Managing Foreign Exchange Risk
The foreign exchange (FX) market is the most liquid sector of the global economy and generates the largest amount of cross-border payments on a daily basis, with an average daily turnover of $5.3 trillion. The FX market facilitates international trade and investments through the determination of exchange rates, conversion of national currencies and transfer of funds.

The landscape of and challenges associated with the FX markets are constantly changing, particularly in view of:

  • new developments in technology – resulting in faster, higher volume trades and exponential increases in participation at the retail and institutional levels;
  • increased cross-border capital flows;
  • increased use of new currencies;
  • consolidation of FX processing in global or regional processing centers; and
  • new developments in global regulations since the 2008 financial crisis.
These developments, along with significant daily trading volumes and global interdependencies between the FX market and payments systems, raise concerns about associated risks and their effects on the safety and soundness of banks and overall financial stability. The risks include principal risk, replacement cost risk, liquidity risk, operational risk and legal risk.

Therefore, it is important for market stakeholders, including banks, industry groups and central banks and regulators to increase their understanding of the existing and emerging issues and work together to mitigate the risks and strengthen the resiliency of the market. The Federal Reserve Bank of New York (FRBNY), in particular, plays an important role in facilitating those discussions and working to promote sound practices through the development and implementation of policies and application of supervisory guidance.
News and Announcements
New York Fed demands better management of FX risks (FX Week) offsite
March 11, 2013

Basel Committee issues final guidance for managing risks associated with the settlement of FX transactions offsite
February 15, 2013

Basel Committee and IOSCO issue near-final proposal on margin requirements for non-centrally-cleared derivatives offsite
February 15, 2013

Fact sheet: final determination on foreign exchange swaps and forwards (US Treasury Department) offsite
November 16, 2012

Basel Committee issues consultative document on managing risks associated with the settlement of FX transactions offsite
August 17, 2012

Basel Committee and IOSCO issue consultative document on margin requirements for non-centrally-cleared derivatives offsite
July 6, 2012

FX market a challenge for CCPs, says New York Fed official (FX Week) offsite
July 10, 2012

New CPSS/Basel guidance on FX risk management to be published soon (FX Week) offsite
July 10, 2012

Archive of prior press releases, news and announcements
Regulations, Papers and Report
Supervisory guidance for managing risks associated with the settlement of foreign exchange transactions (Basel Committee) pdf offsite
February 15, 2013

Second Consultative Document: Margin requirements for non-centrally cleared derivatives (Basel Committee and IOSCO) pdf offsite
February 15, 2013

Final Rule: Determination of foreign exchange swaps and foreign exchange forwards under the Commodity Exchange Act (US Treasury Department) pdf offsite
November 20, 2012

Consultative Document: Supervisory guidance for managing risks associated with the settlement of foreign exchange transactions (Basel Committee) pdf offsite
August 12, 2012

Consultative Document: Margin requirements for non-centrally cleared derivatives (Basel Committee and IOSCO) pdf offsite
July 6, 2012

Progress in reducing foreign exchange settlement risk (CPSS) pdf offsite
May 13, 2008

Supervisory guidance for managing settlement risk in foreign exchange transactions (Basel Committee) pdf offsite
September 2000

Reducing foreign exchange settlement risk: a progress report (CPSS) pdf offsite
July 1998

Settlement risk in foreign exchange transactions (CPSS) pdf offsite
March 1996
Contacts

Chronology of Key Events
1974
In June 1974, Bankhaus Herstatt, a small bank in Frankfurt, Germany, became insolvent and was closed in the middle of the day by regulators. Earlier that day, a number of banks had released payments of Deutsche Marks (DEM) to Herstatt in exchange for US Dollars (USD) to be delivered in New York later in the day. As a result of differences in time zones, the counterparty banks did not receive their USD payments and lost the full value of their trades. The failure caused a string of cascading defaults in a rapid sequence, totaling a loss of $620 million to the international banking sector. This FX settlement risk is known as “principal risk” and may also be referred to as “Herstatt Risk”.
1990 - 1995
A string of subsequent bank failures – including Drexel Burnham Lambert (1990), BCCI (1991) and Baring Brothers (1995) – further magnified the risks associated with FX settlement.
1994
The Foreign Exchange Committee (sponsored by the FRBNY) issued a report on “Reducing Foreign Exchange Settlement Risk” in October 1994. The report defined settlement risk and recommended a set of private sector best practices for reducing settlement risk.offsite
1996
The G-10 central banks endorsed a private sector-oriented strategy to reduce the systemic risk associated FX settlement. The strategy was organized along 3 tracks:
  • Action by individual banks to control their FX settlement exposures, including taking steps to apply an appropriate credit control process.
  • Action by industry groups to provide risk-reducing multi-currency services, which recognizes the significant potential benefits multilateral and bilateral netting arrangements.
  • Action by central banks to induce rapid private sector progress, including seeking key enhancements to national payments systems and other steps to facilitate private sector risk reduction.
Basel released the first report on Settlement Risk in Foreign Exchange Transactions in March 1996.
1998
CPSS issued "Reducing Foreign Exchange Settlement Risk: A Progress Report" in July 1998. The report concluded that encouraging progress had been made. Many individual institutions significantly enhanced the way they managed their FX settlement exposures, groups of institutions worked constructively on risk-reducing multicurrency services, and a number of key payment systems benefited from useful improvements. However, many banks still did not manage their exposures appropriately and industry efforts did not realize their full risk-reducing potential.
2000
Basel issued the Supervisory Guidance for Managing Settlement Risk in Foreign Exchange Transactions in September 2000. This paper was drawn up in consultation with the CPSS and formalized standards around the management of FX settlement risks, including senior management responsibilities, understanding the duration of and measuring FX settlement exposures, setting and using limits, procedures for managing fails and other problems, contingency planning, use of bilateral netting, alternative arrangements for FX settlement risk reduction and internal audit.pdfoffsite
2002
CLS Bank International was launched in 2002. The system operates a PVP mechanism that virtually eliminates principal risk and mitigates other risks. Since 2002, CLS has become the dominant settlement method for settling FX trades – accounting for approximately 65% of the market share by value across 17 currencies.offsite
2008
CPSS issues Progress in Reducing Foreign Exchange Settlement Risk (CPSS) in May 2008. The report analyzed the progress made in reducing systemic FX settlement risks over the prior 10 years and concluded that the central bank strategy achieved significant success, evidenced most visibly by the establishment and growth of CLS Bank.pdfoffsite
2011
The Basel Committee and CPSS established a joint working group in March 2011 to revise the BCBS's Supervisory Guidance for Managing Settlement Risk in Foreign Exchange Transactions (2000), with the goal of ensuring that financial institutions adequately control their foreign exchange settlement exposures.
2012
The Basel Committee issued the consultative document on Supervisory Guidance for Managing Risks Associated with the Settlement of Foreign Exchange Transactions in August 2012.pdfoffsite
The Basel Committee and IOSCO issued a consultative document on Margin Requirements for Non-Centrally-Cleared Derivatives (which includes FX transactions) in July 2012.pdfoffsite
The U.S. Treasury Department issued a final determination providing that certain mandatory derivatives requirements, including central clearing and exchange trading, will not apply to FX swaps and forwards.pdfoffsite
2013
The Basel Committee issued the final Supervisory Guidance for Managing Risks Associated with the Settlement of Foreign Exchange Transactions in February 2013. The BCBS and CPSS intend to monitor banks’ and supervisors’ progress in implementing this guidance, and will commence a review of that progress in 2015.pdfoffsite
The Basel Committee and IOSCO issued the second consultative document on Margin Requirements for Non-Centrally Cleared Derivatives (which includes FX transactions) in February 2013.pdfoffsite
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