Foreign Exchange Archives

Best FX post-trade provider: OSTTRA TriOptima

Supplying both multilateral compression and optimisation services to global FX markets, consistent high performance from TriOptima has seen the firm go from strength to strength in challenging times.
This year’s best FX post-trade provider – named at the FX Markets Asia Awards – is TriOptima. A market leader in portfolio compression, TriOptima has more than 260 clients worldwide. It is the only market player providing both multilateral compression and an optimisation service for FX markets, helping clients simplify operations and optimise resources, limit risk and reduce counterparty exposures. TriOptima continues to refine its service and make portfolio management simpler for the industry.

Phil Junod, senior director, triReduce and triBalance business management at TriOptima, says the company’s solution is highly customisable to reduce risk and exposures. “We have a holistic solution that considers the all-in cost of running a derivatives portfolio and the risk exposures in the portfolio,” he says. Two methodologies are offered – to either compress or optimise – and customers can then focus the specific event on reducing gross notional, capital and margin.

For compression, the triReduce CLS FX service provides capital optimisation and risk mitigation for the global FX market, joining its triReduce compression service to CLS’s infrastructure and market connectivity. Clients benefit from enhanced capital efficiency and leverage ratios, lower operational risks and costs, and actively managed counterparty credit risk. For optimisation, the triBalance solution is one of the most complete services on the market over the broadest range of initial margin (IM) silos across FX, rates, equities and commodities. triBalance helps clients reduce portfolio volatility, limit potential future exposure and manage counterparty risk exposures across multiple risk classes.

Junod says: “We offer this holistic solution, where you are able to address those counterparty risk exposures through different means and you’re able to target exactly what you are looking to minimise.” He explains the importance of a solution that focuses on counterparty risk: “There is a large amount of uncertainty in the market and this, together with expected regulatory changes in major jurisdictions next year, all put the spotlight on counterparty risk exposures.”

This has been a solid year of growth for TriOptima. The triReduce CLS FX compression service helped to eliminate $9.1 trillion of gross notional value from its FX forward portfolios in 2019 – a record for the service. And, despite extreme market volatility in 2020, the service has compressed $4.9 trillion since the start of the year, a 55% increase year-on-year for the service. In addition, the triBalance team is focused on the strength of its services offered when the pandemic first hit.

“Throughout March and April,” says Junod, “we were able to deliver our services consistently and without any disruptions. This is testament to our own capabilities, but also to how important it is to the market to be able to leverage services such as those we offer.”

triBalance has consistently delivered weekly cycles for several years. Over the past year, TriOptima completed the first multilateral optimisation of commodity standard initial margin model (Simm) exposures (using gold and FX), further helping its clients optimise their uncleared margin rules counterparty exposure. This move represented the first optimisation cycle across both FX and commodities exposure silos simultaneously, and worked to further grow overall IM optimisation efficiency, providing a more comprehensive tool to optimise Simm exposures.

Next year, TriOptima plans to continue its drive to improve counterparty risk offerings to the global markets – and to do this in a measured and deliberate way. As Phil notes: “Looking back, we have focused on developing very specific solutions for our customers; however, in the future, there is going to be a much greater focus on achieving synergies for our customers, so that we can address multiple issues simultaneously.”

Keeping the solution holistic and deliberate in TriOptima’s strategies will offer continued success for itself and the markets it serves.

As published in FX Markets in their November 2020 issue.

J.P. Morgan FX Prime Brokerage turns to OSTTRA to cut Designation Notice onboarding times

Challenges

FX prime brokers face cost and complexity challenges managing Designation Notices. These FX tri-party credit agreements tend to be managed on a variety of in-house and third-party platforms, resulting in complex, duplicative workflows and the potential for errors in the setup and maintenance of credit lines.

Our solution

OSTTRA Designation Notice Manager, powered by Traiana, has been adopted by J.P. Morgan FXPB as a single platform to establish, monitor, amend and terminate Designation Notices across all Executing Broker (EB) relationships, including EBs not on the OSTTRA Designation Notice Manager network.

The solution integrates seamlessly with OSTTRA CreditLink, synchronizing limits for real-time monitoring and control of trading activity.

During the project, the OSTTRA team worked alongside J.P. Morgan FXPB to onboard more than 2,000 designation notices. This has resulted in streamlined workflows with the all the EBs already on our network, as well as the ability to manage ‘offline’ EBs using the same tools and processes.

By fully adopting OSTTRA Designation Notice Manager, the team at J.P. Morgan FXPB have seen an improvement in DN onboarding times from up to 8 weeks to less than 3 weeks

“Standardising the management of our DNs on OSTTRA Designation Notice Manager has delivered real advantages. Having all DNs in a single system, managed through a common process has brought efficiencies, cut onboarding times and reduced the potential for errors.”

“The ability to automatically synch limits with OSTTRA CreditLink is also a key benefit, ensuring limits are maintained and monitored in real time. We look forward to working with OSTTRA on the next level of integration, incorporating additional FXPB agreements such as Reverse Give Ups, Double Give Ups and Switches.”

Leah Mallas, Global Head of FX Prime Brokerage and FX Clearing at J.P. Morgan

Customer benefits

Effective, streamlined, and flexible Designation Notice management and intraday risk limit monitoring.

Operational efficiency

A unified solution for managing all Designation Notices, reducing complexity and duplication

Enhanced credit risk management

A golden source of all tri-party credit lines
Integration to either in-house Credit Risk systems or OSTTRA CreditLink to monitor limits in real time

Streamlined infrastructure onboarding

Fully resilient managed infrastructure
Partnership with experienced OSTTRA team for onboarding and ongoing operational support

To learn more about Credit Management, click here or contact us at info@osttra.com.

OSTTRA and Baton Systems partner to launch FX PvP service, mitigating settlement risk in FX markets

OSTTRA will operate an on-demand payment-versus-payment (PvP) service, powered by Baton’s proven distributed ledger technology, designed to mitigate settlement risk in the US$2.2 trillion of daily FX turnover settled outside CLS. The service will be open to FX market participants globally – including market maker banks, investment managers, and large corporates. Initial participants include HSBC and Wells Fargo.

LONDON, 06 March 2024 – Global post-trade solutions provider, OSTTRA, announced today the launch of an FX PvP settlement orchestration service designed to mitigate bilateral settlement risk between participants, while optimising intraday funding, liquidity, and credit risk.

The launch of the new OSTTRA service comes after the Bank for International Settlements’ Committee on Payments and Market Infrastructures (CPMI) last year advocated an increase in the adoption of PvP in FX transactions to reduce FX settlement risk (or “Herstatt risk”). As of April 2022, the Bank for International Settlements (BIS) said that there could be settlement failures in US$2.2 trillion daily deliverable FX turnover, because it either sat outside PvP platforms or as “on-us without loss protection” trades.

The PvP service will be delivered on proven distributed ledger technology (DLT) from Baton Systems (Baton) and marks a significant milestone in increasing market wide access to PvP, helping to address FX settlement risk concerns. The focus will be on settling flows not currently settled on CLS, including non-CLS eligible transactions such as offshore Chinese renminbi, which has almost doubled in the percentage share of global FX trading volumes from 2019 to 2022 according to BIS. Bank and non-bank market participants will also have much greater flexibility to settle FX transactions intraday, without being tied to the CLS cut-off window.

The launch represents the first step in a broader OSTTRA strategy to improve the market structure of OTC markets. It is intended that the service will evolve to include settle-to-market functionality, significantly reducing derivative counterparty exposures, therefore reducing the regulatory capital required under SA-CCR (Standardised Approach to Counterparty Credit Risk).

The decision to partner with Baton follows an extensive market review and due diligence process conducted by OSTTRA. Baton’s solution already orchestrates the settlement of billions of dollars every day, with settlements to date exceeding US$8.1 trillion in value.

Under the terms of the partnership, OSTTRA will take on the operation of Baton’s award-winning Core-FX service, including administration of the rulebook, which governs the end-to-end process and encompasses the secure orchestration of funds, and which provides the framework for achieving final settlement. HSBC and Wells Fargo, early adopters of Core-FX as part of the HSBC FX Everywhere initiative, will join the OSTTRA operated service during the first half of 2024.

Mark Williamson, Global Head of FX & Commodities Partnerships & Propositions at HSBC, commented: “Since 2018, HSBC FX Everywhere has used Baton’s Core FX technology to settle 16 million FX trades across 13 different currencies totalling US$8.1 trillion. Using OSTTRA as a post-trade platform, the wider market will now be able to use the same technology to reduce their FX settlement risk through PvP settlement and compression, as well as optimising their cash flows. Overall, this will significantly mitigate Herstatt risk in the market.”

Chris Leaver, Chief Strategy and Marketing Officer at OSTTRA, added: “There’s huge scope for further post-trade efficiencies across OTC asset classes: this new service represents an important milestone in the evolution of our FX network, extending existing workflows to reduce settlement risk for thousands of OSTTRA clients. We’re excited to have chosen Baton as a partner in this first step of our journey – their proven technology leads the market in real-world, production DLT solutions for institutional capital markets”.

Arjun Jayaram, Founder and CEO of Baton Systems, further commented: “We’re excited to be collaborating with OSTTRA. OSTTRA is a leading player in the post-trade arena with extensive market reach. Through this strategic partnership, we will jointly accelerate and globally scale access to PvP settlement whilst enabling the Baton team to continue innovating and deploying operationally resilient solutions that deliver modern, cloud-based interoperable technology stacks that make our markets more inclusive, safer, and more efficient.”

ABOUT BATON SYSTEMS
Baton Systems is the global fintech company transforming the entire front-to-back post-trade process, introducing interoperable and connected digital market infrastructures from trade matching through to settlement. Empowering financial institutions to take control with automated and configurable rules-based workflows, access to real-time information, and on-demand settlement, Baton’s DLT-based solutions are redefining what post-trade processing should look like: fully connected, friction-free, flexible, and transparent.
Founded in 2016 by Silicon Valley technologists and capital market specialists, Baton’s solutions are now being used by several of the world’s largest financial institutions to facilitate the movement of billions of dollars of cash and securities on a daily basis.

Find more information on how OSTTRA is orchestrating PvP Settlement at www.osttra.com/pvp.

Compression & Optimisation Update – October 2024

“So far 2024 has been a year of significant global events – from general elections and easing interest rates to geopolitical shifts that have impacted the global economy. We have remained committed to supporting the integrity of the markets and empowering our extensive network to mitigate risks effectively, resulting in record performance, innovation in new asset classes and products as well as notable award wins.

Thank you to our network of participants for your continued support and we look forward to delivering even greater efficiencies in the future.”

Erik Petri, Head of Optimisation

FX Options: Rising Activity Puts Post-Trade in Focus

Volumes in FX options markets are surging and there is no sign of a let-up as interest rates change in major economies when newly elected administrations across a record number of jurisdictions are settling in to govern. The election of Donald Trump as US president may drive increased demand for FX options, as both hedgers and speculators look for ways to navigate expected market shifts and uncertainties.

Given the macroeconomic and geopolitical backdrop of 2024 and looking ahead, the popularity of contracts that grant holders the right but, crucially, not the obligation, to buy or sell assets at a pre-agreed price is understandable, since optionality in times of elevated uncertainty is a highly prized feature.

Overall, traded volumes in FX options have risen 58% year-on-year, according to the US Federal Reserve’s latest FX survey, while the Bank of England recorded a 41% rise in the same period.

As underlying volumes increase, idiosyncratic volatility events, such as the spectacular unwind of the Japanese yen carry trade at the start of August 2024, result in peak volumes that put significant pressure on operations in these traditionally voice-dominated markets, particularly in dealer-to-dealer markets, exposing the inefficiencies and vulnerabilities of manual processes throughout the trade lifecycle. This potential for increased operational risk is driving new interest and adoption of electronic processes in both the front and back office, as we’ll explore below.

In the dealer-to-client space, where electronic processes are more established, multi-dealer venues have seen their FX options volumes nearly triple in the past six years, driven by best execution mandates as well as the quest for efficiencies. The dealer-to-dealer market has been considerably slower to migrate to electronic trading, with interdealer brokers (IDBs) still facilitating most of the trading activity. Interdealer clearing volumes have likewise exploded over the past year, bringing focus on operational risk reduction through the removal of post-trade inefficiencies.

Exploding volumes catalyse market structure change

The surge in FX options trading volumes can be measured across many OSTTRA post-trade services, which are used by the industry to efficiently process trades across multiple steps of the lifecycle.

Interdealer Broker Affirmation

The OSTTRA IDB affirmation service (FXBA), which connects dealers with their brokers to enable affirmation and straight-through processing of executed trades, has seen average monthly volumes increase around 16%, from around 34,500 per month in 2023, to 40,000 per month, on average, in 2024, or 25%, comparing the month of October 2023 with October 2024.

This uptick can be seen as a direct result of more front-office activity, but it also underscores the quest for more efficient and automated processes throughout the trade lifecycle. High-volatility stress events in recent years have seared into institutional memories the importance of risk mitigation through low-latency post-trade processes. When execution moves at millisecond speed, post-trade processing needs to keep pace, without growing volumes causing delays or costly errors.

Centrally cleared FX options

Uptake of interdealer clearing has also seen a marked increase over the past year as firms look to manage counterparty risks more efficiently. Illustrating this trend, OSTTRA has seen ticket volumes more than double on its FX options matching and clearing connectivity platform (OSTTRA TradeServ), which manages the workflows required to prepare and submit executed trades for clearing at global central counterparties, from a monthly average of just above 5,000 in 2023 to almost 11,000 in 2024 (comparing the available data from this year and the same time period last year). And 2023 did not present a particular lull in FX options trading, as previous years tended to be more lacklustre.

While the volume of trades sent to clearing remains much lower than the total IDB-affirmed trades, this is changing as more dealers move towards a cleared model. We can fully expect to see FX options cleared volumes continue to increase.

Tri-party FX options (prime brokerage)

The increase in volumes noted in the interdealer market is being replicated by hedge funds trading with executing banks under tri-party agreements, with our tri-party trade processing service – FX ClientLink and Message Center – also seeing substantial and sustained volume increases. We have seen an average uptick in FX options trades of 20% for the first eight months of this year compared with the same period in 2023, and 36% compared with the same period in 2022.

Risk management under the microscope

The surge in FX options volumes has increased demand for the timely updating of traders’ risk systems, ensuring positions are current as soon as technologically possible. OSTTRA supports post-trade messaging through its post-trade notification services, which provide firms with the ability to publish and receive notices of execution across a large network of trading venues, single-dealer platforms and trading counterparties.

Heightened counterparty credit risk has been a big topic in prime-broker industry working groups in recent years, with a growing demand to tie credit limits defined in designation notices with a real-time view into client utilisation for executing brokers. OSTTRA has provided a post-trade view of prime broker client utilisation to executing brokers for many years as part of its credit management suite, which has now been enhanced to support queries on a pre-trade basis.

“Automating this post-trade workflow is crucial for enhancing operational efficiency and reducing risk”

– Steve French, OSTTRA

Early adopters are integrating the service directly into their internal risk systems using a bidirectional application programming interface to perform real-time pre-trade credit checks for FX options against client limits defined in our designation notice management service. In a further enhancement, the monitoring service is being equipped with vega measurement to provide subscribers with options valuation sensitivity.

Exotics take centre stage

Firms that have historically traded vanilla FX options are now looking to trade more exotic instruments, but this can only be supported across the trade lifecycle on an automated basis if all touch points and processes are uplifted to support these trade types. FX options, by their very nature, are more complex than other FX instruments and rely on post-trade events being triggered to access any underlying asset.

The automation and collaborative management of these events, including the various flavours of exercise and expiry, is attracting renewed attention from market participants. To address the growing demand for broader exotics support, OSTTRA expanded its FX options trade processing services several years ago, and is now collaborating with market participants to increase adoption and leverage the long-standing post-trade event management capabilities of its networks. This collaborative effort aims to reduce manual processes and increase FX options’ straight-through-processing (STP) rates across the industry.

Navigating FX options automation: collaboration matters

Our post-trade services play a critical role in managing rising FX options volumes, but a collaborative industry approach is required to increase STP rates and the use of features associated with lifecycle events, including exercise and expiry.

A great example is the partnership between OSTTRA and SpectrAxe to implement an end-to-end solution aimed at streamlining FX options trading by automating the entire trade lifecycle. SpectrAxe, a US-regulated swaps execution facility, has gone live with the first central limit order book (Clob) to facilitate all-to-all trading for over-the-counter FX options. The venue enables hedge funds to trade anonymously with other hedge funds, proprietary trading firms, regional banks and market-makers via their FX prime broker relationships on a ‘lit’ marketplace. It’s the first electronic Clob trading platform for OTC FX options, an area of the market that remains heavily reliant on voice- and chat-based execution or single-dealer platforms.

Specifically, the offering works from price discovery through to execution, booking and risk management within the FX options market – combining SpectrAxe’s price discovery and execution Clob with the OSTTRA post-trade network, using our affirmation and trade notification services. Automating this post-trade workflow is crucial for enhancing operational efficiency and reducing risk. This combined expertise provides market participants with a streamlined, automated process that not only saves time but also significantly reduces the potential for errors.

This intricate web of technology and connectivity provides the flexibility required for broad market coverage and greater participation. It’s a cost-effective way to optimise workflows and mitigate operational risks in the post-trade lifecycle management of FX options and adoption rates suggest a strong appetite to address these challenges as volumes grow and costs and risks multiply.

With OSTTRA, clients can affirm trades from any bank and submit post-trade allocations to any prime broker, streamlining their entire post-trade management practices for FX options and a broad range of other asset classes. For more information, contact info@osttra.com or visit osttra.com/fx

OSTTRA speaks to e-Forex about FX Settlement Risk: Building industry consensus to address the problem

As FX trading faces the dual pressures of shortening settlement timelines and expanding volumes across a wider array of currency pairs, addressing FX settlement risk (also called Herstatt Risk) is becoming increasingly critical. In this special feature on FX Settlement Risk, OSTTRA provides expert insights to e-Forex on the industry’s challenges, the path towards collaborative solutions and increasing the adoption of Payment versus Payment (PvP) settlement mechanisms.

Featured topics include:

FX Settlement Risk: Determining the scale of the problem and taking steps to address it
Basu Choudhury, head of partnerships and alliances at OSTTRA, shares insights into the growth in FX trading outside of traditional PvP services, and discusses the need for solutions that not only mitigate settlement risk but also provide value.
Service spotlight: OSTTRA solutions at the heart of the global FX post-trade community
We highlight the benefits of OSTTRA PvP Settlement Orchestration for market participants.
What can be done to increase the appeal and adoption of PvP?
This article explains why the industry needs alternative PvP models, supporting bilateral settlement and offering more flexibility in terms of settlement times, regardless of where the market participant is based.
Bright ideas, the promise of new technology and prospects for the future
We discuss why the issue lies not in the technology itself, but in the need for adapted models and shared transparency to manage settlement risk arising from recent non-bank growth, with the future relying on distributed data and collaborative workflows that provide transparency and a shared golden record.

Basu Choudhury, OSTTRA

OSTTRA tackles FX risk with new settlement orchestration and expanded optimisation tools

OSTTRA has added settlement orchestration to its suite of FX services to help clients optimise their derivatives portfolios and tackle critical challenges in the market.

Long known as a leader in post-trade processing and optimising portfolios across multiple asset classes, OSTTRA has partnered with Baton Systems to launch an FX payment-versus-payment (PvP) service that offers settlement risk mitigation for riskier currencies. The partnership, announced in March 2024, aims to address the growing risk of FX transactions traded in the market that are not eligible to settle within established settlement services, with offshore renminbi (CNH) at the forefront.

Under the terms of the partnership, OSTTRA now operates the rule book and technology governing the end-to-end process and orchestration of funds. As such, the rule book defines the ownership of funds at each stage of the PvP workflow as recorded on the distributed ledger, thus ensuring ownership of funds is only transferred when both counterparties have fully funded settlement accounts. Given that OSTTRA has been providing the matching capability for Core-FX since 2018, this effective collaboration between the two firms provided an ideal environment for a smooth operational transition.

With billions of dollars settled daily through Core-FX – and more than $8.1 trillion since its inception – Baton’s distributed-ledger technology (DLT) has already left its mark on the FX settlement landscape. To scale the service, Baton sought a partner with a sizeable network, while OSTTRA – whose links extend to the world’s largest banks and buy-side market participants – was looking to develop its own settlement orchestration offering or collaborate closely with an existing service.

“After an extensive market review and due diligence process, OSTTRA concluded that Baton Systems was a very good fit for what we were looking to do,” says Steve French, Commercial Lead, FX and Securities at OSTTRA. “Baton Systems has a proven DLT PvP solution that we look forward to bringing to the wider market to address FX settlement risk concerns.”

The launch of the PvP service is one step in OSTTRA’s broader strategy to improve the post-trade market structure of over-the-counter markets. It follows on from a strong push by the Bank for International Settlements (BIS) for the FX Best settlement orchestration initiative service for FX settlement risk – commonly known as Herstatt risk – by building a robust PvP framework for FX transactions. BIS’s concerns revolve around the growing potential of settlement failures in the $2.1 trillion of daily deliverable FX turnover that sits outside existing PvP platforms.

Already processing more than 80 million trades a month, OSTTRA is well placed to offer on-demand PvP netting and settlement on a bilateral basis across its sizeable network. However, as part of its mission to optimise and de-risk the portfolios of its clients, particularly market-maker banks, investment managers and large corporates, OSTTRA intends to evolve the service to include settle-to-market (STM) functionality – where the variation margin transferred between counterparties is recorded as a legal settlement of a derivative contract – thereby significantly reducing derivative regulatory capital required under the standardised approach to counterparty credit risk (SA-CCR).

“The initial focus of the new settlement service is on the finality of PvP to reduce settlement risk in certain currencies that stand outside the established settlement networks, with CNH being the most obvious one,” says French. “But our greater mission is to reduce overall risk through compression and optimisation – in addition to improving settlement opportunities – to bring down exposures as much as possible.

“The Holy Grail really is to process STM along with PvP settlement – an approach that is much more efficient because it involves linking variation margin with settlement risk, for which there is a massive appetite in the FX industry.”

Steve French, OSTTRA

Broadening portfolio optimisation

Since its inception, OSTTRA’s focus has been to provide innovative solutions to ensure participants can optimise their portfolios in the prevailing regulatory framework, and interact with any new initiatives in the most efficient way. The introduction of uncleared margin rules in 2016, and SA-CCR most recently, has added a layer of complexity to market participants’ post-trade FX workflows since they are now compelled to closely monitor their exposure to each counterparty to minimise the amount of initial margin they are liable to post and the amount of regulatory capital they have to hold.

OSTTRA offers clients a multitude of options to help reduce the regulatory capital they need to hold and decrease the funding costs of their derivatives portfolios. The choice depends, to a large extent, on whether they want to minimise their cleared and non-cleared initial margin exposures, their leverage ratios, and risk-weighted assets under the internal models method and standardised approach, or gross notionals, among others. However, for most participants, it is highly relevant to consider all of these aspects at the same time to avoid negatively impacting one metric when optimising something else. Therefore, the key objective in OSTTRA’s optimisation solution is to consider all the relevant metrics concurrently, rather than taking a piecemeal approach.

“We recognised early on that focusing on one risk factor in isolation can negatively impact other key issues elsewhere and actually increase the cost of maintaining a portfolio,” says Mattias Palm, head of triReduce FX and commodities at OSTTRA. “Unlike other vendors, we are able to optimise simultaneously across multiple risk factors to ensure maximum efficiency while diminishing potential unwanted side effects.”

With links to clearing houses and efficient optimisation choices, OSTTRA’s clients can now minimise their risk exposures even further and more efficiently. Participants can optimise their bilateral and cleared exposures under SA-CCR, alongside their STM exposures. In a similar vein, OSTTRA collaborated with LCH’s ForexClear to develop a mechanism for clearing FX forwards without negatively impacting cleared initial margin.

Alongside the addition of PvP settlement to its optimisation options, OSTTRA has sought to extend the compression of trades in deliverable currencies not included in existing settlement services. The encouraging results achieved with compression of deliverable Russian rubles mean the same concept is now being applied to other non-Continuous Linked Settlement currencies, with particularly promising results to date with CNH. A key concept is that, during such a compression run, specifically targeted transactions are terminated to reduce settlement risk and gross notional at the same time.

“With all of these different tools at their disposal, it has become easier for our clients to optimise their portfolios because they can do more with less,” concludes Palm. “But the overall idea is that, for optimisation to be truly efficient and competitive, it needs to include all cleared and uncleared margining options, as well as capital and gross notional optimisation, compression, PvP settlement orchestration and STM – all of which should be available at the same time to ensure the most optimal results.”

Since the risk factors that are optimised during a weekly run depend on the needs of clients taking part at that time, OSTTRA is working to increase the scope of every run so that all market participants can optimise their portfolio most efficiently in the shortest timeframe possible.

Mattias Palm, OSTTRA

OSTTRA was named Best settlement orchestration initiative and Best compression/optimisation service for FX at the FX Markets e-FX Awards 2024.

This article was originally published by FX-Markets

Herstatt Risk is No Old Hat, Half a Century on from Herstatt Bank Collapse

The 27th of June 2024 marked 50 years since the collapse of German-based Herstatt Bank showed financial institutions the drastic consequences of unchecked settlement risk in foreign exchange markets. But half a century on, ‘Herstatt risk’ – otherwise known as FX settlement risk – appears to be rising for financial institutions.

Let’s briefly revisit what derailed Herstatt Bank all those years ago to grasp the threat to markets today. Essentially, the firm’s risky bets and mismanagement led to substantial losses forcing authorities to close the bank. The speculative US dollar transactions were taking place across different time zones, meaning that many of Herstatt’s counterparties paid in their side of the trade, but received nothing back from the German bank after the regulators shut the firm. Herstatt Bank’s inability to fulfil its payment obligations wreaked havoc across global financial markets, with counterparties out of pocket for the money they never received – a perfect encapsulation of FX settlement risk which coined the term ‘Herstatt risk’.

The crisis conveyed a clear lesson to markets: the longer one party must wait for the other to meet its obligations, the higher the risk of financial losses or disruptions – possibly with systemic ramifications. Thankfully, Herstatt bank had a small footprint at the time of its collapse. But the issue of FX settlement risk lingered unaddressed for decades until the establishment of widespread payment-versus-payment (PvP) mechanisms for exchanging currencies, a process which sees both sides of a trade simultaneously exchange the currency they owe.

PvP has drastically reduced the risk of settlement failure in global FX markets. These safeguards have largely proven effective in mitigating settlement risk in FX markets over recent years. It’s notable that during major market crises of the last 20 years, in particular the great financial crisis and the Covid-19 market disruption, markets have not witnessed a Herstattesque event.

Unlike with Herstatt bank, the current factors causing an elevated risk of settlement failure in currency markets are not risky bets and bank mismanagement. Instead, it is two powerful changes in market dynamics:

changes in regulations related to settlement timelines, i.e. T+1 settlement; and
an uptick in emerging market currency trading.

Settlement at risk
With US securities now trading on a T+1 settlement regime, asset managers, custodians and banks are grappling with the fallout in currencies. In the run-up to the go-live of T+1, much was made of the potential dangers of compressed settlement timeframes in currency markets. In the initial aftermath, we are yet to see the dangers born out in major incidents of FX settlement failure. However, the shortened cycle adds pressure on a system already at capacity.

T+1 arrived against an already deteriorating backdrop, with growing concern from the likes of the Bank for International Settlements that Herstatt risk is on the rise. It cites the growing share of trades that settle without PvP protection as one of the main factors behind the elevated risk of settlement failure, driven primarily by the increase in emerging market currency trading, typically not eligible for today’s PvP mechanisms.

In fact, at the end of 2022, financial institutions sent $2.2tn worth of currencies to counterparties every day without knowing for certain whether they’d get paid. This is according to BIS data which shows a concerning trend: in 2019, just $1.9tn of transactions settled without PvP protection, an amount that rose 15% in the following three years.

Avoiding another Herstatt
Whether for the inter-bank market, bank to client, or custodians supporting their asset manager clients, the two factors together increase the importance of new alternative PvP systems to add on to the current structures that facilitate safe settlement and netting in foreign exchange markets. This is especially true for the emerging market currency challenge.

Broadening the narrow spectrum of 18 currencies currently eligible for PvP settlement would be a good place to start in tackling rising FX settlement risk, helping to address the growth of emerging markets and the swell of volumes in these non-PvP-protected currencies. In particular for the Chinese Renminbi, which is climbing up the ranks of daily FX trading volumes.

Rapid advances in technology are also opening new ways for risk management across all stages of the trade lifecycle, and FX settlement should be no different. Peer-to-peer networks, distributed data applications and shared workflows make FX exposures fully traceable across entire networks, with atomic settlement providing the speed to conduct trades efficiently in times of market stress. Meanwhile, in normal market conditions, network services enable users to optimise liquidity management through the use of netting and payment orchestration, which in turn minimises funding requirements and costs, in addition to reducing settlement risk.

But as always, an industry-wide paradigm shift requires extensive collaboration among peers and competitors. This may seem a dubious prospect, but the alternative is to wait for an FX settlement failure to hit the headlines, hopefully in a less spectacular fashion than the Herstatt collapse of half a century ago. The latter must not be considered an option. After all, while history seldom repeats itself, it often rhymes.

To find out how OSTTRA can help mitigate bilateral FX settlement risk between participants, watch this brief explainer video or contact us using the form below.

Post-Trade Dictionary: Decode Industry Terms from A to Z with this Post-Trade Glossary

BidFX Connects to OSTTRA to Streamline OTC FX Client Clearing

LONDON, SINGAPORE 14th February 2022 – BidFX, the leading cloud-based provider of electronic foreign exchange trading solutions, is introducing support for FX clearing to investment managers via OSTTRA’s clearing connectivity service.

Integration with OSTTRA’s clearing connectivity solution provides Bid FX clients with the ability to submit trades directly to leading CCPs. Participants trading on BidFX can benefit from having their FX NDF trades submitted directly for clearing, at multiple CCPs, without the need to build out direct clearing connectivity. BidFX clients wishing to clear trades will immediately benefit from an established community of more than 30 executing bank clearing counterparties

With the implementation of phase six of the Uncleared Margin Rules (UMR) later this year (September), buy-side firms looking to optimise their balance sheets will currently be weighing up whether, or not, to clear more of their FX trades. As investment managers evaluate the costs and operational challenges of these margin requirements, the connectivity between BidFX and OSTTRA will benefit those who choose to clear more of their FX flow.

Alan Dweck, Chief Operating Officer at BidFX, added: “Buy-side firms trading large volumes of non-cleared FX OTC trades may face additional operational overheads due to UMR. Our initiative with OSTTRA provides these participants with a much-needed range of options for clearing and seamless trading ahead of UMR phase six.”

Patrick Philpott, FX Product Strategy, at OSTTRA, concluded: “Adding BidFX to the existing OSTTRA clearing community increases the options available to market participants wishing to benefit from the efficiencies of FX Clearing with central counterparties. The final phase of UMR reinforces the industry’s focus on initial margin and enhanced standards, and we look forward to working with BidFX and the wider market to ensure widespread access to clearing.”