on their trading patterns and relationships – 40% of daily FX flows will no longer be able to settle through the CLS platform.
In response to a request for comment however, CLS – which settles on average USD6.5 trillion per day for over 70 settlement members and 35,000 third-party participants – noted that its own asset manager research showed that 40-50% of the 1% of CLSSettlement average daily settlement value (ADV) could be impacted by the move to T+1 and could settle outside of CLS.
Lisa Danino-Lewis, chief growth officer, CLS, added: “The outreach also revealed that without any changes to custodian cut-offs or CLS deadlines, more than 50% of respondents said that the majority of their risk can still be mitigated through CLS, while 35% of respondents still have not decided how to respond to the impact of T+1.”
The EFAMA report noted that once shortened settlement cycles are put into place within North America, specific areas of the market, including European asset managers, will have limited access to CLS for their USD trades; CLS having been established to mitigate settlement and counterparty risk.
With a large chunk of trading occurring on market close, asset managers will be left with little time, if any, to submit FX trades to CLS, which has a cut off time of 6pm EST.
The inability to use CLS will ultimately require asset managers use costlier and riskier alternatives, including prefunding, which EFAMA noted as being an inefficient use of capital.
Elsewhere, asset managers could be led to carry out operationally complex FX on trade day with a ‘true-up’ required the next day against the confirmed trade, or in some cases, bilateral settlement with the counterparty bypassing CLS altogether.
EFAMA has urged central banks and regulators to take a more pro-active role in requiring mitigating measures such as an extension of the CLS cut-off time, and improved cut-offs and alignment among the custodial community.
“Without necessary adjustments to make the CLS platform accessible (this will require changes to cut-off times both by CLS and custodians’ own internal deadlines), the asset management industry cannot agree that T+1 will make the system ‘safer for everyone’,” said EFAMA in a statement.
“T+1 implementation today does not represent an absolute reduction of risk in the system. From where asset managers sit, it looks more like a shift away from credit and market risk to an increase in operational and settlement risk.”
EFAMA suggested that regulators should take mitigating measure including requiring the extension of the official CLS cut-off time, as well as encouraging the adoption of later cut-offs which are more aligned with CLS by the custodian community.
Danino-Lewis, added: “Any changes to the existing CLSSettlement service would require regulatory engagement, a comprehensive risk assessment supported by detailed modelling and analysis, as well as requiring the whole ecosystem to make changes to their systems and processes. CLS will monitor the impact of T+1 implementation on the FX ecosystem by continuing to engage its members and the buy-side community and will continue to explore possible solutions to address any challenges which may arise in partnership with our community and other market participants.
“In the meantime, execution and operational efficiency across the asset manager and fund community will be paramount, and for instructions that are same day and do not meet CLS’s 00:00 CET deadline, CLSNet, an automated and standardised bilateral netting calculation service, can reduce funding requirements and the number of payments required by calculating net payment obligations that facilitate payment netting.”