Continuous Linked Settlement (CLS) is a clearing system used by banks and large traders to settle foreign exchange trades. Transactions are settled on a "payment vs. payment" basis, also known as PVP. When a foreign exchange trade is settled, each party pays out (sells) one currency and receives (buys) a different currency simultaneously. This system eliminates settlement risk, also known as Herstatt risk.
The CLS system was created in 2002 by the world's largest foreign exchange banks because of concerns about the impact of potential foreign exchange settlement failures on the international financial system. Foreign exchange transactions occurring across different time zones were not being settled on a simultaneous payment vs. payment basis, which meant that there was risk that the transaction would not be settled as intended if something happened to affect the currency exchange during the waiting period. The increasing size of these types of transactions made this risk unacceptable.
The purpose of the CLS is to eliminate cross-currency settlement risk. The only way to eliminate this risk entirely is to settle both ends of the transaction on a payment vs. payment basis simultaneously. The CLS system was designed to facilitate the settlement of foreign currency transactions in this way, thus eliminating settlement risk.
Payment vs. Payment
Payment vs. payment is a mechanism in the CLS system to ensure that a final transfer of one currency occurs only if a final transfer of the other currency or currencies also takes place. The transfers occur simultaneously regardless of the time zones.
CLS Bank is an institution owned by the foreign exchange community developed to provide the infrastructure needed to carry out payment vs. payment settlement transactions. It operates the largest multi-currency cash settlement system, which handles settlements for over half the world’s foreign exchange transactions.
Settlement and User Members
User members do not have an account with CLS Bank; instead they are sponsored by a settlement member that does have an account. The settlement member settles the user member’s transactions through its account. The sponsoring settlement member is responsible for the financial obligations relating to the user member’s transactions. CLS Bank is simply the processor of the transaction.