HSBC Headquarters

Including the offshore yuan in its blockchain system is just one of HSBC’s latest developments. Bill Lumley reports.

As HSBC Bank and Wells Fargo added the offshore yuan (CNH) to their blockchain-based bilateral foreign exchange (FX) settlements service, the banks announced that this is the first time that a non-continuous linked settlement (CLS) trade had been settled using payment versus payment (PvP) and distributed ledger technology (DLT).

CNH is the fifth currency to be settled between the two banks using a shared settlement ledger that previously encompassed the US dollar, Canadian dollar, UK pound and the euro. Since launching the shared DLT solution in December 2021, HSBC and Wells Fargo have settled more than $200bn in transactions, and in a statement, they announced plans to add additional currencies over the coming months.

These include an eastern European and a Middle Eastern currency, according to Mark Williamson, global head of FX partnerships and propositions at HSBC. “As far as other non-CLS currencies go, we’re just going through and looking at what which ones make sense to settle, which are the ones that we would trade between us and would make a material difference to include,” he says. “We should be live with those in the next month or so, now that we know what we need to do, that we’ve operationalised it and it makes sense.”

He adds that the banks will continue to add other currencies in due course.

Applying innovation

Vince Hindman, global head of rates and FX solutions at Wells Fargo Corporate and Investment Bank, says that expanding the capabilities of the platform to include CNH allows the bank to reduce risk in the payment settlement process. “The collaboration shows that we can pursue innovative technologies and apply them in a way that enhances our existing infrastructure and ultimately benefits our clients,” he says.

The platform itself runs on Baton Systems’ proprietary CORE distributed ledger technology and is governed by the Baton rulebook. The platform enables participants to efficiently settle bilateral cross-border obligations across multiple onshore and offshore currencies, coupled with the flexibility of extended settlement windows to optimise PvP risk reduction opportunities.

HSBC already settled CNH internally using its DLT system. “To extend that to one of our clients was very important and a major benefit for them too, because it reduces Herstatt Risk outside G10 currencies. That risk certainly applies to the dollar/CNH,” says Mr Williamson. “If one of the parties were to go bankrupt during the settlement of paying out dollars and waiting for CNH, or vice versa, that’s where the Herstatt Risk comes into play.”

Having safe settlements, using paying up versus payment, making sure that the funds are available in both accounts, and settling that over distributed ledger technology are the key reasons for doing that, he adds.

Mr Williamson asserts the importance of bilateral as opposed to multilateral settlement. “If we look at HSBC’s trade tickets that come through for FX, then 20% is multilateral and 80% is bilateral. Similarly, the total notional going through the FX business is about 40% multilateral and 60% is bilateral,” he says.

“Ultimately, we’re looking to solve for the 60 and 80 percents. We’re looking at how we can use technologies such as DLT to improve the operational efficiency around that reduce costs and extend the associated risk with our clients using payment versus payment, or safe settlements, for those particular currencies. Where it makes a lot of sense for an emerging market bank like HSBC is to leverage our strengths and our presence in 64 different countries and extend that to our clients utilising this mechanism.”

Multiple benefits

The principle benefits of the bilateral arrangement between Wells Fargo and HSBC are threefold, says Mr Williamson. “First of all, better transparency of our FX trades from deal capture through to settlements,” he says. The second is a better view of the workflow and control around the workflow of those trades as they move through that settlement lifecycle.

The third key benefit is the audit trail, he says. “It means we know precisely where the trades are from type of deal capture, through to settlement and those funds hitting the account. Now, having certainty of when your funds are going to get settled helps with things like intraday liquidity, and how you better manage your cash flows intraday, because you know precisely when those funds have settled, you’ve got a rulebook that sits behind that which describes settlement finality. Those funds are clear and free and available for other segments,” says Mr Williamson.

The shared, private ledger is managed by joint operations teams at the two banks, with full visibility by each of the parties to the relevant FX settlement and shared FX transaction records. According to HSBC, the platform, governed under the framework of an agreed rulebook, facilitates efficient netting and settlement of FX transactions between HSBC and Wells Fargo in the five currencies, including CNH.

Participants in the network are only privy to transactions to which they are a counterparty. Mr Williamson explains: “Having certainty of when your funds are going to get settled helps with things like intraday liquidity, and how you better manage your cash flows intraday, because you know precisely when those funds have settled: you’ve got a rulebook that sits behind that, which describes settlement finality. You know those funds are clear and free and available for other segments.” 

As one of the first banks to use DLT, HSBC has stolen a march on other banks, having used it since 2018. “We wanted to drink our own champagne first,” says Mr Williamson. “We wanted to make sure that we’re able to use it and that it was safe and sound. We’ve got 10 million trades to go between the different entities within HSBC, so we’re pretty confident that we’re able to extend it to our counterparties such as Wells Fargo.” 

Mr Williamson stresses that HSBC is one of the first banks to use DLT in any meaningful fashion. “Baton, which is the underlying DLT provider, is the only live solution. With all the others, there’s lots of great talk and lots of people having a lovely time, but this is the only one that’s used on a daily basis,” he says.

Relationship with regulators

To get this far with the DLT solution, the bank engaged with regulators from the start, says Mr Williamson. “It’s a new technology and therefore a lot of education and awareness is required across the functions and across the group to ensure that we took a risk-based approach when implementing this solution. We didn’t turn the taps on full to start off with, but we made sure that we’re comfortable with the technologies and that we were happy with the way it flowed through, making sure that everyone was educated enough to a level to understand how to operate it.

“The bank has been talking to regulators from early on, to explain what we were looking to do, to explain the way in which it benefits us and to explain the risks that we’re reducing operationally and so on. When you are doing something that hasn’t been done before, you need to have that operational and regulatory background to understand how to adopt this new technology and implement it safely. That challenges a lot of thinking and a lot of legal precedents.”

[other banks] see it as a really concrete and safe way to demonstrate the use of digital

Mark Williamson

Several institutional clients and other banks have shown an interest in the DLT solution, continues Mr Williamson. “They see it as a really concrete and safe way to demonstrate the use of digital.” The appeal, he says, is that it is an overlay that essentially gives a better overview of what is going on between HSBC and its clients.

“There are a lot of tokenisation efforts and so forth,” he says. “But this is using fiat currency. And it’s using DLT as an overlay to existing workflows to help streamline how we do post trade for foreign exchange. Therefore, they see that as a good on-ramp, rather than saying: ‘You know what, I need to get a token, I need to do all this other stuff.’” 

The bank, says Mr Williamson, is using on- and off-ramps that are used by many of its clients. “We’re using matching engines that are used by our clients, and Swift as the off-ramp for payments, and then using the solution as a workflow to get updates of where those trades out through the trade,” he explains.

Emphasising that this is the first time a non-CLS trade has been settled with PvP and DLT, concludes Mr Williamson: “We’re going to continue that journey. From a benefits standpoint there is better transparency workflow and audit trail, and it aligns with many of the goals and aspirations of the FX global code in reducing settlement risk.”

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