NO PAIN, NO GAIN.
TARGET2-Securities (T2S) will come into effect in June 2015, harmonising settlement for cross-border bonds and equities trading in Europe. As the trading community readies itself for implementation, following years of delays, Robert Almanas, Head of International Services, SIX Securities Services takes a closer look at the impact market participants.
In spite of its stated aim to harmonise and simplify the settlement process for companies trading in Europe, at first sight T2S appears to have raised the hackles of the European trading community. At the 2013 Sibos conference, SIX Securities Services spoke with several industry specialists to gauge their perception of the new rules, and the results weren’t positive. The majority of respondents to the survey felt that T2S will have a negative impact, increasing the cost of settlement services in Europe once it is instigated. Another worry raised was the total cost of ownership of T2S. There is clearly a fear that the implementation and operation of T2S will generate costs for financial organisations, as they are forced to overhaul their internal systems, and train staff on the workings of the new settlement platform.
Are these concerns justified? Are financial institutions, not known for their willingness to embrace change, right to fear T2S? Will this new settlement infrastructure create additional pain points for firms, or could it actually bring lasting benefits to the post-trade market, as intended? At this point, while it’s still difficult to map out its potential affects, it looks like the benefits provided by T2S will be mitigated, at best.
For example, many buyside firms are exploring changes to collateral management. T2S should help institutions streamline their processes, and the creation of a virtual collateral pool across all European markets will eliminate some of the inefficiencies inherent in having to transfer securities across systems. However, while this pool will make it easier for companies to access eligible collateral, it will not, in itself, increase the collateral available.
This is a concern because most industry experts are predicting a collateral shortfall to develop in years to come, on the back of tightened risk management processes and the onset of centralised clearing of OTC derivatives. Back-office efficiencies have also been highlighted as a theoretical benefit to be derived from the new infrastructure. Cash management, reporting, and the pooling of securities should all be improved thanks to a common settlement platform. There is an obvious limitation to the scope of these benefits, however. T2S is a settlement platform only and despite creating a unified structure, any securities being handled will eventually have to be returned to the fragmented European post-trade infrastructure.
It’s not just trading firms that will be experiencing changes to their procedures, as T2S will also have considerable impact on market structures dedicated to supporting trading activities. Central securities depositories (CSDs) will see a range of new trading behaviours introduced into the settlement market as market participants will now be able to choose their settlement agent, where once they would have been bound to domestic CSDs. As a result, issuers of financial instruments will be able to select exactly where they want to settle in Europe, particularly as settlement periods will be harmonised across Europe to a T+2 (2 day) settlement cycle. CSDs will enter into a new period of intercontinental competition where quality of service and cost-effectiveness could dictate customers’ settlement preferences.
As a consequence, we can expect to see a proliferation of settlement service providers emerge in the market initially, as new CSDs seek to take advantage of what will be an increasingly service-orientated marketplace. We do not think this will last. The costs and expenses linked to maintaining a CSD will mean that many of those limited to just one single domestic market will fall by the wayside. Trading firms will seek to gain economies of scale and take advantage of the capacity of international CSDs to support their businesses across multiple geographies. This will drive a long-term tendency towards consolidation, with only the strongest CSDs with the broadest scope surviving.
Overall, T2S will bring both positive and negative impacts to the post-trading landscape in Europe. One thing is for sure, though; trading firms must get to grips with the changes coming because the new world is going to dawn. Savvy financial organisations have recognised that despite some of its limitations, T2S will be a game changer, transforming the way firms in Europe undertake trading and settlement activities. To seize the benefits this new paradigm provides, many are collaborating closely with their settlement service providers, to see how value-added services such as collateral management support can be incorporated into their trading activities. By accepting change rather than rejecting it, these companies are positioning themselves to steal a march on their competitors and excel in the brave new world of post-trade post-T2S.