Information event for future DCA holders: Euro liquidity management. Introduction T2S: technical challenges and opportunities for liquidity

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1 DEUTSCHE BUNDESBANK Frankfurt, 16 December 2013 Jochen Metzger Head of the department Payments and settlement systems Information event for future DCA holders: Euro liquidity management in view of T2S Introduction T2S: technical challenges and opportunities for liquidity managers Introduction I am very pleased to welcome you here at the premises of the ECB and to open the information event for future DCA holders. The event has the aim to provide information on the euro liquidity management in view of T2S. The initiative for this event has come from the DCP (Directly Connected Participant) Forum. The members requested more information and clarifications on the liquidity management offered by T2S and the central banks. The Eurosystem has taken up the ball and has organized this info session in close cooperation with Marcello Topa as representative of the DCF and the CSG chair office. The focus is on euro liquidity management in central bank money in T2S. The emphasis is on functional, legal, technical and operational aspects. The session is a result of the joint effort of colleagues from the ECB, 4CB/3CB, Banque de France and the Deutsche Bundesbank and I would like to thank all the organisers and speakers for their effort. Invited have been: the members of the DCP Forum, the TARGET Working Group and the central banks of the ESCB. And I am very pleased to see quite a number of my colleagues in this room.

2 We first planned to invite also the NUGs. Owing to the limited room capacity it has not been possible to do this. However, we might offer - in case of need - a similar session at the beginning of next year to which all NUGs could be invited. Role of DCPs in T2S T2S offers enormous opportunities to all market participants planning to branch out into new business areas. No small wonder, banks, in particular, have been extremely supportive since the very beginning of T2S. Especially the banks which have already expressed their interest to become a DCP on the securities side are reliable partners providing valuable input to the shaping of T2S. All stakeholders in the T2S project have benefited from this input. In the past much has been said on the benefits of T2S on the securities side, on reducing risks in the post-trade environment, on streamlining the settlement process, increasing competition at CSD level and reducing the cost of settling securities transactions. Today, the focus is on the challenges and opportunities for liquidity managers. T2S will not have advantages for the securities side only but even more so for the cash side. We expect substantial liquidity savings for payment banks and their business partners. However these benefits can only be used to the full extend, if a bank decides to become a directly connected DCA holder on the cash side, in other words: a cash DCP. A cash DCP will have access to all functionalities and services offered by T2S. Let me give you some examples: - He can define a minimum or maximum liquidity amount to be available on its DCA.

3 - He has access to all monitoring features, e.g. transactions settled, pending - He can set-up a CMB and see his pending auto-collateralisation positions. - He can get all reports foreseen in T2S for DCA holders, e.g. DCA statement. An ICP would not be able to use all these options and hence I suspect all payment banks will have to become cash DCPs in order to offer the full range of possible T2S cash services to their business partners. In addition, using an A2A connection to T2S, it will be possible to integrate the monitoring and interaction with T2S in the DCP s internal system, e.g. your core banking or treasury system, maybe complemented by information and control functions of TARGET2. Challenges and opportunities In today s world for the cash settlement of securities transactions a bank needs a so-called sub-account in TARGET2. This sub-account is dedicated to a specific CSD s cash settlement process. Therefore, the liquidity of banks participating in more than one CSD has to be distributed over several liquidity pots, each of them dedicated to the settlement in one CSD. Existence of several liquidity pots requires additional liquidity. Possible liquidity surpluses in one market cannot be efficiently used to offset deficits in another market. As a consequence, liquidity buffers have to be established for each sub-account resulting in inefficient use of liquidity and extra cost. By contrast, T2S will provide each market participant with the possibility to use a single dedicated cash account. There will be only one single pot of liquidity for the cash settlement of all CSDs he is participat-

4 ing. Needless to further explain which set-up is more efficient from a liquidity management perspective. However, this opportunity might at the same time also be a challenge for liquidity managers. The liquidity on the DCA will be used for cash settlements in various CSDs. The liquidity manager will have to keep this in mind when managing and controlling the liquidity on his DCA. The DCA features will allow the DCA holder to grant access to its DCA to another entity. This entity could be a CSD, a bank or even a central bank. This entity would then have the possibility to act on behalf of the DCA holder. In case a DCA holder grants access to its DCA to another entity, the liquidity manager of the DCA holder has to be aware, that this entity can use the liquidity on the DCA without further notice or authorisation of individual transactions. Such privileges are necessary to allow the DCA holding bank to participate in several CSDs. In this case the liquidity manager has to consider that besides himself two or more other entities might use the liquidity on its DCA. The liquidity manager has to take care, that all entities having access to its account have a clear understanding on the rights, limitations and obligations in view of the DCA they are using. Those requirements will have to be clearly set out in the bilateral contracts between the DCA holder and his business partners using the account including CSDs, banks and central banks. Further opportunities for liquidity managers When T2S was launched several years ago its main benefit was the expected savings in cross-border settlement fees and given its economies of scale in a reduction of settlement fees more generally. Much attention has been paid to the fact that T2S will reduce the cost of a

5 DvP (Delivery versus Payment) instruction, because it is so easy to comprehend. However, further savings are to be expected in banks back offices due to the use of the harmonised European settlement service with its standardised interfaces, message formats and settlement process. Since the T2S project was launched, the financial crisis and subsequent regulatory requirements have changed the focus of attention which is now on liquidity and collateral optimisation. T2S offers intrinsic liquidity-saving features such as intelligent (optimisation) algorithms and wide netting effects across all participating markets, complemented by the Eurosystem s offer of autocollateralisation across all of them. Together, these factors will considerably reduce bank s liquidity needs. This is very much welcome as since the crisis broke a much larger proportion of interbank activity is now collateralised. Also, regulation is moving in the same direction. EMIR pushes for the collateralisation of OTC derivatives clearing. CRD IV (Capital Requirements Directive) and Basel III will force banks to maintain substantial liquidity buffers in addition to the assets they use as collateral. In short: in the wake of the crisis, the market needs more collateral but at the same time good collateral is becoming scarcer, following a series of rating downgrades. So is it possible to do more with less? The most promising solution to this conundrum would be to increase the velocity of the collateral that is available, ie. a rapid mobilisation and transfer of collateral from where it is to where it needs to be. And precisely the mobilisation of collateral will become much easier with T2S, as it allows for the speedy and efficient transfer of collateral among participating CSDs and their connected clients.

6 In other words: T2S helps you saving precious highly liquid collateral. With each tightening of liquidity rules. T2S and its liquidity saving features become more and more important. I cannot really quantify the liquidity savings enabled by T2S but I see three different options to save liquidity in T2S: o First, the consolidation of the multiple cash accounts for securties settlement in one dedicated cash account, the DCA o second, optimisation across all participating European CSDs in one process and o third, last but not least the service to provide autocollateralisation across all markets participating in T2S. As central banker I see of course a further very important benefit for the market, namely the efficient settlement of all domestic and crossborder securities transactions in Europa in secure central bank money. The Deutsche Bundesbank actively supports the pooling of liquidity. We are proud to offer banks in T2-Bundesbank to open DCAs in T2S and to provide auto-collateralisation already for 22 June 2015 when Wave-1-CSDs migrate to T2S. Clearstream, the German CSD, will only migrate in wave 3 but we want to be T2S-ready in June 2015 nevertheless. Of course, the other Eurosystem central banks, also stand ready to open DCAs right from the start of T2S for banks requesting DCAs. Status of the project T2S is the biggest, most complex and most ambitious infrastructure project on which the Eurosystem has embarked so far. The ECB and the 4CB, ie. the Banque de France, the Banca d Italia, the Banco de Espana and the Deutsche Bundesbank in close cooperation with the

7 CSDs and the users are taking great care to ensure the timely and fully fledged delivery of T2S. As one of the key Bundesbank officials responsible for T2S, I would like to give you a brief status update from a Bundesbank-as-part-ofthe-4CB -related perspective. The development of the T2S core software is finalized with the exception of the recently approved change requests and some requests for change which remain to be developed. The development of the non core T2S software (eg billing, statistics) is almost completed (99%). The next crucial point on our to-do list is to deliver the software by the end of March 2014, ready for the start of the Eurosystem internal acceptance testing. After the internal acceptance testing user testing will start in October 2014 with some pilot CSDs already commencing in July 2014). T2S will go-live with the migration of the first wave of CSDs on 22 June 2015 followed by 3 more waves until the beginning of For us, as central bankers providing the cash accounts for T2S, it is very important to know, about your T2S strategy. How are you going to use T2S? When will you move to T2S? How many DCAs do you need? Moreover, we are also very interested in the technical set-p of your connection to T2S. Will you directly connect as DCP or indirectly through another actor as ICP? Will you use A2A or U2A connectivity? For DCPs: Who is your VAN service provider? Especially for banks migrating in the 1st wave, those decisions and the subsequent information of the Eurosystem is urgently needed. Cash DCPs should be prepared to answer those questions by end of February 2014 at the latest, ie. in less than 100 days.

8 Thank you for your attention. I wish you to get new and useful information, the assurance that T2S will work properly and smoothly, on the cash side and that T2S will ease and make your liquidity management more efficient. I also would like to take the opportunity to wish you all Merry Chrismas and a happy New Year.

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