Settlement risk
Settlement risk arises in transactions involving exchange of
value when we must honor our obligation to deliver without
first being able to determine that we have received the
counter-value. The most significant portion of our settlement
risk exposure arises from foreign exchange transactions.
Through our membership of Continuous Linked Settlement
(CLS), a clearing house for foreign exchange settlement which
allows transactions to be settled on a delivery versus payment
basis, we have significantly reduced our foreign exchange related
settlement risk relative to the volume of our business. In
2005, the transaction volume settled through CLS continued
to increase in absolute terms and reached 59% of overall
gross volumes by fourth quarter 2005, compared to 57% in
fourth quarter 2004. 76% of the CLS volume was with other
CLS Settlement Members and the remainder with so-called
Third Party Members, who settle their eligible trades via CLS
Settlement Members. While the number of CLS Settlement
Members is relatively stable, the number of Third Party Members
we deal with has again nearly doubled during 2005.
Overall market growth has also been significant but CLS has
allowed us to increase our own volumes without our settlement
risk increasing by the same proportion.
CLS does not, of course, eliminate the credit risk on foreign
exchange transactions resulting from changes in exchange
rates prior to settlement. We measure and control this pre-settlement
risk on forward foreign exchange transactions as part
of the overall credit risk on traded products, as described on
page 58–59, Limits and controls.
