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T2S the journey to harmonisation

Feb 10, 2017

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  • gft.com

    T2S the journey to harmonisation

  • TS2 - the journey to harmonisation | 02

    Market participants will be hugely affected by T2S

    and it will force many to review their business models and services as they look to adapt to the

    new environment.

    T2S The journey to harmonisation

    Europes post-trading landscape is about to experience a dramatic

    change following the introduction of Target 2 Securities (T2S).

    The aim of T2S is to reform the industry by providing a single pan-

    European platform for securities settlements in European Central

    Bank (ECB) money.

    The provision of post-trading services within Europe has remained

    highly fragmented along national lines. This lack of integration has led

    to high costs for cross-border settlement transactions. The introduction

    of T2S will begin the process of establishing a truly integrated capital

    market across Europe, harmonising post-trading settlement activities by

    removing cross-border barriers and inefficiencies. T2S will reduce the

    costs and risks commonly associated with post-trade settlements and

    encourage greater competition within the industry.

    Market participants will be hugely affected by T2S and it will force many

    to review their business models and services as they look to adapt to

    the new environment. In anticipation of these reforms, the International

    Capital Markets Association (ICMA) and GFT launched a joint survey in

    the summer of 2014. The survey commissioned by the European Repo

    Council (ERC), looked at industry readiness and attitudes towards Target

    2 Securities. In particular, the survey analysed the level of awareness

    and understanding which market participants have regarding T2S; and

    the depth of practical engagement and understanding they have of the

    consequences on their individual firms.

    The results from the survey have allowed the European Repo Council

    to guide and shape its approach to the provision of T2S information,

    and provide additional advice and training to its members. Opinions

    were canvassed from a cross section of the industry. This included both

    sellside and buyside firms, custodians, central banks and CCPs. The

    surveys respondents represented a broad range of business functions,

    such as front, middle and back office; collateral and technology.

    The emergence of T2S

    T2S will go live in June 2015 and has been developed by the European

    Central Bank (ECB) in response to the challenge of improving

    settlement processes across Europe. It is now over ten years since the

    introduction of the euro and despite the creation of a single currency

    area across 19 countries, it is widely acknowledged that Europes

    post-trade landscape has remained fragmented along national lines.

    The consequence of this has been a great deal of complexity and

    inefficiency built in to the process of making cross border settlements.

  • TS2 - the journey to harmonisation | 03

    T2S is a major initiative which aims to radically change the post-trading

    settlement industry by removing many of these inefficiencies. The

    respondents in our survey reveal a clear understanding of this, with

    over 80% believing it will have a significant impact on their organisation.

    The ECB had identified 15 specific barriers which exist between different

    EU countries that contribute to the complexity and inefficiency of cross-

    border settlements. These barriers relate to tax, legal and technical

    jurisdictions and are known as the Giovannini barriers. These barriers were

    named after the group of financial market experts who came together in

    1996 to advise the European Commission on financial market issues, and

    became known as the Giovannini Group. The group focussed its attention

    on identifying inefficiencies within EU financial markets. They were tasked

    with proposing practical solutions to improve market integration, and as

    part of two reports; the group identified the 15 barriers that prevent efficient

    EU cross-border clearing and settlement. T2S has been introduced to

    reduce these barriers.

    The majority of respondents confirmed they had begun initiatives in

    preparation for T2S, indicating an awareness and understanding of

    the impact it will have on many organisations. With T2S being a new

    technology platform, it is understandable that many respondents believe it

    will actually bring additional operational and technology costs that need to

    be accounted for. We found that participants are strongly aware that T2S

    will be a driver in reducing settlement times, costs and credit risk.

    How great an impact will T2S have on your organisation? Please provide a rating between 1 (low) and 10 (high)

    More than 80% of respondents felt that T2S will have a significant impact on their organisation (an impactor of >5). One surprising and concerning message is that the types of firms that saw T2S being of less impact included custodians and central banks.

  • TS2 - the journey to harmonisation | 04

    It will assist in improving collateralisation practices and increase liquidity

    levels across the industry all of which will help in complying with

    increased regulatory demands which impact collateral management.

    Central Securities Depositories (CSDs) and International Central Securities

    Depositories (ICSDs) will experience the biggest impact from T2S and our

    findings echo this opinion. T2S will increase competition and will force

    these participants to re-evaluate the services they provide and their overall

    business models.

    The challenge facing T2S is whether the proposed benefits can be

    maximised, while at the same time attempts are made to overcome the

    barriers that have traditionally prevented efficient cross-border securities

    settlements. Questions remain unanswered; our findings reveal that further

    clarification is needed on how the transactions of repo trades will be settled,

    as T2S does not currently recognise the linked transactions of a repo trade.

    Initial findings of our research

    Our survey results were published in December 2014. As expected,

    the primary location for our respondents came from inside the Eurozone

    (67%) with another (18%) from non-Eurozone European markets.

    The majority of respondents confirmed they had begun initiatives in

    preparation for T2S, indicating an awareness and understanding of

    the impact it will have on many organisations. With T2S being a large

    technology platform, it is understandable that many respondents believe

    it will bring additional operational and technology costs to account for.

    The challenge facing T2S is whether the

    proposed benefits can be maximised, while at

    the same time attempts are made to overcome the barriers that have

    traditionally prevented efficient cross-border

    securities settlements.

    My organisation is fully aware of the operational implications of T2S

    Over 75% of respondents agreed or strongly agreed that they were aware of the implications of T2S.

    Doing nothing in preparation for T2S is a viable option for my organisation

    Less than 20% of respondents believe that doing nothing was a viable option.

  • TS2 - the journey to harmonisation | 05

    The challenges remain - Connecting to T2S

    The introduction of T2S will not only affect settlement processes across

    Europe, it will impact on the operational technology used by all participants

    in the European securities market. There are two options available for

    connecting to the T2S platform: direct or indirect. The majority of participants

    from our survey intend to connect to T2S indirectly. This is to be expected, as

    direct connectivity will require high levels of capital investment and resources

    for those institutions choosing this option, although they will then be able to

    send instructions directly to T2S. In addition to the high investment costs,

    Directly Connected Participants (DCPs) will require technical development

    work and extensive testing programmes to be undertaken.

    Participants that decide to connect indirectly will send their settlement

    messages to a CSD or (DCPs) that will be responsible for managing

    connectivity to the T2S platform. Many CSDs and custodians who

    will connect directly are currently in the process of updating and

    developing their platforms and systems to support future connection

    to T2S. Although investment costs may be lower for participants

    connecting indirectly, they will still be required to make major

    operational and technology changes. This will particularly apply to

    back office systems, in order for them to work with T2S. This may

    present firms with an ideal opportunity to update their existing

    technology but we believe there will be a wait and see approach

    as the four migration waves are introduced.

    Our survey asked respondents if they intended to review their

    decision to connect indirectly within the next two years; 60% said they

    had no plans to do so. However, this may change should there be any

    amendments made to T2S in the future, requiring additional spending

    on technology. Direct connection in future may eventually prove to be

    a better option for many firms.

    Although investment costs may be lower for participants connecting indirectly, they will still

    be required to make major operational and

    technology changes

  • TS2 - the journey to harmonisation | 06

    Collateral management

    One of the primary objectives of T2S is to improve collateral

    management and increase liquidity levels across the industry. Over 75%

    of respondents agreed that T2S will improve collateral pooling, increase

    liquidity across the industry and create greater triparty interoperability.

    The management of collateral is now under close scrutiny from

    the regulators. Since the financial crisis of 2008, firms have faced

    an endless series of regulations to comply with. In this regulatory

    environment which we believe has now become the new normal for

    industry participants, there are even greater demands for collateral

    holdings to be of a higher quality and quantity than ever before.

    Regulatory initiatives such as Basel III have pushed many institutions

    into reassessing their collateral management and optimisation practices

    and their coverage of liquidity.

    Moving collateral across borders is a costly and complicated exercise -

    T2S allows custodians to centralise their collateral assets into a single

    pool in order to maximise their use and simplify the transfer process.

    By bringing together over 20 CSDs in Europe, T2S is able to integrate

    onto one platform all the securities accounts of a custodian bank.

    T2S migration waves

    First wave Second wave Third wave 12 September 2016 Fourth wave 6 February 2017 22 June 2015 28 March 2016 Bank of Greece Euroclear Clearstream Banking (Germany) Centrlnydepozitrcennchpapierov Securities Belgium SR (CDCP) (Slovak Republic) Settlement System (BOGS)

    Depozitarul Euroclear KELER (Hungary) EestiVrtpaberikeskus (Estonia) Central (Romania) France

    Malta Stock Euroclear LuxCSD (Luxembourg) Euroclear Finland Exchange Nederland

    Monte Titoli (Italy) Interbolsa OesterreichischeKontrollbank Iberclear (Spain) (Portugal) (Austria)

    SIX SIS National Bank VP Lux (Luxembourg) KDD Centralnaklirinkodepotnadruba (Switzerland) of Belgium (Slovenia) Securities Settlement Systems (NBB-SSS)

    VP Securities (Denmark) Lietuvoscentrinisvertybinipopieridepozitoriumas (Lithuania)

    BNY Mellon CSD

    Over 75% of respondents agreed that T2S will

    improve collateral pooling, increase liquidity

    across the industry and create greater triparty

    interoperability.

  • TS2 - the journey to harmonisation | 07

    The aim is that custodians will no longer need to keep oversized

    buffers of collateral in many locations because securities will no longer

    be locked in local markets. By reducing the need for multiple funding

    accounts, it will enable collateral managers to have a more holistic

    view on where collateral is held, all of which provides an opportunity

    to consolidate collateral pools for settlement, securities financing and

    other triparty activities.

    Netting

    T2S will allow the settling of transactions to take place on a reduced

    number of settlement systems, ideally ensuring that participants

    experience the benefits of increased netting efficiency. Settlement

    credit lines should be reduced and participants should see a reduction

    in collateral and leverage ratio requirements.

    However, in practice this may prove more difficult to achieve than at

    first thought. Netting is often completed at a legal level and therefore

    constitutes a Giovannini barrier. It will be very difficult for T2S to help

    reduce the national differences that exist in the legal treatment of

    bilateral netting for financial transactions. There are also further barriers

    to take into account relating to domestic tax regulations and the

    collection of transaction taxes.

    Many of the Giovannini barriers will not be eliminated immediately. It

    remains to be seen whether T2S will help counterparties refine their

    netting agreements with custodians and clearers. It is questionable

    whether T2S alone will be enough to reduce all 15 barriers. It is more

    likely that to remove every barrier will require further legislation being

    passed by individual countries within the European Union.

    Repo trades

    One area of post-trade settlements that potentially requires further

    development is that of repo trade transactions, the tracking of which

    could pose a further challenge for T2S. In our survey, we asked

    respondents if they believed T2S should be modified specifically for

    repo transactions, but there was no overall consensus of opinion on

    whether it should be. This question has been raised as T2S does not

    recognise the on and off leg of a repo trade. The onus will therefore

    lie with CSDs / ICSDs / participants to recognise when the transaction

    is part of a repo trade in order to link the individual transactions. The

    responsibility to settle the transaction will therefore fall with these

    institutions, which will include processing of manufactured payments

    and the issuing of coupons.

    T2S will allow the setting of transactions to take

    place on a reduced number of settlement

    systems, ideally ensuring tha participants experience

    the benefits of increased netting efficiency.

  • TS2 - the journey to harmonisation | 08

    We believe there is scope for further development in the processing of

    repo trades in T2S. The settlement of repo trades could be improved

    if the platform is developed to track the beneficial owners of coupons/

    redemptions. This would ensure that payments reach the owner on

    the specified payment date. The beneficial owner should also receive

    corporate action notifications, immediately removing any risk to them

    of not receiving their rights to elect.

    We recommend that T2S should be developed further so that it has the

    functionality to act as a repository for repo trade data. It would provide

    greater transparency to those parties seeking more information on

    trades. The tracking of repo transactions could also be improved with

    the introduction of a common repo ID. This would link on and off legs

    to ensure all firms can explicitly track closure of multi-leg trades. Finally,

    T2S should be developed to provide a central interest calculation

    facility to reduce the risk of exceptions between parties on multi-leg

    trades at off-leg settlement, thereby reducing failed trades.

    Further policy discussions and consultations will invariably take

    place, but it is important that a single harmonised approach

    is developed which ensures a consistent treatment of repo

    transactions across all markets.

    Conclusion

    T2S is a bold and ambitious project that has taken almost 10 years to

    develop and implement. The first of four migration waves to T2S will

    take place on 22nd June 2015, followed by two further waves in 2016

    and a fourth and final wave in 2017. T2S is another significant step

    towards greater European financial integration and is seen by the ECB

    as an essential piece of reform. There is little doubt that the potential

    exists for T2S to radically alter the European securities landscape. This

    transformation will affect all market participants and we will see greater

    harmonisation, with the reduction of inefficiencies and settlement costs.

    Our survey results reveal industry participants who appear well

    prepared and confident in dealing with the changes T2S will bring.

    They anticipate significant benefits, particularly around the

    management of collateral and the increase in settlement efficiency.

    Despite the positive views expressed, it is important to recognise that

    the introduction of T2S is only the start of the journey in transforming

    Europes securities settlement market. Challenges will remain and at

    least half of the 15 Giovannini barriers will not be removed by T2S alone.

    The benefits of T2S will also take time to emerge as each migration

    wave is introduced.

    T2S should be developed to provide a central

    interest calculation facility to reduce the risk of

    exceptions between parties on multi-leg trades at off-

    leg settlement, thereby reducing failed trades.

  • TS2 - the journey to harmonisation | 09

    If we attempt to predict how the market may look in the near future,

    we can confidently say that T2S will force many participants to

    assess and adapt their existing business models. T2S will introduce

    greater competition to the market and this will naturally create

    winners and losers.

    Those participants who are likely to gain the most from T2S will be

    the International Central Securities Depositories (ICSDs). With multiple

    platforms and operating across a number of different countries, they will

    be in an ideal position to take full advantage of T2S.

    Those smaller CSDs that have traditionally operated exclusively in local

    markets will find the new environment more challenging, reviewing

    their business models and tailoring their services to accommodate

    the changes brought about by T2S. Some CSDs will have to accept

    that they will experience a loss in revenue from settlement services,

    while others will be encouraged to diversify their business models and

    services they provide. There will be some CSDs that will not survive the

    introduction of T2S and will be forced to consolidate by joining forces

    with other CSDs.

    T2S is another significant step towards greater

    European financial integration and is seen by

    the ECB as an essential piece of reform.

    T2S Modified for repo transcations i.e. Should repo transactions be recognised in T2S?

    No clear opinion on whether T2S should be modified for repo with the exception of custodians who were clearly not in favour.

  • TS2 - the journey to harmonisation | 10

    Custodians will also need to evaluate their business models in response

    to T2S. Regional custodians will gain a major advantage from T2S

    by becoming pan-European operators. These firms will be able to

    rationalise their settlement activities by connecting directly to T2S; in

    doing so they can partially bypass CSDs. Opportunities will be available

    to expand beyond their current markets by offering new settlement,

    asset and custody services.

    It is unlikely we will see these changes immediately. The fourth and

    final migration wave to T2S will not be implemented until February 2017

    and it will be some time after this last wave when we will see how the

    market operates as a whole.

    We expect the first wave of migration in June 2015 to be a cautious

    affair and in some respects it can viewed as a test phase. The impact

    of T2S will be more significant in 2016 with the introduction of larger

    markets to the platform; we will then be better placed to evaluate

    the initial success of T2S in its aim of reducing existing barriers in

    the market.

    During the next couple of years we will see a number of CSDs/ICSDs/

    custodians continue with their testing programmes, strategy reviews

    and service provisions in preparation for the migrationto T2S. With such

    a large and ambitious project, nobody can predict the final outcome,

    but we can expect new challenges to emerge along the way. However,

    there will also be new opportunities for many market participants as

    we enter what is certain to be an exciting new era in Europes capital

    markets on its journey to harmonisation.

    The impact of T2S will be more significant in

    2016 with the introduction of larger markets to the

    platform.

  • TS2 - the journey to harmonisation | 11

    Glossary

    ECB European Central Bank

    T2S Target 2 Securities

    ICMA International Capital Markets Association

    ERC European Repo Council

    ICSD International Central Securities Depositories

    CSD Central Securities Depositories

    DCP Directly Connected Participant

    Giovannini barriers 15 specific barriers identified by the ECB which exist between different EU countries that contribute to the complexity and inefficiency of cross-border settlements.

  • TS2 - the journey to harmonisation | 12

    Emily joined GFT Technologies AG in June 2012, bringing with her over 18 years of experience across Securities Financing, Prime Brokerage, Equities, Fixed Income and Structured Trades. She joined from Knight Capital Europe, where she worked for 18 months as Head of London Operations. Prior to her role at Knight Capital Europe, Cates spent eight years at Dresdner Kleinwort, most recently holding the position of Global Head of Client and Cross-Products Services. She also spent six years at Credit Suisse, where she held the post of Vice President Strategic Change Management and Prime Banking.

    Nick brings over thirty years of experience in investment banking and capital markets, working in prominent roles across front, middle and back office functions. Prior to joining GFT, Nick spent 32 years at Credit Suisse where he worked in liquidity management, collateral optimisation and business re-engineering roles. Nick has also been instrumental in creating Target Operating Models for tier 1 banks and consulting banks with their migration and entity rationalisation programmes.

    Specialising in business architecture and process re-engineering, he has extensive experience of creating processes that incorporate efficiencies within workflows that enhance profitability, whilst also assisting clients with their regulatory obligations.

    Featured specialists

    Emily Cates Nick Nicholls

    About GFT

    GFT is one of the worlds leading solutions providers in the finance sector offering consulting, implementation and maintenance for a broad range of IT applications.

    Combining technological expertise and seamless project management with a deep understanding of the financial industry, GFT is a reliable partner for well-known companies all around the globe.

    Headquartered in Germany, GFT has stood for technological expertise, innovative strength and outstanding quality for over 25 years.

    gft.com

    This report is supplied in good faith, based on information made available to GFT at the date of submission. It contains confidential information that must not be disclosed to third parties. Please note that GFT does not warrant the correctness or completion of the information contained. The client is solely responsible for the usage of the information and any decisions based upon it.