Overview

CLS Group (for Continuous Linked Settlement), or simply CLS, is a specialized financial market infrastructure group whose main entity is the New York–based CLS Bank. It started operations in 2002 and operates a unique and global central multicurrency cash settlement system, known as the CLS System, which plays a critical role in the foreign exchange market (also known as forex or FX).

Although the forex market is decentralised and has no central exchange or clearing facility, firms that chose to use CLS to settle their FX transactions can mitigate the settlement risk associated with their trades. CLS achieves this thanks to a central net (bilateral and multilateral clearing) and gross payment versus payment settlement service directly connected to the real-time gross settlement systems of participating jurisdictions through accounts at each of their respective central banks.

CLS demonstrated its risk-mitigation value in the 2008 financial crisis, during which the forex market remained orderly even in times of severe systemic financial stress, and again during market turmoil associated with the COVID-19 pandemic in early 2020. The CLS System's sophisticated payment versus payment concept does not entirely eliminate forex settlement risk, but reduces it considerably among the currencies that it encompasses.

Background

The creation of CLS was a delayed collective response to the turmoil that followed the failure of Germany's Herstatt Bank on 26 June 1974, which highlighted the counterparty risk inherent in the system of multilateral net settlement through which forex transactions were executed at the time. Over the three days following Herstatt's demise, the amount of gross funds transferred by that system declined by about 60 percent.

The core challenge resulted from the practice of settling each leg of a forex transaction independently, and often at different times with a lag, in the country of issue of each currency. Banks often waited three days or more before they knew with certainty that they had received the currency they had bought in a given such transaction. The risk of paying out the currency sold but not receiving the currency bought became known as "Herstatt risk" as well as foreign exchange settlement risk, comprising aspects of both credit risk and liquidity risk.

Similar concerns emerged again following the collapse of Drexel Burnham Lambert in 1989, Bank of Credit and Commerce International in 1991, the 1991 Soviet coup d'état attempt, and the collapse of Barings Bank in 1995.

Creation

Such initiatives also initially included FXNet, which netted trades each day by counterparty pair; the Exchange Clearing HOuse Ltd (ECHO), a London-based multilateral netting system which started operations in August 1995; and Multinet International Bank, a New York State-chartered bank that similarly developed a multilateral forex netting clearing house. Such entities, however, had no direct access to central bank currency, and struggled to achieve critical mass.

Like FXNet, ECHO and Multinet, CLS was established as a private-sector project, even though the impetus came from the central banking community through the CPSS; the project turned out to be highly complex, nearly foundered on several occasions, and at such points required intervention by the BIS to survive. In October 1994, senior executives from large international banks formed the "group of 20" or G20 (not to be confused with the G20 group of jurisdictions, which was formed in 1999) as a common interest group.

Pressure from the central banks, including the publication of the Allsopp report in 1996, led the G20 to meet regularly and focus on a common solution to reduce foreign-exchange-related credit risk. In January 1996, it converged on the solution of a clearing bank operating a payment versus payment mechanism with continuous real-time linked processing and item-by-item settlement, thus the name CLS - meaning that the two legs of a foreign-exchange transaction are settled simultaneously.

By the spring of 1997, the G20 banks determined that the future system should rely on a central bank account and membership in the respective real-time gross settlement system in each jurisdiction (known in the payments jargon as a nostro relationship), but no physical presence other than in the United States, United Kingdom, and Japan in order to save costs. This required ad hoc legislation to be passed in participating countries, and also the extension of operating hours in Australia, Canada and Japan.

On 1 July 1997, the G20 banks jointly established CLS Services Ltd in the UK as the project's first dedicated legal entity; other banks were asked for USD 1 million each to join the project as shareholders, as the project building costs were rapidly increasing from an initial estimate of $40m at end-1995. In July 1998, the project had reached an ownership of 60 shareholders in 14 countries, with total commitments of $160m.

On 1 November 1999, CLS Bank International was established as a New York Edge Act financial institution after the Federal Reserve approved its application, which had been filed on 6 August 1999.

Later development

The original seven currencies were joined by the Danish krone, Norwegian krone, Singapore dollar and Swedish krona in September 2003; the Hong Kong dollar, South Korean won, New Zealand dollar and South African rand in December 2004; the Israeli shekel and Mexican peso in May 2008; and the Hungarian forint in November 2015.

Since it began operations in 2002, CLS has rapidly increased and by March 2017 was settling just over 50% of global FX transactions. As a result, the Financial Stability Oversight Council (FSOC) officially designated CLS a systemically important financial market utility in July 2012.

The single day record for value settled is US$15.4 trillion, set on 15 December 2021. The single day record for volume settled is 3.2 million trades, set on 5 July 2022.

Legal structure

Partly as a consequence of the need for consensus among participating central banks, the CLS Group structure involves entities in several countries. Since 2001, the group's parent company has been CLS Group Holdings AG in Lucerne, a Swiss private holding company. It owns 100 percent of CLS UK Intermediate Holdings Ltd in London (the original CLS company established in 1997 as CLS Services Ltd and renamed in 1999), which in turn owns two main subsidiaries: CLS Bank International, a U.S.

Edge Act corporation, and CLS Services Ltd, a British company that provides operational support to CLS Bank and associated institutions. The only other jurisdictions where CLS is established are Japan and Hong Kong.