The creation of the huge euro market will offer opportunities for triparty services, a collateral management product that has been successful in the US. It allows a liquid investor to place cash against good quality collateral for a period and forget about it, with all the risk management and administration taken care of by the triparty agent, in return for a fee. Attempts have been made to launch triparty services in Europe in the past, but failed because of the small size of the individual markets. With the climate now changing, Julie Fussell of Deutsche Bank explains how the service works

The implementation of European Monetary Union in January and the creation of a single euro market may well lead to an increase in securities lending and repurchase deals thanks to the prospect of a larger, more liquid European securities market.

However, it will also cause some operational challenges, as local clearing arrangements bring with them their own problems for investors. It is expected that cash-rich investors, for example, may choose to use triparty arrangements to facilitate the more onerous tasks of engaging in the market. Furthemore, as the use of triparty services by institutions becomes increasingly popular, a provider offering services across the euro zone countries will be increasingly sought after.

Triparty services aim to provide a solution to business challenges that confront institutions wishing to enter contracts that generate collateral requirements without incurring the operational and administrative costs and risks of supporting such contracts. The types of contracts managed within this service include repurchase agreements, securities lending, swaps, futures and secured loans.

Traditional methods of managing collateral adequacy have many disadvantages. For cash investors, the costs of administering all collateral and pooling cash from many different locations to forecast cash needs, for example risk reporting, margin maintenance and settlement, are high. Triparty services allows the outsourcing of these tasks to a third party which manages different margin levels on security types and individual securities, ensuring a reduction in risk through staff specialisation. In comparison to non-triparty (ie bilateral) contracts of the same type, operational and delivery costs are reduced and substitutions are easier and cheaper, providing greater flexibility and reduced risk for both parties.

To reduce intra-day risk, the movement of collateral is ideally settled on an against-payment basis. Due to complications in settling transactions where the security needs to be processed against a different currency from that being borrowed, most collateral moves against its own currency with foreign exchange transactions converting funds into the required currency. This process limits the securities used as collateral and means that contracts in different currencies are currently collateralised individually. With the introduction of a single currency, all euro-denominated requirements can be collateralised across the euro zone with any combination of euro-denominated securities. It is clear that a larger pool of securities will become available as collateral for a variety of euro contracts.

Although the pool of available collateral will be increased, settlement and safekeeping of the securities will need to be managed and controlled across 11 national central depositories. There will be the potential for a number of different settlements across several CSDs to satisfy a single contract. The triparty service provider must be able to manage and keep track of securities used and provide full risk management reporting on a euro-zone, and global basis. The provider's access to, and understanding of, a large number of national securities markets will therefore be the key to success of its service. European custodians with offices across the region should be in the driving seat with this product.

Triparty agents will need access to a pan-European network and specialised systems if the service they offer is to meet client requirements, whilst maximising efficiency and minimising the costs of operating across a range of markets. A service that combines specialist triparty services with a custody operation, which operates within the euro zone, will increase efficiencies and benefits to buyers. Safe custody of client portfolios and the centralisation of cash within a single provider will enable triparty services to manage contracts more effectively on the client's behalf, allowing the provider automatically to allocate collateral based on the client's portfolio positions and automatically substitute collateral as needed to satisfy the client's trading activity.

Providers able to combine an operation servicing specific client demand with a high-quality core custody service will be in the best positions to meet growing client demand, fuelled by the introduction of the single currency and the changing marketplace in Europe.

Julie Fussell is head of sales and relationship management, global triparty services, at Deutsche Bank in London