Introduction

It is a privilege to be invited to address the Board of CLS – or ‘Continuous Linked Settlement’ in longhand – on what I believe is your first meeting in Australia since 2017.

CLS is hardly a household name. But what it lacks in ‘rizz’, it more than makes up in the critical role it plays in the international financial architecture: massively reducing the risk of settlement failure in the global foreign exchange (FX) market.

As you all know, but is worth repeating for a wider audience, settlement risk is a particularly important issue in FX markets because of the time differences between the major currency blocs. It would be all too easy to pay away one leg of FX transactions during the business hours of that currency, in anticipation of the return leg being paid when the other country wakes up – only to find that second leg interrupted, leaving large, unsettled liabilities. Exactly that happened when the Cologne-based Bankhaus Herstatt was liquidated in 1974 at the end of German banking hours – after Deutsche Mark payments had been made, but before the return US dollar legs had settled. Chaos ensued.

The sums involved in FX markets are truly massive – over US$7.5 trillion a day in 2022, and set to have grown substantially since then.¹ So getting this right matters critically for financial stability. The CLS solution seems obvious today: ensure that payments on both legs are made simultaneously, in central bank money, in each national real time gross settlement system.² But it was 22 years after Herstatt before the international community settled on this plan,³ and another six before CLS opened for business in 2002.

From the start, Australia has been a close partner in CLS’s development. The Australian dollar was one of the seven founding CLS currencies – so we’ve had an operational relationship with you, every day, since the very beginning. On the regulatory side, too, CLS is categorised as a systemically important international payment system in Australia; and we sit on the regulatory college for CLS, chaired by the Federal Reserve Bank of New York.

The Australian dollar itself has long punched above its weight in global markets.⁴ It had the sixth highest daily turnover of any currency in the 2022 BIS Triennial survey, despite Australia ranking only 11th by nominal GDP at the time (Table 1). None of the other top 10 currencies in Table 1 has that level of outperformance while operating a completely free float.⁵

That special status reflects three main things:⁶

1. As a major commodity exporter, Australia’s economic conditions are sensitive to the outlook for global growth; Australian dollar assets have therefore been seen as a good way for investors to manage their risk, gaining ‘risk on’ exposure by going long, or hedging risk by going short.
2. Australia’s geographical position, its openness to capital and its developed FX hedging markets, mean it was historically used to gain proxy-exposure to Asian economies whose currencies are harder to invest in, or where it is harder to issue debt.
3. Australia’s superannuation (or pension) funds are investing an ever-increasing amount overseas. Even today, the sums are huge: Australian retirement savings are the fourth largest in the world, with assets equivalent to around 150 per cent of Australian GDP, half of which are offshore. And that is set to grow further: within a decade the sector will be the second largest globally, with assets rising to around 180 per cent of GDP, and an overseas portfolio share approaching three-quarters.⁷

All of this may be great news for Australian dollar volumes! But it also puts us bang at the heart of a quite exceptional period of uncertainty about the future direction of the global economic and financial system. Some argue we are on the verge of a fundamental shift, with the world breaking into rival, fragmented trading blocks, and a collapse in US dollar hegemony. Others wonder if this may all be a bit overblown, with the global trading system proving more robust, and the US dollar’s role too embedded, to see a serious challenge – for now, at least.

I cannot hope to resolve these profound questions today, but I do want to look at what this uncertainty may mean for Australian investors, and particularly the super funds, as they look out into a turbulent world – and how it could affect the ways they think about managing currency risk in their global portfolios, both now and in the years ahead.

Through a hedge backwards: Australia’s natural advantage?

Australians have always been big overseas investors, both for standard diversification reasons, and because the onshore asset base is relatively small. But they have typically taken only modest levels of protection against FX movements on their riskier overseas asset holdings. The superannuation sector as a whole is estimated to hedge only around one-fifth of the value of its overseas listed equity positions, for example (Graph 1).⁸

To see why that might be, let’s start by reminding ourselves that, other things equal, Australian investors holding US dollar denominated equities are worse off when the Australian dollar appreciates (or equivalently the US dollar depreciates). They can insure against this risk by using FX swaps or forwards to take short positions in the US dollar (against long positions in their own currency). But buying derivatives is often costly – so the benefit from doing so has to justify the cost.

One factor reducing that benefit is the extent to which FX movements can be expected to provide a kind of ‘natural’ hedge against the equity holdings. That would happen in our example if the Australian dollar tended to depreciate against the US dollar when US equity prices fall, offsetting some of the offshore capital losses when converted back to domestic currency. But historically that is exactly what has happened: first, because the US dollar has typically been viewed as a safe haven or ‘risk off’ currency that rises when global conditions are bad; and second, for the reasons I mentioned earlier, the Australian dollar has been seen as one of the standout ‘risk on’ currencies that tend to depreciate when global economic prospects weaken and/or risk-sentiment deteriorates. On that score, the Australian dollar has historically provided a pretty decent ‘natural’ hedge (Graph 2, left hand panel).

If the volatility in the Australian dollar is lower than that in overseas equity returns – as it has been in recent years (Graph 3) – that also reduces the need to take out an explicit hedge, because it just doesn’t form a large part of overall portfolio volatility.

There are several different ways to factor these considerations into a specific quantified hedge ratio. One approach is to calculate the hedge needed to minimise the variance of portfolio returns. I won’t plough through the formalities of how to do that here – and the calculations can be sensitive to assumptions. But the punchline is that – historically speaking – the Australian dollar’s strong correlation with US equities, and its low relative volatility, mean the minimum variance equity hedge ratio has been pretty low. Indeed on some measures it comes quite close to the average levels actually chosen by Australian industry super funds.⁹

For some currencies, such as the Japanese yen, low hedge ratios for US assets have also been driven by high hedging costs, reflecting material differentials in short-term interest rates .¹⁰ But this has not been a dominant factor in Australia (Graph 4).

The times, are they a-changin’?

The debate on everyone’s mind is whether the paradigm underpinning those correlations I’ve just been through is now shifting.

The oft-cited case for the prosecution is that, amidst the huge increase in market uncertainty earlier in 2025 – a situation in which the US dollar would normally be expected to act as a safe haven – the dollar in fact depreciated: falling by around 8 per cent on a trade weighted basis relative to its January peak, with a little under half of this coming in the weeks following the announcement of the Liberation Day tariffs (Graph 5). Dire predictions abounded, including a rumoured mass exodus from US assets, and fears of the end of dollar hegemony in international capital markets.

Uncertainty obviously remains high, and there is still a great deal of water to flow under the bridge. But, to paraphrase Mark Twain, predictions of the death of the US dollar and the Australian hedging model appear somewhat premature, for four main reasons:

1. There is little evidence yet that international investors have substantially reduced their holdings of US assets: indeed the latest data suggest that foreign capital continues to flow into the US (in net terms), particularly on the equity side (Graph 6). Capital inflows into Australia did pick up a little in the June quarter – but the numbers so far do not look materially out of line with historical averages (Graph 7).

   

   

2. The correlation between movements in US equity prices and the Australian dollar remained close to its historical average through the recent market turmoil, with the Australian dollar initially depreciating sharply alongside falling equity prices. That is quite different to correlations with some of the other major currencies (Graph 2, right panel).
3. Implied volatility in the exchange rate between the Australian dollar and the US dollar has remained lower than that in US equities.
4. The cost of hedging against FX risk for Australian investors has been little changed (Graph 4).

Investors in some other countries do appear to have increased their hedging ratios in response to Liberation Day, with market attention focused on institutional investors in Europe and parts of Asia. Those additional hedging flows may have played some role in amplifying the US dollar’s decline for a period earlier in the year.¹¹ In Australia, the super fund sector also increased its equity hedges in the June quarter (Graph 2) – but the pick-up was only small, and market participants report little current expectation of a more material increase in the near term.

Some more structural challenges for super funds’ FX hedging

But none of this means we should be complacent about the scope for a more material regime shift over time. Uncertainty remains elevated, and we are yet to see the full economic implications of the changes to US tariffs play out. It is encouraging therefore that many super funds are strengthening their capacity to think through and manage FX and other liquidity risks.

That also matters because, even if super funds’ average hedge ratios change little in the near term, the size of the market-wide FX hedge book is set to grow significantly over longer horizons, for three reasons:

1. As I noted at the start, total super fund assets are projected to grow from around 150 per cent to 180 per cent of GDP over the next decade.
2. The share of this larger pie devoted to overseas assets is set to rise, given the size of the super fund pool relative to the stock of domestic financial assets.
3. As super funds’ members age over time, they are likely to demand greater certainty of returns, driving super fund portfolios away from equity and towards fixed income. But FX hedge ratios for foreign currency fixed income assets are typically much higher than those for equities, reflecting the very different shape of asset returns and correlations.

The first of these factors alone could see the superannuation sector’s total FX hedge book, currently estimated to be of the order of AUD½ trillion, to double over the next decade. The other two factors will increase this number by some further multiple over the coming years.

Such changes would of course reflect prudent risk management on the part of individual firms. And they would barely touch the sides of a global FX swaps market that exceeds US$100 trillion in stock terms.¹² But they are large relative to the current size of the Australian dollar FX swaps market.¹³ And the terms on which FX hedges are typically offered to super funds today are relatively capital-intensive for the swap providers. So it is likely that super funds will have to extend and diversify their pool of hedge providers over time to avoid hitting concentration limits. They may also be asked to meet increased margining and collateral requirements on their hedging positions.

Many super funds are already thinking hard about what these changes could mean for their future liquidity management.¹⁴ One aspect is ensuring they have sufficient resources to meet potential short-run liquidity needs – for example, to cover increased replacement costs for maturing FX hedges if the Australian dollar depreciates. Those potential liquidity needs appear manageable today under most scenarios. But they will grow over time as the hedge book increases in size. And the practice of using relatively short-term derivatives to hedge much longer term investment – though common amongst many institutional investment communities – means super funds are reliant on continuous access to functioning FX derivatives markets. If these markets were to become impaired such that rolling these hedges became difficult or prohibitively expensive, as occurred during episodes of US dollar funding stresses in both 2008 and 2020, super funds would either need to sell foreign assets or face unhedged foreign currency exposures for a period, both of which could be undesirable in a period of market volatility.¹⁵

Australian banks also rely on the smooth functioning of such markets – in particular, to hedge their foreign-currency denominated funding back to Australian dollars to fund their (mostly) Australian dollar assets. However, their exposure is somewhat mitigated by the fact that their hedges are typically duration-matched to their funding.¹⁶

System-wide liquidity risks are being explored in APRA’s inaugural system stress test, and we look forward to seeing the results of this work.¹⁷

Staying on top of FX settlement risk in the region

All of this increased FX activity may seem like good news for FX markets and hence for CLS – and well it may be. But against the backdrop of such a big increase in scale and a huge range of uncertain and unpredictable macro risks, the need to ensure we retain a laser focus on mitigating settlement risk has never been greater.

The first priority, clearly, is to ensure that as many eligible transactions as possible go through CLS. I look forward to seeing the results of the new global survey on FX settlement data, designed by my old colleague Philippe Lintern and team at the Bank of England, and carried out as part of the BIS’ 2025 Triennial exercise.¹⁸ And I would be interested to hear your estimates of how widely Australian firms active in FX use your service. Five years ago, CLS estimated that around 75 per cent of Australia’s 20 largest super funds used CLS to settle their FX trades – which sounded good but left me wondering what the remaining 25 per cent did, and how this number has evolved since then.¹⁹ Perhaps you can enlighten me today! Given the growth expected in that sector it is important to pursue this issue with gusto.

Just as global fragmentation poses risks to the macro outlook, so it also poses risks to the ongoing goal of eliminating FX settlement risk. As Table 1 shows, a number of key currencies in the Asia Pacific region remain outside CLS – specifically the Chinese Renminbi, the India Rupee, the New Taiwan Dollar and the Thai Baht. I do not underestimate the challenges involved, but we should do all we can, where we can. Extended cutoff times for CLS settlement could help with greater global reach too.

Fragmentation, and the geopolitical risks that come with it, poses heightened cyber and operational risks – issues that I know have preoccupied you as a Board for some time.

And of course there is always the possibility that rival payment systems, built on less sound principles could cannibalise transactions that currently go through CLS. I sympathise with you that it can be hard to keep up with the hype cycle on this front – from Distributed Ledgers to Central Bank Digital Currencies to today’s topic du jour, stablecoins. But it is important that you do, because we must ensure that whatever emerges from this process is as robust as what preceded it. That is why, here in Australia, we are experimenting with new ways of enabling central bank money to circulate on innovative payments platforms through Project Acacia.²⁰ I look forward to hearing an update of CLS’ own work in this area.

Conclusions

Let me conclude.

Your visit comes at a critical moment in the history of the global economic and financial system. Uncertainty is at an all-time high – and many of the principles on which we have long relied are in flux.

Against that backdrop, I have devoted much of my remarks today to reviewing how fragmentation could change the way Australian investors approach currency risk management. So far, little fundamental seems to have changed – the Australian dollar has remained a well-functioning ‘natural’ hedge for global risky assets, and hedging costs are relatively low. But that could all change rapidly – and the structural trends towards growing super fund balances, much of which will have to be invested overseas, makes it ever more important that super funds in particular scale up their risk management and scenario planning capacity. Done successfully that should further add to other resilient features of the system – including the fact that super funds are mostly defined contribution (not defined benefit) schemes, are not levered, and have access to those deep and liquid FX markets that I described earlier.

As a founder currency of CLS, a co-regulator and a leading global currency, we care deeply about furthering the mission of eliminating FX settlement risk. In that context, it is wonderful to see the progress CLS has made, and we look forward to continuing to do all we can to help in that endeavour.

Endnotes

I am grateful to Marcus Miller and George Tyler for their help in preparing these remarks, and to Sue Black, Matt Boge, Matthew Carter, Alison Clark, Ellis Connolly, Alice Frank, Jason Griffin, Gideon Holland, Sarah Hunter, Chris Kent, Brad Jones, Kristin Langwasser, Jahan Mand, Penny Smith, Geoff Stewart, Tim Taylor, Michael Thornley and David Wakeling for their advice and comments. *

BIS (2022), ‘OTC Foreign Exchange Turnover in April 2022’. Preliminary results for the 2025 survey will be released later this month: BIS (2025), ‘2025 Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Markets’. 1

Importantly, CLS greatly reduces the liquidity required to settle these payments. While settlement occurs on a gross basis, the funding required from each participant is based on a multilateral net calculation of its expected position in each CLS-eligible currency. For more details, see Dalzell S (2025), ‘CLS and FX: Pioneering Partnership with Pivotal Purpose’, CLS. 2

For any settlement risk nerds amongst you, the 1996 Allsopp Report is the key text from this period: BIS (1996), ‘Settlement Risk in Foreign Exchange Transactions’, March. 3

For a broader overview of recent developments in Australian FX markets, see Kent C (2025), ‘Australia’s External Position and the Evolution of the FX Markets’, Address to Australian Financial Markets Association/Bloomberg, Sydney, 29 April. 4

Of the first 10 currencies in the table, turnover in the Hong Kong dollar, Singapore dollar and Swiss franc also ranks well above their respective country’s GDP rankings – but Hong Kong and Singapore have FX pegs, and Switzerland retains FX as an active policy tool, where required. 5

A fourth potential factor that might be supporting Australian dollar activity is a practice whereby an Australian FX liquidity provider may on-book an FX transaction initially undertaken in Australia to another entity within the same group but in a different regional location (e.g. Singapore or Hong Kong) for balance sheet and risk management purposes. The report on foreign exchange turnover in Australia conducted semi-annually on behalf of the Australian FX Committee suggests that such ‘related party’ business makes up a greater share of Australian-based institutions total turnover then the global average: Armour C and J Beardsley (2023), ‘Developments in Foreign Exchange and Over-the-counter Derivatives Markets’, RBA Bulletin, March. But the historical lack of data by currency means it is impossible to know if this has affected the Australian dollar disproportionately. 6

The outlook for the size of the superannuation sector is set out in RBAFOI-242512. An industry assessment of the global ranking of the sector is given in SMC Australia (2025), ‘Australians’ Super Savings on Track to Become Second Largest Globally by the Early 2030s’, 24 February. And one estimate of the share of future super inflows likely to be invested in overseas assets (70 per cent) is set out by Australian Super, the largest single superannuation fund, here: AustralianSuper (2024), ‘AustralianSuper Expands International Equities Team with Senior Investment Management Appointments’, 28 November. 7

Every four years, the Australian Bureau of Statistics (ABS) carries out a Survey of Foreign Currency Exposure, funded by the RBA. The survey measures Australian businesses’ foreign currency exposures and the extent to which they are hedged. The latest survey was carried out in 2022 and is summarised here: Atkin T and J Harris (2023), ‘Foreign Currency Exposure and Hedging in Australia’, RBA Bulletin, March. 8

A simple minimum variance hedge ratio can be expressed as 1 minus the product of (i) the correlation between the return on offshore assets and the relevant Australian dollar forward rates and (ii) the ratio of the volatilities in returns on offshore assets and the Australia dollar forward rates. For an excellent exposition of this analysis, see Franulovich R (2025), ‘Superannuation FX Hedging Drivers and Outlook’, Westpac, 31 March. 9

The cost of an FX swap is a function of the difference between the interest rate paid out on US dollars and the interest rate received on the domestic currency (plus execution costs and the liquidity/opportunity cost of meeting any variation margin or collateral requirements). The impact of hedging costs on recent exchange rate developments is discussed further in a recent BIS paper: HS Shin, P Wooldridge and D Xia (2025), ‘US Dollar’s Slide in April 2025: The Role of FX Hedging’, BIS Bulletin, No 105. 10

Of course, correlation does not imply causation: the increase in hedging and the depreciation of the US dollar may have been responding to a common cause. For more on these issues, see Shin, Wooldridge and Xia, n 10. 11

Shin HS (2025), ‘Structural Changes in the Global Financial System and the Transmission of Financial Conditions’, BIS Speech, 19 May. 12

For estimates of the size of the AUD FX swaps market, see Bristow L and M Tang (2024), ‘The Australian Repo Market: A Short History and Recent Evolution’, RBA Bulletin, July 2024. 13

See, for instance, ISDA (2025), ‘Australian Superannuation Funds: Current and Future Uses of Derivatives’, May. 14

For fuller descriptions of the functioning and vulnerabilities in global FX hedging markets, see Shin HS (2023), ‘The Dollar-based Financial System through the Window of the FX Swaps Market’, Paper presented to Peterson Institute for International Economics Conference, Washington DC, 24 March; Shin, n 12. Some of these issues are also discussed in RBA (2025), ‘Chapter 3: Resilience of the Australian Financial System’, Financial Stability Review, April. Super funds’ risk management practices are already evolving to address such risks, for example, through the use of staggered maturity hedges, or ‘ladders’. 15

Bellrose K and Norman D (2019), ‘The Nature of Australian Banks’ Offshore Funding’, RBA Bulletin, December. 16

For more details about the system stress test, see APRA (2025), ‘APRA Corporate Plan 2025-26’. 17

Lintern P (2024), ‘Once More unto the Breach’, Speech at FX Europe, 3 December. 18

Jones S (2020), ‘Super Fund FX Trades at Risk, Investment Magazine, 3 February. 19

See for instance: RBA (2024), ‘Project Acacia – Exploring the Role of Digital Money in Wholesale Tokenised Asset Markets’, Consultation Paper, November; Jones B (2025), ‘Anti-fragility and the Financial System’, Opening Remarks to FINSIA: The Regulators, Sydney, 12 September. 20