TARGET2-Securities (T2S) has now been operating at full capacity for two years. The European Central Bank (ECB) is currently preparing for the technical merger of T2 and T2S platforms and implementation of the CSDR Settlement Discipline Regime, so it won’t be adding any markets, new asset class segments or new functionality for at least two years. So, it’s a good time to review how the system is working. Central banks, being publicly accountable, are skilled at giving updates and despite its relative youth, the ECB is a prime example. It is admirably effective in its communications. The ECB recently issued its 2019 review of T2S and for anyone interested in post-trade market infrastructure it contains a lot of interesting data. Crucially, this is data you can’t find anywhere else.
It appears that the heartfelt and persuasive requests for a delay to the implementation of the CSDR Settlement Disciple Regime – from February 2021 – will not be successful. The response of the policy makers to the most recent submission, this time by ECSDA, is awaited. Perhaps the explicit reference to industry inertia caused by COVID-19 could be successful. We wait.
The two highly contentious issues in the SDR are failed-trade penalties and mandatory buy-ins. Predicting the real market impact of these new procedures requires hard data about how many trades fail and for how long the failures occur. Despite failed trades being the cornerstone of the SDR surprisingly little data has been used by the policy makers. This is why the T2S report, with its wealth of hard statistics, is so useful.
Let’s look first at failed trade penalties. In 2019 T2S processed a daily average of 606,938 transactions with a value of €1.1 trillion. T2S uses two settlement efficiency ratios: the better way to monitor market behaviour is to look at MSEI: Market Settlement Efficiency Indicator. In 2019 the ratio was 93% for both volume and value of trades. So, in basic terms 7% of trades could be penalised. The alternative settlement efficiency measure is PSEI: this includes a number of system generated transactions. Its figure is 97%. Taking the mid-point, 95%, as the real measure means that 5% of trades fail. That’s slightly higher than most industry estimates. The other key factor is how long they fail for?
The report shows an age profile for failed trades. About 25% only fail for a single day. The numbers fall sharply for Intended Settlement Date +2 (ISD) onwards. But because there is no threshold in the rules all those trades – about 30,000 per day – will incur a penalty. The penalty itself might be very small – a €10k trade that fails for 1 day will incur a fee of only €1. But because there is no threshold and no optionality this tiny fee must be applied. The cost of managing the process will almost certainly exceed the revenue.
The SDR also, very controversially, mandates that buy-ins must be activated four days after the Intended Settlement Date (which is normally driven by a T+2 settlement cycle). Therefore, it is the trades that remain unsettled for more than six days that will be subject to a mandatory buy-in process. It appears that about 2% of trades are unsettled at T+7. (This reduces to below 1% on T+16.). This equates to about 12,000 open trades. In today’s market buy-ins are rarely used because they are ineffective. There is no consolidated data on how many buy-ins occur today but it’s likely to be below 100 at any one time. The massive leap in volume, and the obvious huge increase in workload, explains why so many people believe the rules are fundamentally flawed. Especially when there is absolutely no certainty the new model will work.