The Global Financial Markets Association (GFMA) recently explored accelerating foreign exchange (FX) settlement times, but found significant challenges. It concluded it was unclear whether the FX market has an appetite for more T0 activity, given the need for significant investment.
As context, the BIS Committee on Payments and Market Infrastructures (CPMI) published a report on payment versus payment (PvP) in order to reduce significant FX settlement risks in the $7.5 trillion daily FX market. It estimates the risk is $2.2 trillion daily. FX as a key aspect of cross border payments is currently a G20 agenda item. The CPMI’s paper explored several new PvP payment systems, with more than half using distributed ledger technology (DLT).
Last week GFMA published a paper, incluing input from 25 large banks. It outlines three drivers behind accelerated settlement, and one is the regulatory interest gathering steam, as highlighted by the CPMI report.
Adapt or die?
Referring to digital assets and DLT, the authors observe that “new processes and new market participants could create opportunities to change how the wholesale FX market operates.”
In our view this is the key dilemma. Given the high potential cost of transforming existing infrastructure, motivation for change might be weak. But competition from new players means incumbents are unwilling to evolve could cede their market position. The only question is how long it takes.
A fragmented FX future: interoperability critical
The other two motivators for a shift to T0 are technology and efficiency. Regarding technology, the GFMA makes several recommendations, including adopting new PvP and DvP technologies. Market participants must ensure that these are interoperable with digital assets and ‘digital stores of value’ and more general interoperability is crucial.
It concludes that the future will be more fragmented as it’s unlikely the entire market will adopt the same PvP system. GFMA also notes that the sector should monitor and learn from next year’s transition to T+1 in the U.S. securities sector.
When it comes to efficiencies, in reality much of these will come from new technologies. There’s a need for greater post trade automation to achieve these efficiencies, and that automation must ensure all the parties involved in a transaction are in sync.
“Technology could play an important role here through the creation of immutable ‘golden sources’ of transactions as these too will enable the reduction of the time taken to perform any post trade processes,” the authors write.
GFMA also highlights that funding is critical for the feasibility of a shift to T0, mentioning a need for intraday FX swaps and central bank bridges. We’d add that DLT startup Finteum is preparing to launch intraday FX swaps later this year with public commitment from UBS and Natwest as participants.
Overall, the paper makes several practical recommendations. However, its conclusion questions the appetite to bear the significant upgrade costs. And that position must have come from at least some of the 25 banks involved.