In addition to the TARGET2 Securities (TS2) single
settlement engine, other such programmes in progress include the second EU
Markets in Financial Instruments Directive (MiFID II), the European Market
Infrastructure Regulation (EMIR) and the Central Securities Depository
Regulation (CSDR). T2S presents high levels of both risk and opportunity to
central securities depositories (CSDs) and custodian banks as the key
incumbents in the EU settlement system.
While CSDs have definite areas
of cost savings as well as additional spends in re-designing back office
systems in readiness for T2S, for custodian banks the world will become rather
more complicated with new opportunities to connect to T2S for direct
settlement. However for prominent end customers, such as major institutional
investors and multinational corporations (MNCs), T2S looks set to deliver on
its promise of enabling reduced costs for cross-border settlement in the
The T2S programme, which has the Eurosystem as its owner, developer
and future operator, represents an initiative by the European Central Bank
(ECB) and central banks within the EU to integrate and standardise settlement
and depository infrastructure across EU securities markets. The T2S project
has, to date, seen 22 out of the 41 EU CSDs signing the framework agreement
ahead of a scheduled, but delayed, roll-out in 2015 – with a
further year-long delay into 2016 to enable everyone to migrate.
T2S is pushing CSDs, custodian banks, central banks and broker-dealers to
drastically change the way in which they execute post-trade operations. The
primary goal in T2S is to link the national-level CSDs into a single pan-EU
settlement/depository equities platform to improve price transparency, increase
market access, lower settlement costs and promote competition.
Securities Settlement Process in the EU: Pre and
The current settlement process for euro-denominated
securities utilises central bank money (CeBM) accounts. It executes, via the
respective national real-time gross settlement (RTGS) component of TARGET2, the
existing platform for processing of large value euro payments. Once
implementation of T2S completes, each party in a securities transaction will be
able to choose the executor for settlement from the CSDs enrolled with T2S. The
CSDs will continue to maintain their current relationships with market
participants, while central banks will maintain all current relationships with
the respective individual banks. However, all participating CSDs will have to
adopt the T2S calendar for euro settlement, which is the same as the TARGET2
The settlement process proposed under the T2S regime would
kick off at the start of day with the participating CSDs sending their
securities account positions to the T2S system. Settlement will happen on a
RTGS basis between CeBM accounts maintained on T2S. The participating CSDs and
TARGET2 will run their end-of-day processes after the T2S end-of-day processes
complete. The non-settlement processes which affect securities positions will
run outside of T2S operating hours.
In the post-T2S state, T2S will provide only settlement services while
CSDs will continue to take care of other services such as corporate actions,
custody functions, safekeeping and administration.
Even in this
scenario, CSDs are faced with the prospect of having to carry out extensive
redesign of back-office processes and loss of revenue from settlement-related
offerings. However, offsetting this they would gain cost-side efficiencies by
not having to go through custodian banks for executing cross-border settlement;
which could be passed onto customers. It remains to be seen whether CSDs will
be able to obtain even higher levels of cost savings by decommissioning
existing domestic settlement systems with the arrival of T2S. In the overall
industry landscape, availability of choice of CSDs to market participants is
expected to force consolidation among CSDs towards improved competitiveness.
The potential impact for custodian banks is far more complicated,
with T2S presenting high levels of both risk and opportunity. T2S offers
possibilities for custodians to conduct direct settlement through T2S and
develop richer partnerships with CSDs. In the process, custodians will reduce
the number of current intermediaries they work with but will need to add more
settlement-related functions to business operations. There is also the
possibility of overlaps forming in specific service-offerings, with CSDs also
offering custody services. This would pose additional business challenges to
Regulatory Drivers for T2S and Benefits to
The primary driver for the European
Commission (EC) to implement the T2S initiative is to reduce the costs and
processing time associated with cross-border securities settlement in the EU.
With T2S having a mandate to operate on a full-cost recovery basis instead of a
for-profit basis, this is expected to become eminently possible. A key allied
goal for the EC is to allow market participants increased choice of
depositories for securities settlement and better risk diversification
Several beneficial side effects are expected from T2S,
including reduced collateral needs for market participants and increased ease
of cross-border management of collateral. Standardisation of the EU settlement
processes will also receive a boost, with the introduction of unified
euro-denominated settlement processes which would also provide positive ‘domino
effects’, by way of simplified back-office processes and associated cost
savings. The T2S design for real-time settlement between accounts at central
banks would eliminate settlement risk. It would also provide add-on
efficiencies through the use of a single account for both securities held with
CSDs and for cash held with central banks.
Inside T2S: Key
T2S will be based on the existing TARGET2
platform and infrastructure, including processing systems, storage and
networks. Apart from reducing development time and providing known reliability
from a proven architecture, this would provide significant cost savings through
the re-use of resources.
Nevertheless, the open architecture of T2S
means that RTGS systems other than TARGET2 can also be interfaced with T2S.
Although the primary objective of T2S is to provide efficient settlement
services in the eurozone, T2S is designed to be capable of settling other
currencies in addition to the euro. This would allow non-euro central banks to
provide liquidity for settlement of securities transactions in their
While it is not mandated for CSDs to participate in T2S,
all securities with an international securities identification number (ISIN)
and held by a CSD operating in T2S are eligible to be settled through T2S.
There has naturally been some concerns from Euroclear, ClearStream and others
with existing pan-European offerings but the Eurosystem project cannot be
ignored. Along with real-time settlement, T2S provides auto-collateralisation
and optimisation facilities to parties for transactions across CSDs and CeBM
accounts.T2S matches settlement instructions, but also accepts matched
instructions from CSDs which apply the same matching rules.T2S will settle
exclusively in CeBM and will not facilitate the settlement of commercial bank
T2S maintains an exclusive CeBM account for each T2S party
to handle its claims and obligations with a central bank with regard to one or
more CSDs. Each such account is linked with an RTGS account held in TARGET2. A
key feature of the design is that securities accounts balances can only be
changed in T2S. There are three connectivity options available for financial
entities such as CSDs, custodians, broker-dealers and agent-banks:
- Indirect connectivity to T2S.
- Direct connectivity to T2S for
settlement (while using an external provider for asset-servicing).
- Implementing a fully independent self-settlement approach.
Timelines and Current Status
The T2S initiative
crossed several key milestones in 2012, when a total of 22 CSDs (accounting for
almost the entire euro settlement volumes) signed the T2S framework agreement;
a critical step in enrolling depositories with T2S. Among non-euro area central
banks wanting to make their currency available in T2S, Danmarks Nationalbank
signed the currency participation agreement in the same year; with central
banks from Sweden, Norway and Iceland indicating that they are considering
doing so later.
While the participating CSDs/central banks provided
feasibility confirmation for T2S in August 2012 (Sync point SP2), the next sync
point to be met will be SP3 for ‘T2S programme plan comprehensiveness’. Also,
the necessary contractual agreements have been signed between the Eurosystem
and CSDs for operating the T2S programme.
As per ECB programme
management, in terms of the actual development of software systems, development
of more than 95% of the core T2S software modules were complete as of the end
of 2012. At the same time, 60% of module level testing had been completed and
the internal acceptance testing phase had also begun. Key T2S milestones for
2013 include internal acceptance testing and the conclusion of preparations by
the Eurosystem for end-user acceptance testing, although with the year-long
delay announced, the timeframe is somewhat malleable.
As it stands, T2S looks set to deliver
on its promise of enabling a reduced in costs of cross-border settlement for
investors in the EU securities markets. With one of the key drivers for T2S
being the fragmented nature of the European post-trade ecosystem, custodian
banks and CSDs have the most to gain from T2S implementation and are among the
market participants most advanced in T2S adaptation.
On the other
hand, being among the least impacted entities broker dealers are among the
least advanced in preparation for T2S. Leading analyst firms have estimated T2S
implementation budgets to range between €7m and €30m, depending on the size of
the market participant and the extent of redesign needed. The road ahead to the
start of T2S is not expected to be a smooth one – particularly for key actors
in the system such as custodians and CSDs.
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