TARGET2 – SECURITIES – WILL YOU BE READY?
Tata Consultancy Services’ Capital Markets Forum, held on 26 June at the heart of Europe’s political centre, the Maison Grand-Place in Brussels, provided a wake-up call for financial institutions not yet leveraging the TARGET2 Securities project. Delivering lost-cost cross border settlement, T2S will break down a significant barrier in the creation of a single European equities market place. At the forum, entitled ‘TARGET2 – Securities – Will you be Ready?’ leaders in the delivery of the project gave the audience an insight into the next stages of development.
Marc Bayle, TARGET2 – Securities (T2S) programme manager at the European Central Bank. Keeping on track.
With over 50 central securities depositories (CSDs) and central banks signed up to T2S, banks need a strategy in place for participation, to take benefits from this new setting.
As of the end of June 2012, 24 CSDs from within the Eurozone including six non-Eurozone CSDs have agreed to join T2S. The project itself is halfway to completion; the legal framework and the technical documentation are defined, 65% of the coding was completed by the end of March 2012 and by the end of the year nearly 100% of the coding will be done. We are entering a phase of testing heading towards the first markets going live in T2S by June 2015.
Recently the project has delivered several key developments: the new user detailed functional specification (UDFS), complemented by the new versions of SWIFT messages requested by the project’s advisory group; the connectivity package, both in application-to-application mode (A2A) and user-to-application mode, including licences to develop connectivity solutions for SWIFT and Colt who, along with Eurosystem’s CoreNet, have developed services that allow them to connect to T2S.
The agreement for the euro has been fully signed up; the agreement for non-euro currencies has been signed by Denmark for whom it will come into effect in 2018.
We do not expect other non-euro currencies to sign up for next month but there is a chance for a combined initiative in the Scandinavian region in the coming years. Timing is not such a concern for central banks to sign up; there is no deadline and the technical aspect is much less complex for them than for the CSDs.
The main countries not signed up are UK, Norway, Sweden and Poland. While Switzerland’s CSD is participating, its central bank is not, and although the CSDs of Hungary and Romania have adapted to T2S, neither country’s central bank is considering putting their own currencies onto the platform at this stage.
In May the Council of the European Union’s Economic and Financial Affairs Committee, made up of the finance ministers from national governments, reiterated its support for the project to go ahead. The ECB is working closely with the European Commission on its CSD regulation. This is an important plan which will help deliver a harmonised framework between the different markets. It is increasing the legal safety of the CSDs who come to T2S around the specificity of outsourcing by a private entity to a public entity. The regulation will also establish applicable law on securities accounts, and it will help to ensure a level playing field among market participants.
The harmonisation work is now centred on two objectives: finalising the definition of the relevant standards; and the improvement of tools and procedures for monitoring the implementation of harmonisation standards by all project participants. This will help increasing the benefits of joining T2S, in particular for the custodian banks.
Axel Pierron, senior vice president for Celent’s securities & investments group: Leveraging T2S Infrastructure: What are the options?
A study was conducted by Celent, late last year, to form a picture of the costs and savings that T2S offers, based on the views of six major market participants. Overall, non-international CSDs and local custodians will face the biggest impact. Sub-custodians operating in a single country will have difficulty in weathering the changes driven by T2S, so there will inevitably be consolidation amongst them. Those CSDs without an international business really need to move up the value chain to offer an asset servicing business or to become a utility.
Three scenarios are projected for custodians to change their post trade arrangements:
1 – Doing nothing and relying on agent banks or an investor’s CSD services
2 – Direct connectivity to T2S for settlement and using an external provider for asset servicing, either a custodian or a CSD
3 – The full settlement approach and on-boarding of custody activity
Market participants are likely to use a mix of these approaches. There are four main elements of expenditure. The first is system costs. Strategies two and three will require upfront investment and variable costs. The predicted settlement IT costs for both scenarios averages €12.5 million; the additional custody IT costs for the full service model in scenario three will be another €15 million on top, based on accessing two markets.
The second element will be running costs. For scenario two these are modelled at an annual average of €1 million, rising to over €5 million for scenario three.
Although T2S should be able to drive down trading costs in Europe, depending on the way that firms respond to it they will still have to purchase services, the third element, from an external provider, for example a tax agent even in scenario three. Spending under scenario three will of course be much lower for services than in scenario one where actually you are relying on an agent bank.
The cost of liquidity will depend on the market a firm is in and overall trading volumes, making the measurement of its cost impractical for the study. Clearly if a custodian is providing intraday liquidity in a bundled service as in scenario one, liquidity provision will be included as part of that, where firms connected to T2S will have to manage their liquidity more closely; that is set against the gain of having just a single pool of liquidity.
Based on these costs, we found no business case for financial intermediaries with below two million settlement orders per annum to connect with T2S directly. For firms engaging with scenario two, four million settlement transactions per year would be needed to provide a return on investment. For market participants with over €200 billion of assets under custody and managing over four million settlement orders per year, there is business case to connect directly with T2S and taking over the asset servicing function.
Given the costs involved and the period to generate a return on the investment, some banks will find it hard to justify the expenditure to go beyond scenario one.
Prabha Bob, Global Solutions Head, GCP – Capital Markets Group, at Tata Consultancy Services: Driving T2S Transformation
Transformation programmes, like the dematerialisation project in Japan or NASA’s space programme in the USA, have certain common themes: far reaching impact on the business model; long gestation period; complexity in quantification of benefits; and the use of technology as an enabler. The driving force behind such programmes is a belief that it is the right thing to do, an acknowledgement that the team work of stakeholders will put together the jigsaw puzzle and a vision to build a better future.
At TCS we have been following the developments on the T2S front right from 2007 and have had opportunities to work along with our clients.
In our view the T2S adaptation programme of stakeholders – CSDs, custodians, CCPs and national central banks – needs to have a three-dimensional approach encompassing organisation, technology and programme management.
The key challenges facing the stakeholders include building a flexible business model, minimising the impact on clients, enhancing the business value of the IT infrastructure, meeting the quality assurance objectives within the time frame for testing earmarked by ECB and ensuring a multi-phase rollout of an integrated settlement programme.
CSDs, custodians and other stakeholders can deploy a business process and change management framework to ensure a smooth transition to the target operating model. The various dimensions of the framework include:
• Leadership alignment that will set the overall strategy for T2S adaptation
• Organisational design to support new roles and responsibilities
• Business process adaptation for alignment of existing processes and developing new processes
• Improvement opportunity assessment to enhance operational efficiency
• Stakeholder buy-in and communications management
Technology is a key enabler and a portfolio approach should be taken to enhance business value of IT infrastructure. T2S adaptation can be leveraged to align the IT systems to the target state architecture of the organisation. This could involve a technology refresh, consolidation, retirement or integration of applications. It is important to be conscious of the impact that other regulations, such as MiFIR and EMIR, will be having on the organisation’s technology at the same time.
One option being examined by CSDs to minimise the impact on legacy platforms of clients is the support of multiple messaging standards in the initial phase. Another approach by stakeholders could be to develop an integration layer.
Leveraging existing settlement infrastructure for T2S adaptation is another area that calls for deliberation. One option is to develop an add-on component for T2S specific processes on top of the existing settlement system. However the merits of this strategy need to be established through a cost benefit analysis. Maintenance of heterogeneous applications (a combination of legacy systems and products/solutions) for multiple geographies is another aspect of technology transformation that will confront stakeholders. Adoption of a multi-tenant, multi-entity solution with a T2S interface layer and standard settlement engine could be one approach.
From a programme management perspective it is interesting to note that around 50% of the time in an IT project is spent on testing and migration. A key challenge for organisations in the T2S adaptation program is the presence of multiple stakeholders with varying levels of readiness. Testing can be facilitated by developing a test harness for downstream users in the value chain. A test harness is a repository of test cases/scenarios that is accessible by stakeholders, facilitating a level playing field for stakeholders and also enabling the monitoring of progress in the testing phase.
From an end-to-end market testing perspective 50-60 scenarios can be developed and deployed for mock sessions. This would enhance the confidence of the stakeholders.
Another concept is conformance testing whereby users of a stakeholder are assessed for readiness and provided dedicated time and environment for testing. For example a CSD may have ten custodians that are in different states of maturity for T2S adaptation. The custodians are assessed individually before the testing is thrown open to all the ten custodians. Very often simulation tools are used for conformance testing.
The next challenge is migration, and how to ensure consistency and reliability of the T2S adapted solution. We would propose the parallel testing approach with pre-T2S environment running along with the T2S testing environment. Migrated data can be utilised for testing towards the end of the testing phase. Another approach is to conduct business-operations testing. This will give organisations the chance to test an entire day of operations with a focus on meeting SLAs, operations schedule and information exchange with external stakeholders. Performance issues, if any, can also be detected.
The T2S initiative is obviously more complex than the Japanese Demat program and obviously more down to earth than the Moon, Mars and Beyond program of NASA.
But yes – it must take heart from the successful implementation of the Japanese Dematerialization Initiative, and draw inspiration from the visioning that propels the massive Moon, Mars and Beyond mission.
Panel discussion: The rocky road ahead
The panel debate showed that despite the shared vision of T2S among participants there were still some major concerns, around cost and co-ordination particularly.
Yvan Timmermans, chairman of the T2S Belgian National User Group (NUG), National Bank of Belgium (NBB) gave the perspective from a central bank on the project. He explained that the ECB Governing Council decided to discontinue the preparations for CCBM2 (Correspondent Central Banking Model). Therefore each NCB will provide the eligible assets and valuation list (for auto-collateralisation) to T2S individually. T2S will not be negatively impacted by this discontinuation. He said NBB will connect to T2S indirectly via its CSD as, like most central banks, NBB does not have the volume to justify a direct connection.
He highlighted two Belgian specificities. First, the NBB-SSS will probably not have a business case to set up links with the other T2S CSDs. Second, the other Belgian CSD, Euroclear Belgium, is not a Eurosystem-eligible CSD for receiving collateral as it mostly deals with equities that are not Eurosystem-eligible securities. Consequently, only eligible assets issued in NBB-SSS will be usable for auto-collateralisation by Belgian settlement banks.
James Cunningham, European Market and Regulatory Initiatives at BNY Mellon Asset Servicing noted that national specificities were a risk to blocking the achievements of a homogeneous system.
He said, “What we want is a homogenous settlement process as a precondition to T2S; if we don’t have it, then afterwards we are in the same position as today.”
Marc Tibi, head of market infrastructure at BNP Paribas Securities Services said, “We are worried that although we have one single European project called T2S, we do not have one single provider; we have 22 projects, each being handled domestically so the banks have to invest in and deal with 22 projects. That is not intelligent.”
Alex Dockx, T2S programme manager at JP Morgan Worldwide Securities Service said that his firm’s analysis as a user of CSDs was that cost saving existed in the long term with costs incurred in the short-term.
The CSDs on the panel said that they were moving ahead. Jean-Luc Fripiat, director of product management at Euroclear CSDs and Group Services, which has seen four of its group’s seven CSDs sign up, asserted, “There is a strong willingness to join T2S. It will harmonise market practices, lift a lot of technical and legal barriers to have a harmonised solution on Europe,” adding, “There will be a move to an unbundled service model and we at Euroclear are delivering services already for collateral management and asset servicing as well.”
Italian CSD Monte Titoli has begun to develop new services, seeing T2S as an opportunity to become a global post-trade services provider. It has signed up in the first wave of CSDs, committed to testing in mid-2014 and going live in June 2015.
Alessandro Zignani, general manager at Monte Titoli said, “We won’t increase our pricing for T2S to minimise the impact on our community. From a technical and organisational point of view we are organising training with our user group, explaining what T2S is; small and medium size banks are not aware of the full impact.”
BNP Paribas’ Tibi observed that by developing solutions to T2S separately CSDs were creating significant additional costs.
“Monte Titoli said that it is looking at costs of €15 million to adapt to T2S, but Euroclear and Clearstream say costs are in the region of €80-€90 million. Of course there could be some volume effects but not to the tune of €75million. Why have several CSDs separately developed a GUI? Our suggestion is that CSDs should be made to share their viewpoint and best practices.”©BestExecution 2012/13