Settlement risk is unnecessary!
In 1974, settlement risk came to the forefront when the German bank, Bankhaus Herstatt, failed to make its corresponding dollar payments after receiving Deutsche Marks from their counterparties. This created a cascading effect causing more banks to stop making payments and the international payments system to ultimately freeze.
While the industry has made strides to mitigate risk, settlement risk remains a top concern and has increased with the growth in emerging market currencies. Over the last decade, the industry has been focused on improving electronic pricing engines and minimizing latency; now is the time to modernize how we exchange value.
9th Gear has re-imagined the conventional FX process from a “trade then fund” to a “fund then trade” model which is near real-time and mitigates settlement risk. We leverage smart contracts and a private permissioned distributed ledger to digitally transform the FX market. To facilitate dealer participation, we created an intraday lending facility which acts as an alternative source of credit, allowing liquidity providers to facilitate T0 transactions by borrowing in real-time.
Settlement risk has several sub-components: principal risk, replacement cost risk, liquidity risk, governance risk and legal risk. The 9th Gear offering, through its pre-funding model and immutable ledger addresses all but the legal risk, as proper documentation and dealing contracts must still occur.
Pre-funding transactions further negates the need to seek credit approval for transactions removing the need for dealers to make 3rd party payments on their client’s behalf; two time consuming, low productivity items.
Today, retail FinTech offerings with innovative payment efficiency and speed lead the institutional space. Furthermore, traditional trade then fund models open the industry up to failed payments which can cause issues affecting liquidity and leading to high overdraft charges. Most FX spot transactions are traded T0 and settle on T+2. Should a participant fail to deliver their side of the transaction, the receiving institution will likely be overdrawn as it depends on this payment. Reconciliation is operationally intensive and request for good value is time consuming. Pre-funding transactions removes this risk.
9th Gear leverages an immutable distributed ledger along with atomic swap functionality to affect payment vs payment protection on trades. Atomic swaps utilize smart contacts which ensure that either both legs of a currency exchange happen or neither leg happens. Using the distributed ledger as a digital representation of pre-funded assets held at the custodian, we swap digital assets atomically, affecting change in ownership which is immediately reflected at the custodian giving the participants immediate use of funds.
The concept of programable money opens the possibilities of removing many of the frictions which exist today. Believing in the continued digitization of assets and keeping the future in mind, our offering will be interoperable with Central Bank Digitial Currencies (CBDCs) as they are introduced. The industry’s migration to a completely digital 24/7 instantaneous means of exchange and settlement will take time. The underlying digital infrastructure and governance will need to be in place along with the broad adoption of digital assets as an accepted means of exchange, be it a cryptocurrency, stable coin or CBDCs. Many of the current compliance, governance and regulatory reporting requirements could be built directly into the ledger mitigating the burdens within the banking community.
We believe the 9th Gear offering is the first step in the drive to modernize the way we exchange value from the current environment to one where all currencies are replaced with CBDCs allowing for 24hr instantaneous exchange of value.
Settlement risk is unnecessary!
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