T2S the journey to harmonisation

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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

Europe’s 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

survey’s 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 Europe’s

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.


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.


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.


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”


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) Centrálnydepozitárcennýchpapierov Securities Belgium SR (CDCP) (Slovak Republic) Settlement System (BOGS)

Depozitarul Euroclear KELER (Hungary) EestiVäärtpaberikeskus (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 – Centralnaklirinškodepotnadružba (Switzerland) of Belgium (Slovenia) Securities Settlement Systems (NBB-SSS)

VP Securities (Denmark) Lietuvoscentrinisvertybiniųpopieriųdepozitoriumas (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.”


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.”


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

Europe’s 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.”


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.


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 Europe’s 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.”


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.


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

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T2S the journey to harmonisation

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