It has been nearly seven years in the making but the Target2-Securities (T2S) platform is finally just around the corner. The project was formally launched in 2008 with a clear goal: simplify the highly complex and costly s
It has been nearly seven years in the making but the Target2-Securities (T2S) platform is finally just around the corner. The project was formally launched in 2008 with a clear goal: simplify the highly complex and costly settlement system in Europe and in the process make markets far more efficient and attractive.
A big question now, as the 22 June go-live date approaches for the first wave of participating central securities depositories (CSDs), is whether financial firms have positioned themselves to take advantage of the benefits the platform will offer. T2S represents significant opportunities for banks, brokerages and their clients, but it also involves important challenges in terms of business strategies and operational models.
What’s more, the introduction of T2S comes after a period of intense change for the financial industry as firms have had to make major adjustments to their systems and processes in response to far-reaching regulatory initiatives. It has been estimated that over the past five years, some firms have had to allocate as much as 70 to 80 percent of IT budgets to overhaul or upgrade systems and ensure they could meet new regulatory requirements. That represents time, effort and resources that many firms would rather devote to their business, so it’s hardly surprising that so many executives talk about ‘change fatigue’.
New choices
One obvious challenge is how firms will organise themselves in terms of where they direct their settlement. Since the T2S platform will harmonise highly disparate standards for settlement, firms dealing in many markets will have the chance to significantly reduce the number of CSDs they use. That potentially means big cost savings, exactly what T2S was intended to achieve.
This challenge is made all the more interesting by the likelihood that many CSDs will be changing their own business models. The T2S Framework Agreement was signed by 24 CSDs, which will move onto the platform in four waves starting this June, with the final wave scheduled for February 2017.
Those CSDs are about to face a sharp increase in competition as a result of the harmonisation T2S brings. That is likely not only to put downward pressure on settlement costs due to the competition, but also to prompt many CSDs to reinvent themselves with new services. New collateral management and liquidity management services are expected to be offered. So choosing how many and which CSDs to use will be about much more than price.
The importance of better liquidity and collateral management will be heightened by the introduction of Basel III, which calls for greater bank liquidity and decreased bank leverage. For instance, one question firms are grappling with is whether focusing on a single CSD for the bulk of settlement will offer scope for efficiencies when pooling securities.
Basel III, like T2S, has also faced delays in the implementation phase and is now scheduled for 2019. But knowing that these new capital requirements are coming—even if it is not for a few years—raises the stakes for firms considering settlement strategies.
Another point to note: not all of the current CSDs will necessarily survive. Now that competition is about to increase dramatically, markets can expect a certain degree of consolidation to occur in the coming years. It’s not unlike what has been seen in the trading venue landscape, which has been another part of the financial infrastructure that historically was dominated by national heavyweights but which saw a burst of new competition following the Markets in Financial Instruments Directive. Now, some of those venues are beginning to consolidate. It’s quite possible the settlement space will follow the same pattern.
Finally, as firms map out their European settlement and clearing plans, they will need to look beyond what the CSDs are doing. They will also need to listen to their own clients. Will the buy side voice preferences for where they want their trades cleared? The answer is not clear, but sell-side firms will need to navigate all of these issues in developing their settlement strategies.
The good news is that once firms have made their strategic decisions, there will be scope for cross-border settlement optimisation. This is where some of the real benefit from the increased competition should begin to kick in as sell-side firms can take advantage of the new services CSDs provide and the greater connectivity among the network of CSDs that will migrate to T2S.
Positive signs
So far, preparation for T2S appears to have been smooth. No project of this size and complexity is ever without its technical hiccups, but the latest signs are that the platform will go live as scheduled with the initial participating CSDs. A lot of attention is being devoted to the June launch, and with good reason. But the full impact of T2S is unlikely to be known until all four waves are completed. Beyond that are larger questions as to whether T2S expands, or even if other regions such as Asia will be tempted to emulate Europe.
In the meantime, sell-side firms have two important priorities. The first is they need to ensure they have enough flexibility in their operating models to take advantage of whatever happens in the CSD space. Beyond operations, middle- and back-office technology should be reviewed to ensure that it does not hold back any move to a more efficient environment, where some or all of post-trade processing could also be outsourced. The second is they need to engage with the buy side, both to educate clients about T2S and to gain an understanding of what the buy side wants to achieve.
There are positive signals that the industry is aware of both the challenges and opportunities. A recent major survey by the International Capital Markets Association showed that the bulk of market participants see large benefits and significant organisational impact from T2S. Most respondents had plans and initiatives underway. But for those that haven’t, the time to start thinking about what T2S means for your firm is now.
