Currency Program Briefing Book 2

Transcription

1 Currency Program Briefing Book 2

2 Front cover clock: Cosmo Clock, Yokohama, Japan, 1989 Part clock, part giant ferris wheel. The world s largest clock. Introduction CLS Group (CLS) operates the world s largest system for mitigating settlement risk in foreign exchange (FX) transactions. CLS mission is to enhance financial stability by providing risk mitigation services to the global FX market. In support of its mission, CLS has created this Briefing Book to present the benefits of joining CLS multicurrency settlement service. Contents Executive summary... 1 The CLS System... 4 Central Banks for CLS Eligible Currencies... 4 How CLS Works... 5 CLS Operational Timeline... 6 The CLS Community... 8 Benefits of Joining CLS... 9 Eligibility Requirements to Add a Currency The Settlement Membership Process Central Bank Commitments Settlement Member Commitments Contact Information at CLS Appendix 1: Description of Legal Requirements for Currency Eligibility... 16

3 Executive Summary The FX market, Settlement Risk and CLS The FX market is the world s largest financial market by value and is integral to global commerce. The most common transactions spot, swaps and forwards require the exchange of principal in two currencies. As a result, each party to these transactions is exposed to settlement or principal risk the risk that one party delivers the currency it sold but does not receive the currency it bought from its counterparty. The CLS System CLS is supported by a robust and resilient infrastructure within a comprehensive and well-established legal framework. CLS holds an account at each of the central banks of the 17 currencies it settles. Settlement across the books of CLS and funding in each of the 17 currencies is final and irrevocable. CLS funding obligations (Pay-ins), are multilaterally netted to significantly reduce the value of required Pay-ins. CLS is distinguishable from clearing houses that function as central counterparties (CCPs) because it does not become party to any underlying trades, assume counterparty risk or guarantee the settlement of transactions. CLS settles payment instructions relating to a variety of FX transactions: FX spot, FX forwards, FX option exercises, and FX swaps. 1 Due to the potential for loss of the full value of a transaction, settlement risk is widely considered the most significant risk for FX market participants. Furthermore, failed settlements can have systemic impacts. CLS fulfills a fundamental role in the FX market by providing stability through risk mitigation, particularly during periods of crisis. CLS provides FX settlement risk mitigation through its unique payment versus payment (PvP) service, which links to the real time gross settlement (RTGS) systems of each currency CLS settles. In February 2013 the Basel Committee on Banking Supervision published, Supervisory guidance for managing risks associated with the settlement of foreign exchange transactions. This paper highlighted the crucial nature of banks and their supervisors continuing efforts to reduce or manage risks associated with the settlement of FX transactions; for example, by increasing the number of currencies, the scope of products and the types of counterparties that are eligible for settlement through PvP arrangements. 1 CLS also handles payment instructions that relate to options and credit derivatives, but these are not covered in this Briefing Book. 1

4 Involved Parties The CLS community includes the central banks of each participating currency (including five from the euro zone), Settlement Members (direct participants in CLS) and their third party customers (indirect participants in CLS), nostro agents and Liquidity Providers (banks that commit to providing liquidity to CLS in a CLS Eligible Currency in certain circumstances). CLS has over 60 Settlement Members from 24 jurisdictions, which in turn have customers in over 80 jurisdictions. Value Proposition CLS offers unique benefits to its community. For central banks these benefits include: Support for enhanced financial stability Improved visibility of the onshore and offshore FX market from CLS reports, including data relating to currencies settled within the CLS System Support for improved risk management practices Coordinated crisis management processes CLS value proposition to Settlement Members (including Central Bank Settlement Members) provides: Risk Mitigation and Management CLS settlement service mitigates settlement risk, and offers pre-settlement credit risk and operational risk benefits. Capital and Liquidity Efficiencies CLS multilateral netting provides significant liquidity benefits, reducing funding requirements. Operational and IT Efficiencies CLS straight through processing has assisted Settlement Members by supporting enhanced pre- and post-settlement operations and architecture. Business Growth Opportunities Settlement Members can increase credit efficiency, expand the range of counterparties and trading opportunities in new currencies. In addition non-central bank Settlement Members can offer CLS third party services to their customers. Financial Market Infrastructure at the Center of the FX Market CLS robust legal framework and regulatory expertise allow it to be a convening authority that can provide FX market solutions and provide centralized crisis and failure management for the FX market. Risk mitigation and management Capital and liquidity efficiencies Operational and IT efficiencies Business growth opportunities The benefits created by CLS being a financial market infrastructure at the center of the FX market 2 Currency Program Briefing Book

5 Eligibility Currency Eligibility CLS eligibility criteria are designed to ensure that a prospective currency meets the standards shared by the existing CLS Eligible Currencies with respect to: Participant Eligibility The eligibility criteria for Settlement Members and Liquidity Providers include standards related to financial and operational capabilities and liquidity sufficiency, to ensure that commitments to CLS will be met. Central bank support Sovereign credit rating Finality of settlement, finality of funding, enforceability of netting and unity of account, including during a Settlement Member bankruptcy Anti-money laundering Currency convertibility and exchange controls Local banking system stability Sufficient pool of Liquidity Providers for most investment grade currencies RTGS system messaging and timed payments CLS account at the central bank Member Value Proposition Risk Mitigation & Management» Settlement Risk» Pre-Settlement Credit Risk» Operational Risk Risk Mitigation Capital & Liquidity Efficiencies» Multilateral Netting» Liquidity Management Challenges Capital & Liquidity Efficiencies A Financial Market Infrastructure at the Center of the FX Market» Regulatory Expertise and Interface» Common Legal Framework» Centralized Crisis and Failure Management» Convening Authority Infrastructure at the Center of the FX Market A Financial Market Operational & IT Efficiencies Operational & IT Efficiencies» Pre-Settlement» Post-Settlement» CLS Architecture Business Growth Business Growth» Third-Party Provider» Expanded Range of Counterparties» Additional Trading Opportunities from new CLS Currencies 3

6 The CLS System Background CLS was established in 2002 as a private sector initiative to mitigate FX settlement risk. It has grown to include settlement of payment instructions in 17 currencies: Australian dollar, Canadian dollar, Danish krone, euro, Hong Kong dollar, Israeli shekel, Japanese yen, Korean won, Mexican peso, New Zealand dollar, Norwegian krone, Singapore dollar, South African rand, Swedish krona, Swiss franc, British pound sterling and United States dollar. Central Banks for CLS Eligible Currencies Reserve Bank of Australia Bank of Canada Danmarks Nationalbank European Central Bank Hong Kong Monetary Authority Bank of Israel Bank of Japan Bank of Korea Banco de Mexico Reserve Bank of New Zealand Norges Bank Monetary Authority of Singapore South African Reserve Bank Sveriges Riksbank Swiss National Bank Bank of England US Federal Reserve 4 Currency Program Briefing Book

7 How CLS Works Settlement Cycle Settlement Members submit payment instructions relating to their own FX transactions, or they may submit payment instructions on behalf of third parties. Once received, payment instructions are authenticated and matched by CLS and stored until the settlement date. Although Settlement Members can submit instructions at any time prior to the settlement date, Settlement Members generally submit payment instructions to CLS within 30 minutes of execution of the underlying FX transaction. On the settlement date, the settlement of payment instructions in CLS occurs during a two-hour window. Funding, which is a separate but closely related process from settlement, occurs during a five-hour window. 2 Settlement takes place across the books of CLS. Each Settlement Member holds a single multi-currency account with CLS, and at the start and end of a normal day each account has a zero balance. After verifying that the 2 For Asia Pacific currencies, the funding window is three hours (7:00 CET 10:00 CET as detailed in the chart on page 6) settlement of matched payment instructions satisfies several risk management tests, CLS simultaneously settles those instructions on a gross basis by making the corresponding debit and credit entries across the relevant Settlement Members accounts. The diagram on the next page illustrates the CLS operational timeline (without adjustments for daylight savings). CLS operates 24 hours a day, 5.5 days per week, closing on Friday evening and re-opening on Sunday evening, CET. Key operational processes include: 00:00 CET: Initial schedule of timed payments (Pay-Ins) sent to Settlement Members 00:00 CET: CLS calculates and identifies potential intra-day swap transactions between participating Settlement Members, which reduce funding requirements by approximately 76% 06:00 07:00 CET: Handshake is received from each RTGS system 06:30 CET: Revised Pay-in schedule sent to Settlement Members 07:00 CET: Pay-ins commence. CLS simultaneously settles each pair of matched payment instructions by making the corresponding debit and credit entries across Settlement Members accounts at CLS. Multilateral netting results in an average net funding requirement of approximately 4%. CLS makes outgoing payments of long balances to Settlement Members. 5

8 CLS Operational Timeline 24 x 5.5 CET 20:00 22:00 00:00 02:00 04:00 06:00 08:00 20:00 20:45 Credit derivatives (DTCC) cash flows submission window for next settlement day 00:00 Unilateral rescind deadline 00:00 Initial pay-in schedule issueed (triggers I/O swap process) 06:30 Bilateral rescind deadline 06:30 Revised pay-in schedule issued. Central bank pay-in report issued 07:00 Start of settlement Settle Normal processing settlement Instruction input and matching 01:15 I/O swap details available to Members 06:00 07:00 RTGS system handshakes 20:00 CET 22:00 00:00 02:00 04:00 06:00 08:00 Daily funding requirements are determined on a multilateral netted basis resulting in an average net funding requirement of approximately 4%. For every USD 1 trillion of value settled, Settlement Members are required to fund less than the equivalent of USD 40 billion in cash. 3 Robust and Resilient Infrastructure In April 2012, the Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization of Securities Commissions (IOSCO) published the Principles for financial market infrastructures (PFMI), setting out more demanding international standards for payment, clearing and settlement systems. The new standards are designed to ensure that the infrastructure supporting global financial markets is robust and able to withstand financial shocks. They apply to all systemically important financial market infrastructures and replace the 2001 Core Principles for Systemically Important Payment Systems. To facilitate implementation and promote ongoing observance of the PFMI, CPSS-IOSCO also issued the PFMI: disclosure framework and assessment methodology. In line with their recommendation, CLS has published a PFMI Disclosure Framework 4. The framework describes our approach to observing applicable principles during daily operations as a payments system in alignment with the expectations and requirements of our regulators. Legal Framework The CLS system is supported by a comprehensive and well-established legal framework consisting of contractual provisions, statutes and regulations. The contractual provisions in the CLS Rules, Member Handbook and Settlement Member Agreements define the rights and obligations of each Settlement Member and CLS. Also, statutes and regulations in each jurisdiction in which CLS settles a currency or a Settlement Member s head or home office is located provide CLS and its Settlement Members with a high degree of legal assurance with respect to finality of settlement and funding, and for unity of account (including the enforceability of netting). This is true even in the case of a Settlement Member subsequently becoming subject to insolvency proceedings. The CLS legal framework and, specifically, the legal requirements for currency eligibility, are described in greater detail in Appendix 1 Description of Legal Requirements for Currency Eligibility. 3 After aggregate effects of In/Out Swaps discussed below, netting efficiencies inside CLS increase up to 99%. 4 These can be found at: 6 Currency Program Briefing Book

9 10:00 12:00 14:00 16:00 18:00 20:00 09:00 Settlement completion target time 10:00 Asia Pacific funding completion target time (pay-in) 12:00 European / North American funding completion target time (pay-in) Pay-ins / pay-outs Completion of pay-in / pay-out process 10:25 Currency close Asia Pacific 13:00 Currency close European / North America 10:00 12:00 14:00 16:00 18:00 20:00 Comprehensive Regulatory Framework As an Edge Act corporation, CLS is regulated and supervised by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York (together, the Federal Reserve). CLS is also subject to the oversight of the Board of Governors of the Federal Reserve System, having been designated a systemically important financial market utility under Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act by the Financial Stability Oversight Council. Furthermore, the central banks whose 17 currencies are settled within the CLS system have established a cooperative oversight arrangement for the CLS system (CLS Oversight Committee) pursuant to the CLS Oversight Protocol. 5 The Federal Reserve accepts primary responsibility for, and organizes and administers, the oversight and supervision of CLS under this cooperative oversight framework and is the Chair of the CLS Oversight Committee. Achievements Proven Infrastructure for the FX Market During the second quarter of 2013, CLS received on average a daily volume of close to 1,356,000 payment instructions, including those from its aggregation service, with an average daily value of USD 5.15 trillion. At the height of the 2008 financial crisis, during the week commencing September 15, 2008, CLS settled an exceptionally high value of transactions at the time, a USD equivalent of 26.5 trillion. In November 2009, the Foreign Exchange Committee, an industry working group sponsored by the Federal Reserve Bank of New York, observed that CLS served its stated function of reducing systemic risk and ensuring that despite the large notional size of FX transactions around the world, financial institutions had the confidence to make payments into the system because they were protected against the loss of principal. 6 5 A copy of the CLS Oversight Protocol is available at 6 Overview of the OTC Foreign Exchange Market, Foreign Exchange Committee Paper November 2009 (US): 7

10 The CLS Community The CLS community is comprised of central banks, Settlement Members, their third party customers, Nostros and Liquidity Providers. CLS regularly engages market participants on topics related to settlement risk mitigation. Central Banks CLS links directly to the RTGS systems of the participating central banks. CLS holds an account at each of these central banks, through which payments are sent and received. Settlement Members (Direct Participants) Settlement Members are direct participants in the CLS system 7 and are required to be shareholders in CLS Group Holdings AG, the ultimate parent company of CLS. Third Parties (Indirect Participants) Third parties are customers of Settlement Members that wish to settle their FX transactions through CLS, but have no direct access to, or relationship with CLS. Third parties include banks, non-bank financial institutions, multinational corporations and funds. Settlement Members handle all payment instructions and funding on behalf of their third party customers. Settlement Members are responsible as principal, and not as agent or trustee, for processing and all funding obligations arising from payment instructions that are submitted by them to CLS and settled through their accounts with CLS. Nostros A Settlement Member may use a Nostro Agent to send and receive payments on its behalf to CLS in specific currencies. A Settlement Member s relationships with its Nostros are independent from its relationship with CLS. Liquidity Providers Liquidity Providers are banks that commit to providing liquidity to CLS in a currency in certain circumstances (they are often, but are not required to be, Settlement Members). Liquidity Providers may be called upon by CLS if a Settlement Member fails to meet its Pay-in requirements in a particular currency and after other failure management tools have been applied. CLS will call upon a Liquidity Provider to enter into a today/ tomorrow swap or an outright purchase and/or sale of currency. These transactions allow CLS to raise liquidity in the currency it needs to pay out to the counterparties of the delayed or failing Settlement Member(s), in exchange for currency in which it has balances on in its central bank accounts. For an initial assessment of the Liquidity Provider role please request CLS Liquidity Provider Evaluation Guide from your CLS contact or [email protected] 7 In addition to commercial banks, central banks can become Settlement Members, subject to different requirements. 8 Currency Program Briefing Book

11 Benefits of Joining CLS There are unique benefits for central banks and Settlement Members in jurisdictions that add their currency to CLS. Central Banks Enhanced Financial Stability in the Local Market The financial stability of a domestic market is enhanced when its FX market mitigates settlement risk. A robust and resilient settlement system helps mitigate the effects of either external or internal shocks to the market. Settlement Risk Mitigation Through the use of the CLS system, institutions may address regulatory guidance, including the management of their exposure to settlement risk in the FX markets. Insight into the FX Market Central banks whose currencies are settled in CLS receive daily settlement reports and detailed weekly reports on the gross and net values settled in their currencies. This offers unique consolidated insight into the flows of the FX market and its impact on local currency liquidity. Adoption of Best Practices and Standards The adoption of best practices, business continuity processes and resiliency promotes higher standards and better risk management for domestic banks to better compete in the global marketplace. CLS Oversight Committee The central banks of the currencies settled in CLS have established a cooperative oversight arrangement to monitor and oversee the service. The CLS Oversight Committee, chaired by the Federal Reserve, ensures that all participating jurisdictions have a mechanism for mutual assistance in carrying out their individual responsibilities vis-à-vis CLS. The CLS Oversight Committee meets regularly and reviews the strategic direction of CLS in the context of the global FX industry. Settlement Members Liquidity Efficiencies Each day prior to settlement, CLS calculates the funding required of each Settlement Member on a multilateral netted basis, after taking into consideration all payment instructions that are due to settle that day. Multilateral netting results in the total gross settlement value reducing by an average of 96%. Based on CLS analysis of its data, multilateral netting offers nearly double the liquidity efficiencies of bilateral netting. Settlement Members can also elect to participate in a liquidity management tool, the In/Out Swap service, to further reduce payment obligations to CLS and mitigate their liquidity pressures. An In/Out Swap consists of two equal and opposite FX same-day transactions. One is settled inside CLS in order to reduce each Settlement Member s net position in the two relevant currencies. The other is settled outside CLS. The combined effect of these two transactions is a reduction in the funding requirements of the two Settlement Members in CLS, while leaving the institutions overall FX positions unchanged. On average, In/Out Swaps further reduce the multilaterally netted payment obligations in CLS to a funding requirement in CLS of less than 1% of the gross settlement value. Through risk forums and bilateral meetings, CLS has an ongoing dialogue with its Settlement Members on liquidity risk management, and provides detailed information to facilitate the monitoring of each participating bank s liquidity needs and exposure. Operational Efficiencies The CLS service and daily settlement cycle provide a structured environment to maximize the benefits of straight through processing and to minimize operational errors and their associated costs. Real-time information on the status of each payment instruction is provided to Settlement Members. CLS is a catalyst for back-office efficiencies: unmatched payment instructions can be followed up promptly and corrections made as necessary before settlement. The adherence to the CLS operating standards allows for automated matching and settlement of CLS eligible payment instructions, which requires less Settlement Member internal resources than non-eligible payment instructions. In addition, participation in CLS leads to further technology efficiencies. Current Settlement Members recognize a network effect of leveraging CLS architecture and application for standardized payment and accounting procedures for both CLS and non-cls currencies. 9

12 The cash funding required of Settlement Members to complete the daily settlement cycle is substantially less than otherwise would be required to settle all the payments each day. Moreover, the total number of payments required is reduced to an average of 15 per day per Settlement Member, irrespective of the number of transactions and currencies settled. This reduces both a Settlement Member s costs and associated Nostro Account charges and reconciliations. New Revenue Opportunities for Settlement Members Settlement Members are afforded new revenue opportunities through increased trading capacity, and the provision of third party and Nostro services. Increased Trading Capacity The risk mitigation provided by CLS allows Settlement Members to treat CLS settled transactions differently than non-cls settled transactions. Without CLS, the full value of a trade counts against the pre-settlement credit risk limit assigned to a given counterparty. When the limit is reached, trading with the counterparty ceases for the day. CLS settled transactions are treated differently by Settlement Members: some do not attribute their CLS settled transactions against their pre-settlement credit risk limit at all, while others attribute only a percentage of the value of the CLS settled transaction against these limits. This provides Settlement Members with the ability to increase trading while remaining within the same established risk appetite. Third Party Service Provider Currently, 26 Settlement Members provide their third party customers with access to CLS. These third party services are typically an extension of services already offered by these Settlement Members to their clients. By providing the multicurrency settlement service to customers, Settlement Members may generate fee revenues and further strengthen their customer relationships. While banks account for the majority of transactions settled in CLS, third parties include funds, large corporations with active treasuries and other non-bank financial institutions, such as brokers that have significant FX business. 10 Currency Program Briefing Book

13 Eligibility Requirements to Add a Currency The criteria for a currency to become CLS eligible is set forth in the CLS Rules 8 and Member Handbook. In order to meet these requirements, which are described below, the strong endorsement, support and participation of the jurisdiction s central bank and other relevant government agencies is necessary. Written approval from the Federal Reserve is also required. The key currency eligibility criteria are summarized as follows: Requirement Description Sovereign Credit Rating Sovereign long-term credit rating (minimum of BB-/Ba3) Legal Legal framework (finality of settlements and payments, net funding and unity of account) Rule of law Anti-Money Laundering (AML) regime Currency Currency convertibility and exchange controls Domestic Support Commitment from central bank and other authorities Liquidity Providers (minimum of three are required for currencies in most investment grade jurisdictions) Operational Standards RTGS system capacity to make timed Pay-ins RTGS system operating hours in line with CLS cycle RTGS system connection through SWIFT Network CLS account at the central bank For a detailed description of the processes by which a currency is included in the CLS system please request Explanation of phases for on-boarding a prospective currency from your CLS contact or [email protected]. The legal requirements for currency eligibility contained in the CLS Rules are also described in greater detail in Appendix 1 Description of Legal Requirements for Currency Eligibility, Section ii. 8 The addition of a new currency eligible for settlement in the CLS System requires the fulfillment of specified eligibility criteria contained in Rule 3. A copy of the CLS Bank Rules is available at:

14 Sovereign Credit Rating To ensure the resilience of the CLS system, the CLS Rules and Member Handbook require that a jurisdiction s long-term sovereign credit rating must be, at minimum, a Standard and Poor s or Fitch s BB- or a Moody s Ba3. CLS is currently redefining some of the terms of its credit risk policy to ensure broad and safe access to its settlement system. Legal Matters and Anti-Money Laundering (AML) Requirements Legal Matters The addition of a new settlement currency in the CLS system also requires the fulfillment of specified legal eligibility criteria, including requirements that: (i) CLS Bank has determined that there is legislation or regulation (or equivalent) in the jurisdiction of the currency that provides for the finality of (i) the settlement of payment instructions across the books of CLS Bank International and (ii) Pay-ins and other settlement-related payments received by CLS through the relevant payment system for such currency; and (ii) CLS has received a legal opinion that is in form and substance satisfactory to CLS addressing finality of settlements and of payments made to and from CLS Bank s account with the relevant central bank and such other legal considerations as CLS may require. Moreover, Principle 1 of the PFMI requires a financial market infrastructure to have a well-founded, clear, transparent, and enforceable legal basis for each material aspect of its business. (See Sections ii and iii of Appendix 1). AML Considerations CLS is required to comply with the Bank Secrecy Act and the USA Patriot Act, including a customer identification program. CLS is also subject to the regulations of the Office of Foreign Assets Control (OFAC). To comply with these requirements, CLS implements AML and OFAC related compliance programs. These programs require completion of specific due diligence requirements and ongoing monitoring of the activity processed within CLS. Prior to permitting a currency to become CLS eligible, CLS undertakes a due diligence review of the AML/Terrorist Financing Regime (AML/CTF Framework) in place in the relevant jurisdiction to assess whether key requirements of the Financial Action Task Force s recommendations have been implemented. The review also establishes whether any significant gaps exist or special measures have been imposed on the jurisdiction that could create risks to CLS. The review includes onsite visits with the central bank and government agencies, such as the Finance Intelligence Unit. For any prospective Settlement Member to participate in CLS, a due diligence review of the AML/CTF Framework in place within the prospective Settlement Member is undertaken. The due diligence review includes onsite visits with the prospective Settlement Member. Acceptable Currency Restrictions A currency is not required to be fully convertible to be CLS eligible, and CLS currently supports currencies that are not fully convertible. However, in jurisdictions where FX exchange controls exist, it must be clear to CLS as a matter of law and/ or regulation that fundamental processes relating to CLS payments are possible without unduly burdening CLS with reporting requirements and without subjecting CLS to potential legal liability. CLS does not require or seek to encourage further internationalization of a currency as a prerequisite of currency eligibility beyond that which is desired by the local authorities. CLS recognizes there may be restrictions on the payments involving the local currency, whether or not local institutions are involved, as well as on payments involving local institutions but not involving the local currency. Accepting that these restrictions may be in place, it is important that a common understanding is reached between CLS and the central bank regarding what underlying transactions involving its currency or local institutions would be eligible for CLS settlement. Additionally, Settlement Members must take responsibility for their underlying transactions complying with local law and regulation. CLS does not accept any responsibility or civil or criminal liability for any non-compliance by a Settlement Member or its third party customers and CLS will not undertake any monitoring obligations with respect to compliance with those laws and regulations. (See Section iv of Appendix 1). 12 Currency Program Briefing Book

15 Domestic Support The process of on-boarding a currency to CLS requires commitment and support from the relevant central bank. In addition, the central bank s support of banks within its jurisdiction performing the roles of Settlement Members, Liquidity Providers and Nostro Agents is fundamental. It is expected, though not required, that commercial banks with their head or home office in each new jurisdiction with an Eligible Currency will join CLS as Settlement Members. In addition to becoming a Settlement Member, the roles of Liquidity Provider and Nostro Agent are also important to achieve the full benefits of CLS risk mitigation. There is no requirement for Liquidity Providers or Nostro Agents to be Settlement Members, though often a Settlement Member will have multiple roles within the CLS community. There is, however, a requirement that each currency have at least three Liquidity Providers in most investment grade jurisdictions. Core Hours of Operation CLS operates a daily cycle during a five-hour window when the Eligible Currency RTGS systems are open and able to send and receive payments. On each settlement day, the RTGS system is expected to open between and CET and notify CLS of its readiness to commence settlement. The RTGS system should be ready to send and receive payments by 07:00 CET and, under normal circumstances, remain open until at least 10:30 CET for early closing currencies in Asia Pacific and 12:00 CET for the late closing currencies in Europe and North America. Resilience Since failure to make payments in one currency will affect payments and settlement in other currencies, CLS suggests all components of the architecture of an RTGS system be duplicated across separate sites, thus avoiding exposure to single component failures. Operational Requirements The CLS service is delivered using highly secure, resilient and available network connections and strong encryption. The following summary provides the key technical requirements needed for central banks to participate in CLS.»Architecture» CLS requires an RTGS system that can make timely transfers of central bank funds to and from CLS account at the central bank. CLS asks all new jurisdictions to have their RTGS systems connect to CLS through the SWIFT Network using FIN messages. If an RTGS system uses FIN messages over the SWIFT network for their domestic transfers, CLS can connect in the same way as a domestic commercial bank. Other RTGS systems use a proprietary (non-swift FIN based) message protocol. In this case, the central bank will be asked to acquire an application for converting to SWIFT FIN messages. Some central banks require commercial banks to have a local terminal connected to the RTGS system. CLS does not expect to run local terminals in order to access RTGS systems in new jurisdictions. Each RTGS system is expected to send SWIFT FIN messages for each movement in CLS account in real-time. The RTGS system is also expected to send account statements to CLS on demand (for intraday reconciliation) and at the end of the RTGS system business day. 13

16 The Settlement Membership Process For a detailed review of the Settlement Membership process please request CLS Membership Evaluation Guide from your CLS contact or [email protected]. Central Bank Commitments Legislative Changes To address the legal requirements of finality and netting necessary for a currency to be CLS eligible, legislative or regulatory changes are usually required. CLS and its local counsel will work closely with the central bank and other regulators, as appropriate, to determine what changes in law and regulation are required to ensure that CLS requirements are met in this regard so CLS is satisfied as to its obligations with respect to the PFMI. RTGS System During the process for inclusion of a currency in CLS, the central bank and CLS will conduct a thorough analysis of the Operational and IT requirements involved, and what changes and potential developments will need to take place. Once these are completed, rigorous testing and trialling of payments through the RTGS system is performed. Domestic Support Central banks are expected to encourage qualified banks in their markets to play a role as Settlement Members, Liquidity Providers and/or Nostros. While CLS will engage directly with the local banking community, the support of the central bank is integral to the success of this effort. 14 Currency Program Briefing Book

17 Settlement Member Commitments Joining CLS as a Settlement Member The process for joining CLS as a Settlement Member is not required to be simultaneous with the on-boarding of the currency. There have been cases of a Settlement Member from a particular jurisdiction joining CLS before its currency is designated CLS eligible, and of a jurisdiction whose currency is designated eligible even in the absence of a Settlement Member from that jurisdiction. Shareholder and Settlement Membership The prospective Settlement Member, or one of its affiliates, is required to become a shareholder of CLS Group Holdings AG. In addition, the Settlement Member is responsible for an initial account opening fee of GBP150,000 and annual account maintenance fees of GBP120,000 (or GBP80,000 for a central bank. IT Commitments CLS requires Settlement Members to submit payment instructions via SWIFT. SWIFTNet FIN charges for messaging are invoiced directly by SWIFT. These costs should be calculated based on the expected volume of messages to be sent and received and the Settlement Member s SWIFT messaging tier. Price Per Transaction The current CLS pricing policy is based on a tariff with two components; settlement values and volume of payment instructions submitted to CLS. Approximately 70% of the transaction fees are based on settlement values and 30% are based on volumes. The tariff table applies to all Settlement Members and is structured to provide a sliding scale of prices that take into consideration the individual Settlement Member s usage (for volume pricing) and the overall total usage by all Settlement Members for that month (for value pricing). With other factors in the pricing policy remaining constant, the greater the individual Settlement Member s usage and the greater the overall usage, the lower the unit price will be. The unit prices are calculated monthly; accordingly, the unit prices vary monthly. Contact Information at CLS Please send inquiries to [email protected] For additional information on CLS Bank, refer to

18 Appendix 1: Description of Legal Requirements for Currency Eligibility i. Introduction to Legal Framework for the CLS System The legal foundation for the CLS System is governed by the CLS Bank International Rules (the Rules ), the CLS Bank International Member Handbook (the Member Handbook ), and the form of Member Agreements (each, a Member Agreement, and together with the Rules and Member Handbook, the CLS Documents ). The Member Agreement, an identical version of which is signed by all Members, is governed by New York law and creates a legally binding relationship among CLS Bank, CLS Services Ltd. (a CLS Bank affiliate), and the Member-signatory. Most importantly, it binds all parties to the Rules and Member Handbook, which establish the framework and guidelines that govern and set parameters for the delivery of the CLS settlement service. The Rules and Member Handbook are governed by English law. Additionally, CLS Bank complies with the Committee on Payment and Settlement Systems ( CPSS ) and the Technical Committee of the International Organization of Securities Commissions ( IOSCO ) Core Principles for Systemically Important Payment Systems (January 2001) (the Core Principles ). Principle 1 of the PFMI requires a financial market infrastructure, including CLS Bank, to have a wellfounded, clear, transparent, and enforceable legal basis for the material aspects of its business. (Please see Appendix A for the text of Principle 1). CLS Bank will only add a new currency to the CLS System if it is satisfied that it will be able to fulfill its obligations under the PFMI. CLS Bank has Members with head or home offices in 24 jurisdictions (the CLS Jurisdictions ). 9 Each of the CLS Jurisdictions has a well-founded, clear, transparent, and enforceable legal basis legal basis supporting the CLS System, confirmed by CLS Bank on an annual basis through legal opinions satisfactory to CLS Bank. Copies of the opinions are accessible by Members through a secure website and also are provided to the central banks that participate in the CLS Oversight Committee. ii. Overview of Currency Eligibility Requirements The addition of a new settlement currency in the CLS System requires the fulfillment of specified eligibility criteria contained in Rule 3 and the strong endorsement and participation of the local central bank and the relevant government agencies. Pursuant to Rule 3, the CLS Bank Board of Directors, in its sole discretion, may designate a currency as an Eligible Currency only if such currency satisfies each of the following criteria: (a) CLS Bank has received a written request by two or more of the shareholders of its parent company to designate such currency as an Eligible Currency. (b) CLS Bank has received indications from at least three institutions (or such fewer number as the CLS Bank Board of Directors shall expressly approve) of willingness to act as liquidity providers for such currency on commercially acceptable terms, as determined by CLS Bank. (c) CLS Bank has determined to its satisfaction that the currency s relevant payment system(s) would meet CLS Bank s payment system requirements, including opening hours that sufficiently overlap with the CLS System. (d) CLS Bank has deemed reasonable the cost of inclusion of such currency. (e) CLS Bank has determined that adequate risk reduction would result from the inclusion of such currency to justify the investments necessary to include it. (f) CLS Bank has determined that any exchange restrictions or similar conditions on the transferability of such currency are acceptable to CLS Bank. (Please see Section IV below for greater detail.) (g) CLS Bank has determined that the convertibility, liquidity and historical volatility of such currency, the stability of the banking system and rule of law applicable in the jurisdiction of such currency, and other mitigating issues are acceptable to CLS Bank. (h) The relevant central bank has agreed to (i) allow CLS Bank to establish a special account with such central bank solely for the purpose of facilitating transfer of an Eligible Currency from and to Settlement Members, (ii) permit a means of operational access to the account acceptable to CLS Bank, and (iii) contractual arrangements that are satisfactory to CLS Bank. (i) CLS Bank has received a legal opinion in form and substance satisfactory to CLS Bank addressing finality of payments made to and from CLS Bank s account with the relevant central bank and such other legal considerations as CLS Bank may require. (Please see Section III below for greater detail.) (j) CLS Bank has determined that there is legislation or regulation (or equivalent) in the jurisdiction of the currency that provides for the finality of (i) the settlement of payment instructions in the CLS System and (ii) pay-ins and other settlement-related payments received by CLS Bank through the relevant payment system for such currency. 9 Those jurisdictions are Australia, Belgium, Canada, Denmark, England, France, Germany, Hong Kong, Israel, Italy, Japan, Luxembourg, Mexico, New Zealand, Netherlands, Norway, Scotland, Singapore, South Africa, South Korea, Spain, Sweden, Switzerland, and the United States. 16 Currency Program Briefing Book

19 iii. Key Legal Requirements for CLS Jurisdictions In order to ensure compliance with Principle 1 of the PFMI, CLS Bank must receive satisfactory legal opinions regarding, among other things, the enforceability of finality of funding and settlement, unity of account/netting, and default arrangements in the CLS Jurisdictions. In the majority of those jurisdictions, the opinions are based upon specific finality and netting legislation that only applies to systems designated in that jurisdiction pursuant to the legislation. A. Finality of Settlement and Funding Settlement of payment instructions occurs on a gross basis between Settlement Members, while funding between CLS Bank and its Settlement Members accounts in the CLS System occurs on a net basis. Although funding and settlement are legally separate processes, the two processes are linked and run in parallel operationally. 1. Settlement. Settlement occurs when CLS Bank simultaneously debits and credits the accounts of two Settlement Members, respectively, in accordance with eligible payment instructions that were submitted by the Settlement Members. The obligations of the two Settlement Members through whose accounts such payment instructions have been settled are discharged upon the debiting or crediting of their respective accounts to the full extent permitted by applicable law. 2. Funding. Funding is the process by which a Settlement Member transfers currencies into CLS Bank s central bank accounts through the payment systems approved by CLS Bank for effecting those transfers. As part of the funding process, CLS Bank will credit a Settlement Member s account when it is notified of payments received in its central bank accounts. CLS Bank will disburse funds from its central bank account to a Settlement Member through an approved payment system and debit the Settlement Member s account accordingly. 3. Finality of Settlement and Funding. The concept of finality of settlement and funding may be expressed, in general terms, as protection from insolvency and other laws that might otherwise permit a post-settlement reversal of payment instructions or a post-settlement clawback of settled amounts through the CLS System. CLS Bank obtains a legal opinion from its counsel in each CLS Jurisdiction providing assurance that under applicable law, settlement and funding are final across the books of CLS Bank, even after the commencement of an insolvency. 4. Finality Legislation. In the majority of CLS Jurisdictions, settlement and funding may only be final and irrevocable, and the unity of multicurrency accounts respected, if a payment system has been granted special statutory protections by the relevant governmental or regulatory authority (typically the central bank). For example, in the European Union member states, CLS Bank is a designated system under the EC Settlement Finality Directive Directive 98/26/EC of the European Parliament and of the Council of May 19, 1998 on settlement finality in payment and securities settlement systems, and the Financial Markets and Insolvency (Settlement Finality) Regulations 1999 that implement the Settlement Finality Directive in the United Kingdom (each as amended). CLS is also designated in Singapore, Hong Kong, Canada, Australia, and South Africa, among others. B. Unity of Account/Netting CLS Bank maintains a single multicurrency account for each Settlement Member on its books and records. Each Settlement Member account with CLS Bank is considered a single account, even though it may hold multiple currencies. Accordingly, if CLS Bank terminated a Settlement Member and closed-out such Settlement Member s account, CLS Bank would have a claim or an obligation to receive or pay only the net balance. CLS Bank obtains a legal opinion from its counsel in each CLS Jurisdiction providing assurance that under applicable law, unity of account would be respected. C. Default Arrangements In the context of a designated system (such as CLS Bank), default arrangements are the arrangements put in place by the designated system to limit systemic and other types of risks that arise in the event of a participant appearing to be unable, or likely to become unable, to meet its obligations in respect of the designated system. Some examples of CLS Bank s default arrangements are set forth below. 1. Ability to Access Liquidity Facilities. A Settlement Member s failure to timely satisfy a funding obligation may result in insufficient funds in a particular currency. Under CLS Bank s liquidity facilities, each liquidity provider agrees to enter into either foreign exchange swap or outright foreign exchange transactions at market rates upon short notice from CLS Bank. CLS Bank will use funds in its central bank accounts to execute foreign exchange transactions with a liquidity provider to exchange a CLS Bank long currency position (i.e., the currency in which the defaulting Settlement Member has a long balance) with the currency that CLS Bank needs in order to make any required payments to other Settlement Members in the short currency (i.e., the currency the Settlement Members were expecting to receive with respect to settled payment instructions in the currency in which the defaulting Settlement Member has a short position). Liquidity providers have priority for repayment of any obligations owed to them by CLS Bank over amounts due to Settlement Members with respect to settled payment instructions. In addition, the costs associated with CLS Bank s draw on a liquidity facility will be charged to the Settlement Member whose failure to timely satisfy a funding obligation prompted the draw. 2. Combined Loss Allocation. CLS Bank will allocate certain losses to Settlement Members, including a mark-to-market loss originating from a Settlement Member s failure to cover a short position in its account coupled with a significant market move in excess of the haircuts applied to each currency balance in the Settlement Member s account. Any combined loss allocation is mandatory and is assessed on those Settlement Members with settled payment instructions with the failing Settlement Member on the failure date. The assessment cannot exceed a Settlement Member s bilateral net receives with the failing Settlement Member on the failure date. 3. General Loss Allocation. CLS Bank will also, in certain circumstances, assess a general loss allocation on all Members (at a capped amount for each Member) to cover any mark-to-market loss not fully recovered from Settlement Members through combined loss allocation or may result from certain operating losses, liabilities related to central bank and approved payment systems, or certain governmental actions. 17

20 iv. Exchange Control Regimes and Prospective CLS Currencies One of the criteria for a currency s designation as an Eligible Currency is that any exchange restrictions or similar conditions on the transferability of the currency are acceptable to CLS Bank. In addition, CLS Bank requires that the legal opinion for the related jurisdiction must confirm that CLS Bank and its legal framework are not contrary to the exchange controls in that jurisdiction. CLS Bank notes that Article VIII, Section 2(b), of the Articles of Agreement of the International Monetary Fund provides in relevant part that [e]xchange contracts which involve the currency of any member and which are contrary to the exchange control regulations of that member maintained or imposed consistently with [the Articles of] Agreement shall be unenforceable in the territories of any member (emphasis added). 10 Thus, it is critically important that any potentially applicable exchange controls must be analyzed and addressed prior to the admission of a new currency in the CLS System. A prospective currency, however, is not required to be fully convertible to be CLS-eligible. Among the seventeen currencies designated as Eligible Currencies are the South Korean won, the South African rand, and the Singapore dollar, all of which are subject to exchange controls. In jurisdictions where exchange controls exist, CLS Bank seeks to reach a common understanding with the relevant central bank as to the scope of underlying transactions for which payment instructions may be submitted to CLS Bank for settlement and the impact, if any, that the exchange controls would have on related payments, in each case with respect to CLS Bank, its affiliates, its Settlement Members, 11 its liquidity providers, nostro agents, and third party customers 12 of Settlement Members. In addition, CLS Bank seeks to understand and confirm that existing exchange controls will not have an adverse effect on fundamental CLS Bank processes (including finality of settlement and funding, unity of account, and netting arrangements discussed above). A. Permitted Foreign Exchange Transactions An initial topic for discussion between CLS Bank and the central bank of a prospective currency is which CLS Bank-eligible underlying transactions will be eligible for settlement in CLS Bank (commonly referred to as permitted transactions ). Important factors in this discussion are the applicable exchange controls and policy objectives that the central bank has set for its currency. While within the central bank s discretion, the following factors are frequently taken into account by a central bank in determining permitted transactions: Type of underlying transaction 13 Objective or purpose of the underlying transaction Parties to the underlying transaction 14 Residency of the parties to the underlying transaction (resident or non-resident party) Currencies involved (prospective currency and foreign currencies). CLS Bank seeks to understand whether payment instructions relating to all of the underlying transactions permitted under the CLS Bank Documents are permitted under and satisfy applicable exchange controls or, alternatively, whether payment instructions relating to only a subset of those underlying transactions would be eligible for settlement in CLS Bank. For example, prior to designating the South Korean won an Eligible Currency, CLS Bank worked with the Bank of Korea and the South Korean Ministry of Strategy and Finance to clarify which CLS Bank-eligible underlying transactions were permissible under South Korean exchange control laws and would be eligible for settlement in CLS Bank. Ultimately, permitted transactions were distinguished on the basis of type, objective or purpose, parties, residency of the parties, and currencies involved, and the South Korean exchange control regulations were amended accordingly. As a result of those amendments, payment instructions relating to a subset of CLS Bank-eligible underlying transactions are eligible for settlement in CLS in South Korea. B. Related Payments Another topic for discussion between CLS Bank and the central bank of a prospective currency is whether any related exchange controls or central bank policy objectives would impede funding under the CLS Bank Documents. In certain jurisdictions, there may be restrictions on payments involving the prospective currency. Accepting that these restrictions may be in place, CLS Bank seeks to understand whether any exchange control issues arise in the context of the flow of funds that are necessary for CLS Bank to perform in accordance with the CLS Bank Documents and its obligations thereunder. Where a central bank has concerns that the funding required under the CLS Bank Documents would give rise to exchange control issues, CLS Bank undertakes a thorough review with the central bank of each aspect of the CLS settlement service within the exchange control framework. Additionally, CLS Bank s Settlement Members must take responsibility that they comply, and their underlying transactions and related payments comply, with the jurisdiction s law and regulations in all respects. CLS Bank does not accept any responsibility or civil or criminal liability for any non-compliance by a Settlement Member or its customers and will not undertake any monitoring obligations with respect to compliance with those laws and regulations. 10 International Monetary Fund members include CLS Jurisdictions. 11 Settlement Members may be resident financial institutions or non-resident financial institutions using the nostro services of affiliated or unaffiliated resident institutions. 12 Third party customers of a Settlement Member may be resident or non-resident banks, non-bank financial institutions, corporations, or funds. 13 The CLS Bank Documents permit Members to submit payment instructions relating to foreign exchange transactions and over-the counter credit derivative transactions for settlement by CLS Bank. 14 Parties to the underlying transaction may be Members or their third party customers. 18 Currency Program Briefing Book

21 C. Restrictions or Requirements Affecting CLS Bank, Settlement Members, Liquidity Providers, or Nostro Agents or Third Party Customers of Settlement Members Set forth below are key considerations for CLS Bank when exchange restrictions or similar conditions exist in a jurisdiction (i) whose currency is being considered for eligibility in the CLS settlement service or (ii) with resident institutions being considered for direct participation in the CLS settlement service as Settlement Members. As a financial market infrastructure, CLS Bank examines these considerations in detail with the relevant regulatory authorities and its local counsel prior to on-boarding a prospective currency or prospective resident Settlement Member to ensure that the legal basis for fundamental CLS processes, including applicable exchange restrictions or similar conditions, provide a high degree of certainty for the CLS settlement service in the relevant jurisdiction. CLS Bank welcomes the opportunity to discuss with the relevant central bank how these considerations would be treated under existing exchange controls. In that regard, CLS actively engages with relevant central banks to assess each issue with the purpose of identifying and achieving any necessary resolutions based on the relevant facts and circumstances. CLS Bank and its Liquidity Providers Neither CLS Bank nor any of its affiliates may be exposed to any aiding and abetting type liability in connection with settlement in CLS Bank of any underlying transaction that may be in violation of applicable exchange restrictions or similar conditions. CLS Bank may not be required to obtain a license in order to conduct the activities required to provide the CLS settlement service. CLS Bank must be able to establish a deposit account with the central bank and use such account for all purposes related to the CLS settlement service. 15 CLS Bank must be able to (i) receive payments to CLS Bank s central bank account ( pay-ins ) of each Eligible Currency, including the prospective currency, from each Settlement Member and (ii) make payments of each Eligible Currency, including the prospective currency, from CLS Bank s central bank account ( pay-outs ) to each Settlement Member. CLS Bank must be able to maintain a multicurrency account on its books which includes each Eligible Currency, including the prospective currency, for each Settlement Member. CLS Bank must be able to extend short positions on its books in each Eligible Currency, including the prospective currency, for each Settlement Member. CLS Bank and its liquidity providers (which may or may not be Settlement Members) must be able to enter into a foreign exchange liquidity agreement and transactions contemplated thereunder involving each Eligible Currency, including the prospective currency. CLS Bank must be able to make alternative pay-outs in each Eligible Currency, including the prospective currency, to any Settlement Member. CLS Bank must be able to receive payments in each Eligible Currency, including the prospective currency, from any Settlement Member in response to a loss allocation assessed by CLS Bank. Settlement Members and their Nostro Agents and Third Party Customers Settlement Members must be able to submit payment instructions involving any Eligible Currency, including the prospective currency, for settlement in CLS as long as the underlying transactions and related payments comply with applicable exchange restrictions or similar conditions. Settlement Members must be able to offer CLS settlement services to their third party customers and submit payment instructions involving any Eligible Currency, including the prospective currency, on behalf of their third party customers for settlement in CLS Bank so long as the underlying transactions and related payments comply with applicable exchange restrictions or similar conditions. 16 Each Settlement Member must be able to maintain an account in the prospective currency or establish a nostro account with a resident institution (each a local account ), and make and receive pay-ins and pay-outs of the prospective currency from and to this account with CLS Bank s central bank account. Each Settlement Member must be able to receive alternative pay-outs in any Eligible Currency, including the prospective currency, from CLS Bank. Each Settlement Member must be able to make payments in any Eligible Currency, including the prospective currency, to CLS Bank in connection with a loss allocation. Each Settlement Member must be able to participate in In/Out swap transactions involving any Eligible Currency, including the prospective currency. In addition, CLS Services Ltd., an affiliate of CLS Bank, must be able to provide calculation services in support of the In/Out swap program. Each Settlement Member must be able to convert funds in the prospective currency that have been deposited in its local account (i.e., exchange its prospective currency funds into a foreign currency with a resident institution) and remit such converted amounts overseas. 15 For each eligible currency, CLS Bank connects directly to the central bank s real-time gross settlement system and CLS Bank holds an account with each applicable central bank, through which funds are received and paid. 16 The arrangements between Members and their third party customers are private bilateral arrangements that do not directly involve CLS Bank. However, these arrangements likely require payments between the Member and its third party customers arising from underlying transactions that the Member submits to CLS Bank for settlement on behalf of the third party customer, and must generally be unrestricted in the same or similar manner as described above for CLS Bank and its Members. 19

22 Under the CLS Bank Documents, Members may submit payment instructions relating to underlying transactions entered into by parties that may or may not be the Member s third party customers (which may involve the prospective currency). For example, a Member s customer may be acting as an intermediary between the Member and the intermediary s own customer that is the counterparty to the transaction. CLS Bank seeks to understand what these parties standing would be under applicable exchange restrictions or similar conditions. Please send all inquiries to [email protected]. For additional information on CLS Bank and the CLS settlement service, please refer to Appendix A Principle 1 of the PFMI 17 Principle 1: Legal basis An FMI should have a well-founded, clear, transparent, and enforceable legal basis for each material aspect of its activities in all relevant jurisdictions. Key considerations: 1. The legal basis should provide a high degree of certainty for each material aspect of an FMI s activities in all relevant jurisdictions. 2. An FMI should have rules, procedures, and contracts that are clear, understandable, and consistent with relevant laws and regulations. 3. An FMI should be able to articulate the legal basis for its activities to relevant authorities, participants, and, where relevant, participants customers, in a clear and understandable way. 4. An FMI should have rules, procedures, and contracts that are enforceable in all relevant jurisdictions. There should be a high degree of certainty that actions taken by the FMI under such rules and procedures will not be voided, reversed, or subject to stays. 5. An FMI conducting business in multiple jurisdictions should identify and mitigate the risks arising from any potential conflict of laws across jurisdictions. 17 For a full version of the PFMI, including the explanatory notes for Principle 1, see 20 Currency Program Briefing Book

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24 Please send enquiries to US Financial Square 32 Old Slip, 23rd Floor New York NY US tel: fax: UK Exchange Tower One Harbour Exchange Square London E14 9GE United Kingdom tel: +44 (0) fax: +44 (0) Japan Mitsui ni-goukan, Nihonbashi Muromachi Chuo-ku Tokyo Japan tel: +81 (0) fax: +81 (0) Hong Kong 40/F, Suite 4001 One Exchange Square 8 Connaught Road, Central Hong Kong PRC tel: fax: CLS and the CLS Logo are registered trademarks of CLS UK Intermediate Holdings Ltd 2013 CLS UK Intermediate Holdings Ltd.