In the crisis of 2008, known issues of timing and risk within settlement processes caused extreme stress across the industry and led to the failure of major institutions.  

In the crisis of 2008, known issues of timing and risk within settlement processes caused extreme stress across the industry and led to the failure of major institutions.  

Many encountered serious issues managing the liquidity and collateral to meet their settlement obligations. Experienced liquidity professionals were already acutely aware of the complexity and risk of daily management of provisioning intraday liquidity – cash. And in 2008, their concerns were proved when institutions that could no longer meet their obligations failed due to the absence of cash, in the right place at the right time. The Silent Assassin had struck!

Although 2008 highlighted the criticality of intra-day liquidity, regulators and the industry have been slow to reduce the likelihood of a sequel. Initiatives across payments, settlement and liquidity have required increasingly granular and frequent reporting but without significant change to cash settlement processes within and between institutions. Enhancements have typically been undertaken at asset class rather than at an institution level. Since liquidity risks are so clear, and regularly tested, we should look to move away from just measuring to reduce liquidity risk. We have 20th century settlement model with 21st century risk.

Liquidity risk still exists and transaction volumes and values continue to increase, with current gross settlement values across markets of over 5 Trillion dollars a day. And that increased market demand is concentrated on existing settlement banks. This article suggests cross market efficiencies exist that can mitigate liquidity costs and risks whilst supporting growth in market capacity. 

Change activity continues to focus on transactional rather than the underlying payment and settlement activity.  Netting is a logical answer to the capacity and cost challenge, however in many markets – especially complex derivatives – transaction level netting is expensive and largely done where feasible. If institutions can book payments at a gross level and settle netted exposures with major counterparties, considerable savings can be achieved, reducing liquidity requirements, cost and risk, allowing increases in transactional capacity.

This challenge resonates across all asset classes, and it’s across asset classes where most benefit can be derived by institutions. The efficiency of cash settlement systems and liquidity risk management are not sexy topics; this is the domain of the back office!  However, the scale of benefits in terms of cost and capacity justifies attention from Treasury, Risk and Payments organisations. So what to do? Firstly, identify the real cost of settlement in your business, including funding costs. Are there risk capacity constraints that limit profitable business growth? Understand the impact of halving costs or doubling capacity, and remember those same benefits exist across asset classes when assessing institutional benefits.

Regulators have seen the risk of the Silent Assassin – they have shone torches into corners of the back office – and spotted him! It is now up to institutions to decide how they respond and generate capacity and savings enabling business to grow profitability within the enhanced regulatory risk framework.

This article was first published in edition 9 of Rocket, our magazine. Download available Rocket editions here, and save your up to date address in your profile to to indicate your interest in receiving a printed copy of the magazine. Copies are also available to purchase and subscribe to via the shop.

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