Magazine Issues » November 2011

CLEARING AND SETTLEMENT: A slow-moving target

TortoiseThe implementation timetable for Target 2 Securities, the platform project devised to streamline securities settlement in Europe, has been delayed until 2015. Nick Pratt finds out what the implications may be for the industry.

The European Central Bank’s ambitious project to streamline securities settlement in Europe, which is called Target 2 Securities (T2S), has been delayed once again. The asset management industry has not been overly exercised by the debate around T2S. This is understandable; asset managers will not be direct users of the platform, nor are many users of the next body in the chain, the central securities depositories (CSDs).

Nevertheless, there will be indirect implications from T2S that will eventually trickle down to asset managers and their end investors. Any cost savings for custodians should be passed down the processing chain. The fact that T2S allows CSDs and custodians to develop new services in order to compete with each other should also benefit asset managers. But amid the project delays and absent pricing plans, these benefits exist merely in theory.

In March, a T2S working group, set up by the European Fund and Asset Managers Association, called for more clarification around the implications of T2S. More specifically, it wanted to know whether T2S would reduce settlement risk or actually add to it given the involvement of a new actor, the European Central Bank (ECB), which will own and operate the system, into the settlement chain. The working group also wanted to know more about system specifications – the currencies needed, whether there would be fraction handling, and what co-ordination there would be between issuance and delivery. And, of course, the working group wanted to know about cost and whether usage fees would outweigh any potential savings.

T2S has issued its own pricing plan, proposing a 15 cent charge per transaction, but the CSDs are yet to issue any information on what fees they will charge on top of this. Furthermore, the implementation timetable has been repeatedly adjusted, meaning that the original deadline of 2013 has been extended to some time in 2015.

A contractual agreement with the CSDs is not just round the corner.

According to Jan Lemeire, director of product management at Euroclear, there is still not enough information for CSDs to accurately assess what there development and day to day costs will be as a result of T2S. “Much of the technical estimates have been based on the ECB’s User Requirements Document (URD), which was published in 2010, but the User Detailed Functional Specifications (UDFS) will contain more detailed information about system specifications. CSDs will need at least six to nine months to go through all of it.”

This means that any contract signing before the year-end is unlikely and Euroclear would prefer to see the framework agreement signing postponed to June 2012. “This is normal business practice, particularly for a project of this size, because we have to be sure that the work we have done based on the URD will not be jeopardised by any changes or misinterpretations that appear in the UDFS,” says Lemeire.

The fact that CSDs are unsure of what they will charge for T2S settlement means that its own customers (custodians and sub-custodians) have little idea what they will charge their clients. “Because T2S has issued its pricing plan we have a very good idea of what the basic cost of DVP [delivery versus payment] settlement will be between 15 and 20 cent, but we also have to know what the extra costs charged by the CSDs will be and of that we have very little idea,” says Guillame Heraud, head of clearing services at Société Générale Securities Services.

In addition to the pricing proposals from the CSDs, custodians are also waiting for more information on potential volumes and any changes to the business model in terms of providing a cross-border, pan-European CSD service.

“One of the biggest benefits of T2S is the ability to use a single CSD rather than maintain links to 15 different ones. But we don’t know if that will be the best approach or which we would choose. It is likely that the CSD which we currently do most business with would offer the best opportunity to consolidate our costs, but we would have to know the cost, the quality of service, and the volumes at stake before we could determine our choice. If we are to get the full benefit of T2S, we need to be able to make a full comparison.”

Asset managers and their end investors will be expecting to see decreased settlement costs. It may be true that settlement costs for local custody could even increase in the short term as providers will have to absorb the adjustment costs of T2S. But Heraud is confident that over time, and especially for cross-border funds, settlement costs will reduce. “Custodians should be able to improve their infrastructure. They will have fewer counterparties to deal with, they should be able to pool their volume and harmonise their settlement set-up. So I am optimistic that savings can be made from T2S.”

But a growing sense of frustration is accompanying the optimism. Kevin Milne, director of post-trade services at the London Stock Exchange, which also owns Italy-based CSD Monte Titoli, has criticised the “growing sense of negativity” around the project. “It is time for the industry to get behind T2S. It will be a bumpy ride but we have to get through it because the benefits will be huge,” said Milne.

Meanwhile, Tim Keaney, chief executive of asset servicing at BNY Mellon has stated his “extreme disappointment” at the latest delay. “As a global custodian, one of the challenges we face is explaining to our customers why international custody is so much more expensive in Europe, so I was very encouraged by the launch of the T2S initiative and the idea of introducing a harmonised settlement structure in Europe.”

Asset managers, though, remain relatively removed from the debate and still see it as an issue for CSDs and custodians. There is even less interest for asset managers that deal only in domestic funds and especially for UK-based managers, given that the UK has decided not to take part in the project.

However, says Tony Freeman, executive director of industry relations at post-trade processing provider Omgeo, T2S should be seen as part of a general move to shorten the settlement cycle. In fact, a move to mandate T+2 settlement is expected to be announced by the European Commission in the very near future, he says. “The issue of T+2 settlement came up two years ago and has developed as a project in its own right independent of T2S. We expect it to be implemented before T2S and to happen in all EU markets.”

Freeman, therefore, does not think that asset managers should be doing nothing. “They may not be able to get a contractual agreement regarding T2S services but they can prepare for T+2 settlement. They should be looking at system processes and whether they will be able to operate in a T+2 world where a day is taken out of the settlement cycle.”

To achieve this, same-day affirmation of trades is a pre-requisite, he says. “Any transaction has to go from the investment manager to the custodian to the CSD to T2S so needs to get to the end of that chain by the end of the working day in order to be settled overnight. A lot of our clients have this capability anyway, but there is still a big gap between the automated and the non-automated in the funds industry.”

©2011 funds europe