This Technical Note was prepared by Frédéric Hervo (external expert, Banque de France).
Some of this functionality is, however, provided by CHIPS, a private-sector funds transfer system.
73 FR 79110, December 24, 2008.
Although this report covers issues related to CLS, a full review of CLS risk management is beyond its scope.
he net debit cap is based on a multiple of the capital measure of the institution that is linked to an assessment of creditworthiness. The cap can be increased based on business need and the institution’s risk characteristics.
Overnight loans from the discount window facility of the Federal Reserve are, however, fully collateralized, and potential borrowers establish standing pools of collateral to cover these loans. The Federal Reserve has a general lien upon any unencumbered discount window collateral to cover a failure to extinguish an uncollateralized daylight overdraft.
During the public consultation on revisions to the PSR policy in 2008, the Board shifted its approach from treating intraday credit as inherently undesirable to acknowledging the role of the central bank in providing intraday credit to healthy depository institutions: “In the past, the Board also had concerns that accepting collateral to address Reserve Bank credit risk for daylight overdrafts would not provide strong incentives to reduce the level of intraday credit. In particular, there was concern that because of the wide range of collateral accepted by the Reserve Banks, depository institutions would have weak incentives to reduce their use of intraday credit. Under the new strategy, the purpose of Reserve Banks accepting collateral is not to control the level of overdrafts per se, but to mitigate credit risk to the Reserve Banks when they provide intraday balances and credit needed for the smooth operation of the payments system.” The revisions will be implemented in late 2010 or early 2011, but until the revisions take effect, the policy continues to state that “the Board expects depository institutions to manage their Federal Reserve accounts effectively and minimize their use of Federal Reserve daylight credit.”
73 FR 79109, December 24, 2008.
However, if more than £ 1 billion is to be borrowed, the borrowing institution must ensure that the securities of any single issuer (other than the U.K. government and the Bank of England) comprise no more than 25 percent of the total collateral it has repoed to the Bank.
The Reserve Banks monitor the financial condition of institutions to ensure they meet the safety and soundness requirements to access intraday credit. Monitoring tools include, but are not limited to, supervisory information, analytical reporting, and predictive models. Net debit caps establish limits on the amount of intraday credit to any institution. Finally, institutions that pose elevated credit risk are placed on a “watch list” for more frequent monitoring and additional targeted risk mitigation steps, as appropriate.
Source for daylight overdraft data: http://www.federalreserve.gov/paymentsystems/psr_dlod.htm.
In countries where the provision of intraday credit is unlimited but fully collateralized, foreign participants are usually treated like domestic participants.
The range of assets eligible to be pledged as collateral to the Federal Reserve, includes ABS, AAA collateralized debt obligations, commercial mortgage-backed securities, loans, and certain foreign currencydenominated assets. See http://www.frbdiscountwindow.org/discountmargins.cfm?hdrID=21&dtlID=83.
These initiatives have been a collaborative effort by the Federal Reserve and the industry, especially elaborated in the context of the Payment Risk Committee (PRC) and of the Wholesale Customer Advisory Group (WCAG). The PRC is sponsored by the Federal Reserve Bank of New York and works to identify and analyze issues of mutual interest related to risk in payments and settlement. The WCAG advises the Wholesale Product Office of the Federal Reserve Bank of New York, which is in charge of the management of Fedwire Funds and Securities. The composition of both PRC and WCAG consists of the largest institutions, domestic and foreign.
In the context of the PRC and WCAG work, the development of a liquidity-saving mechanism was supported by most of the largest institutions, especially the foreign participants as efficiency gains of moving payments from individual institution queues to a centralized queue that would enable timely matching, offsetting of payments and increased transparency. Some institutions, however, expressed a different view, emphasizing that CHIPS already provides liquidity-saving features and that there is no interest in having also such an arrangement in Fedwire Funds.
Pay-in requirements in the 17 currencies have to be completed by specified times, because of the time-zone differences which oblige CLS Bank to have a funding period compatible with the overlapping opening hours of the different RTGS systems. However, the settlement of the USD funding, which intervenes at a period of time where there are very few competing payments to complete clearly puts less pressure on banks’ intraday liquidity management than the funding in European and especially in Asian currencies. Another source of liquidity pressure is the so-called CLS Pay-In Call, which is the first means of raising additional liquidity in the event that a settlement member fails to satisfy its funding requirements. “Pay-In Call for settlement” would be issued to settlement members that have unsettled payment instructions with the failing settlement member, in order to maximize the number and value of settled payment instructions for that date. Pay-In Calls could pose significant liquidity issues because they are unexpected. The multilateral aspect of funding has substantially decreased the amount of liquidity necessary to settle with finality underlying FX transactions. CLS Bank has provided a liquidity management tool for reducing further the settlement members’ funding obligations. This tool is the In/Out swap program, which permits settlement members to enter into bilateral intra-day FX swap transactions to reduce their short positions in certain currencies and other settlement members’ long positions in those same currencies. The “out” leg of this I/O swap being settled outside CLS, it re-introduces settlement risk. One solution to mitigate this risk would be to create an additional same-day settlement session, which would allow settling in CLS Bank the “out” leg of the I/O Swaps. However, this project, which has been discussed for some time, may in turn create more liquidity pressure for funding in certain currencies.
The terms on which a member agrees to provide such services to third parties are governed through private arrangements that do not directly involve CLS Bank. The increase in the number of third parties in recent years has been one important avenue to broaden the system’s penetration in the FX market (which is estimated to be around 55 percent of the value of total trades in April 2006 according to the CPSS report “Progress in Reducing Foreign Exchange Settlement Risk,” May 2008)
For more details, see the assessment of FICC against CPSS/IOSCO Recommendations for Securities Settlement System (SSSs).
Examples of such risk include difficulties in timely liquidation or obtaining liquidity against collateral because of a market dislocation, or the difficulty for a CCP to find depository banks to hold safely margins collected from its participants.