Continuous Linked Settlement

• Removes Settlement Risk: This approach effectively eliminates settlement risk which is also known as Herstatt risk. It makes sure both sides of a trade happen at the same time, so that no one ends up paying and not getting paid back. 
• Saves Liquidity: Banks use less money when settling foreign exchange (FX) trades. CLS adds up all the trades and calculates the final amount owed, rather than paying for each trade one by one, this is called multilateral netting. During COVID-19 crisis also, this helped in reducing the liquidity needs by over 95%.  
• Follow Regulatory Compliance: CLS follows strict rules made by central banks around the world to make sure foreign exchange (FX) trades are done safely and fairly. It maintains clear records and uses strong systems to manage risk, which helps financial institutions to meet legal requirements and avoid any kind of errors. 
• Handles Large Volumes: It handles more than USD 6.5 trillion amount of foreign exchange (FX) trades every day. This shows that it can support large financial markets without delays or errors. Its strong systems and stable performance make it a trusted part of the global financial system, even when markets are stressed or there is a rise in trading activity. 

How Does CLS Work?

The system for setting FX transactions is based in New York, with operations in London. It uses the Payment Versus Payment (PVP) mechanism, where both parties send their sold currencies to CLS, which releases the bought currency only after receiving the counterpart's currency. 

• Submitting the Trade: Both banks involved in a foreign exchange (FX) trade send the details of their deal to CLS. This includes the amount of currency they want to exchange. 
• Checking and Confirming the Deal: CLS checks the trade details to make sure both sides agree on the terms. This helps in avoiding any kind of mistakes or confusion. 
• Providing Payment Details: Each bank sends the currency they are selling to CLS. CLS holds the currencies and waits for the other side to send their currency. 
• Finalizing the Trade (Simultaneous Settlement): CLS makes sure that both banks get the currency they are buying at the same time. It gives the bought currency only after receiving the sold currency from the other bank. This way, neither bank takes a risk of not getting what they are supposed to. 

Explanation of Working with an Example

1. Bank A in the U.S. wants to buy AUD (Australian Dollars) from Bank B in Australia, in exchange for USD (U.S. Dollars). 

1. Both banks provide their trade information to CLS. 

1. Both banks, Bank A and Bank B will transfer USD and AUD respectively to CLS. 

1. CLS then processes the transactions and ensures that Bank A receives AUD and Bank B receives USD at the same time.