Today Wells Fargo and HSBC announced they’ve agreed to settle foreign exchange (FX) transactions in several major currencies using a blockchain platform. The banks will settle bilateral transactions starting with USD, CAD, EUR and GBP with plans to extend the solution to other currencies. The platform will process around a hundred transactions a week in the early stages and gradually ramp up.
A key differentiator explored later is settlement using commercial bank money instead of central bank money, as happens with CLS.
In 2018, HSBC launched its FX Everywhere platform, which it initially used between banks within the HSBC group but it’s now extending with this partnership. To date, the solution has processed three million intrabank trades amounting to $2.5 trillion.
The offering enables real-time transparency and payment versus payment (PvP) net settlement to cut costs while limiting settlement risks. The banks can choose how many times a day to make net settlements between them.
Now that the platform is being used beyond HSBC, the two banks are looking to add others and hence are considering creating an industry owned central Financial Market Infrastructure (FMI) provider to administer the platform rulebook.
“The platform enables participants to efficiently settle bilateral cross border obligations across multiple onshore and offshore currencies, coupled with the added flexibility of extended settlement windows to optimize PvP risk reduction opportunities,” said Mark Williamson, global head of FX Partnerships & Propositions at HSBC.
CLS, the organization created to reduce settlement risk in the foreign exchange market, also has a blockchain solution, but for the lesser used currencies outside the top 18 that are on CLSSettlement.
First launched in 2018, CLSNet uses blockchain for bilateral payment netting calculations. It only recently started piloting PvP settlement as part of the offering, but that aspect does not use blockchain. A dozen banks are part of the PvP pilot, including Bank of America, BNP Paribas, Citigroup, Deutsche Bank, JP Morgan, Natwest, and UBS.
Meanwhile, the technology that underpins the FX Everywhere platform is the CORE distributed ledger from Baton Systems. While others might label it an enterprise blockchain, it’s not strictly a blockchain, so Baton prefers to call it a DLT. CORE is used in other high profile blockchain applications, including for settling derivatives margins, which JP Morgan uses.
Low risk FX settlement with commercial bank money?
“We are settling wholesale payments relating to FX transactions between banks. What we’re settling is what CLS settles as well. The basic point of divergence between what we do and what CLS does is that CLS settles exclusively in central bank money, which is deemed to be a zero percent rating or riskless,” said Jerome Kemp, President of Baton Systems, talking to Ledger Insights today.
“We are demonstrating to the market today that we’re capable of settling in commercial bank money on a riskless basis with settlement finality.”
He continued, “The vast majority of settlement transactions today that transpire through CLS begin and end their day in commercial bank exposures because the nostros that banks leverage to move money to and from counterparties and CLS are domiciled at commercial banks.”
So how is this riskless? Participants on the Baton platform adhere to the Baton rulebook. In essence, this boils down to a contract between the parties that determines that Baton transactions represent finality. The other aspect is by using DLT, both legs happen simultaneously, with proof of the transaction stored on the ledger as a hash.
Liquidity savings
When it came to using DLT to settle gross equity transactions, the DTCC has previously argued that this could increase liquidity requirements. But that’s not the case for foreign exchange with netting.
“I would argue CLS requires greater liquidity because they operate on a one batch per day (basis). So while CLS manages to reduce the overall multilateral obligations amongst its members, there is still a significant drawdown on market liquidity in order to satisfy that single batch process,” said Kemp.
“They introduced in-out swaps to try to smooth the peaks and the valleys in liquidity, particularly amongst the major currencies that they settle on a daily basis.”
Kemp continued, “As a corollary, I’d argue that the liquidity requirements across Baton are much less significant because we leave it to the actual participants on the Baton platform (to decide) at what threshold they choose to settle.”
The parties can choose to settle at specific exposure levels for particular currency pairs or at certain times of the day that fit in with other liquidity requirements.
“At Baton, we settle within a three minute window, and that immediately allows the market participants to essentially de-fund those settlements and re-use that liquidity over again,” said Kemp. “For that reason, it’s fair to say the Baton system mobilizes a much smaller liquidity footprint than CLS.”
Kemp believes the Wells Fargo HSBC agreement is a banner deal for FX settlement. “What we’ve done today really takes FX settlements into a brand new dimension. One which represents on-demand settlements across a permissioned ledger, without limitations as to 78 members or 18 currencies,” said Kemp.
Update: Comments from Jerome Kemp were added
