FX is a $15 trillion market that is living dangerously – more than half the trillions changing hands every day is exposed to settlement risk. 

This is not a new or unexpected problem. FX settlement risk is sometimes known as “Herstatt risk” after the obscure German bank that failed to keep its end of the bargain for a number of Deutsche Mark / USD trades in 1974, nearly half a century ago.

To mitigate Herstatt risk, central banks threw their weight behind the concept of continuous linked settlement, and this would lead — eventually — to the creation of CLS, which opened its doors in 2002. 

CLS neutralizes FX settlement risk through a payment versus payment (PvP) mechanism that ensures the simultaneous transfer of value between the parties. But it only does so for certain currencies, and only for trades where each counterparty is a CLS member. 

Ironically, CLS would not have directly prevented the Herstatt debacle because this privately-owned bank from Cologne was far too small to have ever been a CLS member and would have had to channel CLS eligible settlements through an intermediary bank. So even though CLS eliminates risk between the direct members, due to the limitations on membership eligibility, it cannot “de-risk” the entire FX settlement chain.