This article was first published in the Securities Finance Times Technology Annual 2021 (p.22).
Read online- https://bit.ly/3grnGMO
We are extremely proud of our recent series B funding round with new strategic partners BNY Mellon, Goldman Sachs, BNP Paribas and Citigroup, and long-standing strategic partner Deutsche Boerse Group. Not only is the €14.4 million financial backing substantial, but the public commitment from our new investors to connect to our platform speaks volumes towards validating our shared vision to accelerate collateral mobility across the global securities finance ecosystem.
We are often asked what we will use the funding for? Well, the simple answer is that it will be used to accelerate market adoption of our platform by expanding our product scope and functionality, while further extending our connectivity to leading triparty agents, custodians and market participants.
In this article, we would like to share a sneak preview of some product development opportunities that lie ahead.
But before doing that, let’s quickly summarise who we are, and what our key value proposition is today. HQLAᵡ's core clients are financial institutions active in securities lending and collateral management. Our unique value proposition is to enable market participants to transfer ownership of securities seamlessly across disparate collateral pools at precise moments in time without moving the securities across custodians. This enables our clients to better optimise their liquidity management and collateral management activities, thereby generating operational efficiency gains and capital cost savings.
Here is a very brief refresher on the background of the regulations and regulatory ratios that were the genesis behind the creation of our platform.
As a result of the global financial crisis, the Basel Committee on Banking Supervision introduced a host of new regulations to promote global financial stability by strengthening the capital and liquidity positions of the banking industry. These regulations were implemented through the introduction of global minimum standards, including the following four key financial ratios: capital ratio, leverage ratio, net stable funding ratio (NSFR) and liquidity coverage ratio (LCR).
The capital ratio measures the riskiness of a bank balance sheet by comparing a bank’s capital position to the amount of risk-weighted assets (RWAs) on its balance sheet, while the leverage ratio is risk-agnostic and simply measures a bank’s capital position relative to the total size of assets on its balance sheet. NSFR represents a bank’s available long-term stable funding (ASF) relative to its long-term required stable funding (RSF) for funding with maturities of greater than one year, and LCR reflects a bank’s ability to weather short-term liquidity shocks by comparing the stock of high-quality liquid assets (HQLA) to the expected liquidity outflows during a 30-day stress period.
Managing across these regulatory ratios is no easy task for the banking industry. This is due to the fact that it is very difficult to manage the ratios in isolation. They often interact in an opposing manner, and an action to improve one ratio may have a knock-on effect of adversely impacting one, or more, of the other ratios. As a result, many banks have created centralised financial resource management teams to help manage the key regulatory ratios, and allocate scarce resources and associated costs in a holistic fashion across trading desks and business lines of their organisations.
What makes managing these regulatory ratios even more challenging is when intraday liquidity and intraday credit are added to the optimisation engine as scarce resource constraints, which is something that more and more banks are now doing.
Some banks already allocate costs for consumption of intraday liquidity and intraday credit to trading desks, and many banks are finalising plans to do so in the near future. This evolving focus on intraday credit and liquidity management is beginning to manifest itself as a significant market pain point. This pain point is piquing market interest in our platform, and here’s why.
While the existing triparty collateral infrastructure works very well for optimising obligations in a single custody location, it suffers from the inability to provide an industrial-strength solution for atomic delivery-versus-delivery (DvD) of baskets of securities across triparty agents and custodians. DvD refers to instantaneous exchange of ownership of one basket of securities versus another basket of securities. Current market practice is to settle collateral upgrade transactions in one of two ways: two free-of-payment (FoP) settlement instructions or two delivery-versus-payment (DvP)settlement instructions. Unfortunately, both settlement practices have drawbacks. The former generates intraday credit exposure, and the latter generates intraday liquidity exposure — both cost capital.
This is where the HQLAᵡ solution comes into play. HQLAᵡ enables DvD ownership transfers for baskets of securities in a collateral upgrade transaction. The HQLAᵡ DvD solution consumes neither intraday credit nor intraday liquidity, and that is why we are seeing strong demand from banks to on-board to our platform, especially from those banks most advanced in optimising intraday financial resources.
The initial design of the HQLAᵡ minimal viable product offering (MVP) was driven by practitioners from leading global banks. The basic idea from the very beginning was for the HQLAᵡ platform to be ‘designed by the industry, for the industry’. Staying consistent with this approach, and based on feedback from our clients, we are now developing the following products to further enhance the HQLAᵡ service:
To accelerate the onboarding of agent lenders to our platform, we are now designing a custody model whereby an agent lender may deliver principal loan securities via custody, while the collateral leg is delivered via triparty still achieving DvD. This is relevant because the agency securities lending community is accustomed to delivering principal loan securities via custody today. Therefore, the custody model we are designing will support scalable onboarding of the broader agent lending community. In addition, the custody model is also expected to open up new business opportunities for our platform. One such opportunity is to expand our product offering from collateral transformation trades, to also enable lending of specific securities to support short-covering activities.
Another opportunity we are pursuing with the custody model is to support capital-efficient intercompany financing trades (firm longs versus firm shorts). Due to Brexit, more and more banks now have bifurcated legal entity set-ups whereby market-making for outright purchases and sales of securities is conducted in one legal entity, and the financing activities to support the outright trading activities are conducted and managed by another legal entity.
The long and short positions of specific securities are typically transferred across the legal entities via internal repo and reverse repo transactions, which consume costly intraday liquidity. The use case we are developing will enable longs and shorts to be transferred between entities on a DvD basis, without consuming intraday liquidity and credit.
To streamline our connectivity to the agency lending community, we will collaborate with third party service providers that specialise in facilitating trade execution and post trade reporting between bank borrowers and agent lenders.
Digital collateral records (DCRs) are the record of ownership of securities that are recorded on the HQLAᵡ platform’s ledger. We are currently designing a prototype for a DCR dashboard to provide our clients with an overview of encumbered and unencumbered DCRs.
One interesting use case that we are pursuing with one of our clients is to leverage this dashboard to enable the client to transfer ownership of unencumbered DCRs between two of its legal entities on a 24/7 basis.
We are also in early design stages for what we are calling a composite DCR (a single DCR to be collateralised with DCRs from multiple triparty locations), and to enable dynamic substitution of DCRs on a DvD basis.
Following the extreme, pandemic-related market volatility from last Spring, we received a significant amount of interest from market participants (both sell-side and buy-side) to leverage our platform for managing margin exposures, both for over-the-counter (OTC) and central counterparty (CCP) derivative exposures. We are currently in discussion with a major EU derivatives CCP to accept DCRs as record of ownership of baskets of securities to satisfy CCP initial margin requirements. We are also considering use cases in the OTC margin space, specifically related to mobilising money market fund units held in Clearstream’s triparty environment.
Our current operating model caters strictly for non-cash ownership transfers, but we plan to expand our product offering to include DvP in the future. One possible use case to pursue is to link our platform to existing payment rails to create a DCR repo market. Another potentially transformative use case under consideration is for HQLAᵡ to interoperate with other distributed ledger technology platforms active in tokenising cash, either central bank money or commercial bank money.
There are certainly many product development opportunities to consider, and we are actively engaging with our stakeholders, our existing clients, and our prospective future clients to help shape our product development, so that our platform remains true to our guiding principle of being ‘designed by the industry, for the industry’.