When the settlement date of an FX forward or cross-currency swap approaches, operations staff check, for each trade, which route will carry the two payments. If a settlement service that links the two payments is available, paying before confirmed receipt can be avoided; if not, it remains.

Herstatt risk from time differences

In foreign exchange settlement, the two currencies are delivered at different times. If the counterparty becomes unable to pay between the payment of one currency and the receipt of the other, you may lose the full principal you paid. This risk is called Herstatt risk (FX settlement risk)1.

Consider a hypothetical example in which Bank A buys USD 10 million from Bank B at 150 yen per dollar and exchanges 1.5 billion yen for dollars on the settlement date. Even when the value date is the same, the dollar leg settles during New York hours, after the yen leg settles during Tokyo hours1. Bank A pays yen first. If Bank B defaults before paying the dollars, Bank A cannot receive them and may lose the full 1.5 billion yen it paid. Bank B receives yen first, so in this example the principal loss falls on Bank A2.

Bank ABank BPaidDefaultStep 1Pay 1.5 billion yenduring Tokyo hoursStep 2Bank B's USDpayment falls dueStep 3Receive the dollarsand settleStep 3'Default and fail topay the dollarsStep 4Risk of losing thefull 1.5 billion yen
Figure 1Settlement of yen and US dollars with a time difference
Figure description

The flow shows the order in which yen is paid first and US dollars later. A loss arises only on the path where Bank B defaults, and it falls on Bank A, which pays yen first.

An example that shows the nature of this risk is the closure of Bankhaus Herstatt on June 26, 1974. German authorities closed the bank at 3:30 p.m. local time. Its counterparties in US dollar and Deutsche mark trades had already paid the marks in Frankfurt earlier that day. After the closure, the bank's New York correspondent bank stopped US dollar payments from its account, so the full amount of the marks was at risk3. Banks began holding back their own payments until they could confirm receipt, and cross-border payments stalled3. In the failure of BCCI in July 1991, a bank likewise paid yen and could not receive US dollars4.

How PvP works

Payment versus payment (PvP) is a settlement mechanism in which the final payment of one currency is made only if the final payment of the linked other currency is made5. It removes the risk of losing the full principal6. The two payments do not have to be strictly simultaneous. Even if their timing differs, it is enough that the legal, contractual, technical, and risk management framework ties each payment to the final payment of the other7.

In the example above, if PvP were used and Bank B defaulted, Bank A's yen payment would not be made, and the loss of principal would be avoided. One remaining risk is the additional cost of replacing the same trade at current rates (replacement cost)8. If the rate is 155 yen per dollar when the trade is replaced, buying USD 10 million costs 1.55 billion yen, which is 50 million yen more than the contract. If the rate is 145 yen per dollar, the purchase costs 1.45 billion yen, so there is no additional cost and the replacement is 50 million yen cheaper than the contract.

The liquidity risk of not receiving a currency when expected also remains89. PvP is a different function from that of a central counterparty (CCP), which steps between the parties and assumes their obligations8.

CLS Bank and settlement members

CLS Bank International (CLS Bank) is a New York bank that specializes in PvP settlement of foreign exchange trades10. It was established with funding from major private banks, and central banks of advanced economies, including the Bank of Japan, were closely involved in its creation11. It began operating on September 9, 2002, with 39 settlement members and 7 currencies10.

Settlement members participate in CLS directly and hold multi-currency accounts at CLS Bank10. Banks, funds, corporates, and other firms that are not settlement members use the service indirectly as third parties through a settlement member12. To become a settlement member, an applicant must meet requirements such as capital and credit rating, technical conditions and testing, and funding obligations. It must also be located in a jurisdiction where CLS has obtained satisfactory legal opinions on settlement finality and netting. As of March 2023, there were 76 settlement members, 95% of them banks13.

CLS Bank is regulated and supervised by the US Federal Reserve System in New York. The CLS Oversight Committee, coordinated by the Federal Reserve Bank of New York (New York Fed), also oversees it. The committee consists of the central banks of the G10 countries and the central banks of the currencies CLS settles10.

From pay-in to pay-out

Bank AMemberCLS BankBank BMemberInstructionPay-in JPYPay-out USDInstructionPay-in USDPay-out JPY
Figure 2Yen and US dollar payments through CLS Bank
Figure description

Bank A and Bank B send settlement instructions to CLS Bank, pay in funds, and receive pay-outs after settlement. Bank A pays in yen and receives dollars, and Bank B pays in dollars and receives yen. Dashed arrows are instructions and solid arrows are funds.

  1. Send settlement instructions (a settlement member, or a third party acting through one). Payment instructions for both currencies of the trade are sent electronically to CLS Bank. CLS Bank authenticates and matches the instructions and holds them until the settlement date12.
  2. Pay in funds (the settlement member). On the settlement date, CLS Bank shows a pay-in schedule for each currency. The settlement member pays in from its own account, or from a nostro account, to the account CLS Bank holds at each currency's central bank1210. The amount paid in is the net amount of the member's payments and receipts in each currency, netted across all settlement members12.
  3. Settle simultaneously (CLS Bank). Of the matched pairs of instructions, those that pass CLS Bank's risk management checks are settled simultaneously on CLS Bank's books12. Settlement takes place only once each party is certain to be able to pay its currency, and settled payments are final and irrevocable1112.
  4. Pay out funds (CLS Bank). The settlement member receives the net amount in each currency. A member's multi-currency account has a zero balance at the start and end of a normal business day12.

Settlement is gross, instruction by instruction, and only the pay-in of funds is net, so the funds paid in are smaller than the gross amount settled.

Consider a hypothetical example in which, in addition to the trade above, Bank A sells USD 4 million to Bank B at 150 yen per dollar for the same settlement date, with no other trades. The gross amounts settled are 2.1 billion yen (1.5 billion and 600 million) and USD 14 million (USD 10 million and USD 4 million). The amounts paid in are 900 million yen by Bank A and USD 6 million by Bank B. In this example, the pay-in is about 57% smaller than the gross amount in both yen and dollars. That reduction is smaller than the average, which in CLS's material is more than 96%12.

Yen funds are paid and received through accounts at the Bank of Japan. The yen funds for CLS transactions are settled through a current account (regular account). The Bank of Japan generally does not allow a party without a head office or branch in Japan to participate directly in its payment system from abroad. CLS Bank, which specializes in settling foreign exchange transactions, is the only exception14. How funds are settled through accounts at the Bank of Japan is covered on the Payment Systems: RTGS, BOJ-NET and Correspondent Banking page.

Eligible trades and settlement hours

As of the paper of the Bank for International Settlements (BIS) of June 2026, CLS Bank settles payments in 18 major currencies, including the yen, US dollar, and euro15. Any combination of two of the 18 currencies is eligible16.

The trades that can be settled are spot trades, FX forwards with a later settlement date (outright forwards), FX swaps, cross-currency swaps, and currency options17. For trades with a later settlement date, CLS Bank holds the instructions until the settlement date12.

Settlement takes place in a five-hour window16. PvP settlement services have cutoff times for instructions. For next-day settlement, an example cutoff is midnight Central European Time (CET)18. For trades that settle on the same day, CLS Bank offers a separate service, CLSNow. As of March 2023, CLSNow covered six pairs of four currencies16.

7 a.m.Settlement starts10 a.m.Target time to complete pay-ins forearly-closing currencies12 p.m.Target time to complete pay-ins forlate-closing currencies
Figure 3CLS settlement times (CET, February 2022 material)
Figure description

The figure lists, in order, the start of CLS settlement and the target times for completing pay-ins. The spacing does not represent elapsed time. The filled circle marks the start of settlement. The pay-in targets fall within the settlement window; the material does not give the order for each trade. The times are the start of settlement and the pay-in targets in CET, from CLS's material of February 202219.

Risk in trades that cannot use PvP

A trade that uses neither a PvP mechanism nor a method that reduces risk, such as netting, is settled one by one with the counterparty through correspondent banks. The time difference remains, and Herstatt risk extends to the full amount of the trade20. In the BIS survey, 36% of average daily settlement in April 2025 settled through PvP. A further 10% (more than USD 1.4 trillion) settled one by one without any method that reduces risk21.

By amount, a quarter of what was settled one by one was eligible for PvP but did not use it. Explanations based on cases include missing the settlement cutoff, difficulty in managing credit exposure to correspondent banks, and tight pay-in schedules22. Three quarters of the trades settled one by one were not eligible for PvP. The reasons are that the counterparty has no direct or indirect access to PvP, that the currency pair is not eligible, and that the trade type is not eligible, and they can overlap. The most common was that the counterparty has no access23.

Other PvP mechanisms exist for currencies outside CLS Bank. B3 in Brazil has settled specific currency pairs since 2002, CCIL in India since 2015, CHATS in Hong Kong since 2000, and Buna in the United Arab Emirates since 202324.

Principle 35 of the FX Global Code recommends that market participants consider settlement methods in this order25.

  1. Use a method that eliminates settlement risk, such as a PvP settlement service.
  2. If it cannot be eliminated, reduce its size and duration. Netting of FX settlement obligations is preferred.
  3. Minimize gross bilateral settlement as far as practicable.

Netting only reduces the amount to be settled by offsetting payments and does not remove the risk. The net amount still has to be settled by another method, and whether the offsetting is legally enforceable if a party defaults also matters26.

Payment checks, reconciliation of receipts, and other work around the settlement date are covered on the Settlement page.

Notes

  1. Bank of Japan, "金融機関の決済リスク管理について" (Settlement Risk Management at Financial Institutions, in Japanese) (external site) (February 2000), Box 2 ("（BOX２）外為決済リスクについて", on FX settlement risk), page 25. ↩ ↩2

  2. The same document, page 26. It states that in a sale of yen for dollars the yen payment comes first and there is a risk of not receiving the dollars, whereas in a purchase of yen for dollars there is normally no such risk. ↩

  3. Bank for International Settlements, "Uncovering FX settlement risk: new measures from the 2025 BIS Triennial Survey" (external site) (BIS Quarterly Review, June 2026), opening paragraphs. ↩ ↩2

  4. Bank of Japan, "金融機関の決済リスク管理について" (in Japanese) (external site), footnote 12, page 13. ↩

  5. BIS Committee on Payment and Settlement Systems and IOSCO Technical Committee, "Principles for financial market infrastructures" (provisional Japanese translation "金融市場インフラのための原則（仮訳）", in Japanese) (external site), Principle 12, footnote 113, page 108. ↩

  6. The same document, Principle 12, key considerations and explanatory note 3.12.1, page 107. ↩

  7. The same document, explanatory notes 3.12.3 and 3.12.4, pages 108–109. ↩

  8. Bank for International Settlements, "Uncovering FX settlement risk" (external site), section "The 2025 methodology for assessing FX settlement risk". ↩ ↩2 ↩3

  9. "金融市場インフラのための原則（仮訳）" (in Japanese) (external site), Principle 12, footnote 112, page 107. Systemic disruption, including a liquidity dislocation, is not removed. ↩

  10. Deutsche Bundesbank, "Continuous Linked Settlement" (external site), sections "Introduction" and "Implementation". ↩ ↩2 ↩3 ↩4 ↩5

  11. Bank of Japan, "頑健な決済システムの構築に向けて" (Toward Building Robust Payment and Settlement Systems, in Japanese) (external site) (speech by Governor Masaaki Shirakawa, November 13, 2009), the paragraph on the mechanism that prevents FX settlement losses. ↩ ↩2

  12. CLS Group, "CLSSettlement" (external site) (February 2022), "How it works – the settlement cycle". ↩ ↩2 ↩3 ↩4 ↩5 ↩6 ↩7 ↩8 ↩9

  13. Committee on Payments and Market Infrastructures, "Facilitating increased adoption of payment versus payment (PvP) - final report" (external site) (March 2023), Table A2, page 28. ↩

  14. Bank of Japan, "日本銀行が運営する資金決済システムに関する情報開示" (Disclosure on the Payment Systems Operated by the Bank of Japan, in Japanese) (external site) (July 31, 2025), page 3 and footnote 10 on page 15. ↩

  15. Bank for International Settlements, "Uncovering FX settlement risk" (external site), section "The 2025 methodology for assessing FX settlement risk". The list of currencies is in note 1 on page 1 of CLS Group, "CLSSettlement" (external site). ↩

  16. Facilitating increased adoption of payment versus payment (PvP) - final report (external site), page 11. ↩ ↩2 ↩3

  17. The same document, Table A1, page 27. ↩

  18. Bank for International Settlements, "Uncovering FX settlement risk" (external site), section "Reasons for gross bilateral settlement". ↩

  19. CLS Group, "CLSSettlement" (external site), "CLSSettlement operational timeline". ↩

  20. Bank for International Settlements, "Uncovering FX settlement risk" (external site), section "The 2025 methodology for assessing FX settlement risk", the paragraph on gross bilateral settlement. ↩

  21. The same document, section "FX settlement risk in April 2025". ↩

  22. The same document, section "Reasons for gross bilateral settlement". ↩

  23. The same document, the same section. The three reasons can overlap. ↩

  24. The same document, section "The 2025 methodology for assessing FX settlement risk". ↩

  25. Global Foreign Exchange Committee, "FX Global Code" (provisional Japanese translation "グローバル外為行動規範" by the Tokyo Foreign Exchange Market Committee, in Japanese) (external site) (December 2024 edition), Principle 35, pages 40–41. ↩

  26. Bank for International Settlements, "Uncovering FX settlement risk" (external site), section "The 2025 methodology for assessing FX settlement risk". ↩

  27. FX Global Code (in Japanese) (external site), Principle 35, page 41. ↩