Jimmy Ho and Sammie Chan discuss Metrobank’s adoption of PvP settlement and how it reflects a broader trend in the Philippine banking industry.
Global Foreign Exchange Committee (GFXC) recently published a revision of the FX Global Code (the Code), reaffirming its position on best practices in the global FX market. Among other updates, the Code places greater emphasis on the use of payment-versus-payment (PvP) settlement mechanisms where available, and provides more detailed guidance on the management of settlement risk where PvP settlement is not used.
These updates are timely because since the early 2000s, FX volumes have continued to increase globally, with the Bank for International Settlements (BIS) reporting average daily trading volumes of USD 6.6 trillion in 2019. In particular, the rate of growth in emerging markets FX trading has been steeper than in G10 currencies, rising from 19% to almost 25% of global turnover since 2016. FX trading in the Philippines grew 46% between 2013 and 2019 compared to the overall Asia Pacific region, which grew 23% over the same period.
The Philippines has been a vocal supporter of the Code, and the country’s central bank, Bangko Sentral Ng Pilipinas (BSP), issued a Statement of Commitment to the Code in December 2020. There has been significant uptake in the banking industry as well with 13 commercial banks having signed Statements of Commitment to the Code since 2019, including the Metropolitan Bank and Trust Company (Metrobank), one of the largest banks in the Philippines.
Metrobank success story
Against this backdrop of increasing FX activity and a global shift towards best practices across the FX market, Metrobank identified increasing settlement risk in their G10 currency trading. It proactively sought to mitigate this risk by adopting CLS’s global payment-versus-payment (PvP) FX settlement system – CLSSettlement – through settlement member bank UBS.
CLS is a financial market infrastructure and plays a critical role in maintaining the stability of the FX market and the wider financial industry. It is subject to the Principles for Financial Market Infrastructures (PFMI) published by the Committee on Payments and Market Infrastructures (CPMI) and the Technical Committee of the International Organization of Securities Commissions (IOSCO).
CLSSettlement settles FX transactions for 18 currencies including USD, EUR, JPY, SGD and HKD. The PvP process mitigates the risk of loss of principal resulting from a counterparty failing to meet its obligations by ensuring that the final transfer in one currency occurs if and only if the final transfer in the other currency also occurs.
Metrobank started settling their eligible FX trades in CLSSettlement in February 2020, as the first Covid-19 infections were being reported outside mainland China. The initial impact of the Covid-19 pandemic put unprecedented pressure on the global economy, and multiple nationwide lockdowns affected investor sentiment. Global financial markets moved sharply in both directions, widening credit spreads and diminishing liquidity around the world.
This created heightened volatility in the FX market, and CLS processed 3.1 million instructions and settled a record USD 13.4 trillion of payment instructions on 18 March 2020. Like many of its peers during this time of market volatility, Metrobank would have struggled to process such high trading volumes from an operational and funding perspective had it not settled its eligible FX trades in CLSSettlement.
Metrobank’s participation in CLSSettlement also enabled the bank to effectively implement straight-through processing for eligible FX transactions while mitigating settlement risk. The bank is now able to automate 80 percent of its processes through a significant reduction in the overall volume of payment messages and resources needed to manually process them.
Adopting global best practices
The CPMI issued a report in 2020 recommending the use of PvP arrangements, where practicable, to reduce settlement risk when settling FX transactions. By using CLS’s PvP settlement service through committed providers like UBS, Metrobank is able to reduce its settlement risk as much as possible.
It remains critical that all market participants strive to adopt global best practices that mitigate risks and establish stronger controls as well as improve operational efficiencies. Industry initiatives such as the introduction of the Code have motivated many FX market participants, including those in Asia, to adopt a best practice approach to settlement and post-trade processing.
Not only does the Code advocate best practices in FX operations and drive greater transparency, but Principle 50 specifically states that market participants should measure and monitor their settlement risk and seek to mitigate it wherever possible.
With 13 banks recently signing a Statement of Commitment to the Code, the Philippines shows a promising trend towards improved operational efficiency and risk mitigation in the industry.
Metrobank’s adoption of CLSSettlement further progresses this goal.