It appears that the project to provide a common technical platform for securities settlement in Europe is gaining in momentum. TARGET2-Securities (T2S) yesterday got another three CSDs to commit to its framework agreement, taking the number of players to over a dozen. And, following doubts about whether the project would go ahead, triggered at Sibos last year when the European Central Bank (ECB) announced yet another delay to the project, it is now on its way to the end game. But the end game has changed somewhat significantly in the last few years.
The initial determinant of the project’s success stems from its ability to reduce settlement costs. An important ingredient here is getting the settlement volumes at a cost of 15 cents per transaction in order to offset the 1.5 billion investment outlay of the project and to make the settlement charge viable for CSDs and their customers. Having Euroclear’s three Eurozone CSDs and Clearstream board means they are well on their way, but the lack of the U.K. and Sweden, which together make up 20% of settlement volumes in Europe, to make the 15 cents settlement charge viable, could spell a pricey move for the CSDs that have committed. It has been known since 2009, when Euroclear had talks with the U.K. and Swedish CSDs about the (un)likelihood of them joining. The Bank of England opted out, and Sweden’s Riksbank decided that, while T2S may have some benefits in the longer term, in the short term it is too costly. They may have always factored in that the U.K. would not join, because, despite the commercial and industrial logic of the U.K. being included, there were always objections from the Bank of England in terms of monetary policy and the control of the sterling area reasons that are unrelated to T2S but which are still valid.
Meanwhile, on the continent, the readiness to join was there. There was strong support from clients to join T2S, says Jan Lemeire, one of the directors of Euroclear’s T2S involvement. The board of the Finnish CSD will take the step in two weeks. With the ECB setting the settlement charge at 15 cents, despite Europes crisis worsening, the bet that settlement volumes will increase by the live date of 2015 could be one of its riskiest yet.
The fact that the project is now a euro settlement system for central bank money has some players holding their breath given that 20% of the volumes are not going to be there. It largely depends on market conditions, says Lemeire. Volumes have been decreasing, which does not bode well for the ultimate goal of T2S – cost recovery. With project costs, which have significantly escalated in recent years, hinging on volumes, there is a risk that the ECB might not be able to stick to the price they put forward. But given that the ECB is not an organization for knee-jerk reactions, the likely approach will be to see what happens to settlement volumes. If they do not pick up, one option might be to stick to the original settlement charge and extend the seven to eight-year amortization period per instruction. But this does not address other costs like lifecycle management and reporting. The project is running out of buffers due to its size and costs, and further delays could spell further costs to keep the resources for project testing – running into millions each month – on top of the costs involved for CSDs to adapt their infrastructures.
The CSDs that have signed the framework agreement maintain a cautious optimism even though they are acutely aware of the risk that project costs might outweigh the benefits of reduced settlement costs. T2S should recognize now that it is not going to result in a reduction of settlement costs in the medium term because of the costs, on top of what CSDs pay for offering settlement. CSDs are not in a position whereby they can decommission existing infrastructure and systems. We should be hopeful, but the initial objectives will definitely not be met anytime soon, says Lemeire.
Again, Euroclear’s and Clearstream’s participation, which together make up 75% of Europe’s settlement volumes, is a significant vote of confidence that the project will go ahead. I think we are at the point now where people who were doubting its viability and questioned whether it was feasible are now reassured. That debate is now over, says Omgeos Tony Freeman. T2S will happen, but the issue is whether it will meet its live date of 2015. Clearstream and Euroclear will be included in the second and third wave of migration given their settlement volumes. Even though it may not be until 2016 when they join, CSDs can now at least focus on what they need to do, rather than is the project is going to go ahead or not.
There may not be a significant rethink on the settlement charge given the ECBs historically cautious approach – take, for example, its strong resolve in the Spanish debt crisis. The ECB has put forward a pricing schedule it will likely do its utmost to stick to.
Again, given the ECBs cautious approach, there is a reasonable level of certainty it will stay where it is. Even though T2S addresses pre-crisis fragmentation and cost issues, six years on the market agenda has changed. Perhaps if it had its chance over it might focus on clearing rather than settlement, considering that is the area most at risk. But these projects have an unstoppable momentum once they get started, especially this one considering the amount of time and money that has been invested.
-Janet Du Chenne