The regulators, still reeling from the deficiencies exposed by the global financial crisis of eight years ago, have undertaken a wholesale review of the way that liquidity is provided, paid for and monitored. They want to make sure that banks can meet their obligations, especially when the market is stressed, and traditional sources of liquidity have dried up.
In the world of securities settlement, this focus on intraday liquidity, has also brought about new opportunities, not least the new T2S settlement system operating in Europe. By establishing a harmonized settlement infrastructure in central bank money, T2S is fundamentally changing the settlement landscape in Europe.
Banks used to provide intraday liquidity for free. In many ways, it was a function of settlement systems that were not harmonized, for instance due to different closing times on different exchanges or different securities. “There are multiple sources of intraday liquidity usage in every single market,” says Francois-Xavier Bouillet, Managing Director, Repo Trading Europe at Goldman Sachs.
“We never worried about it before because this liquidity was free. Everyone had an allowance they could tap. But now because of new regulations such as CSDR, all custodians have to set capital against intraday liquidity usage. They need to monitor it and set cash against it and so they have to charge for it.” One of the panellists suggested that because banks need to hold capital against intraday liquidity, intraday liquidity has a price and that price needs to be charged onto clients. As the cost of collateral has gone up and the yield has gone down, what was once a free commodity is now becoming more expensive.
When banks need to start charging for what had hitherto been a free service, a new business line is created. And as every bank must do the same, it also creates a competitive situation, where those fees come under pressure.
Much the same is happening to the world of investment research, where clients now need to assign a value to this research that was once provided as a part of a wider execution service.
For forward-thinking institutions, this is not just a threat to existing ways of doing business. It is also an opportunity. And for intraday liquidity is now just such an opportunity. But getting from the big picture to a working system carries some execution risk. “The devil is in the detail,” says Bouillet. “There has to be an incentive now for each end user to reach out to their custodian and tell them how they want their system to work.”At Euroclear’s recent Collateral Conference in Brussels, the audience of 600 senior executives from the world of custody, clearing and settlement, were asked what the main drivers behind their intraday liquidity needs were.
The most important, according to nearly half the audience, was collateral mobilization and transformation. This was followed by the need for interoperability between settlement and cash infrastructures. Two other issues were also cited, namely the different settlement cut-off times per currency and also margining calls for cleared and non-cleared activities.
Given this array of drivers, it is no wonder that what on paper seems a relatively simple situation, is actually fraught with difficulties. However, the T2S settlement system being established by the ECB is proceeding smoothly ahead of full harmonization by the end of 2017. It will offer full centralised delivery-versus-payment (DvP) settlement in central bank money across all European securities markets.
T2S has removed barriers and eliminated differences between domestic and cross-border settlement by offering a single market infrastructure. According to market participants, the crucial benefit of the system is that it allows the ECB to provide the liquidity, allowing banks to focus on serving their clients. “What I like is that it means the creation at will by the central banks of intraday liquidity,” says Bouillet. “It greases the wheels of the markets.”
The end users of the T2S system see the benefits in many ways. “From a treasurer’s point of view the benefits of T2S are clear,” says Patrice Braulotte, Treasurer, ECB Collateral Management, Central Treasury at BNP Paribas.
“For instance, if you are settling a trade of French vs Italian government bonds there was always some daily imbalance. Before T2S this imbalance was a concern, but now we will have a single cash account with the Bank of France and we can settle all these international trades via them. So T2S for me is going to bring about the end of liquidity holes in 23 or 24 domestic markets in Europe. Intraday liquidity risks are therefore reduced. This means there will be less need of a buffer and our cash forecasting will be improved.”
For the participants at Euroclear’s Brussels conference, the biggest benefit of the T2S system is the way that it allows such improved operational efficiencies with a single point of settlement. Secondary benefits include the ability to reduce intraday liquidity usage and settle in central bank money as well as the ability to net cash payments and improve repo netting opportunities
“T2S brings a big benefit in that if there is one single cash account and also self-collateralisation, it will help banks achieve lower intraday liquidity usage,” says Eric de Spirlet, Head of Credit and Liquidity Product Management at Euroclear.
By establishing T2S, the authorities now have a greater understanding of the post-trade system, and have a vested interest in making it as simple and transparent as possible. It also shows that when new regulations and market infrastructures come together, what could have been a huge additional headache for market participants, in reality turns into a huge market opportunity.