GC Perspective: BNP Paribas on how to get the most out of T2S

BNP Paribas Securities Services' Phillipe Ruault and Orla Mc Tiernan explain that the agent bank model has more to offer than simple connectivity to T2S.

By Editorial
Under T2S, many directly connected banks will expect to benefit from needing only a single pot of collateral in order to trade across Europe, and that connecting with T2S will reduce the amount of collateral required thanks to the creation of an effective single market. BNP Paribas Securities Services’ Philippe Ruault, Head of solutions for custody, clearing and settlement, and Orla Mc Tiernan, Head of cash and liquidity services, think otherwise.

Speaking to Global Custodian, they explain that the agent bank model has more to offer than simple connectivity, and that banks and brokers should take a closer look at the liquidity benefits they stand to gain by adopting a different business model for T2S.

It is widely held that in bringing 24 markets together, T2S will decrease the collateral required to manage liquidity. Is that not the case?

OM: This makes sense when the effects of cash pooling are taken into account but is not otherwise certain. We believe the liquidity optimisation provided by T2S for an individual bank, broker, or global custodian becoming a directly connected participant (DCP) to T2S or connecting indirectly via a CSD or ICSD is far from certain.

Expectations of intraday liquidity benefits for DCPs rely mainly on the auto-collateralisation mechanism (where T2S automatically collateralises liquid securities in a nominated account to cover shortfalls against settlement obligations in other accounts) and the use of single cash accounts across all T2S markets.

The benefits of auto-collateralisation for intraday liquidity are limited to bonds, however, and will not solve overnight liquidity issues when financing long securities positions.

PR: We ran an analysis of our own data using one month of transactions simulating pre- and post-T2S activity. We examined intraday liquidity needs separately for equity brokers, investment banks and global custodians pre-T2S, with liquidity managed at each market level versus post-T2S, with liquidity managed regionally as if one single market, and found little difference.

Equity brokers, for example, experienced on average a mere 3.1% reduction per day in liquidity requirements when directly connected to T2S. Investment banks fared better, with an average 27% improvement under T2S and most days closer to 20%. Global Custodians in the analysis also displayed around a 20% improvement. These figures are not close to the benefits many expect to see, and leave much room for improvement.

Trading strategies are more regional than domestically oriented: the same investor is usually not taking long positions in one European market versus short positions in another European market. It’s clear that the benefits are not as dramatic as many may have assumed.

What do you think this means for the model of connecting to T2S via an agent bank?


OM: Using the same aggregated client data we analysed our estimated central bank liquidity usage as an agent bank settling our clients’ trades in the main T2S markets versus the same for all market participants if they were directly connected to T2S; the difference is clear.

Equities clients with trades netted at the agent bank model averaged a 65% improvement against those connected directly. For clients using bonds the improvement was an impressive 69%, with a peak on some days around 90%.

PR: Liquidity provision by agent banks could be challenged with auto-collateralisation being extended to the 24 T2S markets, but auto-collateralisation will be made available for only certain types of bonds and will not cover overnight financing needs.  Of course we see agent banks adding a lot of value through asset servicing and settlement as well, services which are strongly linked and nuanced from market to market.

In addition, liquidity optimisation can be generated by an agent bank taking intraday opposing positions (long versus short), reducing liquidity requirements for market participants at the agent bank level, further, when common clients trade against each other agent banks do not need to inject liquidity.

We are also able to assess liquidity optimisation depending on the number of clients an agent bank has. Using trade data from existing clients with various trading profiles, normalised so that intraday liquidity needs are roughly the same for each client, we can show that self-settling requires 40% more liquidity vs using an omnibus account with 3 other clients, up to a 67% difference when 9 clients are involved in the account.

PR: T2S will definitely help to optimise collateral requirements thanks to the auto-collateralisation mechanism but for intraday liquidity management and bonds only.

Agent banks will continue to create true value in asset servicing and settlement, but also in liquidity, taking advantage of client diversification, an effect that firms will not achieve using their own investment streams. Participants using agent banks will see much better intraday funding compared to those that do not.

Banks, custodians and brokers need to speak with their providers to test any assumptions they have made about how to reap the greatest benefit from T2S.

«