Foreign Exchange Settlement Practices in Australia 6. Next Steps and Conclusions

6.1 Action by the RBA

When the RBA resolved to undertake its April 1997 survey, it had an open mind about what, if any, action it would take subsequently. The results of the survey, however, have highlighted that foreign exchange settlement risk in the Australian market must be reduced. As was the conclusion of the 1996 CPSS report, it would be preferable for the private sector to develop a solution.

But there is a role for the RBA in ensuring that progress is made. Indeed, the recent Financial System Inquiry recommended that the RBA give high priority to promoting cost-effective control of international settlement risks. That recommendation has been accepted by the Australian Government.

6.1.1 Netting

Netting is a proven way of reducing settlement risk. The RBA has been actively supporting legislative proposals to give legal certainty to netting arrangements in Australia. Two Australian banks have already indicated a desire to join ECHO once the appropriate legislation has been passed by the Australian Parliament.

6.1.2 Liaison

The RBA has also been following the proposals by CLS Services to establish a vehicle to enable the simultaneous settlement of different currencies in real time. The RBA has stressed the importance of including the AUD, as one of the world's most actively traded currencies, in such a scheme. It has attended meetings with CLS Services to discuss the proposals and the issues involved in including the AUD. The RBA has also adopted the role of facilitating discussions between the proponents of possible private sector solutions and participants in the Australian market.

6.1.3 RTGS

A domestic RTGS system is an essential element for inclusion of any currency in the CLS proposal. As identified in this report, RTGS also provides a mechanism for reducing the times at which foreign exchange payments are at risk. By the middle of 1998, Australia will have a world-class RTGS system for all high-value interbank payments, including the AUD leg of foreign exchange settlements.

6.1.4 Follow-up survey

To monitor progress by the Australian market in reducing foreign exchange settlement risk, the RBA will conduct a follow-up survey during 1998. A decision on the month to be surveyed will be made early in 1998. There is some attraction in selecting April. Apart from providing a consistent reporting period to this initial survey, it would also co-incide with the triennial BIS survey on foreign exchange turnover. However, on the other hand, Australia's RTGS system will be fully implemented during April 1998, so there is a strong case for conducting the survey a little later.

As part of its follow-up survey, the RBA will be requesting that respondents broadly reconcile the value of their foreign exchange settlements with the turnover figures that they supply on a monthly basis. While not all foreign exchange transactions contracted during a given month will be settled in that month, a better understanding of the relationships between foreign exchange turnover and settlements will help in managing settlement risk.

6.2 Action by participants

6.2.1 Re-engineering

This report has highlighted the scope for institutions to reduce substantially their exposure to foreign exchange settlement risk by renegotiating correspondent banking relationships and improving back office procedures. In this way, cancellation deadlines for payment instructions can be extended and confirmation of final payments can be received and reconciled much earlier. The 1996 CPSS report reached the same conclusion and several banks have already achieved substantial reductions in the time that foreign exchange payments are at risk by taking such actions.

6.2.2 Industry commitment

The reduction of foreign exchange settlement risk depends, in part, on the issue being fully understood by participants in the market place. The release of this report should assist greatly in that comprehension process. Once understood and properly quantified, individual institutions then need to make a serious commitment towards tackling the problem, in much the same manner as the banking industry has committed towards reducing risks and improving efficiency in the domestic payments system.

6.3 Conclusion

Foreign exchange settlement risk has long existed, but little real progress has been made towards properly managing it, let alone reducing it. However, that is now changing. In many markets, there is the will and, increasingly, the means to address this problem. The RBA's aim is to ensure that the Australian market and the AUD keep up with that process.