This year is a crucial one on the path to the implementation of the single settlement platform TARGET2-Securities (T2S) – a year of testing.
On 20 January 2014 the first connection between the European Central Bank (ECB) and T2S was successfully established. This was an important part of the preparations to enable the initiation of eurosystem acceptance testing of the platform at the end of last month.
These tests will run from April to September, and then on 1 October the T2S application will be delivered to the central securities depositories (CSDs) and central banks for user testing.
A Host of Benefits
The anticipated benefits of T2S are well-known. It should reduce settlement costs, starting with cross border transactions. It will also enable significant savings in collateral and liquidity costs, clearly a major focus for banks since the crisis.
In today’s fragmented environment, where securities are held at different national CSDs, banks need to hold excess collateral and have multiple buffers in place. T2S will remove this need, as well as making auto-collateralisation a widespread practice.
The harmonisation T2S will drive – such as the adoption of a common interface, common message formats, common rules for intraday settlement finality – should reduce post-trade complexity, in turn yielding major cost savings for banks through securities settlement back office streamlining. Indeed, the ECB’s economic impact assessment in 2008 estimated T2S will result in annual back office cost savings of €48m, with wider harmonisation as a result leading to savings of many times this amount.
T2S should also reduce risk: counterparty and settlement agent risk; settlement risk by offering gross real-time settlement finality in central bank money even for cross-border transactions; and operational risk through a robust business continuity set-up and streamlined processes.
By shaking up the competitive environment for CSDs and custodians T2S will undoubtedly create discomfort for some players, with only the fittest – being those able to adjust to T2S while meeting market needs – surviving longer term. Increased competition will drive gains in terms of pricing and service quality throughout the whole value chain.
Meeting the Schedule
The benefits of T2S can, in theory, only be reaped in reality once the single settlement platform is live, however, and a smooth on-time implementation depends in no small measure on a sizeable number of players successfully completing a complex user testing process, starting this year.
Clearly, financial market participants are well-versed in making and testing the business and technical preparations needed to accommodate major market change. Yet T2S is bigger and more challenging from a testing perspective than most such change programmes. For CSDs, T2S impacts their core business. For the big banks, it heralds change across multiple markets and business lines. For central banks T2S is challenging because it relates to the securities markets – usually outside their core focus area.
In addition, T2S is going live in waves. Testing isn’t a one-shot process – it will go on for a long time, and the sequence of activities will be important – for example, for CSDs that must test their own connectivity to T2S as well as the readiness of their communities, being indirectly connected participants (ICPs), or directly connected participants (DCPs). In short, T2S testing will be characterised by unprecedented complexity for all market players.
Different types of market participant will need to test different elements of their T2S set-ups at different times. In addition to the above, CSDs will need to prepare to test with their market infrastructure counterparties. DCPs will need to prepare to test their direct access capability, their direct connectivity to T2S, and their co-existing channel with CSDs for asset servicing and other purposes, as well as testing with their end customers and potentially their sponsored access customers. Ultimately, and though for them the user testing process will be less onerous, even ICPs will need to prepare to test with their providers.
The Cost of Failure
Players that fail to prepare well for user testing run a range of risks. Indeed SWIFT is hearing from its customers that they have a number of concerns in this area – principally around timing, quality and resources, with the latter being a particular concern for those joining T2S in wave 1.
As mentioned, market participants impacted by T2S will certainly have testing processes already in place – recurring approaches used for other change programmes. Where they could benefit from help is with very specific T2S knowledge.
Take for example the topic of ‘business application headers’. This component of the messages needed to communicate with T2S is new and particular to T2S. Designed to identify the different players involved in a transaction and what roles they play, business application headers are complex to complete, requiring consideration of many scenarios and an understanding of all the participants in the chain and how they interact.
In order to mitigate the risks created by sub-optimal preparation for user testing, players could consider tapping into the expertise of providers that have, through immersion in the T2S programme, developed extensive knowledge of the details of T2S. This could give them easy access to the T2S content they need to plug into their existing testing approaches in order to speed up execution.
In addition, market participants could also take advantage of open collaborative testing platforms during both the design and the testing phases for T2S. Where these tools come backed by the knowledge of people experienced in the business and technical details of T2S, and with integration to platforms containing the technical specifications published by the ECB, they offer particularly useful assistance for players working to prepare efficiently for T2S user testing and ultimately implementation.
T2S testing is a major undertaking, and market participants preparing for this have many other priorities on their plates. It makes sense to take advantage of content, tools and knowledge from providers expert in T2S in order to expedite inhouse training approaches to ensure timely, accurate and complete preparation for T2S user testing – which in turn will underpin successful implementation and go-live of connectivity to this market-changing single securities settlement platform for the eurozone.
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