Progress in reducing foreign exchange settlement risk

May 2008

In 1996 the G10 central banks endorsed a strategy to reduce the systemic risk arising from the settlement of foreign exchange trades. The strategy was motivated by the finding that banks' foreign exchange settlement exposures to their counterparties were in many cases extremely large relative to their capital, lasted overnight or longer and were poorly understood and controlled. This report analyses the progress that has been made over the past ten years and concludes that the central bank strategy has achieved significant success, evidenced most visibly by the establishment and growth of CLS Bank, which currently settles on average more than $3 trillion each day in FX-related payment obligations. However, at the same time, a notable share of FX transactions is settled in ways that still generate significant potential risk across the global financial system and so further action is needed. This report therefore recommends specific actions by individual institutions, industry groups and central banks to reduce and control remaining large and long-lasting exposures and to guard against a risk of reversing the important progress already made.

This report was first issued as a consultative document in July 2007. The CPSS is grateful to those who sent comments during the consultation period.

The report has been prepared for the Committee on Payment and Settlement Systems by its Sub-Group on Foreign Exchange Settlement Risk. The CPSS is very grateful to the members of the sub-group and its chairman, Lawrence M Sweet, for their excellent work in preparing this report.