A study has quantified the benefits of a harmonized settlement infrastructure for eurozone securities for broker-dealers, global custodians and regional banks.
By creating a harmonized and centralized securities settlement platform, which settles in central bank money, TARGET2-Securities (T2S), the study posits the benefits of consolidating assets at the infrastructure level. T2S will start operations in 2015 with participating central securities depositories (CSDs) joining over four waves until 2017.
An Oliver Wyman study, commissioned by Clearstream, reviews the key regulations impacting the post-trade area, highlights the efficiency potentials that can be realized by adapting post-trade models and quantifies the savings potential in three illustrative case studies for a broker-dealer, a global custodian and a regional bank.
Due to the increasing capital, balance sheet, liquidity, collateral and operational requirements, the resulting exposures to a variety of intermediaries, collateral fragmentation, reduced settlement netting potential and operational complexity make the current approach increasingly costly and unsustainable.
By delayering, pooling, netting and simplifying settlement operations, participants can realize cost savings along a number of dimensions, the study finds: capital costs can be reduced by lowering risk-weighted assets and leverage ratio requirements associated with settlement activities;
On top of the cost savings, there are additional benefits generated by reducing exposures, risks and complexity: decreased liquidity risk during stress periods by using central bank settlement credit lines; decreased operational risk through reliance on fewer settlement and payment agents as well as holding securities directly at infrastructure level; potential lowering of depository risk through delegating custody of securities to highly regulated CSDs.
The first case study considers a broker-dealer, which generates daily settlement volumes of € ~30 billion across 10 key T2S markets. Trading assets and liabilities are assumed to be € ~100 billion across these markets (long and short positions). The dealer can save up to € ~70 million annually by consolidating the settlement setup. By moving cash used to support settlement activities from commercial payment banks to the ECB, capital requirements can be reduced given the lower Basel risk weight associated with central bank exposure (amounting to € 2-3 million capital cost savings on € 0.7-1.1 billion calculated cash collateral, due to a 0% risk weight as opposed to a ~20% risk weight).
An estimated 25-30% reduction in overall collateral, needed to support settlement activities, can be achieved by the dealer through pooling collateral in T2S (against a single ECB account), the study finds. As settlement line usage peaks occur at different points in times, aggregate peaks can be substantially lowered by pooling as less buffers are needed, reducing collateral needs and associated funding costs as well as potential capital costs by lowering collateral holdings. € 12-15 million of the cost savings are due to lower funding costs (based on a reduction of € 0.8-1.0 billion in collateral requirements and the net funding cost rate of ~1.5%). The remaining ~3 million cost savings are achieved by the reduction of leverage ratio-based capital requirements (based on capital savings of 3% on reduced collateral on balance sheet and a cost of regulatory capital of 10-12%.
Furthermore, the dealer can potentially further reduce the capital requirement for leverage ratio purposes, by being able to net more cash payables and receivables of securities financing transactions using the same settlement system across markets. These savings amount to € ~2 million for the dealer in the case study based on a conservative assumption of netting, reducing the leverage ratio exposure by € ~0.5 billion.
By consolidating settlement activities across 10 T2S markets on one CSD, the global dealer can reduce operational costs by managing connections to different markets. In the case study, operating cost savings of € 3-7 million are achieved due to streamlining back office operations.
The second case study looks at global custodians and considers that a global dealer that consolidates € ~400 billion worth of AuC, from accounts in 10 T2S markets to a single T2S account at a CSD, and the cash needed for settlements at a single direct cash account (DCA) with the ECB. Settlement volumes are assumed to be € ~11 billion per day across these markets. In this case study, a global custodian can save up to € ~50 million, with €15-24 million coming from the pooling of collateral, resulting in lower funding and leverage ratio-based capital costs.
The final case study considers a European regional bank that has € ~140 billion of securities deposited from local corporates, SMEs, and retail investors; a majority of assets are assumed to be in the banks’ home market, with a small proportion spread over 4-9 other T2S markets. In the case, the regional bank consolidates these assets into one T2S CSD, and streamlines its payment agents in all its markets into a single direct cash account (DCA) at the ECB. Under these conditions, the regional bank can save up to € ~30 million, with up to €~7 million in savings if these banks begin to charge for settlement lines.
T2S to Generate Substantial Savings For Broker-Dealers, GCs and Regional Banks, Study Finds
A study has quantified the benefits of a harmonized settlement infrastructure for eurozone securities for broker-dealers, global custodians and regional banks.