UBS and JD Risk have published a whitepaper examining how distributed ledger technology (DLT) could optimise intraday liquidity management. The paper highlights a Bank for International Settlements (BIS) report, revealing that US Fedwire participants maintain around US$1 trillion in intraday liquidity to manage unmatched payments.
The top ten institutions hold about 60 per cent of this liquidity, averaging US$60 billion each. While these funds earn some interest at central banks, raising additional funds incurs net interest costs estimated at 100 basis points, or US$600 million annually for each institution. The whitepaper suggests that while DLT might not eliminate the need for such liquidity entirely, it could significantly reduce the burden.
CLS and foreign exchange transactions
The paper delves into the example of CLS, a central counterparty for foreign exchange (FX) settlements. CLS enables participants to net FX transactions, purportedly reducing liquidity requirements by 96 per cent. However, netting occurs on a per-currency basis, which means banks with mismatched currency positions still need to fund short positions while waiting to receive payments for long positions. Although CLS offers a workaround through In/Out swaps, this can lead to bilateral settlements outside CLS, reintroducing risks.
UBS suggests that DLT could address some limitations of the CLS payment versus payment model.
Potential of atomic settlement with DLT
DLT facilitates delivery-versus-payment (DvP) or payment-versus-payment (PvP) through atomic settlement, where a transaction either completes fully or not at all. Critics argue that atomic settlement might increase liquidity requirements at certain times due to gross settlement. However, UBS notes the potential for smart contracts to enable netting and dependency-based transactions, reducing the need for large liquidity buffers by ensuring outgoing payments are contingent on incoming ones.
While UBS acknowledges that DLT could transform intraday liquidity management, it emphasises that the technology is still in its early stages.
