With the first wave of TARGET2-Securities (T2S) migration less than 12 months away, an ISS virtual roundtable discussed some of the key issues relating to the pan-European platform for securities settlement.
ISS invited Marco Strimer (head operations at Notenstein Privatbank), Hugh Palmer (head of T2S at Société Générale Securities Services), Adriana Tanasoiu (CEO Depozitarul Central) and Eugene Meintjes (executive director group network management, EMEA strategy at UBS) to consider various factors around T2S.
The discussion began by considering the impact of T2S on competition within the eurozone for new markets such as China and whether it would eventually become the sole settlement platform in Europe.
According to Strimer, T2S fits neatly into the already established competition in trading and clearing that was introduced with the establishment of multiple trading venues and competitive clearing.
“For foreign investors, access into the whole value chain will become easier and cheaper as split position and liquidity will largely be removed. We cannot neglect the smaller brokers and banks that only trade their home market and will support the local CSD for some time to come. However, as soon as issuers stop issuing stock at the domestic CSD, the foundation for a sole settlement platform is truly laid.”
Palmer added that even among the markets joining T2S not all settlement activity would be channelled through the platform, for example sovereign currency settlements in Switzerland and Romania and equities settlements in Greece. In most markets mutual funds will remain outside T2S in the medium term.
“Having a more efficient securities market is a good starting point and China is assuming an increasing role in international financial flows,” said Tanasoiu. “This will bring wider business opportunities for international issuers and those investors looking to diversify their portfolio.”
T2S will be the harmonised settlement platform of the eurozone, but custody and its associated services will remain in the hands of CSDs, she adds. “Settlement adaptation is not only a technology challenge – the commoditisation of settlement will require a full range of services covering the entire lifecycle of the financial instruments.”
Meintjes believes T2S will help strengthen the European marketplace’s position versus other markets, since it fosters more cross-border investments and multi-listings of securities.
“The question for a buyer of post-trade services is their partner of choice for securities settlement, asset services, collateral management and cash/payment bank functionality and in what proximity to the market and T2S they wish or can interface themselves. It is the level of intermediaries in your supply chain that will determine your view on what or who is your sole settlement platform.”
Palmer referred to the management of the platform’s functional documentation by the ECB’s T2S project office as well as the handling of the numerous change requests emanating from various segments of the market that have arisen in parallel as proof of a strong will to keep T2S ‘lean’. “However, it tolerates a certain level of flexibility. When this is used to avoid stifling innovation it is positive, but when it is used by markets as a protectionist measure it is somewhat less welcome. We can hope that market pressures will contribute over time (and in conjunction with the continued harmonisation work) to iron out unnecessary and unjustified market practices.”
The lean T2S concept is the compromise found to cope with existing national specificities in the areas of taxation, legal requirements, reporting and ownership definition and is the right way to keep T2S at a manageable level of complexity and to maintain a certain pressure on the markets to eliminate or harmonise existing specificities, says Meintjes.
According to Strimer, T2S might be an accelerator for operational and technical harmonisation (“looking simply at the discussion on T+2, this clearly is an indicator how the markets align – one by one”) while Meintjes adds that although some of the technical and operational harmonisation will be realised, more effort will be needed from individual countries, especially if the basics lay within local legislation or the local tax regime.
The discussion then moved to the legal and regulatory harmonisation agenda currently pursued by EU legislators, with Palmer explaining that many issues monitored by the Harmonisation Steering Group will be covered by the CSD regulation expected to take effect later this year.
“This regulation will address settlement finality, outsourcing of IT services by a CSD to a public institution, harmonisation of settlement cycle, introduction of a settlement discipline regime and the ability for issuers to choose their place of issuance.”
Meintjes describes CSDR as a milestone in harmonisation of issues around CSDs. “Agreement was achieved and we count now on good second level standards for a smooth implementation, not only supporting safety but also efficient and effective operational processes. Harmonisation of EU securities law would be beneficial for legal certainty in the new T2S environment.”
Palmer reckons T2S is contributing significantly to removing half a dozen out of the infamous list of 15 barriers set out by the group chaired by Alberto Giovannini in 2003 and Strimer agrees that there is a good chance barriers 1, 2, 3, 4, 5 and 7 will be resolved at least at the CSDs participating in T2S.
“The key words in the question ‘will T2S alone help break down six out of the 15 Giovannini barriers?’ are ‘alone’ and ‘help’, since we also believe strongly that T2S will drive harmonisation further in Europe in terms of local market specificities and the focus will shift to breaking down further the cross-border legal, fiscal and regulatory barriers,” adds Meintjes.
On the question of whether the approximate €400m cost of T2S represents value for money, Strimer says that in the context of reaching a common standard across the eurozone countries, the price of removing the fragmented CSD landscape is to be seen as a sensible investment into the future.
“Some of the development costs are already being recouped via channels, thus as a market participant or infrastructure shareholder you will be impacted pre-T2S,” explains Meintjes. “It is the positive knock-on effect of the T2S platform and the initial migration waves, the opportunities to reshape and the benefits across functions/businesses that could eventually lead to value for money further down this road.”
Palmer agrees that it is necessary to take a long term view of the expected benefits. “You need notably to look at the costs T2S will kill, including those linked to the maintenance, renovation and replacement of the settlement systems within each national CSD. When we look at the post trade environment in 10 years’ time, it is likely that T2S will be seen as an investment worth the cost.”
When asked about the effect of the huge decline in settlement volumes since the financial crisis, Strimer observed that lower volumes originate largely from the use of CCPs that are able to net/compress trades to a single settlement instruction and that the introduction of competitive clearing means they are unlikely to rise significantly in the future.
“Collateral mobilisation will increase settlement due to the changing global regulatory environment,” says Meintjes. “Clients must have comfort to invest in the markets and it is the banks’ responsibility to ensure they have the optimal set-up into T2S from a securities settlement, liquidity/funding, collateral management and corporate action perspective.”
Tanasoiu does not believe that T2S fees will be raised post-2018, a move described as ‘a measure of last resort’ for the ECB. “This possibility is covered by the terms of the Eurosystem contract with the CSDs, but this represents just a formal consideration. The main reason is based on the cost recovery period, which is very ambitious.”
Palmer suggests that there is still a fair amount of ‘wait and see’ in the market and a fairly common tendency to not roll-out significant change until the third wave of implementation when the German market comes on board.
“The big challenge is going a step further than the mandatory adaptations to access the platform in order to build or enhance solutions that will correspond to the needs of the main purveyors of transaction volumes – the investment banks, brokers, (I)CSDs and foreign global custodians that constitute the bulk of the sell-side market – upon whose decisions the future of a number of today’s agent banks could be decided.”
He believes prices will fall and refers to real potential for economies in settlement costs and (eventually) settlement price harmonisation across the eurozone. “Consolidation in the CSD space as a result of T2S will come, but again not immediately.”
Unbundled post-trade services and pricing must be transparent and fully understood, says Meintjes. “The risk in country ‘A’ is not the same as in country ‘B’ and the varied degrees of know-how and market development needs to be factored into new pricing models. The general opinion in the market is that T2S will increase – at least during the implementation/amortisation phase – overall costs, thus it is important for a bank to organise its resources accordingly and understand the complexities, risk, offerings, operational capacity and capability.”
In terms of consolidation, he expects the vertically integrated infrastructure groups to remain competitive and probably extend their reach even further. “We would expect to see such increased manoeuvring from the fourth wave onwards, because the main players are more focused on getting their T2S migration spot-on,” he concludes.