The Collateral-Linked Currency Forward (CLCF) Contract: Blockchain-Enabled OTC Currency Forward Market Infrastructure

Abstract

We eliminate the primary source of uncompensated risk from trading in one of the largest sectors of the global financial markets. Market infrastructure enhancements are achieved in the foreign exchange (FX) forward contract market by integrating distributed ledger technology (DLT) into the creation of collateral-linked contracts for currency forwards (CLCF). Specifically, we deploy DLT with embedded automation as the shared platform for bilateral FX forward contracts, including operational provisions of International Swaps and Derivatives Association and Credit Support Annex agreements. Through automation, we link the economics of the currency forward contract and the price-volatility-induced counterparty exposures, bringing intraday counterparty risk to within mutually acceptable ranges. The essential benefits of the over-the-counter market structure are preserved because CLCF contracts remain bilateral to allow for customized terms and conditions between market participants. Reduced concentration risk is also preserved because there is no central counterparty or central clearing organization into which all risks are pooled. As a result, liquidity is enhanced and risk is reduced in the FX forward contract market. <b>TOPICS:</b>Futures and forward contracts, currency, performance measurement, risk management