Offshore renminbi: breaking new ground for a new era of safe settlement

With offshore renminbi (CNH) now one of the world’s five most traded currencies, Alex Knight, global head of Emea at Baton Systems, explains the importance of extending the ease and speed of riskless, payment-versus-payment (PvP) settlement access across currencies outside of the traditional majors, empowering foreign exchange market participants to radically reduce settlement risk

According to the Bank for International Settlements (BIS) Quarterly review, published in December 2022, trading in Chinese renminbi rose by more than 70% to $526 billion per day between April 2019 and April 2022, making it the world’s fifth most traded currency. This increase in turnover is a reflection of more active trading between counterparties outside mainland China, with international turnover doubling in the same period to about 80% of all renminbi (CNY) trading. The ability to safely settle CNH transactions is, therefore, of increasing importance to the market.

In recent years, the focus of the FX industry and its guiding bodies has been on the reduction of FX settlement risk by broadening the adoption of PvP settlement mechanisms. PvP is a mechanism that ensures the final transfer of a payment in one currency only if a final transfer of a payment in another currency occurs.

The 2022 BIS Triennial central bank survey estimates that $2.2 trillion worth of currency trades are at risk of failing to settle on any given day, potentially undermining financial stability. The amount at risk represents approximately one-third of total deliverable FX turnover, and is up from $1.9 trillion in 2019.

Well-established PvP processes have materially reduced settlement risk over the past 20 years. However, the most widely used PvP service in the market only allows access to safer settlement to a limited number of market participants in just 18 currencies. Every day, trillions of dollars’ worth of FX settlements are made without any real protection. Historically, there has been no choice but to settle CNH – and indeed many other increasingly traded currencies – with significant risk exposure.

FX markets are evolving rapidly. Owing to the expansion of offshore trading, emerging market economy (EME) currencies have almost tripled their share of global trading since the early 2000s. The increased internationalisation of EME currencies has led to increased demand for safer settlement processes to be available to a wider range of market participants across a wider range of currencies. So what steps can market participants take to ensure they are not leaving themselves unnecessarily exposed to counterparty risk?

Plugging a gap

Most FX market participants don’t have direct access to the most widely used PvP service in the market, and therefore do not truly benefit from PvP settlement protection. Indirect, or third-party, participants in the service have a highly concentrated settlement relationship with their third-party service provider and can incur credit and liquidity risks. Where PvP is not available (or used), business can be materially constrained, and trading opportunities limited, by settlement risk limits applied by the banks to manage their exposures.

CNH has been one of the most important gaps from a currency perspective regarding the provision of a PvP process. Safer settlement for CNH needs to be based on a scalable and operationally resilient mechanism that provides efficiency and security around the settlement process. The mechanism needs to be deployable against a large number of counterparties – not just the major banks, but also the customers of those banks – using today’s technology solutions so that as large a proportion of the CNH flow as possible can be included in the PvP process.

Baton Systems has demonstrated a navigable pathway to achieving PvP settlement for CNH and other currencies that are not currently provisioned for using the existing PvP settlement process.

A historic breakthrough

Baton’s Core-FX platform, built using distributed-ledger technology (DLT), is the only live solution used in production by large financial institutions to reconcile, net and safely settle bilateral CNH transactions through PvP.

The solution allows all wholesale market participants to eradicate CNH settlement risk, increase market access and open up trading opportunities for the currency.

Baton uses DLT to optimise the FX settlement process and allow for bilateral collaborative workflows that provide for a seamless, friction-free post-trade process. All of the transactional workflow – from trade reconciliation to netting to settlement – is captured and hashed on a permissioned distributed ledger. The entire process, including the guaranteed movement of funds and settlement finality, is established and enforced under the auspices of the Baton rule book, meeting the FX market’s extensive compliance requirements.

Since PVP can operate using commercial bank accounts, users don’t need a central bank account to directly access a PvP settlement solution. This makes a massive difference since it democratises market access, providing flexibility to the incremental roll-out of the solution to settle additional currencies on a PvP basis.

By integrating with existing payment systems and gateways, Baton provides clients the opportunity to participate in on-demand settlement workflows that transpire across Baton’s distributed ledger network. Settlement can be achieved in just a few minutes and can take place multiple times a day. 

Providing for the future

Market participants are looking for a flexible, dynamic, transparent solution that is easy to schedule and quick to orchestrate. This combination of attributes allows users to make the best use of their financial assets and to reuse those assets multiple times each day.

With the FX trading landscape becoming increasingly complex, innovation and new technology are the only ways to ensure the benefits of on-demand riskless settlement can be extended to a virtually unlimited range of users and currencies.

Since its initial roll-out, trillions of dollars’ worth of transactions have been netted and safely settled via Core-FX on a PvP basis. The addition of CNH to the platform demonstrates the ease and speed with which PvP access can be extended across currencies, empowering firms quickly and efficiently to reduce settlement risk exposure. Baton is now working to further expand PvP access by enabling the safe settlement of additional currencies over the coming months.

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