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IPE special report May 2018

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T2S: What happens next?

It will be some time before it becomes clear whether the Target2Securities platform will streamline cross-border transactions or spark unintended consequences with layers of national and international regulations, according to Brian Bollen 

At a glance 

• The introduction of the Target2Securities (T2S) platform is scheduled to run to February 2017.
• T2S should reduce risks and costs as well as making the use of liquidity more efficient.
• Some critics see T2S as part of a trend towards excessive regulation.
• Supporters argue it will make Europe a more attractive place to run funds.

What happens next with the Target2Securities (T2S) platform, beyond its eventual full implementation? It hardly seems fair to ask such a question with the first wave only fully completed in August when Monte Titoli rescheduled to join in, more than two months after the initial June target. But it is the natural human impulse always to want to know what might lie behind the next bend in a journey that has already lasted several years. As Mauro Dognini, the chief executive officer of Monte Titoli, puts it, it is now in the last mile of a marathon.

If the industry experts are right, the answer, or answers, will only begin to emerge following the achievement of full implementation, set to take place in February 2017, the date set for the fourth and final wave of migration. It is already clear, however, to at least some of those who were in the vanguard – the central securities depositories of Greece, Malta, Romania and Switzerland – that the early starters will enjoy a competitive advantage that could prove to be long-lasting. It could make the crucial difference between survival and extinction, prosperity and irrelevance, in the longer term. 

T2S is designed to facilitate post-trading integration across Europe. The goal is to offer core, neutral, harmonised and commoditised delivery-versus-payment settlement in central bank money in substantially all book-entry securities in the zone. In less technical language, T2S aims to enable central securities depositories (CSDs) to outsource their settlement and accounting functions to a new pan-European settlement infrastructure. The political intention is clearly to foster the emergence of a single post-trade market space and to bring down the cost of cross-border transactions in Europe.

T2S will confer two main advantages, says Dognini. First, it will reduce risk and cost. Cross-border settlement is 10 times more expensive than its domestic equivalent; post-T2S the cost will be the same. This will benefit banks connected to the system and they will, in turn, pass that benefit on to investors, he says. Second, cash and liquidity will be used better, relieving some of the capital pressure on broker-dealers.

Leveraging a single infrastructure to access multiple markets will create economies of scale, says Alexandre De Schaetzen, product management director at Brussels-based Euroclear, one of the long-established big two international CSDs (the other being Frankfurt-based Clearstream). “Furthermore, applying harmonised processing standards across markets will also reduce costs and remove existing complexity,” he says.

Cristina Belotti, head of business development, financial institutions and brokers at Societe Generale Securities Services Italy, adds that as T2S is an integrated platform, it will allow the immediate settlement of both the cash and securities legs of transactions, reducing risk. 

Even some of those involved in the project’s minutiae see it as a technical solution in search of a problem, however. They point to the spending of large amounts of money (an estimated total of about €1bn) with no shortening of the settlement cycle or any other immediately obvious benefit. “Settlement was not an issue in Europe and given that T2S doesn’t do everything that our existing settlement system can, we can’t decommission existing systems,” says Tom Zeeb, Division CEO of Zurich-based SIX Securities Services, one of the first-wave participants. “It has created an extra layer that has to be paid for.”

SIX Securities Services

When asked what lessons might be learnt from the experience so far if others are to emulate the Swiss success with the T2S migration, Thomas Zeeb, division CEO of SIX Securities Services,  has one short, clear answer. “Test the hell out of it, both internally and end-to-end with clients,” he says. He estimates that SIX Securities Services produced more than 1.5m additional lines of computer code that demanded huge amounts of testing which, in turn, identified the main areas of concern that were addressed together with the European Central Bank (ECB). 

SIX Securities Services held hundreds of client meetings and carried out 2,500 business test cases with over 200 participants in the Swiss market to get to the point where around 95% of banks were ready. “I’m sure there were times when the ECB was fed up with our legendary Swiss thoroughness and meticulousness but our success is based on extensive testing and being a pain in the neck in terms of our attention to detail,” Zeeb says. 

He adds: “The immediate operational concern over the next three years is to bring the biggest European markets on board and reach market-wide operational stability. Only then, we will start to see the consolidation of the smaller players and other changes in CSDs as they adapt to the new reality and develop new products and services.” 

Zeeb predicts an inflow of settlement liquidity into larger markets on the basis that investors who transact a relatively modest number of deals in the smaller southern European markets will show a natural inclination to use larger northern providers. He also suggests that while the two established international CSDs, Clearstream and Euroclear, will clearly benefit, competition could emerge from other smaller CSDs, or groups of CSDs, including the likes of SIX Securities Services or custodian banks. “T2S makes that a very real possibility,” he says. The introduction of common standards should also help harmonise the handling of corporate actions and tax issues, and that, along with enhanced collateral management, is where savings and efficiencies will be found.

Smooth implementation 
In this view, T2S is a beginning rather than an end. But it is an auspicious beginning, given the lack of drama in its earliest days. Even the postponement of Monte Titoli’s migration can be viewed with a forgiving eye. “For a project of this scale and spend to come in on time and more or less on budget is, frankly, amazing,” says Mike Clarke, director, T2S client and product solutions at Deutsche Bank. “It was a prudent decision to allow Monte Titoli more time; Italy is the biggest market in the first wave and everything had to be just right. 

 “Our experience to date has been extremely positive,” says Zeeb. “We had put together a series of fallback plans that simply weren’t needed.” This belies the dismal tale of pre-launch testing, he adds. “The experience we had was abysmal, the system dropped out as soon as we stressed it with volume. The number of bugs was huge and there were concerns as we went into the migration weekend.”

In the event, it went flawlessly, Zeeb recalls. Plans to collate statistics on problems and their causes were quickly abandoned as T2S was proven to be working, and technically stable. He does, though, issue one caveat: the system is not yet being stressed with substantial settlement volume so sustained operational stability is yet to be proven. While Switzerland is an important international financial centre and is, in fact, the largest of the first-wave markets (excluding for a moment the delayed MonteTitoli) the number of euro-denominated transactions being undertaken by clients there is limited.

Asset managers in a battle

A recent survey carried out by managed data service provider RIMES (the RIMES 2015 Buy-Side Survey), shows how asset managers are gripped in a governance and regulatory battle. As the regulatory focus is shifting from the sell-side banks and moving to the buy-side investment managers and their service managers, growing client demand for data is now having a much larger impact on asset managers’ decisions relating to data management, says RIMES. 

Alessandro Ferrari, the senior vice-president for global marketing at RIMES, says: “It’s a tough and unforgiving market environment for the buy-side at present. Facing pressures from clients to increase data sources and deliver higher levels of data customisation, asset managers are also under pressure to reduce costs and meet incoming regulation, particularly in Europe. It’s a perfect storm.”

Regulation challenges
If T2S is indeed a technical solution looking for a problem, there can only be one group of culprits – national and international regulators. Their proliferation, their tendency to grow almost unchecked and their determination to regulate anything that moves in financial markets provide many of the stories of the modern age. The days of soft-touch regulation have possibly gone for good. 

Banks, insurance companies, asset managers and pension funds, are hemmed in on all sides by a series of oppressive regulatory frameworks. A watch list of current and future regulations compiled and maintained  by Paul North, head of product management for EMEA, asset servicing at BNY Mellon, is forbiddingly long. It covers a list that runs from T2S, CSD regulation and the second Markets in Financial Instruments Directive (MIFID II) to Solvency II, money market reform and Basel III, taking in, along the way, Fair and Accurate Credit Transactions Act (FACTA) and Money Market Fund Reform (the latter two are both American). “You do anything with an asset in the EU, you get regulation,” North states. And this is holding back innovation as people need to take into account non-investment elements of their product range.

Mark Downing, who runs relationship and coverage teams looking after institutions in the UK for BNP Paribas Securities Services, divides regulation into three broad categories. First, those that are related to investor protection, such as the Alternative Investment Fund Manager Directive (AIFMD), UCITS V, Solvency II and Institutions for Occupational Retirement Provision (IORP). 

Second are those that attempt to simplify market infrastructure (European Market Infrastructure Regulation (EMIR), the upcoming CSD regulation, MIFID II). 

Third, are reminders to the investment community that retain full responsibility for investors’ money and they must monitor and supervise outsourced providers accordingly.

In the regulatory maze, unintended consequences insist on surfacing. The aim of the AIFMD asset segregation rules, for instance, is to protect the interests of alternative investment fund (AIF) investors by ensuring that assets are not exposed to events such as bankruptcy of the third party to whom the safekeeping of the funds’ assets may be delegated. However, if this is taken to mean that accounts should be segregated down to the sub-custodian level to enhance investor protection, it could exacerbate rather than mitigate counterparty, operational and systemic risk.

AIFMD asset segregation will compromise tri-party collateral management and securities lending, according to Ross Whitehill, managing director, BNY Mellon Markets Group. He detects mounting concern within the industry about enforced segregation of AIF assets – and most likely UCITS, depending on regulatory harmonisation with AIFMD – across all levels of the custody chain. This will significantly affect the ability of these funds to use tri-party collateral management services and participate effectively in securities lending, he believes, and this will have a significant impact on funding and liquidity in the market, affecting growth and investment in Europe.

North, however, identifies a potential hugely significant upside. He suggests that, as part of the overarching objective of EU regulators to boost jobs growth, Europe will be a much more attractive place to run funds by 2020, as it should be in better economic shape. If the regulators achieve half of what they are striving to achieve, they will be doing well, he concludes.

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