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1. De Nederlandsche Bank Global Liquidity Management in the Future Nynke Doornbos Ohrid, Republic of Macedonia, 21 June 2011 4th Conference on Payments and Securities Settlement Systems

2. 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? Appetizer 2

3. 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 Appetizer

4. 4 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

5. 5 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

6. 6 I Introduction Liquidity mismatches But what if “the shit hits the fan”?

7. 7 Then Central banks / infrastructures can help ! 1. Accept foreign cash as collateral to address a currency mismatch 2. Accept foreign securities as collateral to deal with a collateral location mismatch Your bank I Introduction Liquidity mismatches

8. 8 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

9. 9 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

10. 10 Source: ECB Annual report 2009 II Trends in international liquidity Bad collateral drives out good collateral I Eligible collateral II Used collateral Source: ECB annual report

11. 11 1. The proposed liquidity coverage ratio (LCR) 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 1 outflows cash net Expected assets liquid highly of Stock  II Trends in international liquidity New liquidity standards

12. 12 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 CCP- clearing of OTC derivatives 3. Further development of Eurosystem infrastructure (CCBM2, T2S) II Trends in international liquidity Infrastructural change

13. 13 • 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 II Trends in international liquidity Banks’ observations

14. 14 III Cross-border arrangements Theoretical overview – cash transfer 1. Foreign exchange swaps between central banks 2. Acceptance of foreign cash as collateral

15. 15 III Cross-border arrangements Foreign exchange swaps Home central bank (HCB) Domestic counterparty Foreign central bank (FCB) 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. Inter-central bank swap Foreign Branch or Corresponden t

16. 16 III Cross-border arrangements Foreign cash as collateral Home central bank (HCB) Domestic counterparty Foreign central bank (FCB) Foreign branch of Domestic counterparty FCB gets credit at HCB 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).

17. 17 III Cross-border arrangements Theoretical overview – foreign securities transfer 1. Correspondent central banking model (CCBM) 2. Guarantee model (resembles CCBM) 3. Links between securities settlement systems (SSS) 4. Remote access to securities settlement system 5. Collateral management system (CMS) - collateral pooling by central banks or Tri-Party services by SSS or CSD

18. 18 III Cross-border arrangements Correspondent central banking model (CCBM) Information on collateral Collateral Transfer instruction Information on collateral Domestic credit Home country Foreign country Home central bank Foreign central bank Domestic counterparty Foreign CSD Custodian

19. 19 III Cross-border arrangements Guarantee model Transfer instruction Collateral Information on collateral Domestic credit Information on collateral Inter central- bank guarantee Information on guarantee Home country Foreign country Home central bank Foreign central bank Domestic counterparty Foreign CSD Custodian

20. 20 III Cross-border arrangements Links between SSS/CSDs Domestic credit Home country Foreign country Home central bank Domestic counterparty Foreign CSD Domestic CSD Transfer instruction Information on collateral Domestic CSD Account with Foreign CSD

21. 21 III Cross-border arrangements Remote access to SSS/CSD Domestic credit Home country Foreign country Home central bank Domestic counterparty Foreign CSD Information on collateral Transfer instruction Information on collateral

22. 22 III Cross-border arrangements Collateral management system Domestic credit Home country Foreign country Home central bank Domestic counterparty Foreign CSD Collateral Management System (in any country) Information on collateral Transfer instruction

23. 23 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

24. 24 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

25. 25 IV Improving cross-border arrangements 1. Reduction of settlement times Is that possible?

26. 26 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

27. 27 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

28. 28 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

29. 29 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

30. SIBOS – A gobal Cash & collateral pool Securities CSD Collateral Central bank USD Settlement Securities CSD Collateral Central bank BOE Settlement Securities CSD Collateral Central bank EUR Settlement Securities CSD Collateral Central bank JPY Settlement Intraday Liquidity Market IV Ideas for new infrastructural solutions 5. A global cash pool

31. SIBOS – A gobal Cash & collateral pool Securities CSD USD Settlement Securities CSD BOE Settlement Securities CSD EUR Settlement Securities CSD JPY Settlement Intraday Liquidity Market Central Cash Pool Central bank IV Ideas for new infrastructural solutions 5. A global cash pool

32. SIBOS – A gobal Cash & collateral pool FED BOE ECB BOJ Central Cash Pool Central bank Local Collateral Local Collateral Local Collateral Local Collateral BOJ-NET T2 CHAPS FEDwire 50 100 5 60 215 IV Ideas for new infrastructural solutions 5. A global cash pool

33. SIBOS – A gobal Cash & collateral pool 215 FED BOE ECB BOJ Central Cash Pool Central bank Local Collateral Local Collateral Local Collateral Local Collateral BOJ-NET T2 CHAPS FEDwire 50 100 5 60 40 175 IV Ideas for new infrastructural solutions 5. A global cash pool

34. SIBOS – A gobal Cash & collateral pool FED BOE ECB BOJ Central Cash Pool Central bank Local Collateral Local Collateral Local Collateral Local Collateral BOJ-NET T2 CHAPS FEDwire 175 40 50 100 5 60 IV Ideas for new infrastructural solutions 5. A global cash pool

35. SIBOS – A gobal Cash & collateral pool FED BOE ECB BOJ Central Cash Pool Central bank Local Collateral Local Collateral Local Collateral Local Collateral BOJ-NET T2 CHAPS FEDwire 50 100 5 60 40 60 80 35 IV Ideas for new infrastructural solutions 5. A global cash pool

36. SIBOS – A gobal Cash & collateral pool 35 FED BOE ECB BOJ Central Cash Pool Central bank Local Collateral Local Collateral Local Collateral Local Collateral BOJ-NET T2 CHAPS FEDwire 50 100 5 60 60 80 75 40 IV Ideas for new infrastructural solutions 5. A global cash pool

37. SIBOS – A gobal Cash & collateral pool FED BOE ECB BOJ Central Cash Pool Central bank Local Collateral Local Collateral Local Collateral Local Collateral BOJ-NET T2 CHAPS FEDwire 50 100 5 60 60 80 40 35 175 IV Ideas for new infrastructural solutions 5. A global cash pool

38. SIBOS – A gobal Cash & collateral pool FED BOE ECB BOJ Central Cash Pool Central bank Local Collateral Local Collateral Local Collateral Local Collateral BOJ-NET T2 CHAPS FEDwire 50 100 5 60 215 CLS CLS CLS CLS CLS CLS IV Ideas for new infrastructural solutions 5. A global cash pool

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