What is CLS? How does settlement via CLS work?

DM

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The CLS Group is an American institution founded in 2002 that specializes in the secure settlement of FX transactions. CLS stands for Continuous Linked Settlement. The added value of CLS is that the participating firms can largely eliminate the settlement risk when trading among themselves. Today, CLS offers the settlement of almost 20 currencies, has over 70 member firms and several thousand clients who can use the service as a third party via one of the members.

What is the settlement risk?

When a foreign exchange transaction matures, payments are exchanged between the two counterparties. For example, if you look at a purchase of $100 million against the euro at a rate of $1.10, counterparty A would purchase the $100,000,000 from counterparty B at a price of €90,909,090.91. That is, A delivers the equivalent in euros and B delivers the agreed US dollar amount. According to convention on the spot market, with few exceptions, settlement takes place at time t+2, i.e. in two working days. The settlement risk is now that both parties owe each other a large amount of money, which they must pay in two days. If one of the two counterparties defaults and is unable to meet its payment obligation, the other party would have paid its amount but would not receive the amount owed to it in the other currency.

How does settlement via CLS work?

Each settlement member has foreign currency accounts with CLS for the settlement of foreign exchange transactions. CLS itself has accounts with the central banks for whose currencies CLS offers settlement. On each settlement day, CLS sends simultaneous credits and debits to the respective CLS accounts of the counterparties for the registered payment instructions that are paired between the member banks. Prior to this, CLS checks that both parties are sufficiently funded as part of risk considerations. The simultaneous settlement of both sides of the transaction largely reduces the settlement risk. The member companies are usually banks and brokers that settle a large number of currency transactions on a daily basis. In order to avoid unnecessarily many bookings, all credits and debits per member are therefore netted out in the individual currencies, so that ultimately only one net booking per currency needs to be made. The net view also allows members to hold a much smaller amount of money in their accounts than would be the case with a gross view.
 
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