A foreign exchange transaction consists of two opposite payments. For example, trading kroner against euro entails a payment in kroner by one party to the other party and an opposite payment in euro. Traditionally, the two payments are settled independently of each other, e.g. via correspondent banks in the currencies in question.
If the two payments are not settled simultaneously, the parties incur settlement risk, which is the risk that settlement will not take place as expected, e.g. if one of the parties fails after it has received the currency purchased, but before it has delivered the currency sold. Factors such as different time zones can increase this risk, while also making simultaneous settlement very difficult for the parties. The credit risk linked to traditional settlement can be large and can potentially develop into systemic risk.
In the international payment system CLS, risk on settlement of foreign-exchange transactions is reduced for banks and currency dealers worldwide.
CLS was launched in 2002 with a view to reducing the settlement risk on foreign-exchange transactions. CLS is owned by some of the world's largest banks. CLS was developed with the support of and in dialogue with the central banks of the currencies connected to CLS.
In CLS, foreign-exchange transactions are settled according to the Payment versus Payment (PvP) principle: ensuring that the final settlement of a payment instruction in one currency occurs if, and only if, settlement of the payment instruction for the currency being exchanged is also final.
To ensure that the funds are available, all payments must be effected via the central banks of the relevant currencies, e.g. Danmarks Nationalbank.
CLS offers settlement of foreign-exchange transactions in US, Canadian, Australian, New Zealand, Singapore and Hong Kong dollars, euro, pounds sterling, Swiss francs, Japanese yen, South Korean won, South African rand, Mexican pesos, Israeli shekels, Hungarian forint, Danish and Norwegian kroner and Swedish kronor.