Continuous Linked Settlement is a process by which a number of the world’s largest banks manage settlement of foreign exchange amongst themselves (and their customers and other third-parties). The process is managed by CLS Group Holdings AG and its subsidiary companies and include a settlement bank regulated by the Federal Reserve Board of New York. The Group was formed in 1997 and the settlement system has been operational since 2002. As of February 2009, there were 73 shareholders and 62 settlement members as well as 4,576 Third Party participants (411 banks, corporates and non-bank financial institutions and 4,165 investment funds) that participate in the system.
Since it began operations, CLS has rapidly become the market-standard for foreign exchange settlement between major banks. As of 2008 Sep 17, it settled a record 1,554,166 instructions a day in 17 currencies (which represent some 95% of global foreign exchange trading). These instructions contained a gross value of US$ 8.6 trillion (or about 1,300 U.S. dollars on that day for every person on the Earth). This new record exceeded the previous record for number of instructions settled of about 1,148,000 and is the first time in history when the volume of payment instructions settled in one day has exceeded 1.5 million.
The single day record for gross-value settlement, set on 19 Mar 2008, stands at US$ 10.3 trillion, for 1,113,464 payment instructions.
A key feature of CLS is the settlement of gross-value instructions with multi-lateral net funding. On average, CLS netting efficiency is in the region of 95%; that is to say, each trillion dollars of gross value settled might require aggregate pay-ins of “only” $50 billion.
CLS settles transactions on a payment versus payment basis, also known as PVP. When a foreign exchange trade is settled, each of the two parties to the trade pays out (sells) one currency and receives (buys) a different currency; PVP ensures that these payments and receipts happen simultaneously. Without PVP there is a (small, but with potentially devastating financial consequences) chance that one or more parties could pay away funds to another institution but not receive any reciprocal funds due (generally for reasons of credit-related default)—this is known as settlement risk, or Herstatt risk.
An additional benefit of the CLS system is the increased straight through processing capabilities.