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Central bank money - improving liquidity efficiency

In April 2012 Euroclear UK & Ireland successfully launched a new automated self-collateralisation service for GBP central bank money settlement, significantly reducing the over-supply of liquidity in the market.

The launch affected mainly settlement banks and the Bank of England. It has led to a major reduction in risk by reducing the amount of liquidity required to support DVP settlement in the CREST system by up to 60%.

What has changed?

Until last year, we operated a self-collateralisation service, whereby a member’s purchase of eligible securities could generate additional liquidity for its settlement bank to cover the liquidity needed to purchase the securities. The securities purchased were automatically delivered to the client’s settlement bank and onwards to the Bank of England, generating additional liquidity for the settlement bank.

This service was an ‘on-supply’ model, i.e. purchases that were eligible for self-collateralisation always generated liquidity regardless of whether that liquidity was needed. The effect of this model was to create an over-supply of liquidity.

Liquidity on demand

We have replaced this system with a new auto-collateralisation service that generates additional liquidity for settlement banks only when needed. The new service provides a flexible, automated solution with some new control mechanisms, all of which will contribute to a reduction in counterparty, operational and systemic risk.

How does the new service work?

Automated repos between settlement bank clients and their settlement banks lead to the creation of a pool of potential liquidity-generating assets at the settlement bank level.

These assets can then be used on-demand as and when the settlement bank requires liquidity. Automated substitutions and reimbursements allow clients access to their securities should they need them during the day.

In addition, it is possible to reuse liquidity credit intra-settlement cycle, leading to greater efficiency.

Working with the market

The project was developed in close cooperation with settlement banks and the Bank of England. Toby Davies, Head of Market Services at the Bank of England, said: “The Bank aims to supply sufficient liquidity intra-day to support efficient payment and settlement. These changes allow us still to meet that objective whilst reducing the expansion of the Bank’s balance sheet intra-day. This has been a complex project at the core of the UK's settlement infrastructure and we are pleased that it has been so successfully delivered by Euroclear.”

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