Global Liquidity Management in the Future Nynke Doornbos De Nederlandsche Bank 4th Conference on Payments and Securities Settlement Systems Ohrid, Republic of Macedonia, 21 June 2011 Appetizer The financial crisis was/is a liquidity crisis and the world becomes smaller Today’s presentation: do we need new infrastructures or new central bank arrangements given current trends in international liquidity / collateral? 2 Appetizer Basis: internal research and discussions with banks • Dutch liquidity seminar • European liquidity seminar (hosted by RBS) – 20 banks Work in progress, not necessarily a DNB opinion! 3 Outline of this presentation 1. Introduction 2. Trends in international liquidity and collateral (+ banks’ observations on these trends) 3. Existing cross-border arrangements for transfer of cash and collateral (+ banks’ view on them) 4. Ideas for new infrastructural solutions 4 I Introduction Overview of liquidity problems This presentation is about liquidity mismatches: 1. a currency mismatch (bank is sufficiently liquid in one currency, but not in another) 2. a collateral location mismatch (enough securities collateral but issued/located in the “wrong” country) Solutions are usually easy in normal circumstances: your network of correspondents and custodians can help Your bank 5 I Introduction Liquidity mismatches But what if “the shit hits the fan”? 6 I Introduction Liquidity mismatches Then Central banks / infrastructures can help ! Your bank 1. Accept foreign cash as collateral to address a currency mismatch 2. Accept foreign securities as collateral to deal with a collateral location mismatch 7 II Trends in international liquidity Overview 1. The money market has changed fundamentally after the default of Lehman Brothers 2. Bad collateral drives out good collateral – at the central bank! 3. The Basle Committee on Banking Supervision (BCBS) has proposed new liquidity standards 4. Financial market infrastructures (FMIs) performed well during the crisis. Hence, authorities like FMIs to play a greater role, e.g. CCP-clearing of OTC derivatives 8 II Trends in international liquidity The money market 1. After Lehman Brothers’ default the unsecured market collapsed. Since then it has only partially recovered 2. The secured market has filled part of this gap…. 3. … but the secured market also shows signs of stress 4. Central bank intermediation was/is necessary 5. …. but leads to “crowding-out” of private intermediation 6. The recent sovereign crisis aggravated some problems 9 II Trends in international liquidity Bad collateral drives out good collateral Source: ECB Annual report 2009 I Eligible collateral II Used collateral 10 Source: ECB annual report II Trends in international liquidity New liquidity standards 1. The proposed liquidity coverage ratio (LCR) Stock of highly liquid assets 1 Expected net cash outflows 2. The proposed net stable funding ratio (NSFR): Uses with maturity > 1 year should be funded by means expected to be available for a period > 1 year 11 II Trends in international liquidity Infrastructural change 1. Despite high volumes during the crisis, FMIs have performed very well. Two FMIs even played a stabilizing role: CLS and CCPs. Hence, authorities propagate the use of FMIs if private arrangements have weaknesses 2. Recent initiatives in US and Europe to promote CCPclearing of OTC derivatives 3. Further development of Eurosystem infrastructure (CCBM2, T2S) 12 II Trends in international liquidity Banks’ observations • • • • • • Banks recognised above-mentioned trends No return of the “good old days” on the money market return with an active unsecured market More collateral needed for secured lending, especially when central banks exit Range of high-quality collateral has narrowed Liquidity standards may make collateral scarce (+ possibly fierce competition from non banks) Banks indicate they may need more collateral for OTC derivatives and loss-sharing arrangements 13 III Cross-border arrangements Theoretical overview – cash transfer 1. Foreign exchange swaps between central banks 2. Acceptance of foreign cash as collateral 14 III Cross-border arrangements Foreign exchange swaps Home central bank (HCB) Foreign central bank (FCB) Inter-central bank swap Domestic counterparty Foreign Branch or Corresponden t Domestic counterparty is short of foreign currency cash. In this case the HCB delivers the foreign currency to the counterparty on the basis of domestic collateral (securities or cash). The HCB obtains the foreign currency via a swap with the FCB. 15 III Cross-border arrangements Foreign cash as collateral Home central bank (HCB) Foreign central bank (FCB) FCB gets credit at HCB Domestic counterparty Foreign branch of Domestic counterparty Domestic counterparty is short of foreign currency cash. In this case the FCB delivers the foreign currency to the counterparty. The FCB receives home currency cash as collateral (on an account with the HCB). 16 III Cross-border arrangements Theoretical overview – foreign securities transfer 1. 2. 3. 4. 5. Correspondent central banking model (CCBM) Guarantee model (resembles CCBM) Links between securities settlement systems (SSS) Remote access to securities settlement system Collateral management system (CMS) - collateral pooling by central banks or Tri-Party services by SSS or CSD 17 III Cross-border arrangements Correspondent central banking model (CCBM) Home country Foreign country Information on collateral Foreign central bank Home central bank Information on collateral Domestic credit Collateral Domestic counterparty Custodian Transfer instruction 18 Foreign CSD III Cross-border arrangements Guarantee model Home country Foreign country Inter centralbank guarantee Home central bank Information Information on collateral guarantee on Information on collateral Domestic credit Collateral Domestic counterparty Custodian Transfer instruction 19 Foreign central bank Foreign CSD III Cross-border arrangements Links between SSS/CSDs Home country Home central bank Domestic credit Domestic counterparty 20 Foreign country Information on collateral Domestic CSD Transfer instruction Foreign CSD Domestic CSD Account with Foreign CSD III Cross-border arrangements Remote access to SSS/CSD Home country Home central bank Domestic credit Domestic counterparty 21 Foreign country Information on collateral Information on collateral Foreign CSD Transfer instruction III Cross-border arrangements Collateral management system Home country Home central bank Domestic credit Domestic counterparty Foreign country Information on collateral Collateral Management System (in any country) Transfer instruction 22 Foreign CSD III Cross-border arrangements Current practice Within the Eurosystem • CCBM, to be further developed into CCBM2 • Links between SSS (+/- 20% of X-border transactions) • Tri-Party CMS by Euroclear Bank, Clearstream Banking Frankfurt and Clearstream Banking Luxembourg – NCBs limited access until CCBM2 Eurosystem vis a vis other currency areas • SWAP agreements of Eurosystem with a.o. Fed, SNB • Emergency liquidity arrangements of DNB with HKMA and MAS; similar arrangements by other NCBs Note: Cross-currency-area arrangements are for emergency purposes only and based on cash 23 III Cross-border arrangements Banks' observations 1. Settlement times should be reduced, also within Europe 2. Tri-Party collateral services by CSDs or SSS are also found attractive, especially if CBs are connected 3. DNB-type liquidity arrangements are valuable 4. Banks prefer a global single list of eligible collateral and more harmonised operational/legal procedures 5. For European banks CCBM2 is an important step BUT a global collateral pool, to which the major CBs worldwide are linked, would be a big leap forwards Now let us look at these 5 ideas 24 IV Improving cross-border arrangements 1. Reduction of settlement times Is that possible? 25 IV Improving cross-border arrangements 2. Tri-Party collateral services • Existing Tri-Party systems (XEMAC/GC Pooling - CBF, CMAX - CBL and Tri-party services – Euroclear Bank) work well • Currently only domestic banks can use the collateral at their central bank • CCBM2 will provide a solution for cross-border use 26 IV Ideas for new infrastructural solutions 3. Emergency liquidity arrangements Emergency liquidity arrangements are politically sensitive BECAUSE Prompt emergency liquidity assistance is vital but which authority lends the global bank a helping hand? Also: moral hazard issues and possible monetary policy implications 27 IV Improving cross-border arrangements 4. A single global list of eligible collateral Foreign collateral exposes a central bank to risks: (1) exchange rate risk, (2) operational risk and (3) legal risk How to deal with these risks ? A “global” CCBM seems unrealistic Foreign cash is usually considered less risky than foreign securities and is easier to transfer 28 IV Ideas for new infrastructural solutions 5. A global cash pool Rationale for a global cash pool • Systems interdependencies are high and problems travel fast • Hence, it is essential to have collateral and liquidity available at all times and banks should be able to settle promptly • Different time zones make this difficult for an internationally active bank • The interbank cross-currency market works well in normal times but these markets disappeared during the last crisis 29 IV Ideas for new infrastructural solutions 5. A global cash pool Intraday Liquidity Market USD Settlement BOE Settlement EUR Settlement JPY Settlement Collateral Central bank Collateral Central bank Collateral Central bank Collateral Central bank Securities CSD Securities CSD Securities CSD Securities CSD SIBOS – A gobal Cash & collateral pool IV Ideas for new infrastructural solutions 5. A global cash pool Intraday Liquidity Market USD Settlement BOE Settlement EUR Settlement JPY Settlement Central Cash Pool Central bank Securities CSD SIBOS – A gobal Cash & collateral pool Securities CSD Securities CSD Securities CSD IV Ideas for new infrastructural solutions 5. A global cash pool FEDwire CHAPS BOJ-NET T2 215 Central Cash Pool Central bank 50 100 5 60 Local Collateral Local Collateral Local Collateral Local Collateral FED BOE ECB BOJ SIBOS – A gobal Cash & collateral pool IV Ideas for new infrastructural solutions 5. A global cash pool FEDwire CHAPS BOJ-NET T2 40 215 175 Central Cash Pool Central bank 50 100 5 60 Local Collateral Local Collateral Local Collateral Local Collateral FED BOE ECB BOJ SIBOS – A gobal Cash & collateral pool IV Ideas for new infrastructural solutions 5. A global cash pool FEDwire CHAPS BOJ-NET T2 40 175 Central Cash Pool Central bank 50 100 5 60 Local Collateral Local Collateral Local Collateral Local Collateral FED BOE ECB BOJ SIBOS – A gobal Cash & collateral pool IV Ideas for new infrastructural solutions 5. A global cash pool FEDwire CHAPS T2 BOJ-NET 80 60 40 35 Central Cash Pool Central bank 50 100 5 60 Local Collateral Local Collateral Local Collateral Local Collateral FED BOE ECB BOJ SIBOS – A gobal Cash & collateral pool IV Ideas for new infrastructural solutions 5. A global cash pool FEDwire CHAPS T2 80 60 BOJ-NET 35 40 75 Central Cash Pool Central bank 50 100 5 60 Local Collateral Local Collateral Local Collateral Local Collateral FED BOE ECB BOJ SIBOS – A gobal Cash & collateral pool IV Ideas for new infrastructural solutions 5. A global cash pool FEDwire CHAPS T2 40 80 60 35 BOJ-NET 175 Central Cash Pool Central bank 50 100 5 60 Local Collateral Local Collateral Local Collateral Local Collateral FED BOE ECB BOJ SIBOS – A gobal Cash & collateral pool IV Ideas for new infrastructural solutions 5. A global cash pool CLS CLS CLS CHAPS FEDwire CLS T2 CLS CLS BOJ-NET 215 Central Cash Pool Central bank 50 100 5 60 Local Collateral Local Collateral Local Collateral Local Collateral FED BOE ECB BOJ SIBOS – A gobal Cash & collateral pool