GFMA proposes disruption settlement framework for FX

Russian ruble close-out pain triggers calls for voluntary multilateral pricing framework

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The Global Financial Markets Association (GFMA) is proposing a new framework for market participants to agree a multilateral closing price for foreign exchange contracts in the event of a market disruption.

The trade body is engaging with a handful of law firms and regulators, including the New York Fed, to determine the feasibility of an arrangement that could be used to resolve deliverable FX trades such as spot, forwards and swaps, where bilateral close-out efforts become chaotic.

One idea being floated would see participants voluntarily opt in and agree to submit all affected trades to an independent third party in a disruption scenario – either natural or geopolitical. This party would be tasked with reconciling the trades, determining the close-out rate and calculating present value.

This arrangement could also, in theory, involve an independent committee to determine whether a trigger event has occurred.

James Kemp, managing director of the GFMA’s Global FX Division says a currency-agnostic multilateral solution could play a critical role in allowing participants to adhere to an independently generated price in a disruption scenario.

“It could provide a collective industry solution to a collective industry challenge,” he says.

Kemp adds the association is currently working through the details of such a framework and expects to make a decision on how to move forward by the end of this year.

“We are currently in the feasibility phase to gauge what the risks are, and that the industry can get comfortable in terms of understanding what constitutes a disruption event, who calls it, the make-up of an independent disruption committee, if that’s the route you go, and how that close-out rate is generated,” says Kemp.

Deepak Sitlani, a partner at Linklaters, stresses the need for clarity around triggers: “You need a process that people are generally comfortable with for determining whether or not you’ve had a disruption event and to determine the way in which the close-outs will take place.”

High participation among market participants would be required to maximise the benefits of a multilateral arrangement.

Recent events, triggered by Russia’s invasion of Ukraine on February 24, have bolstered support for a mechanism that allows traders to avoid a scenario whereby prices move against dealers as they all head for the same exit.

The conflict and related sanctions on Russia drove a stark divergence between the Moscow Exchange onshore ruble rate and offshore prices. This fixing, which typically tracks the international spot market closely, diverged by as much as 16 rubles at the end of February as low liquidity made offshore prices more expensive.

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Moex fixes diverged sharply following Russia’s invasion of Ukraine

Kemp explains that this caused complications for firms that had to agree close-out trades with multiple counterparties: “You saw a discrepancy between the onshore and offshore ruble market, and so you had a situation where firms needed an ability to reduce their exposure in the offshore market. You can do that bilaterally but you could face a scenario where you close out with one counterparty and can’t close out with another, which creates a risk mismatch.”

A multilateral framework would allow participants to cash value trades with all counterparties signed up to the agreement if they are unable to transfer a particular currency out of a jurisdiction.

Previous attempts to solve the problem have stumbled. In April, the International Swaps and Derivatives Association and the Emerging Markets Traders Association released a bilateral template that would permit deliverable-ruble-referencing FX transactions to switch to non-deliverable settlement if it becomes impossible to deliver or convert the currency.

Market participants say take-up of this template was low, as sharp moves meant it would have only benefited one side.

During the peak of volatility stemming from the invasion, dealers suggested creating a unified closing price for FX hedges referencing the ruble, according to two sources with knowledge of the proposals.

A market-wide framework spearheaded by the GFMA and available to all banks may be more beneficial than a piecemeal agreement, by bringing greater consensus on the price of US dollar/ruble trades, as well as other problematic emerging market currencies, such as the Turkish lira.

Even so, any veering away from market prices may raise antitrust concerns given banks could, in theory, pick a price that is favourable to their own books. An objective third-party body and a transparent process around how those close-out prices are calculated would, therefore, be critical to the idea’s success.

“That takes away a lot of the risk of a spurious value coming up because people can see how it would be determined before anyone signs up to the agreement,” says Linklaters’ Sitlani.

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