Saturday, February 16, 2013

BCBS: Supervisory guidance for managing risks associated with the settlement of foreign exchange transactions

BCBS: Supervisory guidance for managing risks associated with the settlement of foreign exchange transactions
February 15 2013
http://www.bis.org/publ/bcbs241.htm

The purpose of this guidance is to provide updated guidance to supervisors and the banks they supervise on approaches to managing the risks associated with the settlement of FX transactions. This guidance expands on, and replaces, the BCBS's Supervisory guidance for managing settlement risk in foreign exchange transactions published in September 2000.

Since the BCBS's Supervisory guidance for managing settlement risk in foreign exchange transactions (2000) was published, the foreign exchange market has made significant strides in reducing the risks associated with the settlement of FX transactions. Substantial FX settlement-related risks remain, however, not least because of the rapid growth in FX trading activities.

The document provides a more comprehensive and detailed view on governance arrangements and the management of principal risk, replacement cost risk and all other FX settlement-related risks. In addition, it promotes the use of payment-versus-payment arrangements, where practicable, to reduce principal risk.

The guidance is organized into seven "guidelines" that address governance, principal risk, replacement cost risk, liquidity risk, operational risk, legal risk, and capital for FX transactions. The key recommendations emphasize the following:
  • A bank should ensure that all FX settlement-related risks are effectively managed and that its practices are consistent with those used for managing other counterparty exposures of similar size and duration.
  • A bank should reduce its principal risk as much as practicable by settling FX transactions through the use of FMIs that provide PVP arrangements. Where PVP settlement is not practicable, a bank should properly identify, measure, control and reduce the size and duration of its remaining principal risk.
  • A bank should ensure that when analysing capital needs, all FX settlement-related risks should be considered, including principal risk and replacement cost risk and that sufficient capital is held against these potential exposures, as appropriate.
  • A bank should use netting arrangements and collateral arrangements to reduce its replacement cost risk and should fully collateralise its mark-to-market exposure on physically settling FX swaps and forwards with counterparties that are financial institutions and systemically important non-financial entities.
An annex to the final guidance provides detailed explanation of FX settlement-related risks and how they arise.