Bingeing on block sets: DLT could give FX its ‘Netflix moment’

Blockchain’s proponents say faster settlement times make technology akin to TV’s streaming revolution

  • Distributed ledger technology is speeding up the settlement process from days to minutes and is helping banks capture more trades under a payment-versus-payment structure.
  • Banks say this reduces settlement risk and improves their liquidity and funding management. This in turn leads to huge savings as there are fewer intermediary costs.
  • HSBC and Wells Fargo are already reaping such benefits within their franchises, with the former settling more than $3.7 trillion in FX transactions through using the technology.
  • Banks are exploring DLT’s potential in different asset classes. Many believe they are building the framework for a future in which settlement is digitised.
  • Yet few are willing to predict the demise of incumbent processes such as continuous linked settlement. Others wonder what circuit breakers are in place in a system that settles every transaction in real time.

Maryanne Morrow remembers renting movies from her local Blockbuster in the 1990s. She can still recall the long lines of customers, and the additional fees if VHS cassette tapes were returned late or were not fully rewound.

That was before the widespread move towards streaming, and Blockbuster’s inability to respond to it, forced the video rental company out of business.

Morrow, the founder of distributed ledger technology settlement provider 9th Gear, believes another technological shift – towards DLT – will have a similar impact on the settlement of foreign exchange trades. “The networks are developing,” she says. “I can clearly see the point where we’ll be watching money flow through systems without breaks, reconciliation errors and corrections.”

Although technology currently allows trading to be measured to the millisecond, it can still take days to settle transactions at the back end. But by using DLT to speed up settlement and related post-trade processes, fintech firms believe they can reduce trapped liquidity and capital and operational costs, and bring about huge savings.

With digital currencies becoming more mainstream and decentralised finance taking off, banks are better able to explore DLT’s potential.

“One of the things that excites me is essentially being able to get immediate near-term benefits from implementing and leveraging the shared ledger, such as eliminating settlement risk, improving transparency, reducing friction in operational workflows and improving liquidity and funding management,” says Vince Hindman, head of rates and FX solutions at Wells Fargo. “At the same time, we’re laying the technology foundation for, ultimately, what I see is the longer-term potential of distributed ledger, which is being able to settle digital assets or tokenised assets on the ledger.

“We’re going to move toward digitisation, if you will, of settlement across asset classes. From my perspective, as a business imperative, it’s pretty compelling.”

Providers of the technology agree and are seeing more banks interested in DLT. “All the banks realised that if they didn’t change something, then this thing, one way or another, was going to change their world for them,” says Rhomaios Ram, CEO of Fnality International. “That’s what’s accounted for the mindset shift in banks.”

At the same time, regulators are looking for ways to get more volumes through payment-versus-payment (PvP) settlement systems, after the Bank for International Settlements (BIS) reported a shock drop in the proportion of such transactions in 2020. Sources say regulators want to see clear lines of accountability that they can interrogate if necessary.

Yet while Blockbuster’s failure to keep up with the likes of Netflix led to its demise, market participants do not believe DLT will entirely replace the centralised systems currently in use. Instead, both types of systems are likely to complement each other.

The good place?

DLT is a shared ledger that everyone with the right permissions can access and that can be updated to reflect changing balances between parties. Counterparties can all see the same data at the same time, which reduces the need to constantly reconcile and affirm balances. Everyone can see the status of a trade at any time, and when it is going to be settled.

Leading DLT providers see their networks almost like operating systems akin to those of Android or Apple. Others can plug in apps that use the underlying DLT to handle settlement.

Baton has its own FX settlement system, CoreFX. HSBC uses this for its FX Everywhere platform, with which it has settled more than $3.7 trillion in FX trades with 18 of its global entities.

When Fnality is live, it will be able to offer its settlement technology to projects such as Finteum’s FX swap platform. It is also planned to be the basis for delivery-versus-payment settlement of tokenised assets.

“A client will ring up somebody in London first thing in the morning and say, ‘Hey, we’ve got an Aussie dollar PvP to do. Do you know where that trade is?’” says Mark Williamson, HSBC’s global head of FX eRisk partnerships and propositions, of the systems currently in place. “So, everyone goes into DEFCON One trying to look at their system. ‘Has it gone to Swift?’ ‘I don’t know yet.’ ‘Is it in your op system?’ ‘No.’ ‘Have we got a confirmation?’ ‘Not too sure.’

“Whereas if you’ve got that single dashboard between the bilateral participants, it just takes out all the noise because everyone’s looking at that single version of truth between the different participants.”

The shared ledger also enables counterparties to track in real time the settlement risk they have against each other on a currency-pair basis. Where the DLT operators differ is in what happens next: how and whether payments are netted, when they are sent and where they are settled.

With Baton’s CoreFX, users can see when they have hit a given risk threshold of bilateral netted trades, and can then initiate settlement in three minutes. With a centralised utility like Continuous Linked Settlement (CLS), which needs to batch together trades to do its multilateral netting runs, this would take 12 hours or more.

The shorter settlement period can help banks better manage the amount of funding they need to put towards their settlements. At present, they need to pre-fund their nostro accounts – through which banks settle into CLS – in different currencies so they have enough to cover settlement requirements. If banks know exactly when their settlements will be made and by how much, and if these are being done more regularly, this could reduce the amount of cash they would need to pre-fund as a buffer.

“Imagine that you can recycle essentially the same liquidity pool, the same funding resource two or three times during the course of the trading cycle,” said Jerome Kemp, president of Baton Systems, at the FX Markets Europe conference on June 28. “[This] carries with it some very, very significant implications in terms of reaching greater efficiencies.”

At present, a client might have a $50 million bilateral settlement risk limit that is rigid; when it is hit, a bank cannot trade and loses revenue. But if settlement can be done quickly and regularly on the same day so that the client is unlikely to hit the limit, those thresholds could be lowered – to, say, $10 million – and the bank could spread those settlement limits across more clients.

“Now there is less risk in that system and [greater] velocity, the throughput of money just went up,” says Arjun Jayaram, founder and CEO of Baton. “It opens up new opportunities. The first movers in this actually get a revenue boost from this.”

DLT allows participants the option of immediately settling each transaction gross instead of waiting for things to be netted, though the parties would not necessarily end up better off. Gross settlement requires that every trade is funded at the point of trade, which has a knock-on effect of reducing the available market liquidity. Counterparties currently work within end-of-day trading credit limits. Still, the increased speed from using DLT also reduces the exchange rate risk that comes with having a long settlement window, and which is often included as an additional cost within the spot price.

Look both ways: Using gross or net settlement

In theory, DLT could allow every FX trade to be instantly gross settled in real time, instead of batched together over time, netted down and settled.

Under the current system, if two parties were to do several trades during a day that came to £4 in total but, due to offsetting, netted down to zero, there would be no payment at the end of the day. Yet if the transactions were subject to instant gross settlement, the parties would have to send the money across each time, creating a need for £4 of real money that would not otherwise have been there.

Although gross settlement can be appropriate for some one-off trades and counterparties, most market trades will continue to require netting windows after which immediate settlement can occur. Here, liquidity optimisation is a priority. DLT providers still want to use netting windows to reduce payment requirements.

“You can have an hourly or a six-hourly or a daily netting window,” says UBS’s Jaffrey. “At the end of that netting window, you do the netting. You work out that actually we’re at square zero, or I owe you £2. And it’s at that point that I instantly send you the £2 because it’s digital, as opposed to you waiting two days to get your £2.”

Rhomaios Ram, CEO of Fnality International, says the market structure might evolve and the netting windows become far smaller: “You’ll end up settling very frequently on very small sizes. Basically, that $1 million that everyone has, even though they’re sending billions, goes round and round really quickly.”

DLT also enables banks to reduce the number of intermediaries, such as confirmation vendors or even correspondent banks, that charge their own fees to transfer funds to CLS.

Some of these chains of correspondent banks can be long – especially if the trade is originating from, say, a small corporate, which would require passing through several bank intermediaries before ending up at a global bank. Not only does that take time, as each step validates the payment instruction and checks are carried out for issues such as money laundering; it also generates transaction costs.

A white paper from 9th Gear, citing a 2015 study from the Association for Financial Professionals and a 2018 report from McKinsey, found that the total median cost to send and receive currencies on an FX trade was $42.09 per participant per trade. The paper said 9th Gear’s solution would see the all-in cost shrink to $26.31.

“The power of a distributed ledger means you remove lots of intermediaries in a process,” says Nick Pedersen, global head of digital at NatWest Markets. “And you allow things to happen in real time at a much, much lower cost than they happen today.”

These correspondent bank relationships come with their own counterparty credit risks if a party does not send the funds on to the settlement provider, so there are capital savings at play too.

“The driving factor in this is the risk reduction,” says Hyder Jaffrey, head of investment banking principal investments and the strategic development lab at UBS Investment Bank. “It essentially starts to collapse the credit risk and the counterparty credit risk in the industry models. And it’s those two things that equate to the RWAs [risk-weighted assets] that, ultimately, market participants have to hold as regulatory capital as cover for those counterparty and counterparty credit risks. And those numbers are big.”

That is on top of the potential capital requirement savings from reducing settlement risks. At present, these are mostly determined via the Pillar 2 framework and decided on a bank-by-bank basis by the regulator. There are no publicly available figures for how much capital banks are setting aside for settlement risk, though bank sources suggest settlement at effectively T+0 would result in significant savings.

DLT is also currency-agnostic and does not – at least yet – require rigorous regulatory oversight. It can therefore be used for currencies beyond the 18 covered by CLS. HSBC and Wells Fargo are preparing a pilot programme to use FX Everywhere on Baton to settle non-CLS currencies this year. Lukasz Czarkowski, an operations consultant for global trade services in Franklin Templeton’s Poland office, said at the Europe conference that the company currently uses a vendor to net down non-CLS currencies, but that it is looking to settle more of those trades via PvP.

“We are researching and trying to find the solution which would minimise the risk of exotic currencies’ settlement failure,” said Czarkowski. “PvP is one of the topics we’re most interested in to keep researching and potentially implementing a solution for non-CLS currencies to settle on time.”

Regulators have been happy to let the private sector, which was the driving force behind CLS, figure out how to tackle settlement risk. A source at one central bank says this is still the case, and that there is nothing inherently risky in DLT that would cause regulators to get in the way. However, the source says regulators want to ensure that any novel risks are understood and that there is the right level of accountability.

“There is a lot of talk about these systems being ‘decentralised’,” says the source. “But for regulation, you need someone to be accountable. And we need to understand who is in charge, even in the distributed systems.

“DLT is being increasingly tested in an institutional context and by major banks, and they are very clearly accountable in running those systems. So, it’s possible to have that – there’s clearly always someone in charge.”

Speaking at the Europe conference, Baton’s Kemp said that although regulators would not have direct access to the ledger, in the event of a default they could link each hash that corresponds to an actual transaction flow to counterparties and conduct whatever investigations they needed to.

The source at the central bank says its role now is to make sure the regulatory framework and operational facilities – such as the real-time gross settlement system that allows banks to settle using accounts at the central bank – can evolve as industry standards do.

Designated survivor

Despite the hype, market participants and even tech vendors do not believe DLT will displace CLS in FX settlement.

As HSBC’s Williamson puts it: “DLT is used to complement existing solutions and not used front to back. For example, just because we’ve got an Excel spreadsheet on the trading floor doesn’t mean the whole trading floors run on Excel spreadsheets.”

Although users often voice their frustrations with CLS, one of its oft-cited benefits is its large network. This gives PvP access to a huge number of market participants, which allows the multilateral netting process to remove up to 96% of gross notional value, according to a July report on PvP settlement from BIS’s Committee on Payments and Market Infrastructures (CPMI).

“It does create this credit network where we can settle into a pool without having to hold collateral,” says NatWest’s Pedersen. “That is still useful, independent of whatever technology they build it on.”

Pedersen adds that the network benefits are difficult to replicate. He says NatWest could create a DLT partnership with an Australian bank, for example, but it would only be useful if all the other banks in the world joined as well.

CLS has not stood still. It is working on its stripped back settlement service for non-CLS currencies, which the CPMI report says will initially cover the offshore renminbi, ruble, Turkish lira and Polish złoty, settling against the US dollar and euro.

A CLS spokesperson provided a statement emphasising that any new technology solutions “must deliver efficiencies and/or reduce costs while also meeting extraordinarily high standards of resilience”.

Pedersen believes T+2 settlement still has its place as a safety check on systemic risk: “In a world where everything settles in real time, if there is a big financial collapse or big financial crisis, I do wonder what circuit breakers there are in the system.”

Banks are also used to the existing technology and see little reason to change if there is no regulatory requirement to do so. Pedersen says NatWest participated with four other banks in building a carbon credit trading platform, Carbonplace, using DLT, and that doing so was relatively straightforward because that part of the market is in its infancy and is not used to doing things in a particular way.

“I think we spent collectively amongst the founding banks less than £5 million in the first round of building the technology, which is pretty low,” he says. “But that is because it’s new. When you’re replacing an existing system, you can put another zero on that number, because you have to stand down the system and put something else in place.”

There is also the ongoing need to correct misconceptions about the new technology – for instance, that it is tied to cryptocurrency trading, which implies there is a negative environmental impact from the consensus mechanism used to affirm trades. HSBC’s Williamson says the private ledgers used in FX trading can be designed in ways that reduce those concerns: “If, in the implementation, you’ve got a very small and considered consensus mechanism like we do – we’ve got a matching engine that matches the two transactions – then a lot of that fades away.”

He says these concerns might also start to fade as DLT and blockchain move to less energy-intensive validation frameworks. Ethereum is among those moving to a proof-of-stake concept whereby validators stake crypto as collateral against dishonest behaviour.

These concerns will need to be addressed. Nevertheless, DLT still looks set to become a blockbuster, rather than a Blockbuster.

DLTs explained


One of only two projects currently live, it is being used as the backbone for HSBC’s FX Everywhere platform. The UK bank and Wells Fargo last year began using Baton to settle currency trades outside CLS and are mulling whether to extend it to non-CLS currencies later this year.

Users net bilaterally continuously and settle based on rules set by the counterparties, such as time or risk thresholds. At settlement, which is still conducted via Swift, payment is made from the banks’ nostro accounts at correspondent banks to a designated settlement account at a commercial bank.

Ownership of the funds in those settlement accounts is determined by the Baton ledger. Only when the settlement accounts have all the required funds will the ledger perform a simultaneous change of ownership. Baton says the entire process takes three minutes.


Backed by 15 large bank shareholders, Fnality is setting itself up as the DLT to underpin tokenised asset settlement. Its FX settlement portion, Fnality Payment System (FnPS), will use central bank accounts to initially cover US and Canadian dollars, euros, pounds and yen.

Participants have to be eligible to hold accounts at the central banks’ overnight funds or gain third-party access through a party that does. The system is based on claims that all participants have on funds in an omnibus-style system account at the central bank, so credit risk is not taken to individual members.

Settlement occurs when a participant makes a transfer of funds on the FnPS. For funds to be available in the payment system there must be corresponding funds in the central bank omnibus account. FnPS will act as a record of who owns the money in the omnibus account.

Last April the Bank of England launched omnibus accounts that can be used by FnPS. The European Central Bank and US Federal Reserve also have accounts that would do a similar job, and Fnality is applying for access to them.

9th Gear

Founder Maryanne Morrow says 9th Gear’s technology, in its simplest form, focuses on employing liquidity “either prior to or at the time of execution rather than post-trade”.

The company uses DLT to tokenise the FX transaction and move it through its platform, ensuring finality of funds for payments. Tokens represent the physical cash that is available for trading.

A white paper on its website says the system uses fully collateralised tokens to enable settlement. A US patent for 9th Gear, approved in 2020, says the FCTs would represent different fiat currencies deposited at a custodian and are exchanged via the blockchain at settlement if both parties have sufficient balances.

The company is working with third parties to provide alternative sources of liquidity for participants of the platform.

The CPMI’s July report also suggests the service would allow for multilateral and bilateral netting.

Editing by Daniel Blackburn

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