Dealing with capacity constraints

In the past few weeks, higher volatility in currency markets have no doubt tested trade processing capacity at a number of major dealers. The problem is very real and is only going to grow, with the expected rise in ticket volumes coming in smaller notional sizes from an anticipated rise in retail flows, in addition to algo flows.

So far, two post trade technology vendors have been vocal about their plans to introduce a solution to resolve back office capacity constraints: Traiana and DealHub. They include netting interbank trade pre-settlement to relieve some of the strain.

This poses significant problems for the existing settlement structure of the industry, chiefly for settlement system CLS. The system, hitting its five-year anniversary this September, currently requires banks to settle trades on a gross basis. The reasoning is for the greater good, with reduction in charges per ticket linked to volume increases. CLS said that in consultation with every prime broker in the industry, the decision was made that for the time being, they do not believe netting is going to solve the problem, nor will it save them money to move to accepting netted input.

If netted trades are not going to be accepted for settlement by CLS, then banks will have to settle trades among themselves. This naturally presents an opportunity to vendors out there to come up with an alternative solution to CLS. Alternative – not rival – because CLS has a significant role in reducing settlement and credit risk, as seen in the CPSS report in July. Indeed, FX prime brokers have been able to grow as a result of the reduced cost of credit benefits brought on by CLS.

But the survey also found that some institutions have indicated a growing interest in the use of bilateral netting, a group that continues to grow not least because of the growth of algorithmic trading. The dynamics of the market are changing, and if they are, incumbent systems will have to reflect this. If not, there's a very real opening for vendors to seize the opportunity to develop a system that accurately reflects the evolving needs of banks.