HQLA^X team | HQLA^X

HQLA^X team Charlie Amesbury, Martin O’Connell, Erica De Rosa, and Richard Glen, discuss the firm’s strategy to link DvD and DvP transactions for the creation of liquidity on digital platforms, and the multifaceted approach required for industry wide intraday counterparty credit risk management

Robust counterparty credit risk management has long been a key component for sound risk management in capital markets. The Basel Committee on Banking Supervision’s latest consultative document, ‘Guidelines for Counterparty Credit Risk Management’, underscores the importance of managing counterparty credit risk effectively, particularly in light of recent financial crises and market disruptions.

Given the interconnectedness of modern financial systems, the implications of unmanaged intraday counterparty credit exposure are profound, necessitating timely and effective resolution. Optimised management of intraday counterparty credit exposures will also alleviate liquidity drains, and the need to lock up high-quality liquid assets (HQLA) in the form of regulatory capital. The HQLA^X platform is a solution that provides robust credit and liquidity risk mitigation tools across securities lending, repo and margin management.

Securities lending delivery-versus-delivery

The HQLA^X Securities Lending delivery-versus-delivery (DvD) product solves the market-wide issue of ‘give before you get’ on free of payment exchange of assets. This problem creates significant intraday credit exposure between market participants on a daily basis.

Participants can settle those same securities lending trades — exchanging individual loan securities for collateral provisioned in triparty — over the HQLA^X digital ledger with the collateral swap occurring simultaneously DvD. This HQLA^X innovation eliminates credit risk in the settlement cycle and accelerates deliveries, creating efficiencies on both sides of the trade, which reduce the costs associated with securities finance activity. Our clients experience a reduction in their intraday liquidity spikes, a reduction in fails, an increase in collateral optimisation, and reduced capital costs.

We have leveraged the ‘minimum client IT build’ approach to create our Securities Lending DvD flows that caters for both collateral transformation and short covering trades. Agent lenders and principal lenders can connect to the platform using their existing technical channels, where our DvD functionality enables clients to only give up ownership of the loaned securities on-ledger in exchange for the collateral they require. This includes releasing a portion of the loan book that matches the delivered collateral value, even if the full required value (RQV) has yet to be collateralised. It automates and accelerates the lenders’ loan release processes.
 
Borrowers not only benefit from reduced capital costs due to the elimination of credit risk, but they also experience a reduction in their intraday liquidity needs, a reduction in fails, and an increase in collateral optimisation. There is no ‘locking in’ of securities on the HQLA^X platform, as securities can be freely moved between participants on the platform and to and from the platform to the clients preferred custodian. The collateral posted by borrowers can be provisioned — via title transfer or pledge — through their preferred triparty agent, removing the need to hop collateral between long-boxes to achieve optimised usage.
 
The benefits of the digital ledger for credit risk mitigation are best highlighted where collateral is provisioned in one time zone, and loaned securities settle in a different time zone. In today’s world, collateralising a US Treasury borrow with Japanese government bond (JGB) securities ties up settlement processes and creates credit exposures over hours and days. On the HQLA^X platform, these impacts are mitigated by the DvD capability.

Digital delivery-versus-payment

HQLA^X is excited to bring digital delivery-versus-payment (DvP) solutions to the securities finance market in Q4 of this year. Providing DvP functionality will complement the HQLA^X suite of products, in that collateral mobilised on the platform will be able to be monetised, resulting in increased liquidity across the platform.

However, the largest benefit is that digital DvP enables the development of new intraday repo markets, as the technology allows participants to agree exact opening times and closing times to the nearest minute. By transacting in intraday repo markets, cash borrowers can manage their intraday liquidity requirements more precisely, resulting in decreased funding costs, balance sheet usage, and capital requirements.

On the other side of the trade, cash lenders can generate incremental revenue as cash traditionally invested overnight can now be incrementally lent intraday. Intraday repo is a win-win for all parties involved, while building out another tool in a bank’s arsenal to source liquidity in stress events, to settle securities movements and margin calls.
 
With the HQLA^X platform focusing on collateral mobility, we interoperate with digital cash ledgers and traditional fiat rails to conduct cash movements to facilitate coordinated DvP transactions. The DvP is achieved by interoperating either through direct connectivity or via a transaction coordinator. Both have their benefits, and this approach ensures that we have the technical know-how and functional capability to connect to any of the payment providers.
 
Our two leading partners on this product, Fnality and Onyx by J.P. Morgan, showcase the range of solutions in which we interoperate. The former is a digital central bank money solution, where the digital cash ledger interacts with accounts held at a central bank. The latter represents a digital commercial bank money solution, where the digital cash ledger interacts with cash held in commercial bank accounts.

We also support interoperating with legacy fiat cash with projects ongoing in central bank and commercial bank cash, highlighting how we straddle the digital and legacy worlds. The market is embracing all types of cash and interconnectivity, with the acknowledgement that interoperability is key to developing liquid digital markets and a truly digital ecosystem.
 
Looking towards the future, the ability to link DvD and DvP transactions together will be instrumental in creating liquidity on digital platforms. For example, a securities lending DvD trade may result in a long position of a government security that is intended to be used as collateral in a repo transaction. These two trades can be linked and scheduled to settle at the same time on the digital ledger, decreasing spikes in liquidity and giving the client more control and certainty about their liquidity position.

In times of stress, the option to link multi-legged trades will increase confidence in the system, keeping the financial markets moving through liquidity-scarce events. The creation of these ‘atomic chains’ will result in enhanced collateral mobility, increased liquidity, and a decrease in settlement friction, which will maintain certainty in settlement while generating meaningful cost savings for our clients.

Margin management

Effective collateral re-use is a critical requirement that underpins all securities finance activities. If sufficient eligible collateral cannot be mobilised, either at the right time or in the right place, firms may face settlement delays, be called for additional margin or attract financial penalties.
 
Failure to deliver creates not only credit, liquidity and operational risks, but also has an impact on the reputation of market participants in the face of their clients. For products that are centrally cleared, time is your greatest enemy, as margin calls are required to be covered in full and within tight deadlines. This is where the application of the technology developed by HQLA^X can promote market stability and help to facilitate more efficient collateral optimisation.
 
Diving into the target operating model, clearing houses or central counterparties require that margin calls are satisfied within a prescribed window. If margin calls are not secured in a timely manner with non-cash collateral, cash will be directly debited from a clearing members’ account automatically. For segregated client activities, this creates additional credit, as well as liquidity risks for the period until non-cash collateral is mobilised by the client in question.
 
On paper, the process required to manage the workflow and mitigate these risks is simple: client receives margin call and identifies collateral; client delivers collateral to clearing member; clearing member receives collateral and passes onto the clearing house.

When you consider that this process all needs to happen within a window of 30-60 minutes, it is easy to see why a clearing member would be interested in developing a robust and automated solution for its clients to manage the end-to-end process.
 
This is exactly the solution that HQLA^X is designing collaboratively with an exclusive set of innovative market players that will deploy at scale. Our end-state design leverages our proprietary DvD capabilities to manage substitutions at precise moments in time, as well as leveraging our interoperable partnerships to optimise the usage of non-cash collateral versus cash. In addition, the ability to offer real-time margining between market participants means that clients can cover their mark-to-market in an automated fashion intraday. This allows clients to benefit earlier from the liquidity of any in-the-money positions and also to avoid large credit exposure building up when big swings occur intraday. It also considers opportunities to support uncleared as well as cleared product workflow in future.
 
By decoupling ownership transfer from the movement of assets, HQLA^X is able the improve the latency of our clients’ margin collateralisation process, reduce cross-custodian movements, and improve operational resilience. By removing the uncertainty around settlement timing, with HQLA^X, clients can ensure that failure should never be an option.

The path forward

Effectively, industry wide intraday counterparty credit risk management requires a multifaceted approach. Enhanced regulatory frameworks, consistent global standards, and robust stress testing are critical. Collateral management is a strategic differentiator for firms that do it well, and banks are investing in advanced risk management systems that incorporate real-time data analytics to monitor and manage their exposures.

Platforms such as HQLA^X can consume that real-time data and help banks to achieve capital efficiency, enhanced collateral mobility, mitigated risk of fails, and lower operating costs through coupling the benefits of DLT with legacy triparty and custody infrastructure services.

Collaboration between financial institutions, regulators, and technology providers will be key to developing resilient solutions that can withstand market shocks. By implementing global regulatory standards, advancing risk management practices, and applying those through robust technology, the market can mitigate these risks and ensure a more stable financial environment.