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The story
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
In reaction to these events and following discussion among the G10 central banks, the Bank for International Settlements (BIS) formed successive committees to address the international settlement risk problem, namely the Group of Experts on Payment Systems and the Committee on Interbank Netting Schemes of the Central Banks of the G10 Countries, which in 1990 were replaced by the Committee on Payment and Settlement Systems (CPSS). A series of reports by these groups paved the way towards the creation of CLS, each named after the official who chaired the committee that prepared it:
the "Angell Report" on Netting Schemes (1989), named after US Federal Reserve policymaker Wayne Angell, described the various kinds of internationally related financial netting arrangements;
the "Lamfalussy Report" of the Committee on Interbank Netting Schemes (1990), named after BIS policymaker Alexandre Lamfalussy (and not to be confused with the separate Lamfalussy Report of 2001 which initiated the Lamfalussy process in the European Union), identified minimum standards for the design and operation of cross-border and multi-currency netting schemes, as well as core principles for co-operative central bank oversight of netting system that were to shape the oversight concept for CLS;
the "Noël Report" of the CPSS on Central Bank Payment and Settlement Services with Respect to Cross-Border and Multi-Currency Transactions (1993), named after Bank of Canada policymaker Timothy Noël, analyzed the advantages and disadvantages of different central bank services related to payment and settlement systems, without however recommending a single preferred service option;
the "Allsopp Report" of the CPSS on Settlement Risk in Foreign Exchange Transactions (1996), named after for Bank of England policymaker Christopher Allsopp, extensively described the past episodes, such as the Herstatt failure, and called on the private sector to find practical solutions to remedy the identified risks, and thus represented "a wake-up call for the [banking] industry" that set the basis for subsequent initiatives including CLS.
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.
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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.
In 1996 and 1997, various forms of cooperation were considered between the G20's CLS project and the competing initiatives of FXNet, ECHO and Multinet, eventually resulting in the latter initiatives' full acquisition by CLS Services in December 1997. ECHO's service was discontinued in April 1999, and Multinet was dissolved in May 2000. In April 1998, IBM was selected to develop the CLS technical infrastructure. CLS Bank started operating on 9 September 2002, settling the Australian dollar, Canadian dollar, euro, Japanese Yen, Swiss franc, Pound sterling, and US dollar.
Lawrence M. Sweet, an official at the Federal Reserve Bank of New York seconded at the BIS from 1994, was instrumental in the elaboration of the CLS concept as secretary, then chair of the CPSS Steering Group on Foreign Exchange Settlement Risk. He also chaired the CLS Oversight Committee from its formation in 2009 until June 2018.
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.
The CLS membership and shareholder base has grown accordingly, from 39 members at inception in 2002 to 79 shareholders including 66 settlement members and 24,000+ third-party clients as of September 2017.
From Wikipedia’s article on CLS Group, shared under CC BY-SA 4.0.4