T2S Debate Shifts as Banks and CSDs Focus on Preparation and Co-operation

The TARGET2-Securities (T2S) debate appears to have peaked at this year’s Sibos with the conversation having moved from one of whether it will go ahead to one of how the industry is preparing for the new settlement landscape.

The settlement infrastructure will launch in 2015 and in a panel yesterday, titled “T2S: Movers and Shakers”, the focus for service providers has turned to making the most of the upcoming infrastructure across their organizations.

For BNP Paribas, preparation has taken three stages, said Alan Cameron, head Of Global Strategic U.K. Broker-Dealers and Bank Relationship Management teams at BNP Paribas. “The first has been working with the ECB and local markets on harmonization and fit,” he said. “The second is ensuring clients are given the best services and that our settlement functionality is updated. The third is looking at whether the business model makes sense for asset servicing providers and agent banks –this is tricky subject and one that has not been concluded because of T2S pricing.”

Nadine Chakar, executive vice president Global Collateral Services at BNY Mellon said that challenge lie in the breadth of services offered by the custodian and its size. “For preparation we look at connectivity and a re-engineering of the back-office to take advantage of the functionality and what that means as a custodian and a CSD. So far the focus has been internal.

“We are looking at the testing process and working with the back office. We are running this project at an enterprise level so that all parts of BNY Mellon that are involved in T2S will be ready for 2015.” 

Mark Gem, member of Clearstream International Executive Board said that as a CSD with 40% of settlement volumes it was important to establish pricing for the market at an early stage.  “This points to baseline pricing for the industry and competitors,” he said. “We also have to deal with the fact that a CSD does not do asset servicing in the way that an agent bank does or in the way that a CSD does collateral management. No one has the full deck of cards to provide an end to end service.”

For the level of investment they have made for T2S, market players are expecting the new platform to have long term benefits.  Cameron said the benefit will come from what providers do as a result of T2S. “We talked about pricing, settlement and collateralization but the real change will come from harmonization of systems and processes. We can’t sit back but get involved.”
Chakar described T2S is an enabler but it is not the silver bullet. “Cash, liquidity and collateral will be key. It will make the European market more harmonized and easier to work with but cost reductions won’t work on the first day. Millions are spent on making it efficient but there is still a long way to go.”

Gem said the benefits from T2S depend on how it is leveraged. “In Europe and non-European context it is about mobilizing securities in one place and settlement cash in one account,” said Gem. With that there are mobility of collateral and increase in liquidity benefits but it depends on getting more than just the settlement migration.”

Providing an update on T2S, Jean-Michel Godeffroy, director general, chairman of the T2S Board European Central Bank said the core functions of the system are in place and a billing system has been developed. “We are doing everything to deliver on time unless a problem of the magnitude we have not seen,” he said.

The panel audience was then asked if they expected T2S to launch on time.  47% replied yes while the remainder, 53%, replied no.

“First the focus was on costs but once we announced the 15 cent per transaction charge it was how much cost would they add on,” said Godeffroy. “However, with market pressure there is convergence towards zero. This makes sense—we have cross-border and domestic but good news is that costs are going to the secondary assets, which is a core benefit in light of financial crisis i.e. helping market participants to concentrate their collateral in one place.”

Cameron said that pricing 15 cents is somewhat misleading and has made market participants expect too much. “We are not certain what CSDs will charge but it will be more competitive for settlement than for asset services – the former subsidizes the later,” he said.

Gem added that ICSDs have a key role to play in price setting. “We feel it is incumbent on us to lead the way,” he said. “In first place we won’t charge additional settlement fees. It means reengineering around settlement fees. The core question is what will the CSDs do—some might reengineer safekeeping. The degree of discounts may be reduced. What matters are the benefits that are to be unlocked for those costs—the prices to be reduced from safekeeping marginally increases in aggregate but against that you have opportunity to settle from one place and from one cash account whether in the payment system or European settlement in the correspondent bank.”

Panelists then discussed whether T2S is dependent on the move to a T+2 settlement cycle and the CSD regulations, which come into force next year. Godeffroy said: “Today  T+2 is part of CSDR but the market will deliver T+2 anyway—it’s not a controversial part of CSD. But CSDR is needed for T2s and to adjust to T+2 efficiently.”

Gem added: “Clearly CSD regulations are not a prerequisite for T2S and whatever its passage in the harmonization processes  it is not on our path from a T2S process. It’s important that CSDR champions  T+2  but it is not dependent on T2S, which is simply an outsourcing of CSD settlement to a new platform.” 
Panelists agreed that T2S will also have an impact in the securities industry in an international context, Godeffroy said: “T2S will make access to Europe easier.”

Gem added: “What it will do it reduce the costs of capital for institutions and make it easier to distribute products to investors from Europe.”  
Chakar agreed that T2S makes Europe more accessible. “For others looking at monetary union the advantage is cheaper access from European markets to the rest of the world,” she said. “It also means more efficiency on a timely basis.”

T2S will also change the make-up of the industry. The competition for settlement services will change because of CSD outsourcing. Pricing will also change and it will perhaps lead to consolidation, said Cameron. “It will have a big impact on CSDs and for agent banks it is more about scale and investment in systems. A combination of CSDR and T2S will mean more consolidation. We see more CSDs popping up and a new breed of CSDs. Local CSDs will have challenges. For agent banks it means a change in scale and a change in the business model. For global custodians our value proposition and business model is seeing an incredible amount of change in terms of asset servicing for which you need scale and deep pockets – the book is yet to be written but there will be lots of change.”

Gem also predicted consolidation and noted there are new entrants in the CSD space.  “There have been some retirements in sub-custody and global custody before T2S. Nobody knows the costs and margins. But from a materialistic paradigm the view of T2S is something where assets can be mobilized and a single cash account for settlement can only be got if providers cooperate in collateral management, asset services and with the ECB in a different way. The debate has shifted—it will probably lead to consolidation but we have to go through half time first.”

Godeffroy concluded: “In five years from now there will be no national CSDs. That does not mean that only big ones will service the market but it  may help the smaller ones to attract clients because we price settlement at the same price for everyone.  Local custodians will also disappear and the move will be towards European or regional custodians. The national banks—French or German banks may disappear and become European banks. Custody is changing and T2S is contributing to that.”