Give thanks for the Fed – intraday liquidity reflections from New York

By Pete McIntyre | 3 December 2019

I’ve just returned to the UK after a week in New York where I was able to test the latest thinking and progress on intraday liquidity in the US and Canada.

Here I provide six reflections on how firms are addressing the intraday challenge - keep reading to the end as reflection six explains how the Federal Reserve is increasing the intraday pressure.

1) Intraday liquidity is now too narrow a definition

I talk about intraday liquidity all the time. In fact, I’ve even been accused of proselytising, which I am quite proud of, but I’ve started to realise that the phrase ‘intraday liquidity’ is too narrow in summarising the problems and opportunities in this space. Some people (those I’ve not yet managed to convert) might see ‘intraday’ as something only for risk management to look at ‘after the fact’ ie break down yesterday’s liquidity activity into minute by minute periods, so that peaks and troughs can be identified and reported on. But this is only the first step in the process as it doesn’t put you in control of events as they happen.  

Instead, we should consider intraday liquidity as only one component of a much wider topic that I refer to as real-time treasury ie being able to understand what is happening on all your treasury activity in real-time. If you have a real-time treasury capability then you can monitor, manage, control and optimise your intraday liquidity and this is where the real challenges and opportunities lie.

2) Machine learning is coming

I had lots of discussions about how machine learning (or artificial intelligence if people want to get really adventurous) should be able to help firms understand the ‘what next’ for liquidity positions. We’ve seen it adopted already in the client-facing space, particularly the retail customer world eg instant credit applications, real-time fraud analytics, KYC activities.  

The consensus was that we expect to see similar uses of machine learning in the areas of funding and liquidity in the next wave of industry transformation. In particular, firms are building up days/months/years of rich data history on their intraday activities. Machine learning can exploit this history to predict future patterns of liquidity usage and create intraday liquidity projections. These projections can identify problems ahead of time and provide early warning indicators of stresses if actual profiles stray too far from expected.

3) The customer is king

Whether a customer is a corporate, a complex financial institution or a consumer, their activities are fundamental to shaping a firm’s own intraday liquidity profiles. After all, you have to maintain enough liquidity throughout the day to be able to process your customer payments when they come to settle. Understanding, anticipating and forecasting these customer activities is increasingly expected to shape firms’ intraday liquidity management actions.  

Ultimately, influencing how your customers behave will be essential to optimising your own use of intraday liquidity, but this is easier said than done. For some customer groups ‘good behaviour' can be encouraged eg through pricing policies. But in many markets might not make commercial sense to charge for intraday liquidity and in other markets it can be unrealistic eg in instant payments schemes where a bank needs to provide liquidity to the settlement scheme to allow its customers to make payments 24x7. As a minimum, a firm needs to understand its actual and expected customer intraday profiles to take appropriate actions and optimise liquidity.

4) Don’t forget about corporates

I had more discussions than expected about corporates and how corporates with complex treasury infrastructures need their own intraday/real-time treasury capabilities. For example, a corporate with business in many countries will need to make and receive payments in multiple currencies. This implies a multiple nostro, multiple provider bank model. Such corporates will need more sophisticated nostro management capabilities than those many banks who only operate in one or two countries.

As for a bank, liquidity is precious and as the corporate moves to a 24x7 world, it will require its own sophisticated intraday systems plus support from their provider banks to create the required intraday insight. Provider banks might be able to deliver this insight as a (revenue generating?) service but more complicated corporates with multiple banking providers will need their own intraday infrastructures just as in a sophisticated bank treasury.

5) North American payments architectures are being overhauled which will impact intraday controls

Change is needed and is coming in the world of payments. Payments Canada is rolling out a new RTGS plus instant payments and other enhancements to the retail payments architecture. The US authorities are making similar noises through the FedNow initiative.

Firms need to accept this fundamental change to current liquidity management orthodoxies. The funding and liquidity management landscape will be very different with customers taking advantage of 24x7 payments, nimble challengers taking share from established players and treasuries taking advantage of new opportunities to manage assets in real-time. Those who respond well will have huge advantage over the laggards.

6) North America is slowly, finally, waking up to Intraday - the Fed is a big driver for this

As with the rest of the world, it is regulatory attention that tips firms into improving intraday (even though the non-regulatory business case is enormous). In the US, major institutions have long been investing in intraday, mainly due to resolution planning where intraday liquidity is a key component. But I saw how the next tier of firms are now engaging with the intraday agenda and the reasons why are interesting.

First, intraday volatility. Scarce intraday liquidity in the market has been a news story recently. The Fed had to step in to inject liquidity into the market in September. These liquidity challenges have been publicly discussed by such luminaries as Jamie Dimon of JP Morgan and Steve Mnuchin, the US Treasury Secretary. The headlines mean treasurers are in the spotlight to prove they understand their intraday liquidity requirements and can act quickly to source liquidity quickly when times get tough.

Second, the game is changing. Firms see established rules of the intraday game changing. In the US, many firms - particularly Foreign Banking Organisations (FBOs) - typically park huge group assets as cash in a US dollar account at the Federal Reserve. Hence US legal entities/branches retain oodles of liquidity so don’t worry too much about running out of intraday cash. But the US government is concerned that locking up this liquidity is not helping the economy. The word is out to expect changes, such as interest rates on long (or short) balances at the Fed or more technical means of disincentivising sluggish liquidity management. Forward-thinking liquidity managers are anticipating needing much more active control of intraday positions.

Third, regulatory pressure. The Fed is now ramping up the regulatory pressure. Having already addressed intraday for very large, systemically important banks it is now moving to the next set of targets and has just launched a horizontal review of intraday liquidity. Horizontal reviews ask standard questions to groups of regulated institutions to check compliance against supervisory policies. Firms are now scrambling to respond by mid-December. 

Regulatory attention moving down from the most important firms to the next tier is completely normal. It’s already happened in the UK, where smaller entities have been snapped out of intraday lethargy as the Prudential Regulation Authority moves its focus to them.

I understand the intraday capabilities of many US firms and FBOs in the US. Having seen the review questions, I anticipate many firms receiving Matters Requiring Attention (MRAs) since their current capabilities are not up to scratch. For those firms previously reluctant to make the leap to intraday improvement the Fed really has left no place to hide. Such firms need to be able to:

  • Provide actual metrics explaining intraday activity. There will be no excuses accepted as firms have had many years grace to prepare for this.
  • Explain how the intraday liquidity buffer has been sized (you do have a standalone intraday buffer don’t you?) and how you access intraday credit. Also explain your intraday stress testing models and how they inform buffer calculations.
  • Identify business lines, products and clients that drive intraday usage.
  • Describe systems and processed used to measure, monitor and manage activity in real-time during the day. You can’t make up these systems and processes at short notice, they should have been established for many years.
  • Show the right governance is in place to manage intraday activity, monitor risk and take speedy action if stresses develop intraday.  

Firms with great intraday capability have nothing to worry about, but those who don’t should start preparing the business case to invest very soon.

Closing thoughts

It was a very productive few days in New York and it’s telling just how much intraday requirements, regulations and firms’ responses are starting to standardise across both sides of the Atlantic. I look forward to visiting in 2020 to test progress and see the Fed’s response to the horizontal review.

For more information on Planixs and our intraday liquidity and treasury management solutions, please visit: www.planixs.com

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