T2S, the common settlement platform being implemented by the European Central Bank, is designed to increase efficiency and reduce costs by improving post-trade harmonisation in Europe. But it will impose change on market participants, including custodians.
T2S, the common settlement platform being implemented by the European Central Bank, is designed to increase efficiency and reduce costs by improving post-trade harmonisation in Europe. But it will impose change on market participants, including custodians.
Unlike central securities depositories (CSDs), custodians have a number of options when it comes to leveraging T2S. These range from keeping their existing post-trade arrangements to connecting directly to T2S and consolidating their post-trade arrangements on a pan-European basis. But custodians, like all affected market participants, do need to review their post-trade arrangements and their back-office systems in preparation for T2S. Even for those banks that decide not to join directly, T2S has a potential impact. The level of change required could be major, and the timetable is challenging. Choices need to be made—and soon.
In light of this, the fact that a recent report by independent analyst Celent—The European Post-Trade Ecosystem under T2S: Dealing with Complexity—shows a mixed picture of market participants’ readiness for T2S is a cause for some concern. The report is based on a detailed survey of major participants in the European post-trade environment, including sub-custodians and global custodians. It shows that while the biggest custodians likely to connect directly are among the most advanced in their preparations (closely following the CSDs) there are nonetheless gaps in their planning for T2S, especially when it comes to impact on operational processes, integration requirements and budget allocation.
The integration and mapping challenges created by T2S should not be underestimated. For communication with T2S, market participants will have to adopt the new ISO 20022 formatted T2S messages, but, as Celent points out, the adoption of ISO 20022 by market infrastructures and market participants will not happen at a uniform rate Europe-wide. Custodians will still need to be able to communicate using other messaging formats, and since T2S will not harmonise other post-trade processes such as asset servicing, those operating in multiple markets will still need to accommodate local specificities. The connectivity picture could also become more complicated with the need to establish links to T2S, though there are opportunities to reuse existing infrastructure to access the new platform.
The question of budget allocation is also an important one to answer sooner rather than later—because, as Celent finds, the back office adaptation costs for T2S are significant. The level of investment required to modify a back office to operate in the T2S ecosystem will vary depending on the number of markets accessed, settlement volumes, current market practices and the approach taken, says Celent. For a market participant that decides to adapt its current back-office system using a combination of communications hub and message translators, the spend will be in the €7 million range. But for players that decide to completely revamp their back office systems, the investment will be between €12 million for the settlement function only and €27 million if custody is added on top.
The break-even on such investments will be governed by settlement volumes: by Celent’s reckoning the first option is really only valid for participants handling more than one million settlements a year, the second for those with more than four million and the third for those with more than 10 million.
According to Celent, the rest of the banks affected to a lesser extent by T2S are lagging even further behind in their preparations. The new platform will change the way settlements work in a way that is not yet clear, and this will affect even those custodians that do not join directly. Detailed industry debate on this has yet to happen, but already some questions are being raised. For example, T2S will generate much more intraday information about settlements than is typically available today. To what extent will direct users of T2S make this data available to indirect participants? Will it facilitate a better understanding of settlement times and states, reducing uncertainty and risk? Depending on how the situation plays out, there will be systems implications for custodians using T2S indirectly, and it could well pay to investigate these as early as possible.
In the conclusion to its report, Celent warns again that many players do not have a clear strategy for the future of their European post-trade infrastructures, a situation which needs to be remedied as the T2S go-live gets ever closer. The analyst advises that market participants, including custodians, conduct detailed planning of their T2S adaptation programmes, ensuring their strategies are aligned with their volumes. It recommends a number of best practices, including:
Designing a ‘T2S Transformation Framework’ to ensure a structured, phased approach to transformation;
Adopting an IT portfolio approach for adapting to T2S—identifying and evaluating opportunities for consolidation, retirement or integration of applications, or outsourcing;
Consolidating communication interfaces for settlement through T2S so that business applications across the enterprise (for all geographies and all lines of business such as core settlement reporting) are serviced by a single communication hub; and
Using messaging converters (in-house developed or third-party) to minimise impact on existing systems.
In the complexity of the evolving European post-trade landscape one thing is very clear: now is the time for custodians to tap into sources of expertise in order to get to grips with the impact of T2S on their businesses and operations. They need to determine the approach they will take—direct or indirect connectivity, back office adaptation or wholesale reworking—and then make and budget for an appropriate implementation plan to achieve readiness in good time. For more information about the report, The European Post-Trade Ecosystem under T2S: Dealing with Complexity, contact info@celent.com.
