By Anoushka Rayner, Head of Growth, Commodities, Paxos
A staggering $2.2 trillion of daily currency turnover is subject to settlement risk, with the percentage of non-CLS currency trading skyrocketing, according to a Bank of International Settlements (BIS) paper last month. But as governments and central banks consider “sharpening regulatory incentives” to encourage take-up of safer FX settlement offering greater protection in the form of payment versus payment (PvP), has anyone stopped to think about settlement across commodities?
After all, a lot of an investment banks FX and commodities post-trade operations are managed across the same desks. Therefore, when trying to solve the frankly huge settlement risk gap in FX, it only makes logical sense to address longstanding settlement inefficiencies across commodities at the same time. Particularly when one considers the added layer of complexity when it comes to commodities settlement.
Sure, in FX there are clearly issues to iron out due to not having protection through PvP across certain currencies. Although at least in FX all the activity is carried out through corresponding banking networks. In commodities on the other hand, half the settlement goes through the corresponding running banking networks, while the other half goes through a sperate clearing network. This leaves the industry two separate systems to settle precious metals and cash – neither of which can currently connect with each other. As a case in point, it is all well and good a J.P. Morgan and HSBC making the settlement of gold more efficient, but unless all their clients are also centralising their cash dollars through them, then the goal of PvP simultaneous settlement through a single network is simply a pipe dream.
However, it is not just about PvP. Much more also needs to be done to protect overpayments from going out of the door in the commodities market. There are still far too many firms overpaying due to human errors for instance. Then there is the thorny issue of trying to nett down of positions. Due to the higher interest rate environment, there is a genuine need to make funding much more efficient by laying multilateral payment netting on top. This would mean that firms not only reduce their risk through simultaneous settlement, but become much more efficient by only having to make one payment movement.
Ultimately, if the industry is looking at ways to reduce counterparty settlement risk, manage time zone challenges and settle with confidence in FX, then surely commodities has to run in parallel. As central banks continue to assess operational barriers to the use credit facilities by new PvP providers in FX following the BIS findings last month, attentions must also turn towards addressing longstanding settlement risk in commodities. According to the LBMA, in excess of 90% of all precious metals traded on the interbank/wholesale/OTC market clear over unallocated Loco London accounts. With this in mind, from a risk perspective, it’s imperative that new thinking is adopted to account for unallocated precious metals volumes where safe settlement is currently not a reality.
