The FX industry veteran behind a proposed payments netting service reckons it could save global banks hundreds of millions of dollars a year by reducing interbank payment flows and associated liquidity and capital management obligations.
Cash Netting Services (CNS) is an information service created to help banks identify netting opportunities on a bilateral basis.
Banks settle a net position with a single payment at the end of each netting session using existing payment methods. Some payment infrastructures incorporate netting mechanisms, such as Clearing House Interbank Payments Systems (CHIPS) for USD payments.
However, the schemes currently available have limited flexibility – operating prescribed payment/netting windows – and are currency specific, which means banks need to set up specific infrastructures for each currency.
CNS analyses high-value payments data from participating banks and, at agreed times, calculates and publishes net cash positions per currency between pairs of banks, providing details of all payments included in the net calculation.
Net payment obligations are determined by bilateral netting agreement (by currency) between pairs of participating banks. In accordance with the terms of these agreements, participating banks receive payment messages in Swift format to facilitate net payments.
The service is currency agnostic, allowing banks to see netting opportunities in payments in any currency. Participants agree times and lengths of netting periods by CNS counterparty by currency and determine maximum exposures per session.
Banks that have large mutual payment flows can post payment messages to CNS before the opening of that currency’s payment window. Each pair is informed of the net position at the payment window opening and a single payment between them settles all payments due.
International banks are required to hold sufficient high-quality liquid assets to meet prescribed liquidity coverage ratio obligations.
Nick Dyne, CNS
CNS co-founder Nick Dyne reckons that approximately $1 trillion of high-quality liquid assets are required to be held in bank payment systems to support the $10 trillion paid daily between banks after existing asset-specific netting and payments compression.
“The banks we are working with agree that costs associated with liquidity buffers [interest charges and the opportunity cost resulting in assets not being used efficiently] range from 50 to 150 basis points,” he says.
At an average of 100bp, that is an annual cost to leading banks of approximately $10 billion.
“We are working with these banks to analyse the total compression that can be achieved through CNS and the corresponding benefits,” he adds. “Our expectation is that annual savings will be in the hundreds of millions of dollars.”
When asked how many of the eight banks that are assessing the company’s proposition would need to participate for CNS to achieve critical mass and/or viability, Dyne observes that the service’s revenue is linked directly to the netting it is able to achieve.
“Therefore, if two banks have sufficient mutual flows to be netted, then just two are required to start,” he continues. “Obviously, though, there is a network effect so the more banks that participate, the greater the collective benefit.
“We are not taking a big-bang approach to on-boarding customers – we plan to start with a maximum of four and grow the number of participants from there.”
Dyne previously worked with CNS co-founder John Barber at Logicscope, where they developed a multi-participant FX straight-through-processing network.
“Since the acquisition of Logicscope by Markit in 2011, John and I have been considering a number of opportunities that play to our knowledge and expertise in financial markets connectivity and processing efficiency,” he explains.
“We started looking at the potential of high-value payments netting in 2016 and started to approach banks at the beginning of this year.”
CNS uses industry-standard messaging protocols, which should increase its attractiveness to banks already under pressure to satisfy a raft of new transparency, risk and capital adequacy compliance obligations.
According to Dyne, these institutions have neither the appetite nor resource capacity to take on notable technological or workflow changes and are unwilling to trust high-value, high-volume activity to unproven technologies.
Participating banks would pay an annual subscription to join the service and a tiered set of fees based on volume by currency and number of bank pairs.
“Given the minimal changes each bank will need to make to its infrastructure in order to take advantage of the service, we expect to be in testing with the first banks in early Q3 2018 and going into production a couple of months later,” concludes Dyne.
“Joining costs will be in the low millions of dollars and we are confident that participants will see a return on their investment very quickly.”