Collateral mobility remains a key focus point of securities finance market participants, but existing settlement practices come with certain pain points. What is the key pain point expressed by the market?
Elisa Poutanen: When discussing the topic of industry pain points with our clients, the number one theme we hear is the inherent fragmentation across legacy securities settlement system infrastructure, particularly in Europe, and the resulting inability to execute collateral transfers in real-time, at agreed precise moments in time, on a 24/7 basis — for example, without securities settlement cut-off times.
The fragmented nature of the legacy custody ecosystem results in market participants needing to transfer securities across a very fragmented set of custodial locations. Cross-custodial movements of inventory consume precious intraday liquidity, create settlement risks, require market participants to hold excess buffers and often result in suboptimal collateral allocations. We estimate that inefficient collateral management can cost Tier 1 participants between €50 million and €100 million per year.
How can new technology, such as DLT, help to alleviate pain points caused by fragmentation?
Poutanen: HQLAX specialises in delivering real-time liquidity management and collateral management solutions for institutional clients. Our goal is to create greater certainty and efficiencies for the global securities lending and repo markets through our proprietary platform that leverages distributed ledger technology (DLT).
HQLAX makes the transfer of ownership of securities seamless across disparate collateral pools by removing the cross-custody movement of ISINs. This is a simultaneous exchange of ownership of securities conducted on a delivery-versus-delivery (DvD) basis.
Our platform is fully integrated with the existing marketing infrastructure — the large custodians and triparty providers are connected on the platform to enable collateral to move freely and precisely. Our goal is to enable frictionless transactions that are much more efficient and streamlined, eradicating data discrepancies, reducing back-office activities, and minimising operational risk and settlement failure.
A key aspect of our model is that ownership transfer of collateral happens without movement of the underlying securities between accounts at the custodian or the central securities depository (CSD). By decoupling ownership transfer from movement of assets, exchange can take place simultaneously, in real-time and when required, without the need to move the securities physically.
Borrowing a quote from my colleague Richard Glen, when speaking at an industry event earlier in the year, “settlement time is the new settlement date”. Historically, trade collateral had a date on which it was due to settle. But by using HQLAX, firms can specify the exact point in time the collateral should be exchanged, allowing for intraday trading for example.
What are HQLAX’s key value propositions?
Poutanen: The DvD transfers take place at precise, designated moments in time and create a secure and accurate record of the transfers. Through this, HQLAX helps clients better optimise the allocation of their long inventory of securities to meet their ever-expanding collateral obligations by providing greater control and certainty, leading to improved profitability through the benefits listed in the table.
DvD is the leading day one value proposition. As more participants join the platform, the efficiencies brought about by DLT will proliferate as we progress towards redefining collateral mobility. As a provider of DLT, HQLAX aims to be the precision tool for clients to deliver those efficiencies within their collateral management processes. Collateral management used to be viewed uniquely as an operational pain point. Today, for those doing it well, it can be a strategic point-of-difference, creating a competitive advantage.
What are the products today that have kicked off the pathway to redefining collateral mobility?
Charlie Amesbury: The firm’s founding principle is to provide frictionless ownership transfer of securities. Our operating model is based on the premise of mobilisation through immobilisation. A lot of the friction in collateral management is due to the cross-custodian moves required to service the different collateral obligations across the custodial network. Our first product, bank-to-bank lending on a triparty-versus-triparty basis, enables our clients to perform collateral upgrades or downgrades without the need for a cross-custodian move of the physical security. In this operating model, we have bifurcated the existing limitation that physical settlement into an account determines ownership of that security. What HQLAX has built means, legally and operationally, we can transfer ownership of securities on our ledger in a frictionless manner, while the underlying physical security stays within its original custodial or triparty environment.
Building on the success of that initial product, we have expanded the offering to include lending on a bilateral-versus-triparty basis, facing other banks and agent lenders. Focusing on our Agency Securities Lending product, as we pursue our ‘built by the market, for the market’ ethos, BNY Mellon and J.P. Morgan agency lending partnered with us to shape this use case to make it operationally, and technically, as similar to the existing flows today while generating capital efficiency savings for its users. We maintain the frictionless ownership transfer from the initial product, but we have added in automated on-ramping and off-ramping of the loan securities so that they can interoperate seamlessly in today’s existing banking infrastructure.
In these first phases, we have built a model that can simultaneously transfer ownership of securities at precise moments in time, without cross-custodian movement. Adding in the ability to on-ramp and off-ramp the securities, while realising capital cost benefit, has meant that clients have been comfortable putting significant volume onto the platform knowing the loan securities exchanged on our platform can be used within existing markets as they have done so pre-HQLAX.
What is the roadmap for 2023 and how does it tie into HQLAX’s “redefining collateral mobility” mission statement?
Amesbury: As we look towards the goal for our clients to be able to allocate their digital collateral records (DCRs), on-ramped from any location, towards any collateral obligation without the underlying physical movement, we are adding two other key elements — margin management and DvP repo. With the launch of these two products in 2023, HQLAX will have the technical functionality to service the entire €24.3 trillion collateral obligation market.
Our margin management tool enables our clients to be able to manage margin exposures for OTC and CCP (to be added in 2024) derivative exposures when it goes live. The aim is to make allocating non-cash collateral in the form of our DCRs as easy and as fast as allocating cash, thereby increasing utilisation of collateral while decreasing the use of more costly cash. It takes the operational headache away from allocating ISINs to cover margin calls, allows for automated substitution and paves the way for real-time margining.
In addition, we expect to launch our DvP repo offering towards the end of this year that will encompass the largest part of the collateral obligation market. The launch of this product showcases two important things for our company. First, the ability to monetise our DCRs versus centrally-backed and commercially-backed digital cash. Second, to exhibit our ability to interoperate with different digital ledgers to ensure we are breaking down isolated silos of capital. In pursuit of this, we are partnering with two digital coin providers, Fnality and Onyx, that will be the ‘P’ leg to our ‘D’ leg. Each will bring their own benefits, but principally we will be delivering to market the ability to trade repo intraday and term, with increased operational resilience and precision. Both legs will be managed from a central location, reducing cross-funding movements while providing the functionality to trade across regions regardless of market opening hours.
Plug these products into a client’s collateral optimisation engine and the benefits of HQLAX are significantly multiplied, maximising collateral optimisation across both collateral obligations and all custodian and triparty agents.
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