Euroclear’s Marije Verhelst and Rebecca Carey reflect on how market turbulence is impacting settlement efficiency and collateral availability and explain how the firm is helping clients to manage this volatile market
Global markets have been highly volatile in 2022. Rising inflation, tightening monetary policy, including rapidly rising rates and reversing of Quantitative Easing (QE), have mixed with a febrile geopolitical situation. This has led to high market volumes and deteriorations in the value of securities globally.
At the same time, new regimes have come into play such as Uncleared Margin Rules (UMR) Phase 6 and Central Securities Depository Regulation (CSDR), both of which have the intent of increasing the use of collateral and making financial markets more robust. All of these factors are driving a need for settlement efficiency like never before.
To discuss this situation in greater detail, Marije Verhelst, head of business development, securities lending and collateral management at Euroclear, and Rebecca Carey, product manager of transaction processing at Euroclear, share their insights on what has been happening and what Euroclear is doing to help its clients.
There have been high volumes and high volatility in the market this year. What have you seen in terms of how these have affected your business?
Marije Verhelst: Volatility in the market typically translates into higher settlement volumes and, often, to higher volumes in our lending products — Autoborrow and GC Access. During this time, our collateral business volumes have been very strong as we have seen growth in all the business lines — UMR, triparty securities lending and triparty repo.
In terms of settlement efficiency, it should be noted that efficiency rates fell by several percentage points in Q3 2021 and so we started 2022 at rates that were already low compared to previous years. This was followed by a further dip in March 2022, at the start of the war in Ukraine. While we have seen some recovery in 2022, we are still not back at the levels seen in the first half of 2021.
There are several reasons for failing, but it is clear that the majority of settlement fails are due to lack of securities. The second largest reason for fails in Euroclear Bank is late matching.
In terms of settlement efficiency and collateral shortfalls, is this period of volatility different from previous times, such as March 2020?
Rebecca Carey: You would expect temporary settlement efficiency issues in periods of high stress such as in March 2020, at the start of the Covid crisis, in March 2022, at the start of the war in Ukraine, or in October 2022, given the stresses in the gilt market. However, it is unusual, at least in the recent past, to see such a long period of high activity and low liquidity. For the latter, the various (QE) initiatives certainly play a role as a substantial amount of HQLA assets are sitting in central banks’ accounts and are not always properly lent back to the market. Limited HQLA supply and massive cash positions — combined with massive positioning on expectations of rate increases — have compounded the issue of collateral shortfalls.
In addition, this time round, we have had the double impact of volatility in the market together with the application of sanctions. While it is hard to put any exact figures on it, it seems clear that the screening processes that all intermediaries have had to put in place have impacted straight-through-processing rates, which have had a knock-on effect on settlement efficiency.
You mentioned the recent gilt market volatility in the UK. What insights can you give us about settlement efficiency and collateral during recent weeks?
Verhelst: In recent weeks, gilt settlement volumes in the UK reached unprecedented levels following the turmoil in financial markets. Volumes of specific gilts doubled, as did the self-collateralising repo volumes that help to inject liquidity into the system. Nevertheless, there was consistent pressure on market participants and, as such, settlement efficiency dropped by a few percentage points. However, we are seeing a recovery of those settlement efficiency numbers as of the end of October.
To support the market, Euroclear UK & International extended system deadlines by 15 minutes to alleviate some of the operational pressure in the market. This extension of the settlement window followed an earlier extension by 30 minutes at the start of the Covid crisis. This additional time was given to enable market participants to ensure instructions were matched in the system.
Earlier in November 2021, Euroclear UK & International introduced an extension of the Delivery-by-Value (DBV) window to allow all-day settlement of collateral operations. This helped move the volume of settlement earlier on the intended settlement date, and to reduce systemic and credit risk due to intra-day credit exposures. The Euroclear Bank Autoborrow service has also been made available in Euroclear UK & International to avoid settlement fails on deliveries between Euroclear UK & International participants.
Finally, on 21 November, and following a market consultation, Euroclear UK & International will extend auto-splitting (partialling) to gilts. This is expected to further enhance settlement efficiency.
Earlier this year, the new CSDR regime came into force. How has this settlement discipline regime performed over the course of the year?
Carey: Considering the high level of activity and the liquidity shortage in many securities, it is probably too early to draw meaningful conclusions at this stage on the impact of the settlement discipline regime, introduced in February this year. Since its introduction, the number of daily penalties at Euroclear Bank has remained at levels around 60,000 per day.? Anecdotally, the average penalty fees are around €50, whether at Euroclear Bank or at Euroclear Belgium, Euroclear France or Euroclear Nederland (the ESES CSDs) on T2S. At Euroclear Bank, penalties for late matching account for around 20 per cent of the number of penalties. But in terms of cost, late matching now accounts for over 30 per cent of the cost of the penalties.
What tools does Euroclear have to help clients meet the requirements of this new regime?
Carey: At Euroclear Bank and the ESES CSDs, we continue to see an increase in the take up of partial settlement services, which have become a significant tool to reduce fails. At Euroclear Bank, we have seen the contribution of auto-partial to settlement efficiency increase from around 2 per cent a year ago to 3.5 per cent now.
It should be noted that auto-partial cannot be used by custodians if client assets are not segregated, as there would be risk of mixing client assets. Therefore, to allow a wider use of partialling across the entire client base, we will introduce a partial release in Euroclear Bank. This will allow custodians to request a partial delivery when their underlying client has only a part of the position.
Verhelst: We see very few fails due to lack of purchasing power — lack of cash or absence of a credit arrangement. Euroclear Bank extends over €100 billion of credit every day to our participants to support their settlement activity, across more than 50 currencies, covering all time zones.
In addition, whenever a client that is participating in the Autoborrow programme faces a lack of securities to settle a delivery, our Autoborrow service kicks in and automatically triggers a loan. This enables borrowers automatically to tap into Euroclear Bank’s €1.6 trillion pool of lendable securities — without the need to instruct. These loans are fully automated and will be generated at the start of the day and throughout different runs during the day. They will also be reimbursed automatically as soon as the securities hit back into the account. Borrowers will only pay borrowing fees on loans still outstanding at the end of the day. Autoborrow contributes a further three per cent to settlement efficiency.
How else are you helping settlement efficiency in the wider post-trade space as a whole?
Verhelst: In addition to our settlement optimisation measures such as auto-partial and our Autoborrow programme, we offer a number of tools that help our clients to improve collateral mobility. One is the collateral allocation interface. This tool allows collateral givers to transfer collateral to other triparty agents to cover exposures with counterparties that have accounts with those triparty agents and not in Euroclear Bank. It also automatically recalls the securities as soon as they are required for settlement in Euroclear Bank. Therefore, it prevents fails even if securities are initially located outside Euroclear Bank. This service is available with three triparty agents: BNY Mellon, J.P. Morgan and Clearstream Banking Luxembourg.
Furthermore, our Open Inventory Sourcing service enables the management of inventory held with other CSDs and custodians. This tool transfers collateral to Euroclear Bank while ensuring sufficient collateral remains locally to satisfy domestic delivery obligations. If a security is required in the local market to make a delivery, our service automatically triggers a substitution and transfers the security back to the local market, therefore also contributing to the settlement efficiency in the local market. This service exists in Euroclear UK & International, Euroclear France and Euroclear Nederland, and through two custodians in Italy, and Spain.
Carey: We are also addressing the wider market problem relating to matching and exception management, because instructions that are not matched on time are the cause of over 30 per cent of the cost of penalties.
To help with that, we launched EasyFocus last year to provide insight to clients that can help in the prioritisation of exceptions. By leveraging Artificial Intelligence (AI), EasyFocus provides predictive insights into unmatched settlement instructions that carry the highest risk in terms of settlement failure and CSDR penalty impact. This saves time and resources by identifying the unmatched instructions that matter the most. Taskize, our query resolution network, can then help to resolve the exceptions with a single, streamlined digital channel to manage the penalties and appeal process and achieve significantly reduced resolution times for the daily operational issues.
