Digital FX settlement volume tipped to rise tenfold

An under-the-radar effort to digitise the settlement of fiat currencies may be about to attract some real volume.

Nex Group and Baton Systems have built a real-time settlement system for foreign exchange trades, using distributed ledger technology (DLT) to cut the traditional two-day post-trade cycle down to as little as three minutes.

Since it was rolled out last year, daily volumes on the platform have climbed to over $10 billion. Arjun Jayaram, CEO and founder of Baton, predicts that figure will increase tenfold by the end of 2019 as more currencies are added to the service.

“We are testing volumes five or six times of what is currently processed,” he says. “We expect to end the year with 10 times that volume as other currencies come on.”

Jayaram is looking for “that volume to explode and at year end to be about $100 billion of asset value”.

The settlement service, which is available on Nex’s Infinity platform, uses DLT to replicate the network of correspondent accounts that banks use to make and receive international payments. Baton’s software connects these accounts to a shared ledger where trades can be agreed and settled in real time. Nex handles trade matching and confirmation, and settlement finality is protected using the same legal constructs found in correspondent banking.   

The platform currently uses DLT to settle nine major currencies: euro, sterling, yen, Mexican peso and the Australian, Hong Kong, New Zealand, Singapore and US dollars. The Canadian dollar, Swiss franc and Chinese yuan are among those next in line.

By reducing FX settlement times to a matter of minutes, banks can take much of the cash that is currently set aside to guarantee future payments and put it to other uses. That could generate significant capital and liquidity savings for banks. A large global bank with multiple legal entities is already using the service and a number of other banks are testing it.

Baton’s system could be a pragmatic alternative to the issuance of fully fledged central bank digital currencies (CBDCs), which remain a largely theoretical concept.   

Central banks in Canada, Europe, Hong Kong, Japan and Singapore have been working with DLT firm R3 since 2015 to create digital representations of their currencies.

But last month, Agustín Carstens, general manager at the Bank for International Settlements (BIS), poured cold water on the idea, which he said could undermine financial stability and have “huge operational consequences” for central banks.

Meanwhile, blockchain firm Clearmatics is developing a so-called utility settlement coin (USC) for G10 currencies, which would be backed by central bank deposits.

IBM has a similar project, but Stanley Yong, global lead for CBDC solutions, says the tech giant is steering clear of G10 currencies. “In terms of wholesale bank payments we are not working with any G10 currency right now, because they tend to be a bit more cautious,” he says.

Nex is involved in both the USC and IBM projects. Andres Choussy, head of trade and portfolio management at Nex Optimisation, says those efforts have been stymied by local rules and regulations that have made it difficult to create a global standard for CBDCs. “There are many different rule-making changes that would be required in each jurisdiction, so it is a slow process,” he says.

Choussy hopes the CBDC projects will eventually succeed. Until then, settlement cycles will span multiple days due to time-zone differences and the operating hours of central bank payment systems. Nex’s system circumvents this problem by allowing commercial banks to deal with other directly. “Leveraging commercial bank infrastructure instead allows us to do near-real-time settlement almost on a 24/7 basis,” he says.

Jayaram says CBDC projects are several years away from implementation because central banks must first agree on a common set of bankruptcy definitions and operating rules. So Baton has focused on working with commercial banks rather than central banks. “We move real assets in real bank accounts, using DLT to make clearing and settlement faster.”

Nex is also working with another blockchain company, Axoni, to develop a DLT-based settlement system for equity swaps, which will plug into Baton’s FX service.

“On equity swaps we are partnering with Axoni – creating DLT records of equity swap lifecycle events all the way through to settlement,” says Choussy. “The idea is that when we get to settlement – the movement of cash or securities – we will connect those movements to our FX network that is already connected to all of these banks so they can settle in a streamlined way.”

This article first appeared on sister site Risk.net