CLEARING & SETTLEMENT: Target practice

The deadline for T2S is approaching. Nicholas Pratt examines what benefits may be on offer for investment managers and what opportunities may be missed.

Target2Securities (T2S), the project to create a single centralised settlement platform for European securities, looks finally destined to meet its latest implementation date after several years of postponements.

“There will be no delays,” said Yves Mersch, member of the executive board of the European Central Bank recently. “The software is in place and is being tested. Soon we will open it up to be tested in the market by CSDs [central securities depositaries] and will deliver it in two years’ time.”

Yet even if T2S does meet the latest implementation target – and there are some doubts it will – there will still be several issues for investment managers to consider, both before and beyond implementation, if they are to gain the full benefit of the T2S project.

The first issue is whether investors and investment managers can expect to see any savings in settlement costs. This is the primary objective of T2S but just as the Markets in Financial Instruments Directive (MiFID) was meant to reduce the cost of securities execution, the initial development costs for service providers may well be passed on to end investors thereby wiping out any potential short-term savings.

The ECB has committed to a settlement fee of €0.15 which will be charged to the CSDs but the CSDs will have to decide whether they absorb that charge, pass it directly onto their customers or add further charges on top to cover their development costs, at least in the short-term.

“It is very important to distinguish between the cost of T2S and the tariffs of the CSDs,” says Alexandre de Schaetzen, director of corporate strategy at Euroclear. “The €0.15 charge for T2S will come on top of current CSD tariffs. In the short-term it will be an additional cost but there will be some longer term benefits that will help to reduce these costs over the longer term.”

One of these benefits is a more competitive CSD market. By commoditising the settlement process, T2S has led CSDs to consider expanding their asset servicing capabilities to areas like collateral management which should become a more streamlined process within the T2S framework, says Robert Almanas, managing director, International Services at SIX Securities Services.

“The creation of a virtual collateral pool across European markets will certainly eliminate some of the inefficiencies inherent in having to transfer securities across systems.”

“A single collateral pool will probably mean there will be simplified processes over time but it will depend on how products are shaped by each individual bank,” adds Göran Fors, global head of custody
at SEB.

And while there will be clear advantages for investment managers from the settlement and custody of the underlying securities within their funds, for the settlement of the funds themselves, there are fewer visible advantages from T2S.

When the project was first conceived in 2006, it was focused solely on securities settlement; investment funds were not considered. This was, of course, pre-crisis when trading volumes were still high, as were the T2S board’s forecasts of the volumes they could expect on the platform.

Now that T2S is looking for additional volume, it has looked to the investment funds market. Domestic funds are largely settled through domestic CSDs and they will simply move to T2S. But much of the cross-border funds processing that takes place in Luxembourg and Ireland does so outside of the CSDs and this is the volume that T2S is considering to capture.

In July 2012, the ECB appointed former BNY Mellon head of asset servicing operations in Europe, Middle East and Africa, Paul Bodart, to the T2S board and he will be a central figure in any plans to include cross-border funds settlement on T2S. But despite the will of the T2S board there will be some significant challenges that are unlikely to be overcome without changes to the current T2S specifications – a prospect that is unthinkable if T2S is to hit its 2015 deadline.

“Cross-border funds processing definitely fits the purpose of T2S but the key question is how the different stakeholders in the cross-border processing chain will adapt to the T2S framework because it will not be advantageous to all of them,” says Mathias Papenfuss, head of operations, Clearstream.

“Some may say that T2S will make the current model more efficient. But the current model also creates financial benefits for some and it will be difficult to remove those benefits. Indeed, much conceptual and design work would need to be undertaken first, to convince all fund processing stakeholders of T2S benefits.”

Under the current model it would be the transfer agents (TAs) that could miss out on revenue if the settlement of cross-border funds was to move to T2S. However, there was a similar issue when the T2S project began and the CSDs and international CSDs faced missing out on revenues gained from settlement fees. Their opposition gradually receded as it became evident that T2S was a reality and it would be best to accept it and find a way to make it work for the best. It may be a similar case for the TAs.

The most likely scenario, says Isabelle Olivier, head of clearing & settlement, Emea, at Swift, is the co-existence of both models – the current model and the T2S model – to cover the contradictory interests of different participants – from the TAs looking to defend their stake in the process to the institutions that consider T2S an opportunity to consolidate settlement of both domestic and cross-border funds on one pan-European platform.

“I expect more discussion on the topic and the costs, benefits, disadvantages and market practices,” says Olivier. “Each player in the funds industry will make its own judgment and its own business case and act accordingly.”

There will also be administration, reporting and distribution issues from settling cross-border funds on T2S, says Gudrun Goebel, chief operations officer for fund processing services Luxembourg for Societe Generale Securities Services.  “Cross-border funds have multiple distribution channels and different markets such as Asia and Latin America that are not supported by T2S. These channels are chosen by the investors not the fund and are a key attraction to investors.”    

The cascaded “CSD within a CSD” or “omnibus within an omnibus” structure in which funds would be held on the T2S platform is also unhelpful in terms of reporting and compliance. Certain domiciles like Luxembourg make the asset manager responsible for ensuring the eligibility of end investors in their funds and this would be a difficult process to control if their fund shares are held in the aforementioned fund structure, says Goebel.

The biggest problem, though, for the ECB and T2S is actually persuading the investment funds industry that cross-border funds would be in any way better served by settlement via T2S even if the above issues are solved.

“The funds industry is clearly looking for more automation and standardisation to support a more efficient and growing cross-border distribution process end-to-end,” says Swift’s Olivier. “However there is no evidence at this moment that the funds industry is pushing for a massive migration towards T2S, as it will not solve all the issues that industry faces.”

Euroclear’s de Schaetzen foresees a similar scenario. “Cross-border fund settlement costs are already very low and they occur within an infrastructure that, although not perfect, still operates quite well. So it is unlikely that the industry will see much advantage in changing the existing settlement process in order to integrate cross-border funds into T2S.”

©2013 funds europe



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