Viewpoint : Intraday liquidity : Darryl Twigg

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THE IMPORTANCE OF INTRADAY LIQUIDITY.

Darryl Twiggs, Head of Product Management at SmartStream, gives his view.

The Bank for International Settlements’ Monitoring Tools for Intraday Liquidity Management, which was published in April 2013, provides national supervisors with the tools for monitoring “large, internationally-active” banks’ intraday liquidity risk, which it defines as: “The risk that a bank is unable to manage its intraday liquidity effectively, leaving it unable to meet its payment obligations at the time expected, which impacts its liquidity position and that of other parties.”

The necessity for intraday liquidity comes from banking activities that involve large value payment and securities settlement systems. The introduction of risk management mechanisms such as Real-Time Gross Settlement (RTGS) payment systems and Delivery Versus-Payment (DVP) settlement in the securities markets, has resulted in the critical need for intraday liquidity.

Without sufficient intraday liquidity these systems could come to a halt or become gridlocked, especially in cases where the settlement bank decides to delay or postpone payments, for example, in order to reduce their intraday liquidity costs, or where certain market scenarios prevent a bank from having sufficient intraday liquidity to meet their settlement obligations.

Some of the questions regulators are asking are: Which banks have sufficient intraday liquidity to meet settlement obligations in normal and stressed market conditions? What contingencies should they put in place to react quickly?

For financial institutions and regulators there are obvious lessons to be learnt from the Lehman Brothers catastrophe, and although banks already have some systems in place to manage the risk implications, regulators want to see a more disciplined approach from internationally active banks.

For front office trading?

The front office of every bank produces a summary report at the beginning of each day, which is used as an indicator for trading during the day. As markets move, this summary report remains static – traders will be making decisions on old information and possibly making decisions that could affect the liquidity position of their books. With intraday liquidity they can take advantage of knowing their liquidity positions in real-time and have a holistic view of the current trading environment.

The accuracy of the summary reports at the beginning of the day can be questionable. This is made more complicated by market positions changing in different time zones, especially where money is swept from one country to another. The management of intraday liquidity is therefore becoming a front office tool, whereas traditionally it has been the focus of the back office. Organisations are also looking to make best use of these tools across operations and meet KPIs.

Implications of delayed payments

Failing transactions will bring payment and security settlement systems to a halt, which can result in drastic systemic implications given that all market participants are connected in the transaction chain of activities. The bigger implications of delayed payments and settlement problems can be catastrophic – as was demonstrated during the financial crisis.

The key issue is with correspondent banks who will bear the brunt as very few are able to provide detailed real time reporting.

Most banks’ legacy systems and processes work on an end-of-day or overnight basis and are not geared towards providing real time or intraday information. In addition, trade information is dispersed across different trade and transaction processing solutions which in turn creates IT and data access challenges. There is a need for banks to find a way to aggregate data across these different silos in order to gain a holistic view of their positions, liquidity and exposure.

What banks need to consider

Financial institutions need to act now, they need consider the business benefits of improved visibility of their liquidity and understand the inherent risks associated with having no intraday reporting. The case for implementing intraday liquidity monitoring tools is strong both from an operational and regulatory perspective.

The banks that continue to operate blind without visibility of their exposures are likely to be left behind the curve and will have no control over their risk exposures. One of the biggest challenges for banks will be to capture timely and quality data from their own internal IT and operational silos, and from correspondent banks. Correspondent banks will suffer with the changes as few today are able to provide the level of detailed real time reporting that monitoring tools require.

To manage data challenges banks will need to migrate from cash management solutions focused on settlement to systems that support the new T+0 operational paradigm. These systems will need to be configurable, open and flexible enough to accept cashflow data across the whole lifecycle of a trade so that banks can be more predictive in their approach to cash and liquidity management. As national regulatory supervisors will want to drill down into the details of specific transactions and how it impacts a bank’s intraday liquidity position, doing nothing is not really an option; neither is trying to outsource the problem to a third party, who given the interdependencies of counterparties in the transaction value chain could become a source of risk and stress. Banks need to integrate the monitoring tools within their operations, making them part of their everyday cash and liquidity management processes. After all, what bank wouldn’t want to know its real time liquidity exposure, to know that all trading activity can be funded and that it is maximising its use and investment of funds?

© BestExecution 2014

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