The ECBâs Target2Securities initiative for securities settlement is gaining momentum but questions still remain around the eventual cost to participants. Nicholas Pratt asks what these unanswered questions could mean for fund managers and investors
Recent weeks of national bailouts, IMF visits and austerity budgets have kept the European Central Bank busy as various delegations have battled the wintery weather conditions to pay a visit to the ailing economies under its supervision. The extent of the problems in Ireland, Spain and Portugal have not only stretched the ECB’s travel budget, but threatened the very currency the ECB was set up to administer. So, while the existence of the euro remains in some doubt, one wonders how much attention is being paid to the ECB’s other numerous initiatives, such as the Target 2 Securities (T2S) project which aims to introduce a pan-European platform for clearing securities.
The T2S initiative was first introduced back in 2008 as part of the European Commission’s plan to harmonise the settlement landscape in Europe which it felt was inefficient, disparate and overly expensive. Under T2S, cross-border settlement would take place via the ECB’s platform, to which the central securities depositories (CSDs) and central banks of both euro and non-euro zone countries would all hopefully sign up. Therefore a securities transaction between two different European markets would be settled as if it were a domestic transaction, creating substantial savings for all concerned, especially the end investor.
The plan was initially welcomed by the banks but met with resistance from the various CSDs who are currently responsible for ensuring settlement in Europe’s various member states. However in the last six months, the project has garnered much wider industry acceptance. The CSDs have realised that T2S is a reality and are no longer questioning its legitimacy but are instead asking about the practical details. In return, the ECB has published a pricing proposal for settling transactions (estimated at 15% per transaction) and amended its implementation timetable so that the first phase begins in 2014.
According to Paul Bodart, executive vice president and head of Emea operations at the asset servicing division of BNY Mellon, there are three outstanding issues with T2S that must be resolved before its implementation. The first concerns harmonisation. “The technical side of the project and actually delivering the platform appears to be well on track,” says Bodart. “But ensuring there is harmony in most of the legal and processing rules of all the participating regional markets is critical because you cannot automate complexity and there will be little point having a pan-European platform if all of the operating rules are different in each country.”
The second issue concerns the intentions of the non-Eurozone states such as Switzerland and the UK which have yet to commit to the project. Obviously the more markets that are involved, the greater the transaction volume and the cheaper the transaction costs, although the ECB’s proposed price of 15% per transaction does not appear to presuppose the UK’s involvement. “The difference in price may not be very significant on a domestic basis, but it is a significant difference for the cross-border market. Of course it would be terrific if the UK did join T2S because it is a huge market,” says Bodart.
Banks and other participants will also have to make a significant initial investment to update their systems to work with the T2S platform but the majority of them are aware of the savings that come from a single centralised settlement structure. “The big benefit is that banks will no longer have to continually pay for all the changes made by individual CSDs,” says Alan Cameron, head of clearing, settlement and custody client solutions at BNP Paribas Securities Services. “Recently we have seen Euroclear’s system undergo a number of changes and before then we had Italy’s CSD upgrade its local settlement platform. But under T2S we will just have to make a one-off change. We expect this to be a significant saving but we are unable to put a number on what that saving will be.”
While uncertainty is never helpful, there can be some comfort taken from the fact that banks will at least be saving money in these areas – it is just unclear how much. What is more concerning for banks and also investment managers is the uncertainty over what they will still have to pay for, particularly in relation to the charges from the CSDs. “As users, we would like to get more information about what the CSDs will charge,” says Diana Dijmarescu, managing director, global market infrastructures, treasury & securities services, Emea at JP Morgan. “If banks connect directly to T2S, will there still be a contractual charge from the CSDs? There is a danger that the CSDs will seek to recuperate their costs and we have to monitor this. We have to look at the cost of asset servicing in an unbundled context and we have to look at the end-to-end cost of asset servicing plus settlement. But the goal is to reduce our costs and then pass those savings onto investors.”
Echoes of MiFID
Some investors and fund managers may feel that they have heard similar sentiments before in connection to the Markets in Financial Instruments Directive (MiFID), a similar EU initiative aimed at bringing pan-European harmonisation to the execution of securities trades. And while the transaction charges of the execution venues have been reduced, the cost to brokers and dealers of unintended market changes and the fragmentation of market liquidity means that MiFID is yet to produce savings for the end investors.
However, Eric de Nexon, head of strategy for market infrastructures at Société Générale Securities Services, believes there are important differences between MiFID and T2S. “The issue with MiFID is that the market has fragmented because more competition has been introduced. What is amazing is that because of fragmentation, while execution fees have decreased, the need for multiple executions has increased, as well as the cost of managing additional complexity. So for intermediaries, the benefit has been nil or at least significantly reduced. However, the opposite effect should result from T2S because it is about bringing CSDs together on one platform and should result in more consolidation not more fragmentation.”
A domestic bank can maintain its existing relationships with local CSDs under T2S, but any bank with ambitions of facilitating cross-border transactions, such as SGSS, will have to make changes to its business model and settlement platforms to connect to T2S and manage its transactions directly rather than through agent banks. Nexon does not believe these costs will be passed onto end investors in any way. “The trend in custody is for reduced fees so I do not see how we could increase costs, even if there is some initial cost involved in adapting to the T2S platform.”
The various national CSDs, however, will not only have to pay for the upgrades to the T2S system, they also face losing out on the settlement services they currently provide. There is, therefore, the possibility that the CSDs will increase the cost of the services they retain in order to recoup any extra costs or loss of business. “This is a competitive environment and I’m convinced this will not happen because we can easily change to another supplier,” says BNY Mellon’s Bodart.
But what about the bank’s own clients, the asset managers? Can they expect to see any savings passed down to them? “T2S will succeed in reducing the cost of my supply but will it instantly reduce the cost I charge my client? Probably not. The pricing will be based on the type of client, their volume and their transactions. However, we have seen the average unit cost of securities processing go down consistently over the last ten years (at an approximate rate of 7%). And institutional investors operating in the cross-border market should be able to see savings from near enough the beginning of T2S.”
But while T2S brings in competition among CSDs and sub-custodians for settlement, this is not the case for asset servicing, says BNPP’s Cameron, so the costs of T2S may be passed on disproportionately between the competitive and non-competitive markets. “There is still a monopoly around the asset servicing side of the CSDs, but on the competitive, settlement side you could easily see the larger CSDs absorb the costs of T2S rather than passing them onto customers and then gobbling up the smaller CSDs that cannot afford to do that. So it is a strange mix of competition and monopoly in the CSD market and it is difficult to see how it can be changed.”
The priority says Cameron, is for the CSDs to get on with making the necessary changes to implement T2S and create the harmonised settlement environment that will generate the long-term savings for all participants. However, he fears that too many CSDs are focusing their time and money on trying to be global custodians.
“The big question is about the business model that we want CSDs to have. I don’t think the world needs many more global custodians and we do not want to be subsidising the CSDs efforts to expand those parts of the market where they already have a monopoly. We think market infrastructures should concentrate on being market infrastructures and not take the money that they get from that monopoly position to build up other businesses that there is not too much demand for.”
These concerns may be unsurprising coming from an asset servicing bank that also operates in the custody space, but are investment managers also concerned about the potentially harmful implications of T2S? Not according to Cameron. “I have not found asset managers particularly interested in the post-trade settlement area in the past. But they probably have a louder voice than they think if they were to get involved.”
©2010 funds europe