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Managing Payment Liquidity in Global Markets: Risk Issues and Solutions

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Managing Payment Liquidity in Global Markets: Risk Issues and Solutions THE PAYMENTS RISK COMMITTEE MANAGING PAYMENT LIQUIDITY IN GLOBAL MARKETS: RISK ISSUES AND SOLUTIONS Report by the Cross-border Collateral Pool Task Force New York March 2003 _____________________________ The Payments Risk Committee is a private sector group comprising senior managers from several major banks in the US, sponsored by the Federal Reserve Bank of New York. The Committee identifies and analyzes issues of mutual interest related to risk in payment and settlement systems. Where appropriate, it seeks to foster broader industry awareness and discussion, and to develop input on public and private sector initiatives. Current members of the Committee are Bank of America, Bank One, Citibank N.A., Deutsche Bank, Fleet Bank, HSBC USA, JP Morgan Chase, State Street Bank and Trust, The Bank of New York, UBS, Bank of Tokyo-Mitsubishi and Wachovia Bank. Foreword The following document is the result of a study of potential implications for global intraday liquidity arising from recent developments in the global financial markets and global payments environment. It is not meant to be a definitive roadmap to improved payment liquidity risk management, but is intended to stimulate dialogue on the issue, and to suggest some possible identifiable actions by market participants and national authorities. Naturally, each financial institution's response to these market conditions will be governed by its own unique set of circumstances. Because of the broad nature of the topic of intraday liquidity, the Payments Risk Committee decided to limit the scope of its investigation to three areas: • Studying the market need for enhanced cross-border intraday liquidity services, that is access to intraday liquidity by financial institutions operating in foreign markets. The project attempted to analyze the rationale for such services, giving the greatest considerations to the overall liquidity and systemic risk benefits. • Evaluating possible private and public sector solutions that would ensure the continued and efficient availability of liquidity in the global markets during times of market crisis. • Establishing recommendations for preferred solutions that will lead to more effective and efficient global intraday liquidity management. We hope that you find the following document both interesting and useful. The Payments Risk Committee will continue to pursue its initiatives with the private sector, as well as with the central bank community, in particular: • Encouraging private sector development of new, well-constructed services that, over time, will enhance market participants’ ability to respond effectively to accelerating intraday liquidity demands in global markets; and • Liaising with the G-10 central banks in the area of extending eligible foreign collateral for intraday RTGS liquidity. Lori Hricik Chair The Payments Risk Committee The present publication is also available on the Payments Risk Committee Web site (http://www.ny.frb.org/prc/). 1 Table of Contents Page 1. PREFACE 1.1. The Working Group and Task Force ………………………………………… 4 1.2. Members of the Cross-Border Collateral Task Force ……………………… 4 1.3. Acknowledgements …………………………………………………………. 6 2. EXECUTIVE SUMMARY 2.1. Background …………………………..……………………………………… 7 2.2. Overview and Scope of Report ……………………………………………… 9 2.3. Summary of Key Findings and Conclusions ………………………………… 11 2.4. Recommendations …………………………………………………………. 15 3. DEMANDS ON GLOBAL PAYMENT LIQUIDITY: MARKET DEVELOPMENTS. 3.1. Introduction ………………………………………………………………….. 18 3.2. Adoption of RTGS by Central Banks ………………………………………… 18 3.3. Growth in Domestic and Cross-Border Financial Transactions ……………… 20 3.4. The Move to DVP and Other Elements of Securities Settlement ……………. 21 3.5. Clearing House Funding Obligations ………………………………………… 23 3.6. Greater Asymmetry of Payments …………………………………………….. 25 3.7. Increased Client Demand for Intraday Payment Services ……………………. 25 3.8. CLS Bank …………………………………………………………………….. 26 3.9. Increased Interdependencies Between Markets and Market Infrastructure … 29 3.10. Market Stress Scenarios: September 11, 2001 ……………………………… 31 3.11. Increased Role of Foreign Banks in Domestic Markets …………………… 34 3.12. Summary …………………………………………………………………… 35 4. CONSTRAINTS TO SOURCING CROSS-BORDER INTRADAY LIQUIDITY 4.1. Reliance on Central Bank Intraday Credit …………………………….……… 37 4.2. Constraints to Accessing Intraday Credit at Foreign Central Banks …………. 38 4.3. Increased Demands for Collateral in Financial Transactions ………………… 40 4.4. Summary ……………………………………………………………….…….. 41 5. PRIVATE SECTOR DEVELOPMENTS IN CROSS-BORDER LIQUIDITY MANAGEMENT 5.1. Developments at Individual Banks …………………………………………… 43 5.2. Developments at the Industry Level ………………………………………….. 44 5.3. Possible Private Sector Solutions ……………………………………………… 46 5.4. Summary ……………………………………………………………………… 50 6. CENTRAL BANK SOLUTIONS: RATIONALE/BENEFITS 6.1. Rationale ………………………………………………………………………. 52 6.2. A Solution: Cross Border Collateral Pool Facilities. …….…………………….. 52 6.3. Benefits ………………………………………………………………………… 53 2 7. CROSS BORDER COLLATERAL POOL FACILITIES: DESCRIPTIONS 7.1. Securities Collateral Pool Model ………………………………………………. 57 7.2. Cash Collateral Pool Model …….……………………………..………… 67 7.3. Central Bank Guarantee Model ……………………………………………… 76 7.4. Summary …………………………………………………………….………. 80 8. CROSS-BORDER COLLATERAL POOL FACILITIES: LEGAL & RISK ISSUES, COST IMPLICATIONS AND PUBLIC POLCIY CONSIDERATIONS 8.1. Legal Issues …………………………………………………………………… 82 8.2. Non-Legal Risks ………………………………………………………………. 85 8.3. Cost Implications ……………………………………………………………… 88 8.4. Public Policy Considerations ………………………………………………….. 89 9. CROSS-BORDER COLLATERAL POOL FACILITIES: USE/IMPACT FOR INDIRECT CLEARING BANKS 9.1. Use of Facilities by Indirect Clearing Banks …………………………………. 93 9.2. Benefits to Indirect Clearing Banks ……………………………………………. 94 9.3. Issues …………………………………………………………………………. 95 9.4. Impact to Correspondent Banking Relationships ……………………………… 96 10. CONCLUSIONS ………………………………………………………………….. 97 Annex 1: Glossary Annex 2: Comparative tables of select central bank RTGS credit facilities Annex 3: Statistical tables on financial market activity Annex 4: Comparative tables of cross-border collateral pool facilities Annex 5: Clearing cycles for RTGS systems for CLS currencies Annex 6: Securities CCP Comparison to CCBM (Europe) Annex 7: Scandinavian Cash Pool 3 1. PREFACE The Federal Reserve Bank of New York established the Payments Risk Committee in 1993 as a means of inviting the input of commercial bankers in formulating recommendations for improving the quality of risk management in payment and securities settlement systems. Senior executives with broad payments systems experience from banks active in the payments business were invited to participate in the Committee. In addition to its primary role of formulating risk reduction recommendations, the Committee’s objectives are to promote better understanding of payments risk issues among market participants; to enhance knowledge of the payments systems infrastructure in the U.S. and overseas; to circulate research on payment systems to participants and the public; to promote better communication between private sector institutions, the Federal Reserve Bank and, where appropriate, other bank supervisors within the U.S. and overseas; and to provide a forum for discussion of technical issues in payments systems. The Committee is sponsored by the Federal Reserve Bank of New York and is composed of representatives of Bank of America N.A., The Bank of New York, Bank One N.A., JP Morgan Chase, HSBC USA, Citibank N.A., Deutsche Bank AG, State Street Bank and Trust Co., UBS AG, Bank of Tokyo-Mitsubishi, Fleet Bank and Wachovia Bank. There is also participation by the Federal Reserve Bank of New York and the staff of the Board of Governors of the Federal Reserve System. The Committee is supported by a Working Group of mid-level executives, which conducts research regarding topics designated by the Committee and drafts reports and studies for Committee approval. 1.1. The Working Group and Cross-Border Collateral Pool Task Force In September 2001, the Committee requested that the Working Group undertake a study of the market need for enhanced cross-border intraday liquidity management services to support global payment activity. The Working Group was asked to concentrate its study on the rationale for such services, giving specific considerations to the overall liquidity and risk benefits. The Working Group was also asked to evaluate possible solutions (both private sector and public sector) that would ensure the continued and efficient availability of global payment liquidity, particularly in times of market stress. The Working Group was charged with establishing recommendations for preferred services with the following guidance from the Payments Risk Committee: (1) recommendations should not call for the building of new infrastructure; solutions should build upon existing processes, infrastructure and market practices and (2) there should be preferred recommendations for solutions that could be put in place in the near term for use in times of market crisis. Due to the broad range of issues and their scope, the Working Group assembled a Task Force to examine the issues and draft a report. The Working Group recognized the need to involve additional experts, and individuals representing banks were recruited from outside of the Committee member banks. A full list of the members of the Task Force is presented below. 1.2. Task Force Members 4 MEMBERS
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