CLS Group

Not to be confused withCLS Holdings.

CLS Group

CLS Bank is headquartered atOne Financial Square(center) inLower Manhattan
Industry	Financial services
Founded	July 1997
Headquarters	Lucerne(holding), New York(bank)
Area served	18 currency jurisdictions
Website	www.cls-group

CLS Group(forContinuousLinkedSettlement), or simplyCLS,is a specializedfinancial market infrastructuregroup whose main entity is the New York-basedCLS Bank.It started operations in 2002 and operates a unique and global central multicurrency cash settlement system, known as theCLS System,which plays a critical role in theforeign exchange market(also known as forex or FX). Although the forex market is decentralised and has no central exchange or clearing facility, firms that chose to use CLS to settle their FX transactions can mitigate thesettlement riskassociated with their trades.CLS achieve this thanks to a central net (bilateral and multilateral clearing) and grosspayment versus paymentsettlement service directly connected to thereal-time gross settlementsystems of participating jurisdictions through accounts at each of their respective central banks.

CLS demonstrated its risk-mitigation value in thefinancial crisis of 2007–2008,during which the forex market remained orderly even in times of severe systemic financial stress,and again during market turmoil associated with theCOVID-19 pandemicin early 2020.The CLS System's sophisticatedpayment versus paymentconcept does not entirely eliminate forex settlement risk, but reduces it considerably among the currencies that it encompasses.

History

Background

The creation of CLS was a delayed collective response to the turmoil that followed the failure of Germany'sHerstatt Bankon 26 June 1974, which highlighted thecounterparty riskinherent in the system of multilateral net settlement through which forex transactions were executed at the time. Over the three days following Herstatt's demise, the amount of gross funds transferred by that system declined by about 60 percent.The core challenge resulted from the practice of settling each leg of a forex transaction independently, and often at different times with a lag, in the country of issue of each currency. Banks often waited three days or more before they knew with certainty that they had received the currency they had bought in a given such transaction.The risk of paying out the currency sold but not receiving the currency bought became known as "Herstatt risk"as well as foreign exchange settlement risk, comprising aspects of bothcredit riskandliquidity risk.Similar concerns emerged again following the collapse ofDrexel Burnham Lambertin 1989,Bank of Credit and Commerce Internationalin 1991, the1991 Soviet coup d'état attempt,and the collapse ofBarings Bankin 1995.

Creation

In reaction to these events and following discussion among theG10central banks, theBank for International Settlements(BIS) formed successive committees to address the international settlement risk problem, namely the Group of Experts on Payment Systems and the Committee on Interbank Netting Schemes of the Central Banks of the G10 Countries, which in 1990 were replaced by theCommittee on Payment and Settlement Systems(CPSS).A series of reports by these groups paved the way towards the creation of CLS, each named after the official who chaired the committee that prepared it:

• the "Angell Report" on Netting Schemes (1989), named after US Federal Reserve policymakerWayne Angell,described the various kinds of internationally related financial netting arrangements;
• the "Lamfalussy Report" of the Committee on Interbank Netting Schemes (1990), named after BIS policymakerAlexandre Lamfalussy(and not to be confused with the separate Lamfalussy Report of 2001 which initiated theLamfalussy processin theEuropean Union), identified minimum standards for the design and operation of cross-border and multi-currency netting schemes, as well as core principles for co-operative central bank oversight of netting system that were to shape the oversight concept for CLS;
• the "Noël Report" of the CPSS onCentral Bank Payment and Settlement Services with Respect to Cross-Border and Multi-Currency Transactions(1993), named afterBank of Canadapolicymaker Timothy Noël, analyzed the advantages and disadvantages of different central bank services related to payment and settlement systems, without however recommending a single preferred service option;
• the "Allsopp Report" of the CPSS onSettlement Risk in Foreign Exchange Transactions(1996), named after forBank of EnglandpolicymakerChristopher Allsopp,extensively described the past episodes, such as the Herstatt failure, and called on the private sector to find practical solutions to remedy the identified risks, and thus represented "a wake-up call for the [banking] industry" that set the basis for subsequent initiatives including CLS.

Such initiatives also initially included FXNet, which netted trades each day by counterparty pair; the Exchange Clearing HOuse Ltd (ECHO), a London-based multilateral netting system which started operations in August 1995;and Multinet International Bank, aNew York State-chartered bank that similarly developed a multilateral forex netting clearing house.Such entities, however, had no direct access to central bank currency, and struggled to achieve critical mass.

Like FXNet, ECHO and Multinet, CLS was established as a private-sector project, even though the impetus came from the central banking community through the CPSS; the project turned out to be highly complex, nearly foundered on several occasions, and at such points required intervention by the BIS to survive.In October 1994, senior executives from large international banks formed the "group of 20" or G20 (not to be confused with theG20group of jurisdictions, which was formed in 1999) as a common interest group.Pressure from the central banks, including the publication of the Allsopp report in 1996, led the G20 to meet regularly and focus on a common solution to reduce foreign-exchange-related credit risk. In January 1996, it converged on the solution of a clearing bank operating apayment versus paymentmechanism with continuous real-time linked processing and item-by-item settlement, thus the name CLS - meaning that the two legs of a foreign-exchange transaction are settled simultaneously.By the spring of 1997, the G20 banks determined that the future system should rely on a central bank account and membership in the respectivereal-time gross settlementsystem in each jurisdiction (known in the payments jargon as anostrorelationship), but no physical presence other than in the United States, United Kingdom, and Japan in order to save costs.This required ad hoc legislation to be passed in participating countries, and also the extension of operating hours in Australia, Canada and Japan.

On 1 July 1997, the G20 banks jointly established CLS Services Ltd in the UK as the project's first dedicated legal entity; other banks were asked for USD 1 million each to join the project as shareholders, as the project building costs were rapidly increasing from an initial estimate of $40m at end-1995.In July 1998, the project had reached an ownership of 60 shareholders in 14 countries, with total commitments of $160m.On 1 November 1999, CLS Bank International was established as a New YorkEdge Actfinancial institution after the Federal Reserve approved its application, which had been filed on 6 August 1999.

In 1996 and 1997, various forms of cooperation were considered between the G20's CLS project and the competing initiatives of FXNet, ECHO and Multinet,eventually resulting in the latter initiatives' full acquisition by CLS Services in December 1997.ECHO's service was discontinued in April 1999, and Multinet was dissolved in May 2000.In April 1998,IBMwas selected to develop the CLS technical infrastructure.CLS Bank started operating on 9 September 2002, settling theAustralian dollar,Canadian dollar,euro,Japanese Yen,Swiss franc,Pound sterling,andUS dollar.

Lawrence M. Sweet, an official at theFederal Reserve Bank of New Yorkseconded at the BIS from 1994, was instrumental in the elaboration of the CLS concept as secretary, then chair of the CPSS Steering Group on Foreign Exchange Settlement Risk. He also chaired the CLS Oversight Committee from its formation in 2009 until June 2018.

Later development

The original seven currencies were joined by theDanish krone,Norwegian krone,Singapore dollarandSwedish kronain September 2003; theHong Kong dollar,South Korean won,New Zealand dollarandSouth African randin December 2004; theIsraeli shekelandMexican pesoin May 2008;and theHungarian forintin November 2015.

Since it began operations in 2002, CLS has rapidly increased and by March 2017 was settling just over 50% of global FX transactions.As a result, theFinancial Stability Oversight Council (FSOC)officially designated CLS asystemically important financial market utilityin July 2012.

The single day record for value settled is US$15.4 trillion, set on 15 December 2021. The single day record for volume settled is 3.2 million trades, set on 5 July 2022.

The CLS membership and shareholder base has grown accordingly, from 39 members at inception in 2002 to 79 shareholders including 66 settlement members and 24,000+ third-party clients as of September 2017.

Group organization

Legal structure

Partly as a consequence of the need for consensus among participating central banks, the CLS Group structure involves entities in several countries. Since 2001,the group's parent company has been CLS Group Holdings AG inLucerne,a Swiss private holding company. It owns 100 percent of CLS UK Intermediate Holdings Ltd inLondon(the original CLS company established in 1997 as CLS Services Ltd and renamed in 1999),which in turn owns two main subsidiaries: CLS Bank International, a U.S.Edge Actcorporation, and CLS Services Ltd, a British company that provides operational support to CLS Bank and associated institutions.The only other jurisdictions where CLS is established are Japan and Hong Kong.

Shareholders

CLS Group is a commercial entity that is operated on a not-for-profit basis, like other financial utilities such asDTCCandEuroclear.Its shareholders have governance rights but do not gain dividend income or an increase in the value of their shares from retained earnings. As of 2022, CLS's website disclosed 79 banks from multiple jurisdictions as its shareholders.

Supervision and oversight

CLS Group Holdings AG, while a Swiss entity, is regulated and supervised by theFederal Reserveas abank holding companyin the United States.The Federal Reserve also regulates CLS Bank International, which it supervises as a bank. Under the unique concept initially defined in the Lamfalussy Report of 1990, the central banks of issue of the currencies (other than theUS dollar) that settle in the CLS system are involved in the group's "oversight" but without a regulatory or supervisory mandate; theFederal Reserve Board,supported by theFederal Reserve Bank of New York,is the "primary overseer" of CLS Group and CLS Bank, a role it exercises in consultation with the other participating central banks.The CLS Oversight Committee was formed by the participating central banks in 2009, succeeding earlier committee formats,and operates under a Protocol finalized in December 2015.

As of 2022, the CLS Oversight Committee has 23 members: the respective central banks of issue of the 18 CLS currencies, plus five national banks of theEurosystemthat are also members of theG10,namely those of Belgium, France, Germany, Italy, and the Netherlands.

Leadership

The management of CLS Bank is based in New York.The CEO of CLS Group and CLS Bank has been, successively, Joseph De Feo (2000-2005), Rob Close (2005-2010), Alan Bozian (June 2010-2012), David Puth (August 2012-December 2019), and Marc Bayle de Jessé (since December 2019).

The boards of both CLS Group and CLS bank have been chaired, successively, bySuzanne Labarge(June 2001-June 2003), Fritz Klein (June 2003-2005), Mark Garvin (2005-June 2007),Gerard Hartsink (2007-October 2014), Ken Harvey (October 2014-June 2022),and Gottfried Leibbrandt (since June 2022).

Operations

CLS operates apayment versus payment(PvP) settlement service which mitigates settlement risk for the foreign-exchange transactions of its settlement members and their customers (third parties). CLS Bank is connected to thereal-time gross settlementsystems of participating jurisdictions and holds accounts at their respective central banks, typically enabled (outside of the United States) by ad hoc legislation that exempts CLS from local establishment requirements. As such, CLS Bank is connected toFedwirein the United States,TARGET2in the euro area,CHAPSin the United Kingdom,SICin Switzerland, theReserve BankInformation and Transfer System (RITS) through theSWIFTPayment Delivery Service in Australia, KRONOS in Denmark,CHATSin Hong Kong,BOJ-NET in Japan,BOK-Wire in South Korea, ESAS in New Zealand,Norges BankSettlement System (NBO) in Norway, MEPS+ in Singapore, SAMOS in South Africa,RIXin Sweden, etc.

CLS operates a global multi-currency cash settlement system through which settlement risk can be mitigated withfinalityusing a combination of PvP (payment versus payment) settlement over CLS central bank accounts, localreal-time gross settlementssystems (RTGS) and multilateral payment netting supported by a resilient infrastructure.

In a PvP system both sides’ payment instructions for an FX transaction are settled simultaneously. Without PvP there is a serious risk that one party to an FX transaction will deliver the currency it owes, but not receive the other currency from its counterparty, resulting in the loss of principal. This is known assettlement risk,or “Herstatt Risk”,after the German bank,Bankhaus Herstatt,which collapsed in June 1974 leaving many of its FX counterparties with significant losses.In 1995 theBank for International Settlementspresented a possible solution on a PvP basis.In an advancement to this proposal the G20 banks founded an earmarked financial institute, the CLS Bank International.

Following an FX transaction, settlement members submit payment instructions to CLS. These instructions are authenticated and matched by CLS and maintained by the system until settlement date. The CLS daily settlement cycle operates with settlement and funding occurring during a five-hour window when allreal-time gross settlement(RTGS) systems in the CLS settlement currency jurisdictions are open and able to make and receive payments. This enables simultaneous settlement of the payments on both sides of an FX transaction.

Each settlement member holds a single multi-currency account with CLS. At the start and end of a normal settlement day, each settlement member has a zero balance on its account. Under normal operations of the settlement service, CLS starts and ends the day with a zero balance in its central bank accounts and in its settlement member accounts. Settlement members may submit instructions relating to their own FX transactions as well as the FX transactions of their third-party customers directly to CLS.

CLS holds accounts with each of thecentral bankswhose currencies it settles.

On each settlement date, upon determining that the accounts of the submitting settlement members satisfy several risk management tests, CLS simultaneously settles each pair of matched payment instructions by making the corresponding debit and credit entries in the settlement members’ accounts at CLS. The settlement of the payment instructions and the associated payments are final and irrevocable.

For example, (GBP/USD = 1.50, EUR/USD = 1.25):

• By trades:
  • Member 1: Buys 1,000 GBP/USD from Member 2
  • Member 2: Buys 1,000 EUR/USD from Member 3
  • Member 3: Buys 1,000 GBP/USD from Member 1
• By currency positions:
  • Member 1: Owes USD1500 and GBP1000, collects USD1500 and GBP1000
  • Member 2: Owes USD1250 and GBP1000, collects EUR1000 and USD1500
  • Member 3: Owes USD1500 and EUR1000, collects USD1250 and GBP1000
• CLS then multi-laterally nets the total obligations:
  • Member 1: Pays 0.0 and receives 0.0
  • Member 2: Pays GBP1000, and receives EUR1000 and USD250
  • Member 3: Pays USD250 and EUR1000, and receives GBP1000

These obligations are funded into and from each member’s respective multi-currency account.

Another key element of the CLS Settlement Service is the liquidity efficiencies delivered through multilateral payment netting. On each day participants will very likely have more than one trade to settle—in practice, major banks will have hundreds or thousands of trades each day. Each day prior to settlement, CLS calculates the funding required of each settlement member on a multilateral netted basis. The amount of cash required by CLS to settle all payment instructions is reduced, allowing each settlement member to transfer only the net amount of its payment obligations in each currency, rather than the total amount of each trade to be settled. On average, CLS netting efficiency is in the region of 96 percent.

In addition to the usual settlement service, the in/out swap processis done before the settlement windows to reduce the payment obligations to CLS and to mitigate liquidity pressures. An in/out swap is an intraday swap consisting of two equal and opposite FX transactions that are agreed as an intraday swap.

One of the “legs” is settled inside CLS in order to reduce each settlement member’s net position in the two relevant currencies. The other “leg” is settled outside CLS.

The in/out swap further compresses payment obligation by an average of 75%, which results in a funding requirement in CLS of less than 1% of the total gross settlement value.

CLS currencies

CLS has expanded the number of currencies it settles over the years and currently (mid-2022) settles:

Country/entity	Symbol	Currency
Australia	AUD	Australian dollar
Canada	CAD	Canadian dollar
Denmark	DKK	Danish krone
Eurozone	EUR	Euro
Hong Kong	HKD	Hong Kong dollar
Hungary	HUF	Hungarian forint
Israel	ILS	Israeli new shekel
Japan	JPY	Japanese yen
Mexico	MXN	Mexican peso
New Zealand	NZD	New Zealand dollar
Norway	NOK	Norwegian krone
Singapore	SGD	Singapore dollar
South Africa	ZAR	South African rand
South Korea	KRW	South Korean won
Sweden	SEK	Swedish krona
Switzerland	CHF	Swiss franc
United Kingdom	GBP	Pound sterling
United States	USD	United States dollar

See also

• SWIFT

References

External links

• CLS website