Managing the rising tide of settlement risk in cross-border payments and the future development of CLS

Abstract

Cross-border payments sit at the heart of international trade and economic activity and typically involve the settlement of a foreign exchange (FX) transaction requiring the payment of one currency for the receipt of another. One of the main risks in such transactions — settlement risk — is that one party delivers the currency it has sold but does not receive the currency it has bought from its counterparty, resulting in a loss of principal. Because many currencies are paid at different times of the day, there may be a significant gap between the payment of one currency and receipt of the counter-currency. This paper will highlight the current rise in settlement risk associated with cross-border payments and the reasons behind this phenomenon, as well as how settlement risk can be addressed through payment-versus-payment (PvP) settlement, which ensures the final transfer of a payment in one currency occurs only once the final transfer of a payment in another currency has taken place. Given the projected growth in cross-border transactions, the paper concludes that the mitigation of settlement risk is crucial and that, for now, this is best tackled by following the recommendations in the FX Global Code, namely to settle eligible currencies via PvP, and for non-eligible currencies, leverage netting solutions.