The fifth and final wave of Target2-Securities (T2S) is almost upon us, with the Baltic central securities depositories (CSDs) of Estonia, Latvia and Lithuania gearing up to migrate to the pan-European settlement system alongside Spain’s Iberclear.
For many, however, the fourth wave, completed between 3 and 5 February, was the real biggie, as Clearstream Banking in Germany made its migration, reportedly doubling volumes on the platform to 500,000 transactions per day. With Luxembourg’s LuxCSD also joining in wave four alongside the Slovakian, Slovenian, Hungarian and Austrian CSDs, Clearstream claims that the wave brought volumes on the platform up to 80 percent of the expected final total, while Yves Mersch, a member of the executive board of the European Central Bank (ECB), put this figure at closer to 90 percent.
Transitioning the 17 European markets to a harmonised settlement platform has been a project 10 years in the making, and by most accounts, it’s been a successful one, albeit not yet quite complete.
Speaking at the Government Borrowers Forum in Luxembourg in May, Mersch said: “T2S has integrated the securities settlement business, bringing the economies of scale it needs.”
Looking to the future, Mersch welcomed the proposal for international central securities depositories to move Eurobonds to T2S, and the addition of the Danish krone to the platform, scheduled for October next year. Mersch also suggested that some CSDs outside of the EU have expressed interest in joining T2S. According to Mersch, the platform has significantly reduced the cost of CSD settlement. He said: “Our initial cost estimations showed that the average fee per domestic CSD settlement in the euro area was €0.73, while cross-border transactions were up to 10 times more expensive. The launch of T2S has brought the transaction fee per instruction down to €0.15.”
However, despite his general positivity, Mersch added: “T2S is built on a full-cost recovery principle and we continue to monitor the cost recovery prospects. Consequently, in the first half of 2016 a review of the T2S operating costs was launched.”
He continued: “Despite the positive market trend, we cannot rule out that the price list will need to be adjusted after 2019 and/or the cost recovery period extended.”
From the point of view institutions, the fourth wave marked a certain milestone, with the go-live of significant volumes potentially acting as the defining signal of the platform’s success. For some, it was the point at which they really started to consider how they could best benefit from it.
Julien Kasparian, head of UK sales and relationship management, banks and broker-dealers at BNP Paribas, says: “Most financial intermediaries waited for at least wave four before assessing possible optimisations. For some of them, wave five is also a big leap.”
He adds: “The short sequencing of all T2S migration waves and complex adaptations for each of them has often led to delaying more strategic moves.”
With regards to expansion and further development of the T2S platform itself, Tony Freeman, executive director of government and industry relations at the Depository Trust & Clearing Corporation (DTCC), foresees a period of relative calm and reflection following the fifth wave.
“In the next phase, the ECB will likely be focusing on getting the markets accustomed to the change, ensuring smooth running, and making sure that the platform is operating to the fullest possible extent,” he says. “According to the ECB data, the platform has helped achieve impressive improvements in terms of cost cutting and settlement efficiency.”
Freeman says: “The primary goal of the project was to create a more streamlined, harmonised and competitive post-trade market environment in Europe. There are very clear signs of that starting to happen as a result of T2S.”
Previously, custodian banks would have had a different sub-custodian in each of the 17 T2S markets. The new set-up, however, has meant a move towards an agent bank model, with one bank performing settlement services across some or all of the 17 markets. According to Freeman, this new model is leading to a more competitive and streamlined market—exactly what the ECB had in mind.
T2S has proven popular among the global custodians, Freeman says, giving them more flexibility and allowing them to offer a more harmonised service in Europe.
“Fragmentation of the European market made it challenging for global custodian banks to operate here,” he says, adding: “T2S will provide them with a platform on which to build a bigger European business by standardising the settlement process.”
One blip that has emerged in the T2S landscape is the fact, while settlement volumes may look healthy, cross-border activity makes up little of the total.
According to Kasparian, in January’s volumes cross-CSD transactions accounted for just 0.14 percent of transactions. And this did not pick up following the grand wave-four migration—in March, cross-CSD transactions still accounted for 0.36 percent.
In its monthly earnings report for April, Clearstream cited legal barriers that make it complex to hold securities cross-border, suggesting that this leads to high transaction costs and uncertainty among investors.
Marc Robert-Nicoud, CEO of Clearstream, said: “The harmonisation objective requires both infrastructure development and a change in market behaviour. T2S migration has not yet translated in market participants changing their model to take full advantage of the T2S benefits.”
He went on: “When contributing to market safety and efficiency, market harmonisation should be welcome by all market participants.”
Clearstream is continuing with the development of T2S solutions in order to best deliver on the ambitions of the project, Robert-Nicoud said, adding: “We see these efforts as critical to ensure that the market gets the benefits of the investments made over the last years.”
Kasparian calls the lack of cross-border activity “a deliberate choice of market participants”.
He says: “We [BNP Paribas] believe that cross-border settlement in T2S is efficient, and current volumes of cross-CSD settlement do not prevent reaping the full benefits of T2S.”
However, he notes that, at least with regards to cash, BNP Paribas research suggests T2S does allow for very efficient optimisation of liquidity across markets, specifically through the use of central bank money and cross-border auto-collateralisation, “which allows eligible securities to be held in one market to fund transactions settled in others”.
On the other hand, Freeman suggests that this is simply a case of patience. He points out that T2S is not yet complete as a fully-operational pan-European platform and, although wave five is a comparatively small one, the market will be following it closely.
To expect cross-CSD activity to have already become the norm is “unrealistic”, he says.
“These changes are highly complex. Existing service providers and new service providers will have to work together to successfully implement the new model. This will not be simple.”
“However, we expect to see the breakdown of the regional siloed model over the next year or so, which will likely lead to a prominent, and rapid, growth in cross-CSD activity.”
While the final wave of migration may be just around the corner, the changes the platform will bring about are by no means coming to an end. With the potential for new markets, currencies and solutions for shares, bonds and exchange-traded funds trading on the platform, the possibilities are extensive. But, having taken 10 years to get this far, the ECB is in no hurry to make any more major changes. As Freeman says: “This isn’t a race, and the ECB is known to be a very methodical organisation that focuses on the long term goals.”
As it stands, Mersch, at least, appears to be happy with the platform’s progress. At the Luxembourg forum, he said: “T2S has not only harmonised the settlement of securities across Europe and brought forward post-trade harmonisation ... it has also optimised their liquidity and collateral management, which many regard as being the greatest benefit.”