T2S making waves in liquidity management
T2S is shaking up the European post-trade landscape, with new possibilities to pool cash and collateral and reduce the cost of financing your activity in both central bank and commercial bank money.
With the start date for the European Central Bank’s (ECB) TARGET2-Securities (T2S) settlement platform almost upon us, an important issue for market participants is how to optimise intra-day liquidity in the new European landscape. This is driven partly by new regulations, including Basel III and EMIR, that introduce additional capital charges for credit and liquidity consumption as well as the need for high quality collateral.
At the same time, new opportunities in T2S for firms to more efficiently manage their liquidity in Europe are gaining increased attention. For one, T2S effectively creates a new, central bank money liquidity environment. Today, most international firms leverage a single commercial bank money liquidity pool from an agent or an international central securities depository (ICSD). In T2S, firms that wish to do so will also have the opportunity to settle their European domestic activity out of a single central bank money cash account, reducing the cost of funding.
The extent to which a shift will take place in Europe towards the use of central bank money liquidity for intraday financing, however, will only be known after T2S is fully rolled out. What is certain is that there are ways for firms to reduce liquidity costs in both the ICSD and CSD environments while maintaining or even strengthening their access to immediate and guaranteed liquidity. Firms will need to make decisions about which environment best suits their needs – or whether they can adopt an approach that utilises the best of both worlds.
Reducing intraday liquidity costs
“In the new T2S environment, market participants are looking for efficient intra-day and end-of-day cash management in order to reduce their credit consumption for settlement,” says Edwin De Pauw, Head of T2S Product Management, Euroclear, “and access to sufficient liquidity funding sources is vital to allow them to support their, and their clients’, business under any market conditions.”
By centralising activity in either an ICSD or CSD, the cash pooling and netting effect that can be achieved across all T2S markets will reduce credit usage and significantly increase funding opportunities. Furthermore, firms will be able to take advantage of an auto-collateralisation functionality whereby collateral is automatically posted with the central bank to cover intra-day settlement needs across all T2S CSDs. Cash and securities deadlines will also be optimised in T2S, enabling cash to be transferred back into the ECB’s TARGET2 cash system as late as possible, or collateral moved between the CSD and ICSD environments.
While efficient funding support is key to liquidity management, other elements that contribute to reducing liquidity costs include high levels of settlement efficiency; access to a broad range of counterparties, instruments and central counterparties (CCPs); and real-time reporting/forecasting facilities.
From a liquidity perspective, the choice of whether to centralise post-trade activity in a CSD connected to T2S, or in an ICSD, will depend on various factors individual to each firm such as where its counterparties are, where they can access credit and liquidity in the most cost-effective way, and how much of its activity in T2S-eligible securities is funded by liquidity from more global activity (in EUR or non-EUR).
When deciding on their network strategy, however, firms not only need to consider where to hold their assets to meet their short-term liquidity needs in the most efficient way, but also consider asset servicing and financing.
Indeed, collateral mobilisation on a global basis is a top priority for financial institutions as regulations require them to post more collateral to finance and support their activity. In T2S, firms will be able to pool collateral either by consolidating assets in the same location where they have their settlement activity, or by using a collateral management service provider that moves the inventory of assets where it is needed for financing purposes. The use of collateral optimisation and transformation services will then enable firms to convert the quality of collateral for onward re-use, e.g. for CCP margin calls, to meet regulatory requirements and reduce their liquidity costs.
Connecting both worlds
To access liquidity and reduce the cost of managing it, firms may be looking for a reduced number of providers through which they can pool cash for all markets, access bespoke liquidity management services and receive real-time consolidated reporting for their European and non-European activity. In addition, collateral management services that are efficiently interconnected with T2S – such as those offered through Euroclear’s Collateral Highway in both the ICSD and CSD environments – will enable firms to smoothly transfer collateral for activities both in commercial and central bank money and between their business in Europe and globally.
“It is important in T2S for firms to be able to easily access financing opportunities with both domestic and international counterparties,” says De Pauw. “Given our position as an open market infrastructure that straddles both the ICSD and CSD worlds, we will ensure seamless interoperability between the two environments so that our clients can strike a balance that’s right for them between running either a single, global financing book or multiple financing books, while at the same time minimising their liquidity costs.”