FX Settlement System CLS Considers Adjusting Deadline to Prevent Disruption of US Equity Market, Reports Reuters

By Laura Matthews

NEW YORK (Reuters) – A recent change in U.S. regulations concerning stock market transactions has prompted CLS, a key player in financial infrastructure, to consider delaying settlement instructions for foreign exchange trades. This potential adjustment comes in response to requests from foreign asset managers who rely on currency trades to finance their U.S. securities transactions.

Starting May 28, 2024, these investors may encounter increased foreign exchange settlement failures due to a ruling by the U.S. Securities and Exchange Commission that requires investors to settle equity transactions one day after the trade (T+1). Currently, currency trades that fund these transactions settle within two days, necessitating that investors adapt their processes to ensure that these trades are included in CLS, the largest multi-currency settlement system for FX trades. If these trades are excluded from CLS, the involved parties will have to settle them bilaterally, which would be less efficient and more risky.

The SEC’s initiative aims to mitigate market risk, a concern that has gained attention since the trading events surrounding GameStop Corp.

Marc Bayle de Jessé, chief executive officer at CLS, emphasized the importance of maintaining the stability of the financial system and the broader FX ecosystem. "We are willing to liaise with regulators and settlement members to explore possible solutions," he stated in a recent interview.

According to estimates from Bayle de Jessé, nearly $65 billion per day in foreign exchange transactions from asset managers could be affected by the upcoming deadline. CLS is currently evaluating whether its CLSSettlement services can accommodate later submissions and considering the feasibility of shifting its midnight CET deadline for FX trade instructions to ensure they can be included in the settlement session without causing market disruptions.

Asset managers have expressed concerns about the tight timeframes for syncing equity and FX settlement cycles. CLS has acknowledged this feedback and is exploring adjustments to its cut-off time. Natalie Berkecz, global head of regulatory product at a major custodian, remarked, "It would be ideal if CLSSettlement considers their current cut-off time so that more markets can instruct in time. There is a real risk that many participants won’t be able to meet the condensed timeframes."

Implementing these changes will require regulatory engagement and various risk assessments. CLS, established in 2002 to reduce settlement risk, currently settles an average of $6.5 trillion in FX transactions daily within a market that sees over $7.5 trillion in trades.

The U.S. Federal Reserve oversees CLS Bank alongside the central banks of the currencies it settles. Bayle de Jessé indicated that if no changes occur within firms, around 1% of the transactions from funds, including those from U.S. entities, could be impacted by the transition to T+1.

As of June 2022, foreign investors held $24.8 trillion in U.S. securities, accounting for approximately 19.6% of the market, according to data from the U.S. Department of the Treasury and the Global Financial Markets Association.

The process will be further complicated by the specific cut-off times imposed by custodians, which are also set to become more stringent.

Managers who miss CLS’s cut-off for submissions would need to settle trades bilaterally, ultimately sacrificing cost efficiency and increasing counterparty risk. CLSSettlement is known for reducing funding requirements significantly, by over 96%.

"This really contradicts the objectives that T+1 aims to achieve," Berkecz concluded.