Hastening Settlements Reduces Trading Risk

The world's major financial institutions are counting on real-time information and nearly instantaneous transactions to reduce the risk involved in worldwide currency trading. Seven central banks, including the U.S. Federal Reserve, and 66 major financial firms spent $300 million and six years building a global system to automate the trading and settlement of foreign currency exchanges. They began rolling out the Continuous Link Settlements system last week.

Citibank processed $2.5 billion in currency trades on the system during its first day. "The efficiency gain is that we have fewer payments to do and fewer reconciliations," says Michael Knorr, Citibank's global CLS product management head. "And we'll have real-time information available during the process."

Faster settlements are important because world events, major economic news, and interest-rate changes can have an immediate effect on the value of a country's currency. Banks trade about $3 trillion in currency every day. In the past, two banks would agree on an exchange rate, clear the deal with their respective central banks, then wire the money to each other--a process that could take two or three days, which created risk. During that period, a bank could go bankrupt, exchange rates could change, or other developments might occur, and a good deal could end up being a bad deal by settlement time. "There's a need for the banks to see this risk eliminated, because the value and size of the trades have become so large that if something went wrong, the effect would be catastrophic," says Joseph DeFeo, president and CEO of CLS Bank International, the entity created to operate the trading system.

CLS hired IBM to build the network and the computing infrastructure, which is based on server clusters running AIX, DB2 databases, proprietary middleware, and custom trading applications. Security and reliability were top priorities. To meet the Federal Reserve's requirements, the trading system includes multiple levels of authentication. For resiliency, it includes two matching systems in separate locations with immediate failover and a third backup site that can be brought online immediately.

Another challenge was to ensure that each member bank could link into the CLS system through gateways IBM set up. Each bank had to develop its own applications to facilitate the real-time trading and was provided with a graphical user interface from CLS to make it easier to connect to the system.

CLS began a phased rollout last week in which small groups of member banks conducted trades with one another to test the system. Those groups will expand during the next few months until trading is completely open. In time, CLS plans to add more central banks, currencies, and financial institutions to the system.