An international group of financial institutions announced a far- reaching agreement Tuesday to streamline the settlement of foreign exchange transactions and reduce risk in the process.
CLS Services Ltd., a company backed by the influential committee of investment and commercial bankers known as the Group of 20, said it will acquire multibank settlement networks currently operating in London and New York.
These organizations, Exchange Clearing House Ltd. and Multinet International Bank, would join forces with CLS Services and institution it is planning to form in New York, CLS Bank, to create a unified settlement system for interbank currency transactions.
The objective is to comply with risk-reduction principles espoused by the Bank for International Settlements and the affiliated central banks of the Group of 10 industrialized countries.
Bankers, central bankers, and regulators have been working for more than 20 years on ways to minimize the consequences of a bank failure like that of Bankhaus Herstatt in Germany in 1974, which threatened a domino effect around the world because of unfulfilled payment obligations.
With an anticipated 36 banks, among the biggest and most influential in the world, expected to be in the shareholder group of the combined CLS organization, it could shape up as a major milestone toward the eradication of what became known as Herstatt risk.
A consolidated settlement program would eliminate the confusion among bankers who could not decide among the competing alternatives, said Larry V. Recknagel, chief executive officer of Multinet in New York.
"It gradually dawned on all of us that we really needed to get the industry on the same page," he said.
"I think people have been waiting for the shoe to drop (to decide) where to start investing," said Jill Considine, president of the New York Clearing House Association. "Having some idea of what is happening will be very useful for the industry."
That money-center group in 1995 published a "green book," titled "Risk Reduction and Enhanced Efficiency in Large-Value Payment Systems," with recommendations for mitigating Herstatt risk.
The Bank for International Settlements' "orange book," "Settlement Risk in Foreign Exchange Transactions," followed last year, recommending continuous linkages among national settlement systems.
CLS officials said they will relocate from London to New York after the merger and integrate the multilateral netting services of both Echo and Multinet. Stephen G. Thieke of J.P. Morgan & Co. would continue as chairman. Bjorn Flismark of Skandinaviska Ensklida Banken and Garrett Glass of First Chicago NBD Corp., the chairmen of Echo and Multinet, respectively, would join the CLS Services board.
Multilateral netting reduces the many dealings among participating institutions to a net debit or credit position that can be paid in a single currency. While net settlements are considered less risky than transaction- by-transaction alternatives, they can be highly complex and Herstatt risk continues to loom.
"The idea is to create an integrated set of services that all fit together," Mr. Recknagel said. "Industry participants can choose from each and not have to worry too much about their investments becoming obsolete."
Electronic Clearing House, or Echo, supervised by the Bank of England, was the first of the multilateral netting organizations to go live, in 1995.
But industry observers said Echo, an initiative of European banks, has struggled with development and maintenance costs and has not attracted sufficient foreign exchange volume to pay for itself.
Multinet, a New York-chartered bank, has also struggled to build volume, said Chase Manhattan Corp. managing director Dennis Oakley.
Chase owns Multinet with First Chicago NBD Corp. and the leading Canadian banks.
CLS Services will still have at least one formidable competitor, FX Net of London.
FX Net, which facilitates bilateral or one-to-one netting between frequent transactors, "addresses a market need," Mr. Oakley said. "I believe it will be around for a while."
CLS Services, meanwhile, was incorporated in July and is backed by some of the most powerful players in the $300 trillion forex market. William J. McDonough president of the Federal Reserve Bank of New York and chairman of Bank for International Settlements' committee on payments and settlement systems, which produced the "Orange Book," said he applauded the proposed merger, and "looked forward to working with the developers of this initiative."
'I am particularly encouraged by the willingness of those with diverse interests in the marketplace to act cooperatively in the creation of risk reducing services," Mr. McDonough said.