FX Net and Multinet have signed a letter of intent to develop a clearing and settlement service for foreign exchange contracts.
FX Net, a London-based netting service, is primarily used for settling foreign exchange contracts between banks using bilateral agreements.
Multinet, which is owned by eight U.S. and Canadian-based banks, is a proposed special-purpose bank designed for multilateral netting. It awaits regulatory approval from the Federal Reserve Board and the New York State Banking Department.
Officials from FX Net and Multinet say the planned service would reduce the risk that a foreign exchange counterparty will fail to deliver payment in one currency after having received payment in another.
FX Net handles about 5,000 trades daily, with an average daily gross settlement volume of $173 billion. With its bilateral netting, the service has reduced settlement risk in the trades it handles by 51%.
Observers said that multilateral netting, which would be provided through Multinet, would improve settlement risk reduction to about 80%.
"Ideally, what we'd like to do is move together (as an industry) to a multilateral netting system so we can all get the benefit," said Dennis Oakley, a managing director with Chemical Banking Corp. and a member of FX Net's board.
In multilateral netting services, credits and debits between trading parties in various countries are netted out, leaving just one balance to be settled. Only two parties participate in bilateral netting, which sometimes leaves more outstanding balances.
Mr. Oakley said the FX Net board of directors had been working for several years to develop an arrangement with either Multinet or Echo, the Exchange Clearing House Ltd.
Echo is a London-based multilateral netting service that started last summer.
Mr. Oakley said Multinet had to change its business philosophy slightly in order to come to an agreement.
Graham Duncan, a consultant to Echo's board of directors and its former chief executive, confirmed that FX Net had approached the clearing house in the last two years.
FX Net's propositions were declined because, "We did not feel it was in the interest of our users," Mr. Duncan said.
In addition to anticipated regulatory hurdles, Mr. Duncan said that "FX Net has a cost base; the clearing house has a cost base. Bringing them together does not actually get you any synergies or economies," he said.
Under the terms of the agreement, which is expected to be formalized in the spring, Multinet will accept bilaterally netted cash flows into its service the day before settlement.
If all the risk measures meet Multinet's standards, the New York-based bank will accept those trades and provide an additional multilateral netting transaction to settle foreign exchange obligations.
"My goal is to have by this time next year a couple of beta banks up and running," Mr. Oakley said.
Garrett Glass, chairman designate of Multinet and senior vice president of First Chicago NBD Corp., said, "Linking the two services will help bring the benefits of multilateral netting to sophisticated global trading firms in a short period of time."
Multinet has been trying to get a bank charter for about two years, but has been delayed because regulatory agencies have asked for several changes in Multinet's operational structure. Regulators want more operational controls given to the bank shareholders.