HQLAX released a white paper showing an estimated $80 billion intraday credit risk arising from settlement exposures, and $119 billion of intraday credit exposure for securities lending transactions.
Securities financing tools play a critical role in optimizing financial resources for banks in a market structure increasingly reliant on collateral. These transactions, however, introduce intraday credit risk, arising from both the settlement process and market fluctuations that alter the value of securities or collateral provided by borrowers to protect lenders.
This risk is further amplified by the intraday credit lines provided by settlement agents to transaction participants, compensating for the fragmented and complex network of custodians and securities depositories that manage ownership records of securities.
In addition, regulators are also reducing the applicability of internal models for aspects of the capital calculation, or applying output floors (as with Basel IV) on the capital requirements based on a percentage of a standardized capital calculation.
HQLAX‘s research approach showed that one third of intraday securities lending exposures would be zero risk weighted, one third would attract a 20% risk weight, and another third would attract 100%, suggesting $32 billion of RWAs for intraday settlement exposures of $80 billion, and $16 billion of RWAs for intraday potential future exposures of $39 billion.
In this context, HQLAX discusses in the white paper how potential future regulations could evolve to address intraday credit risk, and the impact this may have on bank financial resources. Additionally, there is an assessment how emerging technologies, such as distributed ledger technology (DLT), could offer solutions to mitigate these risks, potentially reducing the capital requirements associated with any future regulatory measures.
In addition to mitigating credit risk, distributed collateral ledgers also solve for a number of additional post-trade risk scenarios.
Firstly, the technology enables synchronized ownership transfers at precise moments in time. Irrespective of whether this is deployed to support securities lending, repo or margin arrangements, it enables settlement to become certain and predictable.
Secondly, firms are able to fully optimize their usage of available inventory irrespective of the deposit location. Margin calls can be met in a timely manner, intraday requirements can be secured without friction and collateral buffers can be minimized.
Finally, as demonstrated in end-to-end tests as well as recent European Central Bank, DLT solutions are becoming, by design, interoperable. This will enable market participants to create an ecosystem where atomic settlement is supported without restricting freedom of choice.