T2S: The story so far
A decade in the making, Target2Securities (T2S), the European Central Bank’s (ECB) settlement engine providing true delivery versus payment (DVP) with central bank money across Europe’s securities’ markets, is on the cusp of completion. T2S will potentially remedy many of the barriers hindering efficient EU cross-border clearing and settlement, as outlined in the Giovannini Group reports.
Twenty-two central securities depositories (CSDs) from 20 European markets have now transitioned onto T2S, with the largest wave going live in February 2017. This saw CSDs in Austria, Germany, Hungary, Luxembourg, Slovakia and Slovenia join T2S in what was widely acknowledged to be a frictionless migration
With T2S nearly 90% of transactional volumes operating through, industry participants are now preparing the push for the fifth and final wave of migrations, which will see CSDs in the Baltics (Estonia, Latvia, Lithuania) and, most importantly, Iberclear in Spain, transition onto the platform beginning in September 2017.
Spain: A complex T2S market
The migration of Spain’s Iberclear onto the T2S platform has the potential to be more complicated than most.
One likely headwind is that amendments which would bring Spain’s Securities and Markets Law into line with T2S, will be made late, if at all. Despite industry lobbying, the rules, which relate to proprietary assets of primary market participants and CSD members, are likely to be made late in the game, leaving stakeholders uncertain about which type of account structure they should adopt. This could lead to late changes to Standard Settlement Instructions (SSIs) and inadequate testing of the final account set-ups.
Other challenges include Spain’s share registration system, which determines ownership. Unlike most T2S markets where registration is optional, in Spain it is mandatory. Whereas in other markets, the beneficiary is placed in the “Party 2” matching field, in Spain, this field will be used to match registration details. This could cause turmoil, creating the risk of cross-matching when chains of trades are settled in the same entity. This non-standard matching of Party 2 and Party 3 in Spain has resulted in the main settlement entities having to adjust core settlement systems to adapt to Spain.
Partial settlement procedures in Spain will also be reformed as they are currently only allowed in the main settlement period. Under T2S, partial settlements are permitted in the last overnight batch and late in the real-time settlement cycle, which will force account and operational changes. Also, due to the registration system in Spain, and to avoid the poaching of stock across registration names, partial settlement will not be possible for deliveries when a client is holding a third party account and managing settlements in multiple registration names.
Learning from other markets
Leveraging the experiences of other T2S markets will be critical if the final migration wave is to be seamless. Key to this will be preparation, communication and adaptation, which can be achieved by regular testing of T2S processes ahead of the migration, to identify any unforeseen risks or complications.
In fact, Spain is performing four Wave Migration Demo Runs ahead of the T2S migration –more testing than the previous waves went through – which should help identify potential issues.
Nonetheless, there was consensus that testing of 100% volumes ahead of the Spanish Market Reform (SMR) was productive for infrastructure and participants, but not for the underlying investor community. This is because client environments are not built to test such high volumes and financial institutions are vigorously lobbying against these requirements. Other issues in previous waves included matching problems arising as a result of the changed SSIs. Again, BNP Paribas Securities Services is being highly proactive in liaising with Iberclear to publish non-definitive SSIs at intervals prior to the go-live date.
Realising the potential of T2S
T2S implementation has some way to go, with stakeholders yet to realise the full operational benefits of the platform. With transactional volumes having been lower than anticipated, settlement costs did not recede as extensively as proponents expected, while platform migration costs were quite significant for market participants. It may be some time before the cost benefits can be recouped.
But what have the key positives of T2S been? The existence of a cash and securities accounts under T2S will bring about a number of liquidity benefits, which is particularly critical due to the high collateral demand for OTC margining under the European Market Infrastructure Regulation (EMIR), as well as bilateral OTC margining requirements. Furthermore, counterparty risk should also be curtailed under T2S as transactions are settled in central bank cash.
Immediate T2S advantages such as improved liquidity and collateral mobility have been welcomed by the industry, but it may take a bit longer for settlement cost benefits to fully crystallise, and this will require some patience from the platform’s users.