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Continuous Linked Settlement: History and Implications Zurich Open Repository and Archive University of Zurich Main Library Strickhofstrasse 39 CH-8057 Zurich www.zora.uzh.ch Year: 2007 Continuous linked settlement : history and implications Schaller, Alexandra Posted at the Zurich Open Repository and Archive, University of Zurich ZORA URL: https://doi.org/10.5167/uzh-163690 Dissertation Published Version Originally published at: Schaller, Alexandra. Continuous linked settlement : history and implications. 2007, University of Zurich, Faculty of Economics. Continuous Linked Settlement: History and Implications Dissertation for the Faculty of Economics, Business Administration and Information Technology of the University of Zurich to achieve the title of Doctor of Economics presented by Alexandra Schaller from B¨osingenFR approved at the request of Prof. Dr. Hans Geiger Prof. Dr. Rudolf Volkart The Faculty of Economics, Business Administration and Information Tech- nology of the University of Zurich herewith permits the publication of the aforementioned dissertation without expressing any opinion on its views. Zurich, December 5, 2007 The Dean: Prof. Dr. H. P. Wehrli f f Acknowledgements I would like to thank Hans Geiger for his solid support and Itzi Klein for the relentless critique and inspiring conversations. Furthermore, I would like to thank CLS Group, in particular Jim Hughes, for providing the data set, Jonas Luell and Stefan Amstein for coding and preprocessing the data. f Zurich, September 2007 Alexandra Schaller f Contents 1 Introduction 1 1.1 Scope . 2 1.2 Design . 2 2 Basics of Settlement 5 2.1 Scope of Clearing and Settlement . 5 2.1.1 Settlement Finality . 6 2.1.2 Payment versus Payment . 6 2.1.3 Provision of Performance Guarantee . 6 2.1.4 Settlement Risk . 7 2.2 RTGS versus Net Settlement . 8 2.2.1 Real-Time Gross Settlement . 8 2.2.2 Net Settlement . 9 2.2.3 System Stability Aspects . 12 2.3 Settlement Problems in Foreign Exchange . 13 2.4 Potential Solutions . 13 2.4.1 Money Market Fund Shares . 14 2.4.2 Contracts for Differences . 14 2.4.3 Extension of Payment Systems’ Opening Hours . 17 2.5 CLS Currencies and Payment Systems . 17 2.5.1 United States Dollar and Fedwire . 17 2.5.2 Euro and TARGET . 18 2.5.3 Pound Sterling and CHAPS . 18 2.5.4 Swiss Franc and SIC . 19 2.5.5 Australian Dollar and RITS . 19 2.5.6 Canadian Dollar and LVTS . 20 2.5.7 Danish Krone and KRONOS . 21 2.5.8 Hong Kong Dollar and CHATS . 21 2.5.9 Japanese Yen and BOJ-NET . 21 2.5.10 Korean Won and BOK-Wire . 22 2.5.11 New Zealand Dollar and ESAS . 22 ii CONTENTS 2.5.12 Norwegian Krone and NBO . 22 2.5.13 Singapore Dollar and MEPS+ . 23 2.5.14 South African Rand and SAMOS . 23 2.5.15 Swedish Krona and RIX . 23 2.5.16 SWIFT . 24 2.6 Chapter Summary . 25 3 CLS Environment 27 3.1 The Foreign Exchange Market . 27 3.1.1 Foreign Exchange Products . 28 3.1.2 Currency Composition . 29 3.1.3 Settlement of Foreign Exchange Transactions . 29 3.1.4 Emerging Risks During Settlement . 31 3.2 Causes for Central Bank Concerns . 32 3.2.1 Collapse of Bankhaus Herstatt . 33 3.2.2 Drexel Burnham Lambert Group . 34 3.2.3 Bank for Credit and Commerce International . 35 3.2.4 Attempted Soviet Coup D’Etat´ . 36 3.2.5 Barings Crisis . 37 3.3 Reports of the CPSS . 38 3.3.1 Angell-Report . 38 3.3.2 Lamfalussy-Report . 39 3.3.3 No¨el-Report . 40 3.3.4 Allsopp-Report . 42 3.3.5 Progress-Report . 44 3.3.6 Supervisory Guidance-Report . 45 3.4 Chapter Summary . 45 4 History of CLS 47 4.1 The G20 Meetings 1994 - 1997 . 47 4.1.1 Selection of the Model . 48 4.1.2 Transforming the Project into a Company . 50 4.1.3 Other Initiatives . 55 4.2 CLS Services Ltd. 1997 - 1999 . 57 4.2.1 Procurement Strategy . 57 4.2.2 Merger with ECHO and Multinet . 58 4.2.3 Recapitalization in Summer 1998 . 60 4.2.4 Contract Issues with IBM . 60 4.3 CLS Bank International 1999 - 2002 . 61 4.3.1 Structural Changes . 61 4.3.2 First System Tests . 62 CONTENTS iii 4.3.3 Project Delays . 62 4.3.4 Recapitalization in Summer 2000 . 63 4.3.5 More Tests, Trials and Delays . 63 4.3.6 Bringing the System Live . 64 4.4 CLS in Operation 2002 - 2005 . 66 4.4.1 Renegotiating the Service Agreement . 66 4.4.2 Business Continuity Planning . 67 4.4.3 Service Disruptions . 68 4.5 Chapter Summary . 68 5 Design of CLS 71 5.1 CLS as a Bank . 71 5.1.1 Corporate Structure . 71 5.1.2 Corporate Governance . 72 5.2 Membership . 74 5.2.1 Settlement Members . 74 5.2.2 User Members . 75 5.2.3 Third Parties . 76 5.2.4 Nostro Agents . 76 5.3 Eligible Currencies . 76 5.4 Settlement and Funding . 77 5.4.1 Settlement versus Funding . 78 5.4.2 Submission and Initial Processing of Instructions . 78 5.4.3 Matching . 79 5.4.4 Pay-In Schedules . 81 5.4.5 Queue Formation and Splitting Process . 82 5.4.6 Settlement . 83 5.4.7 Pay-Outs . 84 5.5 Risk Management Framework . 84 5.5.1 Overdraft Facilities . 85 5.5.2 Liquidity Providers . 88 5.5.3 Loss Sharing Arrangements . 89 5.6 Liquidity Management Framework . 90 5.6.1 In-Out Swaps . 91 5.6.2 Needs for Other Tools . 95 5.7 Chapter Summary . 95 6 Impact on Credit Risk 97 6.1 Introduction . 97 6.2 Data Availability . 97 6.2.1 Global Foreign Exchange Turnover . 98 iv CONTENTS 6.2.2 CLS Turnover . 99 6.3 Elimination of Credit Risk . 102 6.3.1 Global Turnover Approach . 102 6.3.2 Individual Bank Approach . 103 6.4 Chapter Summary . 104 7 CLS Settlement Structure 105 7.1 Network Literature Review . 105 7.2 Network Analysis . 107 7.3 The Data Set . 109 7.4 Research Design . 110 7.5 Descriptive Statistics . 111 7.6 Network Statistics . 112 7.6.1 SM Subgraph . 117 7.6.2 TP Subgraph . 118 7.7 Further Results . 120 7.7.1 Development of SM Size . 120 7.7.2 SM Business Structure . 123 7.7.3 TP Business Structure . 125 7.8 Chapter Summary . 126 8 Liquidity Aspects 131 8.1 Introduction . 131 8.2 Definition of Bilateral Net Sell Position . 132 8.3 Regression Analysis . 133 8.3.1 Basic Regression . 134 8.3.2 Controlled Regression . 137 8.3.3 Relative Regression . 137 8.4 Chapter Summary . 141 9 Conclusion 143 9.1 Critique and Further Research . 144 9.2 Food for Thought to Practitioners . 145 A Keyword Index 147 B CLS Key Figures 153 Bibliography 155 Curriculum Vitae 169 List of Figures 3.1 Characteristic of a Foreign Exchange Contract (author). 32 3.2 Settlement Risk Phases (Geiger & Spremann 1998). 33 3.3 Changing Status of a Trade (CPSS 1996). 43 3.4 Chronological Overview (author). 46 4.1 Project Delays (CLS 2002k). 66 5.1 CLS Corporate Structure (CLS 2004b). 73 5.2 Participants of the CLS System (CLS 2006). 75 5.3 Simplified Instruction Flow (author). 80 5.4 Time Line of Settlement Process (CLS 2006). 83 5.5 Liquidity Provider Transaction (author). 89 6.1 Average Daily Foreign Exchange Turnover (BIS 2007). 99 7.1 GV Distribution of Settlement Members in April 2006. 113 7.2 GV Distribution of Third Parties in April 2006. 113 7.3 Degree Distribution in April 2006. 115 7.4 TP-Degree Distribution in April 2006. 118.
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