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Post-trade processing may not be the most glamorous area of finance, focusing as it must on resilience, risk management and scalability, with little of the drama of return generation that characterises the front office. But the post-trade space in foreign exchange is going through a renaissance of sorts, much of it driven by industry-led initiatives rather than the direct force of regulatory mandates.
In the past year alone, some of the most notable developments include the addition of the Hungarian forint to the CLS settlement system, the development of a clearing service for physically delivered FX options and the launch of a compression service for FX forwards and swaps.
These are important steps forward for an industry that has long recognised settlement risk — the possibility that a counterparty might fail to deliver — as the most significant threat, but is now beginning to tackle other risks as well.
Regulators appear to have deliberately held back from regulating FX at the same speed as interest rate and credit derivatives. But both US and European regulators have consulted with the industry and decided not to proceed for the time being. A number of reasons have been given, including the fact that only one clearinghouse — LCH. In spite of the decision to hold off on a mandate on both sides of the Atlantic, some level of voluntary clearing is already taking place.
Since its launch in , LCH. Demand for clearing on a voluntary basis in the future may be driven not just by the need to be prepared for an eventual mandate, but also by the economic incentives for clearing that will be introduced by separate regulations. Basel III, for example, will introduce higher capital requirements for derivatives not cleared through a central counterparty CCP , while margin requirements for non-centrally cleared derivatives will be phased in from September Many practitioners believe such economic incentives offer a more natural way for the market to adapt to clearing, rather than using a mandate as a blunt instrument to force clearing before the market is operationally ready.
A similar approach is likely to be taken to the use of electronic platforms in Europe, as MiFID II will include incentives to use such platforms. The expansion of the ForexClear service to FX options, expected later this year, will be a seminal development for the industry as it follows extensive work to find an appropriate clearing mechanism for deliverable FX instruments.
Unlike NDFs, interest rate swaps and credit default swaps, FX options, swaps and forwards are physically settled, creating a much bigger challenge for CCPs. With these three elements in place, the industry is moving towards a robust solution. Clearnet plans to offer compression as part of its clearing service for FX options. Adding currencies to CLS also remains a top priority across the industry. While the addition of the Hungarian forint in November marked a major milestone as the first currency to be added to the system since , the fact that fast-growing currencies such as Chinese renminbi and the Russian ruble are not yet settled in CLS represents a considerable source of risk.
CLS is committed to expanding its currency coverage and is in active dialogue with authorities in both China and Turkey, but positive moves forward in Russia were stalled in after international sanctions were imposed against the country.
The so-called blockchain is an encrypted public ledger that maintains a decentralised record of transactions. Over the past year, the concept of a distributed ledger has sparked a number of industry initiatives designed to bring together market participants to consider and test possible use cases. But while the momentum behind blockchain gathers pace, some FX industry practitioners are more cautious, suggesting that while the technology could yield significant efficiencies, there is a need to tread carefully when dealing with a global payment system.
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