Using blockchain to settle foreign exchange transactions
Wells Fargo is collaborating with HSBC to optimize settlement of foreign exchange transactions and reduce settlement risk.
Technology has transformed the way we bank today and continues to bring about dramatic changes in the industry. That’s one reason why Wells Fargo and HSBC are using a blockchain-based solution for the netting and settlement of matched foreign exchange (FX) transactions.
Using ‘transformative technology across our industry’
Underpinning this initiative is a focus on mobilizing the power of distributed ledger technology, or DLT. Blockchain, a form of DLT, is the recordkeeping system behind bitcoin and other cryptocurrencies. Specifically, Wells Fargo and HSBC will jointly use a shared settlement ledger to process U.S. dollar, Canadian dollar, British pound sterling, and Euro transactions. Using blockchain technology, this solution provides each bank with ongoing real-time transparency of settlement status for matched FX transactions in the applicable currencies. It will enable both parties to use Payment-vs-Payment, or PvP, settlement netting in an efficient manner, which will reduce settlement risks and associated costs of processing FX transactions.
“We are pleased to announce that we will be utilizing blockchain technology for the first time in the settlement process of cross-border payments,” said Mark Jones, co-head of Macro, Wells Fargo Corporate & Investment Bank. “We are extremely excited to be collaborating with HSBC on a project which places both organizations at the forefront of blockchain innovation. We believe this will be the first step of many utilizing transformative technology across our industry in the years ahead.”
A potential game changer with a path to real time settlements
While DLT technology is not unfamiliar to those following cryptocurrencies, its evolution and development continues in non-cryptocurrency applications. Some think it holds the possibility of being a game changer in the FX settlement space. On this view, it could evolve into infrastructure reducing the need for intermediaries (e.g. network operators and other banks) currently involved in settling FX transactions.
This project can be viewed as a step in DLT’s evolution. Wells Fargo and HSBC will continue to agree to foreign exchange transactions separately from the underlying DLT technology. However, those agreed transactions can be tagged for sending to the shared ledger, where they can be “matched” with other FX transactions having the same currency obligations, and then netted and settled on a PvP-basis after the technology confirms the resulting currency obligations are funded.* Both Wells Fargo and HSBC can observe this process happening on the shared ledger.
The shared, private ledger is expected to enhance the speed and efficiency of settlement, as it provides a framework for keeping track of FX transactions submitted to the ledger and a shared set of rules optimizing PvP netting opportunities between Wells Fargo and HSBC.
The banks will be able to net bilateral payment obligations and settle on a pre-agreed cadence multiple times per day within the flexibility of the settlement windows enabled by this technology.
The offering builds on HSBC’s FX Everywhere platform, which according to HSBC has settled over three million intrabank trades worth over $2.5 trillion since going live in 2018. If the technology is successful, the parties would aim to incrementally expand the system to add more participants and to introduce a central Financial Market Infrastructure, or FMI, provider to administer the platform rulebook.
The platform runs on Baton Systems’ blockchain inspired proprietary CORE distributed ledger technology and is governed by the Baton rulebook. The platform enables participants to efficiently settle bilateral foreign exchange transactions across multiple currencies, coupled with added flexibility of extended settlement windows to optimize PvP risk reduction opportunities.
* One of the biggest risks in foreign exchange trading is settlement risk: One party pays its currency obligations to the other party before the other party makes its payment on the counter-currency in that FX transaction. Put another way, settlement risk is akin to your Wells Fargo teller giving you CAD for your trip to Canada before you pay Wells Fargo your USD. The period of time before the counter-currency is paid exposes one party to the risk that the other party doesn’t pay. Under this technology, when the ledger gets confirmation that both parties have the applicable funds in their account, it can cause the transfer of ownership on the ledger concurrently with the underlying account balances being updated.