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BCBS and CPSS to Issue Guidance on FX Settlement Risk

The Basel Committee on Banking Supervision (BCBS) and the Committee on Payment and Settlement Systems (CPSS) are establishing a joint working group to revise the BCBS’s Supervisory guidance for managing settlement risk in foreign exchange transactions, which was published in 2000.

The group, chaired by Jeanmarie Davis, senior vice president at the Federal Reserve Bank of New York, plans to issue revised guidance by the end of this year for public comment.

Foreign exchange settlement risk was identified as a significant risk to market participants in a 1996 CPSS report entitled Settlement risk in foreign exchange transactions. An update to that report, entitled Progress in reducing foreign exchange settlement risk, published in May 2008, found that, through mechanisms such as CLS Bank, the financial services industry has made substantial progress in reducing FX settlement risk.

The report noted, however, that part of the market still settles in a manner that does not mitigate FX settlement risk and that some bilateral settlement exposures are large in relation to capital. The 2008 report recommended further action by individual institutions, industry groups and central banks.

The setting up of a joint working group signifies the re-launch of the planned work between central banks and supervisors, which had been postponed with the onset of the financial crisis. This is an important step to ensure that market participants focus on FX settlement and that their exposures are properly controlled, the committees say.

The guidance issued by the BCBS in 2000 was before CLS Bank and other payment versus payment (PVP) settlement systems were operational and does not fully reflect advances in the market and key differences between trades that settle through sound PVP arrangements and those that settle bilaterally through correspondent banking relationships.

The revised guidance will address these and other developments with respect to FX settlement risk management, the committees say.

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