Foreign exchange risk may have just gone down. With the launch of its Domestic Settlement Service, or DSS, Citi is aiming to eliminate much of the risk in interbank foreign exchange trades.
Designed for central banks in the world's developing economies, DSS reduces settlement risk by simultaneously settling both sides of FX transaction, according to Puneet Singhvi, head of correspondent banking products with New York-based Citi ($1.8 trillion in assets). One party can default before the funds are settled, leaving the other exposed to significant loss, he adds.
"There are two legs to an FX transaction -- one party pays its part of the transaction, and the other must pay its part," Singhvi says. "But sometimes there's the risk that the other party won't pay in time. The timing issue creates FX settlement risk."
Many developing countries don't have the payments infrastructure to support a simultaneous settlement process, he continues. The DSS service, which Citi is offering to central banks as a white-label service, is Web-based, however. Subscribing banks interface with the back-end engine, which receives and calculates the trades in real time, via a portal.
DSS matches both sides of each transaction that enter the portal and nets them to generate a single transaction amount, Singhvi says, stressing that the system supports same-day settlement. "We pull in funds and pay out funds," he comments. "We do the final settlement."
A Positive Impact
Axel Pierron, an SVP with Celent (Boston), believes the service will create a positive ripple effect in the FX market, resulting in increased global volume. "The implementation of Citi Domestic Settlement Service will certainly impact positively the development of the inter-bank FX market in developing countries," he predicts.
"The reduction of settlement risk will have two major impacts on the market," Pierron says. "First, since settlement risks are reduced, market participants will be able to increase their transaction volume without worrying about an increase of the settlement risk. Second, smaller institutions in developing countries will have easier access to the FX market since counterparties will be less worried to trade with them."
Camara de Compensacion de Divisas de Colombia, Colombia's Clearing House, has been using the service since November. Ninety percent of its FX trading occurs via DSS. according to Citi.
Singhvi says the bank is in talks with other central banks in developing markets. "Many banks have been thinking about doing this, but they just couldn't find the right solution," he asserts. "They are looking for someone to provide it to them. FX settlement and risk is a sensitive area, and a robust solution is needed."
And the need for a global solution will only increase as global trade volume grows, Singhvi adds, noting that as volume grows, so too does the risk. "As economies and currencies liberalize and open up, there will be fewer restrictions on how to trade FX. So the timing is just right for us," he says.
"FX has really become a commoditized instrument," relates Celent's Pierron. "Therefore, technology plays a great role in accelerating the growth of transaction volume by pushing forward an industrialized approach and by lowering transaction cost and risk. In developing countries, there is a current need for solutions that can increase the efficiency of FX markets. With Citi's track record in this field, it is not surprising to see that some centralbanks are choosing a partnership approach with Citi to improve their market infrastructure."