Euroclear UK & Ireland (EUI) has become the first foreign financial market infrastructure to connect to the Federal Reserve’s national settlement service, how will this enhance your settlement offering?
Clients are now able to settle transactions in US dollars in central bank money which addresses credit and operational risks between settlement banks and allows for greater efficiencies.
Typically in cross-border settlement with commercial bank money, the intermediaries involved take risks on each other which may be passed on to the clients. In the new service, when a market participant settles against dollars in the system, there is the finality of settlement at the moment the transaction occurs and the ownership of the security moves against the certainty of cash payment. Historically, settlement had been in commercial bank money whereas now it is a claim in central bank money. The settlement bank is now paid in central bank money the same day across accounts at the Federal Reserve Bank of New York.
Previously, firms faced a residual risk. Essentially if a bank in the chain of settlement defaulted, the rest of the banks in that chain would be exposed to that insolvency. However, now with our model, EUI calculates net settlement bank positions and instructs payments directly onto accounts at the Federal Reserve Bank of New York through its National Settlement Service. Users’ settlement banks guarantee the cash proceeds and are themselves protected against the risks on other banks in the system.
Settlement banks can now track what is going on intraday and throughout the settlement lifecycle more efficiently and are confident they themselves will be paid. The ability of all settlement banks to make the required payments in the Federal Reserve accounts is underpinned by funds held by the banks at the Bank of England. This provides payment protection and certainty against the risk of intra-day insolvency events between settlement banks.
EUI is the first foreign infrastructure to be given direct access to the Federal Reserve’s National Settlement Service in the US which is a great honour. EUI is now able to offer settlement in three currencies, sterling, euro and US Dollars all in central bank money.
How long did it take you to come up with the infrastructure and implement it?
It has taken quite some time to complete this project. We have been working on this for over three and a half years. It was helped along by the Central Securities Depositories Regulation (CSDR), which requires CSDs that don’t have a banking licence—which is true of most domestic CSDs—to settle in central bank money.
This requirement reflected the practice of most domestic CSDs of connecting to its local central bank. It raised an issue for us as we were settling in dollars which was not our domestic currency but we were using commercial banks as intermediaries. The legislation meant we either had to get a banking licence; stop providing dollar services or we had to find a new way to settle in central bank money. We chose to be innovative and do something that no other CSD had done before and built this service.
As a former central banker, I knew this would not be easy and would involve many hurdles. But our initial conversations with the Federal Reserve were very positive. We discussed with them the options available and the risk analysis for each as we sought to protect financial stability.
The Federal Reserve’s National Settlement Service was tailor-made for our type of activity. It is used for the settlement of mutual obligations like local credit card transactions and is a very efficient service. We decided this was the best mechanism for the new settlement model.
Euroclear’s funds assets under custody were 10 percent in H1 last year, what other successes did you achieve in 2018 and do you see the results continuing to increase into this year as well?
Yes in terms of Euroclear Group’s results, we had a solid 2018. The value of securities held on behalf of Euroclear clients, increased by 3 percent to over €29 trillion. The number of daily collateralised transactions mobilised by Euroclear’s Collateral Highway was up 11 percent to €1.28 billion and fund assets under custody increased by 10 percent. In terms of the UK CSD which I run, we have seen a similar evolution especially in the growth of our assets.
What are your predictions in the settlement space this year, do you think there will be any particular hot topics or trends?
We sometimes describe ourselves as financial plumbing, and the thing about plumbing is that you don’t always want to know how it works, you just want it to work every day. Operational resilience is at the core of everything we do and there is a huge amount of effort and resource allocated to this. We, like the rest of the market, are focusing on cybersecurity and are providing a lot of training and awareness for our staff. By the nature of our business, risk awareness is always at the top of our list.
Providing a smooth transition into Brexit will also be a key focus for firms in the UK next year. There is a lot of uncertainty in the wider market about what will happen and we are working on a wide range of scenarios and informing clients. As always, we will seek to minimise their risks and maximise their opportunities to improve efficiency.
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