Merrill to settle its forex trades via Citi

Citigroup has won a coveted deal to settle Merrill Lynch’s forex trades on its behalf on the new Continuous Linked Settlement (CLS) service for FX.

The contract was signed at the end of 2002, said Citigroup’s CLS project manager, Michael Knorr, although both banks have kept quiet until now.

As about 20 banks jostle to secure third parties to use their CLS services, the Merrill deal - as a top investment bank in wholesale FX - is so far the most high profile revealed.

Janice Barefoot, first vice-president at Merrill Lynch in New York, said the bank chose to use CLS as a third party because: "We didn’t have the infrastructure. We didn’t have the budget. We would have had to have started down the course two years ago - it’s not a decision you just make today."

The bank is currently implementing the technology. "We couldn’t have waited any longer," said Barefoot. CLS, which reduces settlement risk in forex by releasing both sides of a trade simultaneously, was launched on September 9.

While Merrill is one of 67 shareholders in the CLS initiative, it had "ruled out very quickly" the option of offering third-party CLS settlement to its client banks, said Barefoot. That led to the decision that there was little point in becoming a settlement member [the term used for banks such as Citi that hold direct accounts with CLS], said Barefoot.

Merrill is in the middle of a build-up in FX, and Barefoot said one of its key concerns was whether using another bank to settle its forex trades would be perceived as a competitive disadvantage. As such, FX management wanted to ensure the move would not be inflexible as its business changes. "The FX business did want to know this didn’t lock them in forever. They would like to think it’s possible to change their minds down the road," said Barefoot.

On the criteria used to decide which settlement member to use, Barefoot said one factor excluded from the initial stages was price. "Price we put on the side," she said. "Pricing [among all tenders] was competitive, that’s all I’ll say. We were better off picking who we felt was best on the other criteria - such as operational model, technology solution, customer service, implementation and project management - and then looking at price."

Data confidentiality is emerging as a big factor for banks choosing to use a settlement member for CLS. Merrill said it asked for proof of ‘Chinese Walls’ in its requests for proposals. "In more than one case, we were offered an independent audit opinion," said Barefoot.

About 23 global banks are actively pitching their third-party services to client banks. 27 third parties are live on CLS, although about 130 third-party contracts have now been signed.