The unsecured money market remains one of the least modernised areas of finance. Despite volumes of around €200bn a day in Europe, it continues to be dominated by voice brokerage and bilateral trading, which together comprise roughly 85% of the market. Institutional money markets have remained relatively untouched by new digital models and solutions.
As a consequence, treasurers seeking unsecured funding, or to deposit cash, often find it difficult to get the breadth of liquidity and counterparties they want. The problems faced when looking to transact include lack of visibility over spreads, and difficulty achieving a full view of best execution. If you use just a few brokers, as many treasurers do, you will see just a small subset of potential counterparties – in a massive market with no central pricing data.
Know your client (KYC) and counterparty risk assessments have also contributed to corporates only dealing with a set of counterparties they know well. Yet there is an increasing number of banks, and therefore potential counterparties, available to transact with. This includes: foreign banks with establishments or full subsidiaries in the UK and Europe; challenger banks; and niche regional banks.
Bank of England and European Central Bank (ECB) reports have evidenced these problems, with half of banks saying the unsecured euro money market is not efficient or is limited in its efficiency. For example, 45% of money market transactions still occur within national markets (i.e. borrower and lender from the same country) in Europe.
The 2008 financial crisis further exposed weaknesses in money markets, with a massive liquidity shortfall in interbank lending. Subsequent regulation has had a significant impact on banks in terms of balance sheet constraints. Quantitative easing has aided money market liquidity so far, but the structural problems of money markets remain to be exposed.
In the current ultra-low-rate environment, companies are anxious to get the best short-term return, particularly in light of cash pools growing in recent years to a massive €1tr. for non-financial corporates in Europe. Despite the scale of demand, however, the lack of viable electronic trading options has hampered treasurers’ ability to find new appropriate counterparties and increase transaction efficiency.
Moreover, money market providers have focused almost exclusively on offering clients request for quote (RFQ) trading protocols, making effective price discovery more challenging.
Taken together, these multiple strains and inefficiencies underline the need for a new model for money markets that brings the scale of efficiency and regulatory compliance that financial institutions have enjoyed in other market segments.
Moreover, treasurers face pressures to do more with less and have their time spread across a vast number of tasks. Better workflow is critical to giving the treasurer efficiency and much-needed thinking time and frees them up for more strategic work. So, treasurers who traditionally relied on established money market relationships via voice are looking with more urgency at how they can operate more efficiently with digitisation.
Financial institutions and corporates are now exploring new, more efficient ways to lend or borrow funds – which can only lead to a more integrated and efficient functioning market. New electronic platforms stand to become more accepted as they offer greater price discovery, market transparency and proof of best execution, along with greater access to deeper and less correlated liquidity pools. Importantly, new technologies can now improve the time-consuming KYC process, with Hyperledger-based applications using biometrics to simplify the on-boarding and overall KYC process, while still meeting the most stringent compliance requirements.
We envisage that new digital networks of institutional treasurers and banks will emerge across sectors and geographies, with market data as an important by-product that makes it easier to determine market rates for lending and borrowing in different currencies. Digital transformation in money markets is now poised to rapidly catch up with what we have seen in other asset classes in recent years.