Why Clearing is More Than a Settlement Process

Thanks to the efficiency of our global financial infrastructure, clearing services are these days viewed as a commodity business. In other words, all treasurers expect flawless settlement of high value, cross-border treasury and commercial payment instructions every time, by all their financial institutions.

Deep and continuing investment by the banking industry in SWIFT, the interbank messaging network, in the national high value clearing systems in the different countries, and in upcoming settlement mechanisms such as Continuous Linked Settlement (CLS), have ensured these necessary levels of timeliness and reliability. As a result, the focus of attention has lately moved away from the technical aspects of settlement to considerations of liquidity and operational risk management.

New Issues: Liquidity and Operational Risk Management

These two issues have assumed a growing importance as our businesses and economies become increasingly fast-moving and interdependent. The shocking events of 11 September 2001 grimly highlighted this interdependence - and also demonstrated the fundamental resilience of our infrastructure.

Clearing paradigms such as Continuous Linked Settlement (CLS), were built to eliminate inherent risk within the treasury settlement process, allowing for payment versus payment settlement of currency trades. In a catastrophic situation like 9/11, the CLS network would have supported the elimination of one way flow and reduced the liquidity issues of that day and several days thereafter.

In a trading environment, clients and their financial institutions go to great lengths to confirm the intent of the global counterparties in the trade to reduce the risk of non-payment. Unexpected operational issues can cause payments not to be made on time and on contract. The CLS network creates an environment where both halves of the exchange do not flow unless they both settle — eliminating the need to back value and deal with laborious compensation issues — and reducing the industry risk in payment settlements.

The capital size and liquidity position of the financial institutions who had limited interruption in service on 9/11 played a strong role in maintaining a freely moving payments market. Although significant liquidity was available in the market, there were significant numbers of one way trades, which created concentrations of liquidity difficult to manage against.

Following the 9/11 incident, we encourage our clients and vendors to re-assess their partner arrangements, and we recommend that treasurers take a close look at the liquidity and operational risk management procedures of any financial institution selected for clearing services. This means:

• Having a clear understanding of the institution's balance sheet: how long would the institution be able to sustain a situation where only some transactions were settling?
• Ensuring that clearing partners are scale players: what amounts is the institution investing in technology for payments and clearing? (As one example, artificial intelligence can be employed to intuitively correct transactions for automated processing. This is critical during a situation like 9/11.)
• Maintaining a credit relationship with clearing partners that ensures a preferred customer status, even if the payment business is not very large.
• Auditing a clearing partner's normal operational and contingency arrangements: as well as hot site and back up procedures, what telecommunications strategies are in place to ensure transactions can be re-routed if necessary? Are operations centralised or distributed?
• Review your own contingency arrangements. Plan and test alternative routes to your clearing partners.

User-driven Value

Along side this focus on liquidity and operational risk management, there is a definite trend in clearing services towards more user-driven interoperability between financial institutions and corporations. SWIFT offers SWIFT for Corporates by which corporates can communicate with their banking partners directly using the same message standards, software and network that the banks use to communicate with each other.

The use of the SWIFT for Corporates, across the banks and their clients, reduces implementation costs to establish and switch, and ensures improved processing through better Straight through Processing.

Another continuing trend is the imperative of timely information about transactions as well as the underlying settlement itself. We see an increasing volume of ad hoc inquiries for various types of data about transactions — this data can be invaluable to treasurers for error reduction, performance measurement and trendbased analysis. Clearly, there is an opportunity to provide information tools and informed data, enabling customers to search, aggregate and analyse the data that banks hold about their transactions.

Pinpointing the exact position during and anticipated at the end of day through improved information exchange, will support our clients working capital optimization programs. Also, it will ultimately reduce operating costs due to errors, which can now be correct same day.

These are some of the ways in which we believe financial institutions distinguish themselves from their competitors when it comes to delivering integrated clearing services across the liquidity, risk and information elements of the transaction. For all these reasons, we still believe that the clearing business is more than just the settlement process.