How using commercial bank money is accelerating and democratising market access to PvP settlement

Baton’s Core-FX™ solution challenges the notion that access to central bank money is a prerequisite for progressing access to PvP settlement. Instead, as Baton’s Tucker Dona explains, advancements in distributed ledger technology (DLT) and cloud computing are now proving that foreign exchange transactions can be risklessly settled using commercial bank money on a PvP basis with legal settlement finality. In doing so, democratising direct access to safer settlements by allowing a broader range of FX market participants to effectively reduce their counterparty settlement risk exposure and accelerating the pace with which PvP access can spread across additional currencies.

As outlined in the July 2022 CPMI consultative report focused on facilitating increased adoption of Payment vs Payment (PvP), the legacy PvP settlement process (and indeed some of the models that are being put forward as potential new entrants) operate on a central bank payment model – that’s to say that the liabilities of the central bank are used as the settlement asset. 

The model has greatly reduced the risk of financial failure for the 18 currencies eligible for PvP settlement via the market’s predominant infrastructure. However, this mechanism requires settlement participants to have access to central bank accounts – and access is far from universal. 

Additionally, it requires the jurisdiction of the currency to recognise the settlement process (and most importantly the finality of settlement) in law. Furthermore, the underlying payments systems need to operate according to a globally standard daily timeframe, often well outside the core operating hours of the relevant central bank. This is a very arduous process.

The central bank account market access challenge

In most jurisdictions, only the very largest banks have central bank accounts, with other institutions (wishing to settle on a PvP basis) having to leverage accounts that they’re using at one of the major nostro banks. For example, a potential participant such as a large asset manager or hedge fund will have nostro accounts at very large commercial banks (that in turn will have a central bank account), but the larger asset managers and hedge funds won’t have their own central bank accounts. So, overall, just a small fraction of the FX market participants settling in a given currency will have direct access to central bank money.

“In most jurisdictions, only the very largest banks have central bank accounts”

A more efficient settlement process

Baton’s Core-FX solution has been designed to provide direct, on-demand settlement for FX payments on a PvP basis using commercial bank money. Core-FX eliminates settlement risk by simultaneously changing ownership of the currencies using settlement accounts at commercial banks. Once this has occurred, funds can be moved from the settlement account into the destination nostro accounts for each party. All of this takes place within a matter of minutes. This allows participants to de-fund those settlements immediately and recycle liquidity within the same business day – thus improving the firm’s ability to optimise both their funding and intraday liquidity management processes.

“Baton’s Core-FX solution has been designed to provide direct, on-demand settlement for FX payments on a PvP basis using commercial bank money” 

Why using commercial bank money offers the opportunity to accelerate access to PvP settlement across a broad range of currencies 

Participants using Core-FX are bound by the Baton rulebook, meaning that users can benefit from the latest decentralised technology alongside the certainty of a defined governance process with settlement finality. From a legal perspective, the key jurisdiction is the location of the settlement account. The Baton rulebook already benefits from clean opinions on settlement finality across a number of key jurisdictions, permitting PvP settlements across a broad range of currency accounts that can be operated in these jurisdictions. With additional legal opinions being sought as a matter of priority, the expansion of currency coverage will continue to develop at pace.

“With additional legal opinions being sought as a matter of priority, the expansion of currency coverage will continue to develop at pace”

Therefore, by settling in commercial bank money, instead of central bank money, Baton can allow for wider participation in FX PvP settlement, as well as accelerating the roll-out of PvP availability across a broad range of currencies. 

“Core-FX eliminates settlement risk by simultaneously changing ownership of the currencies using settlement accounts at commercial banks”

A new concept for the market

Using commercial bank money to settle transactions with PvP is a relatively new idea. Baton can help market participants to understand the process by giving them the opportunity to test Core-FX via a demo environment with dummy trades, presenting a thorough understanding of how Baton’s settlement process works. 

Baton Core-FX allows settlement participants the flexibility to bilaterally net and then to settle those netted transactions on a PvP basis on-demand, multiple times per day. This flexibility is in contrast to other PvP settlement processes which operate on the basis of industry-wide, multilateral netting and allow for settlement just once a day within a very defined window.

With Core-FX, the decision of when to net and when to settle the netted amounts lies with the two counterparties to a transaction, Collaborative and configurable settlements can be effected at a time, or times, of the participants’ choosing, giving almost immediate access to funds and providing the opportunity to radically reduce counterparty settlement risk and intraday liquidity usage.

By using commercial bank money to settle cross-border payments, Baton is able to extend PvP to more market participants and across a broader range of currencies at speed. As a result, the market will benefit from reduced exposure to Herstatt risk by settling more transactions overall via PvP, which aligns with industry good practice. 

“By using commercial bank money to settle cross-border payments, Baton is able to extend PvP to more market participants and across a broader range of currencies at speed”

I hope that this blog explains how the use of commercial bank money by Baton Core-FX can optimise the settlement process and reduce risk.  Please reach out if you have any questions or would like further information by emailing [email protected].