BoE archives reveal little known lesson from the 1974 failure of Herstatt Bank

From Bank Underground –

“In June of 1974, a small German bank, Herstatt Bank, failed. While the bank itself was not large, its failure became synonymous with fx settlement risk, and its lessons served as the impetus for work over the subsequent three decades to implement real-time settlement systems now used the world over. Documents from the Bank of England’s Archive shed light on a lesser known aspect of Herstatt’s failure – the chain reaction it caused across financial centres as banks in different countries delayed settling their payments to each other. The lesson for policymakers today to grapple with is: when a bank fails, could we still expect surviving banks to delay making payments, with a potential chain reaction in the payment system?

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CLS wins legal battle in settlement 'patent' dispute

From Finextra

“The US Supreme Court has found in favour of CLS Bank in a long-running patent dispute with Alice Corporation over the abstract notion of intermediated settlement.

In its opinion statement, the Supreme Court said: "We hold that the claims at issue are drawn to the abstract idea of intermediated settlement, and that merely requiring generic computer implementation fails to transform that abstract idea into a patent-eligible invention."”

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International Payments Training Course – Johannesburg – 22 & 23 May 2014

Probably the least understood aspect of modern banking practice is that which relates to international payments. Yet this practice is as old as history itself.

The course has been specially designed to provide a comprehensive foundation for understanding payments in a global context, covering the key principles, concepts, infrastructures, practices, issues, and current developments in the world of international payments and international trade.

This course will be of especial interest to payments professionals who wish to expand their knowledge base and advancing their careers into the global payments arena.

Join us in Johannesburg, South Africa on 22 & 23 May 2014 for a 2-day intensive course on International Payments.

Places are limited so you need to act NOW!

What You Will Learn

• Foreign exchange & currency principles 
• High-value global payments 
• Retail International Payments 
• Alternative Payment Arrangements & Systems (Correspondent Banking, Hawala) 
• Purpose & role of SWIFT, 
• Purpose & role of CLS 
• International Payments & the Law 
• International Standards, Conventions & Principles 
• Financial Action Task Force (FATF) 
• Anti-Money Laundering 
• Global Clearing & Settlement 
• Liquidity & Treasury management 
• International trade facilitation 
• How International Trade is financed 
• Risk management, and 
• Legal & Regulatory issues.

Which organizations should attend?

• Commercial Banks 
• Central Banks 
• Investment Banks 
• Bank Regulators 
• Asset management firms’ representatives 
• Pension funds 
• Hedge funds 
• Leasing companies 
• Insurance companies 
• Fund managers 
• Other financial institutions

Who should attend the Course?

This is an intensive 2-day primer for payments professionals on International Payments. This course has been tailored for payment professionals, either in commerce or banking who need to gain a closer understanding of International Payments.

For more details about our Johannesburg International Payments training course please visit our BLOG

For a full brochure e-Mail us at courses@citadeladvantage.com with INTPAY-JHB in the subject line or REQUEST BROCHURE on-line.

To Register for this course: e-mail us at courses@citadeladvantage.com requesting a registration form or REGISTER ON-LINE

What we are reading … 21st March 2013

The Risk Involved With Trading Foreign Currency - http://dld.bz/apKU3

Euro zone crisis: What does a guarantee mean? http://econ.st/YmlaYU

Girl Scouts Are Smart Cookies When it Comes to Mobile Payments http://dld.bz/cqXqR

The great Cypriot bank robbery http://www.finextra.com/Community/FullBlog.aspx?blogid=7477

How Banks Can Win the Cyber-War http://www.americanbanker.com/video/how-banks-can-win-the-cyber-war1057581-1.html 

The rise of tablet banking http://businesstech.co.za/news/banking/33703/the-rise-of-tablet-banking/

The Risk Involved With Trading Foreign Currency

By Stanley Epstein, Principal Associate, Citadel Advantage.

The word “risk” is pretty high in most folk’s awareness these days. This greater consciousness of the “R” word has in part been driven by the 2008 financial crisis and its persistent refusal to “go away”. Any article on risk needs to set its baseline by ensuring that the word “risk” has a clear definition.

There are many different explanations of the word risk. My preference is to keep it short and to the point. Dictionery.com’s definition that “risk” is “exposure to the chance of injury or loss” suits me fine.

The concept of trading in foreign currencies also needs some explanation. The events of the past few years have led to the impression that foreign currency trading is somehow “bad” and that it is linked to speculation and shady deals.

Let us dispel this notion at the outset. Foreign currency is a vital component that is linked directly to cross border trade and cross border investments. Importers need to pay for their imports; exporters need to be paid. Financial institutions need to invest money in other countries as they seek to maximise returns in respect of shareholders, pensions and the like. Foreign loans may be held in respect of short, medium and long-term financing requirements.

Trading in foreign currencies is a highly skilled, specialist operation. It is usually carried out by banks, brokers and specialist financial institutions.

Although there is a wide range of risks that can be classified as relating to foreign currency trading I am going to limit myself to three “core” risks that affect this type of activity – currency risk, settlement risk and operational risk.

Currency Risk

The price that a currency is traded at is the exchange rate (or the foreign-exchange rate, forex rate or FX rate). It is always stated in terms of another currency. The FX rate spells out how much one currency is worth in terms of the other – e.g. one British pound is worth 1.60 US dollars.

Currency risk is the risk that comes about from the change in price of one currency against another. This usually occurs as a result of changes in demand for one of the currencies. Changes in demand are often driven by changes in basic macroeconomic conditions such as inflation, employment, taxation, changes in cross-border trade or other factors. Political instability or civil disturbances can drastically change the FX rate in literally seconds.

When businesses conduct transactions in different currencies, the business is exposed to risk. The risk arises because the currencies price may move in relation to each other between the start and the finalization of the transaction. Revenue and costs can move up or down as exchange rates change. If a firm has borrowed money in a different currency, the repayments on the loan could change or, if the firm has invested in another country, the returns on investment may alter with exchange rate movements — this is usually known as foreign currency exposure.

Settlement Risk

Settlement risk is the risk that one counterparty to a transaction does not deliver a security or its cash value according to the agreed settlement terms after the other counterparty has already delivered security or cash value for its side of the deal.

This particular risk was very prevalent in foreign exchange settlements because of the nature of FX settlement practices. This risk is also known as Herstatt risk after the German bank that made this type of risk famous. On 26th June 1974, German bank regulators withdrew that bank’s license to operate. They did this at the end of the banking day in Germany (4:30pm local time). However some banks had undertaken foreign exchange transactions with Herstatt on that day and had already paid Deutsche Mark to the Herstatt, believing they would receive US dollars later the same day in the US from Herstatt's US accounts. 4:30 pm in Germany was 10:30 am in New York! Herstatt’s failure stopped all dollar payments to its counterparties at that time, leaving these counterparties unable to collect payments due to them. Today CLS Bank, which was eventually created as a result of these events, has eliminated this type of risk in the seventeen currencies that are covered (as of the end of 2010).

Operational Risk

An operational risk is one that comes about from the carrying out of a firm’s business functions. Operational Risk is defined in the Basel Accords as “the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events”.

This type of risk is very wide ranging. It comes about from the risks connected to people, systems and processes through which the firm operates. Included are other categories such as fraud risks, legal risks, physical or environmental risks.

There are many operational risks that can be directly related to Foreign Currency Trading. In what follows I highlight a few that I consider the most critical.

Electronic trading with customers – FX trading activity is increasingly centered on remote electronic workstations. This requires much greater care regarding special precautions concerning passwords and system access. These measures would include recognizing the importance of guarding individual passwords, protecting the software and hardware on individual workstation and the need to have up-to-date virus protection.

24/7 Operations and “Off-Site” Trading - Foreign exchange trading takes place on a continuous round the clock basis. Twenty-four-hour trading can distort the distinction between regular end-of-day and intra-day position risk limits. This change requires that additional control procedures are in place for trading that is conducted outside of normal business hours, either from the office or elsewhere.

Mistrades – These could arise for a number of different reasons such as an unacceptable counterparty name was presented or the cover amount presented could not cover the transaction

Disputes – Usually come about over misunderstandings or errors either by a trader or a broker. Managers and traders need to recognize that when a trade is aborted, it may not be possible for the broker to find another counterparty at the same original price.

Product design – The development of new products must be properly supported and approved. This covers a whole gamut of issues such as product approval, implementation procedures, signoffs by legal, compliance, tax, audit, systems, operations, business unit, risk management, and accounting departments.

What is a “Safe Haven” currency?

In this short video Andy Busch, BMO Capital Markets, explains about safe haven currencies.

US FX market free from official intervention in second quarter

US monetary authorities did not intervene in the foreign exchange markets during the April—June quarter, the Federal Reserve Bank of New York said in its quarterly report to the US Congress.

During the three months that ended June 30, 2010, the dollar appreciated 10.4 percent against the euro but depreciated 5.4 percent against the Japanese yen. In this period, the dollar’s trade-weighted exchange value appreciated 3.6 percent as measured by the Federal Reserve Board’s major currencies index.

You can download the Report HERE.

Bank Training – Critical Element for Today’s Banker

Banking has changed dramatically in the past decade. These changes have been so far reaching that the old disciplines that were core to the successful banker of the 1990s have long since relegated to the dusty back shelf.

To succeed in banking today the banker has to master a wide range of new disciplines. Although he may never become a true expert in these he or she still needs to have a sufficient working knowledge of the subject to enable a reasonable level of effective decision making.

This is equally true for bankers at the “coal face” such as those at the front desk or in the back office as well as those in the more lofty towers of head office, be they in accounting, audit, strategy, planning, operations or the like.

This is why staff training is so very critical. Bankers today need to understand the wider world, whether it is the operation of payment systems, credit cards, real time gross settlement, Swift, ACH operations, electronic payments, mobile payments and so on.

They also need to have a clear understanding of where banking and bank operations are heading – what is done today and how it will be done tomorrow. Technology continues to change the world. To keep up with these changes, to exploit them to your organizations benefit you first need to understand them. Just look at how the Mobile Phone is redrawing the banking world. New applications and processes for the Mobile Phone are being developed and launched by the day.

Of course all these changes also bring with them new dangers and risks – ways in which the ever vigilant banker and his staff may be duped. So an investment in Operational Risk Management training is also critical. What is operational risk? How it can be mitigated? What is fraud and how do you manage it? What is Business Continuity and how do you set it up? All these are key issues that the modern banker needs to know about.

Citadel Advantage offers a wide & comprehensive range of professional courses and training for commercial and central banks in the areas of; Operational Risk Management (for Basel II and for back-office risk mitigation), Specific Operational Risk Management areas including Business Continuity Planning, Anti Money Laundering & Payment Systems, and Liquidity Management.

We also offer a range of Workshops and Introductory Lectures dealing with the main areas covered in our full courses. If you can't find the exact course in our schedule that you are looking for, contact us. We may be able to build a course for your specific needs. Professional courses and training are available at a centralized venue, regionally (currently in Southern Africa & Western Europe), or In-house on your premises.

We use real-life case studies to illustrate the course material, so enhancing the learning process.
Our training courses are offered as:

• Public Courses: Citadel Advantage provide courses and lecturers to the key banking and risk training organizations around the world as well as in its own name. Ask your local or regional provider of banking and risk training courses for a Citadel Advantage course.
• In-house Courses (at your location or offsite at a location of your choice): Citadel Advantage provides cost-effective in-house training programs that allow you to determine the, depth, attendee size, length and sequence of the training within the security of your own organization. If you have 5 or more people to train our In-House training service will save you money. All Citadel Advantage courses can be run on your premises anywhere around the world.
• Tailored Courses (to meet your organization's specific needs): Citadel Advantage also provides tailored training services to the banking and financial sector. We can tailor any course to your needs or develop a new course within a relatively short period of time as required.
• CAPMen Program (the “Citadel Advantage Personal Mentoring” program): This service is designed to provide non-judgmental and professional support to those (Mentee) in senior management or aiming to reach senior management positions requiring an in-depth competency in the areas “Payments & Settlements” and “Operations Risk Management”. “CAPMen” Mentoring utilizes the full range of our experience and specialized professional courses to provide coaching, guidance and advice on a one-to-one basis, in your offices, helping you, the professional, set new goals, broaden your vision and build strategies. “CAPMen” mentoring also helps develop personal management skills such as creative thinking, decision-making, problem-solving, and effective use of resources.
  
• For details of our current course offerings please see; http://www.citadeladvantage.com/schedule.htm
  Our full course catalogue may be viewed at; http://www.citadeladvantage.com/catalog.htm

Are We Heading Into Chaos – Again?

By Stanley Epstein - Principal Associate, Citadel Advantage Ltd.

This is the time of year when the financial services industry, or at least the “techie” element heads off to some exotic venue for the annual SWIFT jamboree. SWIFT as we all know is the global financial messaging operator. And as part and parcel of what they do, they have also created the messaging standards on which the financial world to a very large degree depends.

Of course there are huge exceptions, especially in the United States where most banks are not members of SWIFT. But in the rest of the world any bank that is worth its salt is a part of this very important element of the financial system’s operating backbone.

So with this as a background, I am somewhat taken aback to read that the international financial messaging standard which has become so ubiquitous over the past three decades is under “attack” for want of a better word.

Banks are, by all accounts, moving to back to proprietary systems for many of their new messaging requirements. There are many reasons for doing this; existing messaging systems can’t meet specific unique requirements, development cycles for new messaging standards are too long, existing services are too expensive (given the surge in message numbers), platform migrations are too complicated or not yet budgeted for and so-on. Now, I don’t want to get into the pros and the cons of all these issues. Everyone has surely got their own very valid points of view on this. And this question of the whys and the wherefores surely has material for many, many debates.

What does concern me however, is the fact that perhaps we are now plunging headlong into an ever increasing period of infrastructural chaos because of these actions. Are banks short term goals clouding the bigger picture?

If the financial industry as a whole looses this one – and we head into a new period of multiple, competing and incompatible messaging standards – we face years of soaring operating costs and other miseries as we try to bridge these developing operating gaps in the future.

My own view is “please let’s think this through properly before we condemn the next two decades of banking to immense problems”.
What are YOUR thoughts?

FREE Foreign Exchange Operations Risk Guide

The Foreign Exchange Committee (FXC) is an industry level body that includes representatives of major financial institutions engaged in foreign currency trading in the United States. It is sponsored by the Federal Reserve Bank of New York.

The foreign exchange (FX) market is the largest and most liquid sector of the global economy. Operations risk affects all aspects of the financial world and FX is certainly not an exception. Best practices for managing FX operational risk is available free from the FXC. To download in PDF format use the following link - http://newyorkfed.org/fxc/2004/fxc041105b.pdf