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FRM Part II · FRM Exam Part II · Intraday Liquidity Risk Management

A bank trades FX and settles through CLS (Continuous Linked Settlement). What is the principal risk that CLS is designed to remove?

CLS is designed to eliminate Herstatt risk, the principal risk that one leg of an FX trade is paid while the counterparty fails to deliver the other. It does so through payment-versus-payment, settling both currency legs simultaneously and conditionally.

  1. AHerstatt (principal) risk, by settling both legs of an FX trade simultaneously on a payment-versus-payment basisCorrect
  2. BInterest rate risk on overnight balances held at the central bank
  3. COperational risk from using several correspondent banks
  4. DMarket risk from exchange rate movements between trade date and settlement date

Explanation

CLS uses payment-versus-payment so a bank cannot pay one currency without receiving the other. It does not remove market risk from rate moves before settlement.

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