Beyond T2S Optimising liquidity management in...

Deutsche BankGlobal Transaction Banking

Beyond T2S

Optimising liquidity management in securities settlement

Contents Introduction /3 Liquidity challenges in T2S /4 LiquiditybenefitsofT2Sarchitecture/6 Liquidity optimisation in T2S /7 AdditionalliquiditysolutionsT2Smightfacilitate/10 SolutionsbeyondthescopeofT2S/11 Whatisthefutureoutlook?/12

WiththeintroductionofTARGET2-Securities(T2S),thesettlementofsecuritiesinparticipatingmarketsbecomesrealtimeandrequiresupfrontfundingincentralbankmoney.Settlement Providers who act as T2S Payment Banks are requiredtoanticipatetheirliquidityneedstofacilitatethesecuritiessettlementprocess.Thiswhitepaperexploresfourkeyaspectsoftheliquiditymanagementprocessforinvestors and their service providers: liquidity challenges in T2S;liquiditybenefitsofT2Sarchitecture;additionalliquiditysolutionsT2Smightfacilitate;andsolutionsbeyondthescopeofT2SthatcouldneverthelesshelptosimplifyandalleviateliquiditychallengesforT2Sparticipants.

ThearchitectureofT2Shelpsintheprocessofliquidityoptimisationinspecificwaysthatthepaperoutlines.Italsoconsidershowreporting requirements relating to T2S can be accommodated andlooksbeyondtheplatformitselfforadditionaltechniquesthatcustodiansandotherT2Sserviceprovidersmaybeabletooffertomitigatebroaderliquidityconstraints.

3 Liquidity management in T2S

Introduction

Cross-bordersecuritiessettlementinEuropehas,overthepasttwodecades,requiredlinksthroughachainofintermediariesfromtheinvestordowntoanationalCentralSecuritiesDepository(CSD)ontheonehandandanationalCentralBank(NCB)ontheother.Thelastlinksinthischainhavetraditionallybeenhandledbyalocalcustodianwithdirectmembershipatbothofthesemarketinfrastructures.SettlementhastypicallytakenplaceinCentralBankmoney(CeBM)atamarketlevel(betweenthecustodianandtheCSDandCentralBank)andincommercialbankmoneyataclientlevel(betweenthecustodiananditsclient).

Overthepastfewyears,astrongeremphasis on risk management in thedesignofmarketinfrastructurehasbeenreflectedintheshifttowardsreal-timegrosssettlement(RTGS)inlarge-valuepaymentsanddeliveryversuspayment(DVP)insecuritiessettlement,bothassociatedwith greater liquidity pressures on participants.

WiththeintroductionofTARGET2-Securities(T2S),thesettlementofsecurities in participating markets becomes real time and requires upfrontfundinginCeBM.Inthisregard,T2Sofferscustodyclientsachoice:tosettleintheclient’sCeBMthrough its own Dedicated Cash Account(DCA)orviathecustodiansDCA/CustodianCeBM.Sofarclientshave yet to demonstrate a particular preference,thoughtheavailabilityoftheseoptionshasyettobemarketed.Custodians will nevertheless need toshowflexibilitytoaccommodatewhatever approach the client ultimatelyadopts.

Evaluatingliquidityrequirements and opportunities

Settlement Providers who act as T2S Payment Banks are required to anticipate theirliquidityneedstofacilitatethesecuritiessettlementprocess.Inthiscontext,howcanmoreeffectiveallocationofcashandricherfundingopportunitiesbestbeachieved?

Inexploringanswerstothisquestion,thesecondinourwhitepaperseriesfocusesonfourkeyareas:

Â liquidity challenges in T2S;

Â liquiditybenefitsofT2Sarchitecture;

Â additional liquidity solutions T2S might facilitate;and

Â solutionsbeyondthescopeofT2Sthatcouldhelptosimplifyandimproveliquidity

THEARCHITECTUREOFT2SHELPS

INTHEPROCESSOFLIQUIDITYOPTIMISATION


Liquidity challenges in T2S

BeforetheimplementationofT2S,liquiditybufferswerehelddiscretelyineachmarket.Thisinvolvedbilateralarrangementsbetweenclientsandprovidersforintradayliquidityprovisioning.WiththerolloutofT2S,firmsthatrelyonintradayliquidityarelookingatwaystominimisetheliquiditytheyusefromproviders,particularlyinlightoftheprogressiveimplementationofnewregulatoryrequirements.Severalofthesehavetheirownimpactonliquidityneeds.Suchregulationsinclude,butarenotlimitedto,BaselIII,theLiquidityCoverageRatio(LCR)andtheSupplementaryLeverageRatio(SLR).

Client

Provider

Client

option

Provider

Pre T2S Post T2S


Regulationsimpactingliquidityinclude,butarenotlimitedtoBaselIII,theLiquidityCoverageRatio(LCR)andtheSupplementaryLeverageRatio(SLR)

BASELIII

BaselIIIisaframeworkofglobalregulatorystandardsonbankcapitaladequacyandliquidityagreedbyCentralBankGovernorsandHeadsofSupervisionandendorsedbytheG20.Itsaimistoensurehigherandbetter-qualitycapital,betterriskcoverageandabuild-upofcapitalasabufferintimesofstress.

TheBaselCommitteeonBankingSupervision(BCBS),inconsultationwiththeCommitteeonPaymentandSettlementSystems(CPSS)hasdevelopedasetofquantitativetools(BCBS248)toenablebankingsupervisorstomonitortheintradayliquidityriskofbanksundertheirsupervisionandtheabilityofthosebankstomeetpaymentandsettlementobligationsunderbothnormalandstressedconditions.AccordingtotheBIS,ThenewBaselIIIliquidityrulesmarkthefirsttimethatspecificglobalquantitativeminimumstandardsforliquidityhavebeenintroduced.

LCR

Theliquiditycoverageratioisdesignedtoensurefinancialinstitutionshavethenecessaryassetsonhandtorideoutshort-termliquiditydisruptions.Itdoesthisbyensuringthatbankshaveanadequatestockofunencumberedhigh-qualityliquidassets(HQLA)thatcanbe converted easily and immediately in private markets into cash to meet their liquidity needsfora30calendardayliquiditystressscenario.

SLR

TheSupplementalLiquidityRatio(SLR)isanon-risk-basedmeasureintendedtobea“backstop”totherisk-weightedcapitalrequirementsunderBaselIII.Itlimitstheamountofleveragethatabankingorganisationmayincur.

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ii

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LiquidityBenefitsOfT2Sarchitecture

ThearchitectureofT2Sitselfhelpsintheprocessofliquidityoptimisationinfourspecificways:byintroducingtheoptionofasinglededicatedcashaccount(DCA)withaparticipatingCentralBank;throughitsAuto-Collateralisationfacility;bytechnicalnetting;andtheuseofanovernightsettlementcycle(Seebelow).

ThefirstofthesedoesawaywiththeneedformultipleeurocashaccountswithdifferentCentralBanksintheEurozone.OnlyoneeuroCentralBank cash account – the dedicated cashaccount(DCA)–issufficientforall T2S transactions to settle in all T2Smarkets.

Inaddition,bothsecuritiesaccountsand cash accounts are integrated onasingleITplatform.Theplatformaccommodates both the market participants’securitiesaccounts,held

ateitheroneormultipleCSDs,andtheirdedicatedcashaccounts(DCAs)held with their respective national CentralBankexclusivelyforsettlementinT2S.DCAsareinturnlinkedtoacashaccountinTARGET2viatherelevantCentralBank.Theuseofthismodel allows T2S to connect any securities account at a participating CSD with any cash account at any participatingCentralBank(SeeDiagram1).

*FacilitatesaSinglecentralbankfundingforallT2Smarkets

T2S Platform

Client

AgentBank

AgentBank Agent Bank

AgentBank

CSD

Local Settlement platform



CSD CSD CSD CSD CSD

NCB NCB

Client

NCB Single NCB*

Pre T2S Post T2S


CLIENTSSHOULDLOOkTOWORkWITHTHEIRPROVIDERSNOWTODEVELOPSOLUTIONSTOTHEIRLIQUIDITYNEEDS


Theavailabilityofthesetechniqueswill,tosomeextent,dependonclients’accountpreferences.DeutscheBankclientscan,forexample,choosewhethertosettleintheirownCeBMandtakeotherservicesfromtheBank or they can settle in Deutsche Bank’sCeBMandenjoyotherbenefitsattachedtothis,suchasthebank’sprefundingserviceanditsowncreditlineswiththeBundesbank.

Impactofovernightsettlementcycles

T2Shasadoptedtheuseofanovernight settlement cycle to settle themajorityoftransactions.FortheperiodSeptember-December2015,T2Ssettled,onaverage,1.87millionsecuritiestransactionspermonth.Some76%weresettledovernight,comparedto24%intra-day.Theresultofthisistosubstantiallyreduceintradayliquidityrequirements.

Technical netting

Technical netting reduces the needforcashandsecuritiesbygrouping transactions into a set and calculating the net quantities and amountstobesettledonanall-or-nonebasis.Thesenetquantitiesandamountsarethebasisforthe checks against the available resourcesandassessmentofintradaycreditrequired.

Partial settlement

Partial settlement enables splittingoftransactionswhere only limited resources remainavailable,providedthesettlement instructions agreed bythecounterpartiesallowforit.

Settlement optimisation algorithms

Thesefavourthesettlementoftransactions with a higher level ofpriority,followedbytheoldestintendedsettlementdate,inawaythatmaximisesthevolumeandvalueofsettlement.OptimisationalgorithmsexaminealltransactionsindifferentISINstoidentifychains.

Auto-collateralisation

Auto-collateralisationisacostefficientwaytocreateadditionalintra-dayliquidity,usingthevalueofsecuritiesonflow(securitiesreceipttransactions)andonstock(securitiesholdings).Byflaggingtheseforauto-collateralisationusage,T2SallowsthetransformationofthestockvalueintoextraintradayliquidityontherespectiveDCA.This,inturnenablesRvPsecuritiestransactionstosettlewithouttheneedtofillthelackofcashontherelatedDCAthroughaliquiditytransferfromaT2account.

Auto-Collateralisationconsistsoftwotypes:oneinvolvingcreditprovidedbythecentralbanktothepaymentbank(DCAaccountholder);andasecond,clientcollateralisation,wherethepaymentbank(DCAaccountholder)providescredittoitsclients.Byfacilitatingoptimalusageofliquidityandsecurities,auto-collateralisationisexpectedtosignificantlydecreasebanks’liquidityneedsandborrowingcostsaswellasthenumberoffailedinstructions.

Liquidity optimisation in T2S

T2Saimstoimprovesettlementratesbyofferinganumberofoptimisationfeatures:


i General reporting requirements

InordertomanageliquidityefficientlyT2Sparticipantsrequireappropriaterealtimeintra-dayreportingthatallowsforpropercashforecasting,calculatingtheirliquidityneedsandcateringforrespectiveliquiditytransfersintotheirDCAaccount,inatimelyandautomatedmanner.

T2Sparticipantsalsoshowdifferentrequirementswhenitcomestoreportingformats;someareSWIFTISO20022compliant,whilstothersrequireSWIFTISO15022messagesandsomemayhavespecificadditionalreportingneeds.

ii T2S reporting offering

ConnectivitychoicetoT2Sforbothsecuritiesaccounts(SAC)andDCAaccountshasanimportantbearingonreportingoptions.Participantscanchoosewhethertoconnectasanindirectlyconnectedparty(ICP)ordirectlyconnectedparty(DCP)forboththeirSACandDCAaccounts.ThetypeofT2Sconnection(ICPorDCP)triggersthereportingthatparticipantsreceive.LiquidityreportingforDCPscomesinISO20022format,whileICPswillreceivereportingintheCSD’sexistingformatusuallyISO15022.

iii Service providers’ reportingoffering

Liquidityreportingtodayalreadyformspartoftheserviceproviders’coreserviceofferingandisprovidedtoclientsviaSWIFT,web-toolsandotherformats,accordingtoclients’needsandserviceproviders’flexibility.

Whenitcomestoreportingrequirements,“real-time”iskeyintwoways:itenablesefficientmanagementofintra-dayliquidityandallowsclientstomeetregulatorydemands.Serviceprovidersmuststayflexibletomeettheseclientdemands.

Reporting

Additional liquidity solutions T2Smightfacilitate

T2SPARTICIPANTSREQUIREAPPROPRIATEREALTIMEINTRA-DAY

REPORTING


LIQUIDITYREPORTINGTODAYALREADYFORMSPARTOFTHESERVICEPROVIDERS’CORESERVICEOFFERING


WhileinteractionwithT2Sinvolvesspecificliquidity-relatedoperationsthatparticipantswillneedtoaddressonadailybasis,thebroaderobjectiveofliquidityoptimisationmaybeenhancedbydrawingontechniquesthat,whilebeyondthescopeofT2Sasaplatform,mayhelpalleviateliquiditydemands.

SolutionsbeyondthescopeofT2S

Theavailabilityofcollateraloptimisationtoolsallowsforthecreationofnewflowfinancingsolutions(“FlowFinancing”)toprovide working capital liquidity tofinancialintermediaries.Clientssuchasbrokerdealers,whomayhave limited access to unsecured finance[duetoregulatorypressure]couldbenefitsignificantlyfromFlowFinancing.DeutscheBankisworkingwithanumberofbrokerdealerstorealisethispotential.

Flow Financing

Flow Financing is a potentially cost-effectivetoolavailablethroughanagentbankprovider.Itallowstheagentbank,toadvancecashagainst long securities in a client’s account(whichmaybeintransit).Thisiseffectivelyaformofovernightrepo which allows the securities to beavailableforthenextdaylightsettlementcycle.Thisiscostefficientfortheclientandtheagentbank.Toillustratethebenefits,weprovidetwoexamplesofabrokerdealerclientofanagentbank.

Example1.Failedtradefinancing

Assume the broker dealer has a securities account and a cash account withtheagentbankthatactsasitscustodian.Foreveryselltrade,theagentbankdeliverssecuritiesandreceivescash,whileforeverybuytrade;itreceivessecuritiesanddeliverscash.

Thebrokerdealerwouldnormallybeflatsecuritiesattheendofeachdayandwillholdsomeresidualcashinthecashaccount.Onmostdays,however,theclienthassecuritiesremaininginitsaccountassometradeswillnothavesettled.Inthisevent,theanticipatedcashwouldnothavebeenreceivedintheclient’scashaccount,whichwouldconsequentlybeindebit.Thedebitpositioncreatescreditriskfortheagentbankandhascostimplicationsfortheclientastheagentbankleviesoverdraftfeestocoverthebalancesheetcostsofthisrisk.

As the broker dealer will normally have title to the long securities in its securities account it could try to repo the securities overnight to raise cashandoffsetthedebitbalance.Inpracticethisisnotpossibleasi)repomarketswillhaveeffectivelyclosedsomehourspreviouslyii)thereislimitedappetiteforovernightrepoandiii)thecut-offtimesforinterbankcashpaymentsmeanend-of-dayfinancingisonlypossibleusingintrabankcashpayments.

Thesolutioninthisexampleisaflowfinancingtransactionwherebythebrokerdealerandagentbankenterintoafinancingagreement.Thebankutilises long securities in the securities account as collateral and provides shorttermcashtotheclient,equaltothevalueofthesecurities,minusahaircut(apercentagepointdiscountontheassetvalue).Thisreducestheoverdraftandoffersacosteffectiveandefficientbalancesheettradeforboththebankandthebrokerdealerclient.Thetradeisthenreversedoutfirstthingthefollowingday.


Diagram2[FlowFinancingvisuallydemonstrated]

CLIENTSCANBENEFITFROM

FLOWFINANCINGSOLUTIONS

Example2:TimeSensitiveObligations

Inthisexamplesimilartotheoneabove,theclient(typicallyabroker-dealer)hasanobligationtomeetatime-sensitivepayment(e.g.amargincall,CLSPay-inetc).Suchpaymentsarepartofthedailytransactionflowoftheclient’sbusiness.Theclienttypicallyholdssufficientcashtomeettheseobligations,butmaybeunabletogetthecashtothesettlementbankintimeowingtotightoperationalconstraintsandchallengingtime-linesimposedbythemarketinfrastructures.

Clientscanbenefitfromflowfinancingsolutionsthatallowthesettlementbanktouserepo-likeinstrumentstofacilitateintra-bankpaymentssecuredbyagreedcollateral.Thecollateralistransferredviatitletransferorpledgeusingtripartiteinfrastructuresorviaseamlesscollateral mobility solutions enabled by the harmonisation and simplificationofferedbyT2S.

Thisallowstheinstitutiontooutsourceitstime-sensitiveoperationalobligationswhilstfocusingoncoretreasuryandfundingactivities.

Cash

Agent Bank TriParty Agent Client takes delivery of securities and simultaneously pays out cash. Due to failed trades, securities remain in the client’s securities account and no cash is received

Securities are transferred from the client’s securities account to the Agent Bank’s securities account, held with a TriParty agent

On receipt of securities, the Agent Bank makes a cash payment to the client’s cash account to the value of the collateral that was received

On T+1, the Agent bank will utilise a PoAto make a cash payment from the client’s account back to its own account

Following payment, the securities will be returned to the clients securities account held with the Tri-Party agent

The securities will then be available in the client’s securities account to attempt onward settlement

The client will receive cash from the settlement of the security and their cash account with the Agent Bank will be credited with the cash

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4 3 5 2

Cash

Cash

DB A/CDB AG LDN

DB SecuritiesA/C

Client A/CDB AG LDN

Client SecuritiesA/C

Cash

Securities

Securities

Securities Securities

CLIENTSSHOULDLOOkTOWORkWITHTHEIRPROVIDERSNOWTODEVELOPSOLUTIONSTOTHEIRLIQUIDITYNEEDS


Whatisthefutureoutlook?

Clientsshouldalsobelookingaheadtofuturerequirements.How,forexample,willtheadventofamulticurrencyenvironmentaffectthebenefitsofcashpoolinginT2S?Althoughthebenefitsforeurowillremain,poolingbenefitsacrossmultiplecurrencieswillnotbepossibleintheT2Splatformalone,sinceseparateDCAswillnowberequiredforeuroandothercurrencies.Multiplecentralbankrelationshipswillthereforecontinuetobeneeded.Clientsshouldlooktoworkwiththeirprovidersnowtodevelopsolutionstotheirliquidityneedsinthemulti-currencyenvironment.

Bringing T2 and T2S closer together

TheEurosystemisexploringsynergiesbetweenT2andT2Swiththeaimofdevelopingapan-Europeaninstantpayments solution and assessing thepossibilityofharmonisingandimproving collateral management arrangementsintheEurosystem.

Inordertosuccessfullyachieveaharmonisationofthetwoplatforms,itis imperative that the industry works together,consideringtheneedsofallkeyindustrystakeholders.

Afirstreviewofindustryparticipantsyieldedthefollowingneeds:

Â StabilisationoftheT2Splatformbeforeconsideringamerger with T2

Â TheinclusionofkeyT2/T2S industry stakeholders in the dialogue on a potential platformmerger

Â A clear and well prepared time line

Â Considerationofmessagingformat(s),includingaviewondigitalisation

Â Considerationofnon-operational T2 holidays andworld-widetime-zoneneedsinlightoftherequiredoperatingwindowoftheT2Ssecurities business

Conclusion

Althoughcomplex,liquiditymanagementcanbesimplifiedwiththehelpofspecifictoolsavailablewithin T2S as well as tools provided bytheclient’sagentbank,whichare complimentary to the technical platform.Experiencedagentbanksarewell positioned to help guide clients inthisregard.Clientsshouldconsiderthe ideas contained within this paper as potential contributors to alleviating liquidity pressures in a post T2S environment.

ThisbrochureisforinformationpurposesonlyandisdesignedtoserveasageneraloverviewregardingtheservicesofDeutscheBankAG,anyofitsbranchesandaffiliates.ThegeneraldescriptioninthisbrochurerelatestoservicesofferedbytheGlobalTransactionBankingofDeutscheBankAG,anyofitsbranchesandaffiliatestocustomersasofAugust2016,whichmaybesubjecttochangeinthefuture.Thisbrochureandthegeneraldescriptionoftheservicesareintheirnatureonlyillustrative,doneitherexplicitlynorimplicitlymakeanofferandthereforedonotcontainorcannotresultinanycontractualornon-contractualobligationorliabilityofDeutscheBankAG,anyofitsbranchesoraffiliates.

DeutscheBankAGisauthorisedunderGermanBankingLaw(competentauthorities:EuropeanCentralBankandGermanFederalFinancialSupervisoryAuthority(BaFin))and,intheUnitedkingdom,bythePrudentialRegulationAuthority.ItissubjecttosupervisionbytheEuropeanCentralBankandtheBaFin,andtolimitedsupervisionintheUnitedkingdombythePrudentialRegulationAuthorityandtheFinancialConductAuthority.Detailsabouttheextentofourauthorisationandsupervisionbytheseauthoritiesareavailableonrequest.

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