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CLS plays a fundamental role in the foreign exchange (FX) market. It is a market infrastructure that enhances financial stability through the mitigation of FX settlement risk globally. It does this through the operation of the CLS Payment-versus-Payment (PvP) settlement service which mitigates settlement risk for the FX transactions of its Settlement Members and their customers (Third Parties). Originally created as Continuous Linked Settlement and operational since 2002, CLS is an “Edge corporation”, a limited purpose bank regulated by the Federal Reserve Bank of New York.

Settlement Service
CLS operates a global multicurrency cash settlement system through which settlement risk can be mitigated with finality using a unique combination of PvP settlement over CLS central bank accounts,, local real time gross settlement (RTGS) systems and multilateral payment netting supported by a robust and resilient infrastructure.

In a PvP system both sides’ payment instructions for a FX transaction are settled simultaneously. Without PvP there is a serious risk that one party to a 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 as settlement risk, or “Herstatt Risk”, after the German bank, Bankhaus Herstatt, which collapsed in June 1974 leaving many of its FX counterparties with significant losses.

How it works
Following an FX transaction, Settlement Members submit payment instructions to CLS. These payment instructions are authenticated and matched by CLS. Payment instructions are maintained by the system until settlement date. The CLS daily settlement cycle operates with settlement and funding occurring during a five-hour window when all real 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 a FX transaction.

Each Settlement Member holds a single multicurrency 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 payment 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 the central banks whose currencies it settles. CLS, Settlement Members and the national RTGS systems communicate via SWIFT.

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.

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%.

Fundamental to FX
Since it began operations, CLS has rapidly become the market-standard for foreign exchange settlement. The single day record for gross-value settlement, set on 19 March 2008, stands at US$10.3 trillion, for 1,113,464 payment instructions. The single day record for gross-volume settlement, set on 21 September 2011, is 1,960,492. These instructions contained a gross value of approximately US$ 8.9 trillion.

In 2002 CLS was launched with 39 Members and seven currencies. As of May 2012 CLS has 73 Shareholders, 61 Settlement Members and over 15,000 Third Party participants.

Currencies
CLS is actively engaged in a currency expansion program and currently settles the following currencies: