Credit, FX and Liquidity Risk

Nexus relies heavily on the existing risk management within domestic IPS schemes. IPSs already have strong risk management regimes which mostly eliminate credit risk and settlement risk within the domestic system, either through pre-funding and collateral arrangements or the use of immediate settlement in central bank money. Cross-border payments through linking IPSs can build on this risk management (although there will be some cross-border exposures that need to be addressed outside of the domestic IPS).

Credit, FX & Liquidity Risk by Actor

The following table summarises the key sources of FX, credit and liquidity risk across all the roles in a Nexus payment. Overall, FX risk in the arrangement is limited. However, the FXP may be exposed to credit risk against the Source and Destination Liquidity Providers if the FXP holds positive balances with them. The Destination Liquidity Provider also faces some liquidity risk, in that it does not control the rates offered by the FX Provider and therefore cannot control the demands on the liquidity it holds at the Destination IPS. However, this risk can be managed via an agreement and communication between the FXP and Destination Liquidity Provider.
FX Risk
Credit Risk
Liquidity Risk
None - Sender is given certainty over the FX rate to be applied before they commit to the payment
None – if payment fails, funds are returned.
Source Bank
None – Only deals in own currency
Source Liquidity Provider (SLP)
None. Only deals in own currency.
No or limited exposure to Source Bank – Domestic IPS scheme should require (a) pre-funding in central bank money or (b) high quality collateral to cover Source Bank’s obligations in case of default
No exposure to FX Provider (SLP receives funds before crediting FXP's vostro account)
None – receives funds. Does not pay out funds.
FX Provider (FXP)
Minor – between time of issuing quote and time customer completes payment (eg 5-6 minutes)
None once the Sender has clicked “Send Payment” The FX Provider will receive exactly the amount expected in the Source Currency and pay out exactly the amount expected in the Destination Currency.
FX risk may be voluntarily held on balance sheet after payment - See note below. This risk is external to Nexus.
Exposure to Source Liquidity Provider, which holds funds on behalf of the FXP.
Possible exposure to the DLP if FXP holds a positive balance with them.
Needs to monitor funds at DLP. Can offer worse rates if liquidity is running low.
Destination Liquidity Provider (DLP)
None. Only deals in own currency.
Case 1: No exposure to FXP if FXP already held a positive balance at the Destination Liquidity Provider. In this case, the DLP simply reduces the balance of the FXP's account before making the payment to the Destination Bank.
Case 2: Exposure to FXP if DLP extends credit. If FXP does not hold a positive balance at the DLP and the DLP allows them to go overdrawn, the DLP is extending credit to the FXP and has a credit exposure against them. This is a choice by the DLP to provide credit to the FXP and not a risk inherent to Nexus. (The DLP can choose to reject payments where the FXP does not have a sufficient positive balance.)
Some liquidity risk – DLP does not control the rates offered by the FXP and therefore cannot control the flows out of their IPS account.
However, the DLP must use liquidity in IPS settlement account to make FXP’s payments as well as their own customers” payments.
Requires management and communication with the FXP.
Destination Bank
None – only deals with own currency
No or limited exposure to the Destination Liquidity Provider, depending on the robustness of the IPS’s own risk management
None – only credits Recipient after receiving funds via IPS
None assuming jurisdiction has a deposit insurance scheme in place

Risks External to Nexus

Two risks in the table above are voluntarily taken by the participants and are not intrinsic to the Nexus arrangement:
  1. 1.
    Possible credit exposure of the Destination Liquidity Provider to the FX Provider: The Destination Liquidity Provider may choose to extend credit to the FX Provider by allowing it to make payments without first having a positive balance at the DLP. This is a business decision by the DLP to extend credit (ie lend) to the FXP. It is a risk the DLP has voluntarily chosen to take on, for business reasons, and sits outside of the Nexus arrangement.
  2. 2.
    Possible FX exposure on FX Provider’s balance sheet after payment: After a payment is made, the FX Provider will hold a different mix of currencies on its balance sheet. The value of these assets can fluctuate as the FX market fluctuates. The composition of the FX Provider’s balance sheet is a business decision taken by the FX Provider. This risk is therefore external to Nexus.