From a cash perspective, market players can be roughly divided in two categories:
- Self-financing players, ensuring liquidity through their own central bank account or their agent bank account, while leveraging assets eligible at central banks to get an intraday credit line and optimising liquidity cost. Their objective is to limit the liquidity and collateral required to fund settlement. However, even investors with traditionally long cash balances can find themselves in need of liquidity solutions, especially in specific market conditions causing turnover to peak.
- High financing consumers. These rely on their agent bank to get intraday credit lines, with or without collateral. Their objective is to secure sufficient credit lines at a reasonable cost of liquidity and collateral. For example, some agent banks are able to extend credit on the basis of the portfolio instant valuation, avoiding the need to immobilise collateral regardless of the asset class.
In all cases, ensuring the liquidity of the system while minimising its costs is the Holy Grail of both treasurers and collateral managers. Now that 90% of total foreseen volumes have been onboarded in the platform, does T2S help achieve this goal? We propose to answer this question leveraging our experience since T2S’ launch, across all T2S major markets.
Intraday liquidity cost is not only the cost of liquidity…
The first and obvious cost of intraday liquidity is how much the treasurer has to pay to source the cash he will inject in the T2S dedicated cash account. This cost is highly dependent on the available long cash balances or the cost to source collateral. Also, having to mobilise significant amounts of cash to fund the settlement activity precludes from using this cash as collateral or to invest it in money markets.
On the contrary, not foreseeing enough cash may result in settlement fails or blocking, which could trigger penalties, buy-ins, collateral neutralisation by central banks, unability to cover exposures and finally client dissatisfaction. Strict monitoring must be put in place, and responsiveness is the key.
Moreover, there may be a need for an arbitrage between relying on free purchasing power obtained thanks to NCB auto-collaterisation and using the collateral for other purposes such as tri-party collateral management platforms and /or CCPs margin calls coverage.
Hence, intraday liquidity costs is not only the basis points the treasurer may pay to fund the settlement activity, but also the cost of optimising this resource across multiple needs, choosing and implementing the most relevant setup, while deploying the required tools and monitoring it throughout the day.
The BNP Paribas Securities Services case
From a fragmented to a centralised, consolidated cash setup
Before T2S, BNP Paribas Securities Services had to maintain four EUR cash account with the central banks of the main EUR markets to fund the settlement activity we were operating on behalf of our clients. Obviously, this implied a number of cash transfers between each of them, but also a close monitoring of standing order liquidity transfers to cover the needs of all these accounts (both initial needs and throughout the day), and a delicate management of late trades close to each market DVP cut-off.
In addition, each market had its own way to benefit from central banks collateralised intra-day liquidity financing, ESES and Monte Titoli being the only CSDs integrating (in a different way) an auto-collaterisation mechanism.
Four different teams, in four countries, managed the Treasury operations.
With T2S, we have been able to rationalise the setup in every aspect:
A single DCA for all our T2S markets (unless requested by clients), maximising the netting effect across Europe
NCB auto-collaterisation activated whenever and wherever possible, with the ability to collaterise transactions with stock held out of the CSD where it settles
A single treasury team to operate the DCAs in close interaction with the settlement teams, a harmonised cash accounting setup and cash reconciliation concentrated in one place for the whole T2S activity
Liquidity optimisation: show me the numbers
Beyond the operational efficiency gains, what about true liquidity optimisation? Does a setup with a single DCA and cross-borders NCB auto-collaterisation match T2S promises?
Here is the result of our analysis, based on the settlement activity of BNP Paribas Securities Services since Wave 1 and which include all T2S major markets (ESES markets, NBB, Germany, Italy), migrated before Wave 5.
This graph shows that, while NCB auto-collaterisation amount increases, it does so less than settlement turnover. There are two explanations to that.
The first is that BNP Paribas Securities Services’ clients fixed income activity is much more important in Italy (Wave 1) than in Germany (Wave 4). However, this does not explain the absence of a “bump” with Wave 3 (ESES markets migration in September 2016). The reason is simple: the netting effect. With 90% of its Continental Europe volumes settling in a single DCA, the netting effect has significantly limited the need to bring additional cash or collateral to the system.
The next graph better highlights this netting effect.
For each wave, we have calculated the NCB auto-collaterisation intensity, defined as the ratio of average monthly NCB auto-collaterisation amounts to the average monthly purchases. At 20,5%, the ratio for Wave 2 is significantly higher with a high fixed income activity both in Monte Titoli and NBB-SSS. It starts decreasing in Wave 3 then Wave 4, where activities are more mixed equities and bonds, to below 14%. We expect Wave 5 (including the Spanish market) not to change this trend.
In a world of cash scarcity and increased cost, with T2S, we have been able to drastically simplify the cash setup across markets, and optimise the intraday liquidity. Our numbers have demonstrated that both NCB auto-collaterisation and netting effects cross-markets allowed for limiting, or even suppressing the need to bring cash to the system during the day. T2S also brought substantial efficiency gains on treasury operations, and a reduction of the risk stemming from liquidity fragmentation.
However, the target setup needs to be carefully considered, and depends on the liquidity profile of each player (liquidity requirements, eligible collateral, netting effect), as self-funding is not always cheaper than the one that could be provided by a payment bank. Finally, the implementation also requires specific attention to remaining market specificities (positions/account earmarking for NCB auto-collateralisation, close links management, cash incomes paid out of T2S…) and internal operational aspects while using a single DCA for multiple markets (treasury organisation, NCB auto-collaterisation transactions release, cash accounting and reconciliation).
- DCA: Dedicated Cash Account. Cash account opened with a National Central Bank, linked to the securities accounts in T2S and used by T2S for payments (DVPs, incomes and dividends).
- Payment bank: Owner of the DCA. In T2S, the payment bank and the owner of the securities account may be different.
- NCB Auto-collaterisation: An automated T2S feature allowing to obtain from the National Central Bank (NCB) an intraday cash facility in case of lack of cash in the DCA. This is granted in exchange of eligible collateral being purchased or held in the securities accounts.