The continuous Linked Settlements (CLS) Bank is a falt accompi, and payments system that traditionally handled foreign exchange messaging and settlement and adjusting to the reality that fees arising form the $600 trillion per year in gross foreign exchange transactions, formerly split among the Clearinghouse Interbank Payment System (CHIPS), Federal Reserve's Fedwire, and Society for Worldwide Interbank Financial Telecommunication (SWIFT), will instead go to CLS.
As a result, CHIPS and Fedwire are now competitors as well as regulatee and regulator. SWIFT hopes to become CLS's messaging service.
The CLS was developed by the G-20, a group of private, international banks, in response to 1996 recommendations by the Bank of International Payments's Committee on Payment and Settlement Systems that the private sector devise a way to manage Herstatt Risk-the possibility that a default by one "leg" of a foreign exchange transaction could cause a global cascade of defaults.
The G-20's plans were greeted with concern that settlement risk reduction be used to justify the concentration of market power. However, the political problems that might have made life difficult for the plan have apparently been resolved.
A formal organization charged with creating the computerized technical infrastructure to operate the complex settlements system, CLS Services Ltd., is headquartered in London. A full-time manager, J.P. Morgan managing director David Roscoe, is in place. In October, a Request for Proposals with a November 25 deadline was issued to potential suppliers of goods and services. An earlier agreement to include smaller banks-G-40 group members-involved in foreign exchange in ownership of CLS allayed fears that CLS would be a monopoly. Moves to bring the world's foreign exchange netting organizations under the CLS umbrella have consolidated settlements operations. This Fall, the group forming the CLS agreed to locate the CLS Bank-the actual body, as opposed to the company creating the body-in the United States, under the regulation of the Federal Reserve. The location is still up in the air, but CLS plans to operate in 2000. Against this background, CHIPS, Fedwire and SWIFT had little choice but to adjust.
CHIPS, which last year attributed 35 percent of its volume to foreign exchange settlements, says it began shifting focus from so-called "spot" deals in 1995, when it noticed the netting schemes, especially London-based FXNet, cut into its volume growth. CHIPS instituted reforms including a patent-pending method of guaranteeing settlement finality, a "rolling," intraday settlements system, and a new focus on global electronic data interchange (EDI) payments as a source of income."The foreign exchange volume is going to dry up one way or the other, whether it goes to a centralized system or not," says CHIPS evp John Moore, adding that profit margins are narrowing. "We're putting EDI on CHIPS to make it more attractive to corporations, so we can take a piece of the (payments) volume," when electronic funds transfers begin flowing in '99, Moore says.
Since most electronic funds transfers will flow over the Federal Reserve's automated clearing house line, this brings CHIPS firmly into competition with Fedwire. And Fedwire, says Dara Hunt, the svp at the New York Fed, is ready. It consolidated automated processing and cut prices to 40 cents per transfer this year, and plans a second price cut next year.
Hunt downplays Fedwire's problems as a competitor and a regulator of CHIPS."Fedwire has a tradition of being largely a domestic payments system," she says. "Our role has never been predominately foreign exchange." She adds that the Fed deals with regulation by clearly dividing responsibility.
SWIFT, meanwhile, is probably in the best position to prosper. Already the messaging service for TARGET, the European Monetary Institute's mechanism for euro-denominated funds transfers, it feels it's in an excellent position to be the CLS's service as well. "We're interested not only in messaging, but also in (supplying) any other valued-added service that SWIFT has," including confirmation matching, interactive communications services and "store-and-forward" services, according to Lazaro Campos, SWIFT manager for CLS operations.
The challenge for the CLS, agree all observers, is to meet its ambitious timetable. "It's a big project," says one, "and they have a lot to accomplish."
-reinbach tfn.com
