How far will Target2-Securities (T2S) implementation be affected by the move to T+2, and when can we expect the shorter settlement cycle to be in place?
Angus Fletcher (pictured): With the exception of Spain, it seems that most European markets will be looking to move to a T+2 settlement cycle on October 6 2014, in other words before the January 2015 deadline set by the CSD regulation (CSDR). A relatively short testing phase – currently about three months – for T2S will start at some point in Q1 2015, before the first wave of T2S begins. For market participants there is a lot to complete in a relatively small window.
It is worth noting that precisely what is included and excluded from T+2 isn’t yet entirely clear: individual markets will determine their own scope based on their interpretations of CSDR. This amplifies the testing and go-live challenges that the industry will face prior to T2S.
Secondly, CSDR stipulates penal settlement fines and a new buy-in regime that also raises questions. Who will drive buyins, who will implement the fines and on what basis, and will these be brought in by markets for the October 6 go-live.
Graham Ray: Both the range of market interpretations and general implications, such as fines, means that there will be opportunities from the implementation of T+2. Firms like ours will leverage the solutions we can offer, notably through fail-efficient settlement solutions.
When T+2 is rolled out, fails will occur in some places and providers must provide mechanisms to reduce their impact. With the cycle more compressed, all participants – whether on the buy side, the sell side or from the custodian community – will need to analyse their processes.
What role is the debate about asset protection playing in the implementation of T2S?
Ray: In the first case, the question of account structures carries important questions of legal ownership, which may be more complex than they appear on paper. Does the proposed legal documentation cover appropriate liability management to ensure a clear ownership, accountable and a responsible party matrix is in place for each function within T2S, for settlement and all activities impacted by settlement?
The asset protection question is particularly important because of the serious reputational risks if things go wrong. There has been a significant increase in regulatory focus on the liability chain – who is responsible for ownership of assets and who can be counted on to return them in case of severe market stress or a default.
All of the above points need to be considered when reviewing how the engagement model between providers and clients is structured in a post-T2S world.
Fletcher: As usual, ensuring safety comes at a price. This means there are opportunities for firms in ensuring that every stage of the trade lifecycle works for participants both in terms of risk and cost, and any post-trade models being brought in as a result of T2S will need to cater for both. Expect to see a number of alternative models explored, many of which will be tried and possibly discarded in the period following Wave 1. It will take time for new robust models to emerge.
Given the time pressure around testing and migration, how well is the industry consultation process working? Ray: We have a live example here in the Directly Connected Participant Forum, a forum chaired by Deutsche Bank and Citi. This provides an effective voice to help ensure that the first wave of T2S is harmonised and efforts are fully coordinated.
Currently the forum has been vocal over the need to provide standard documentation, appropriate time and support for the testing phase in planning for the migration waves.
There are currently three months before Wave 1 testing begins, this is not a long time. It is very important that end users are canvassed during this time, as well as CSDs, to identify potential challenges thrown up by the test case scenarios. For its part, the industry needs to devote a lot of time and effort to the testing cycles for both T+2 and T2S.
What progress has there been beyond Europe towards shorter settlement and a better functioning post-trade landscape?
Fletcher: DTCC is looking closely at reducing settlement to T+2 and has even suggested a T+1 cycle. The final dates have not yet been announced, but are likely to follow closely the shift in Europe. While settlement risk would be reduced further by a move to T+1 this would create considerable challenges around prefunding, FX and in securities lending.
In Asia, the Asean post-trade initiative is investigating how to make the posttrade space more efficient and we can look forward soon to announcements around how clearing and settlement will be improved.
Ray: The biggest challenge in Asia is the legal framework – the job of harmonising so many distinct jurisdictions is harder than the challenge faced in Europe. Certainly, there is a degree of variation in how European directives are interpreted by national lawmakers and regulators, but there is a single regulatory framework.
Will the European experience benefit these efforts?
Fletcher: The work around creating industry standards – such as those governing corporate actions processing – could have value beyond Europe.
Separately, we understand that the ECB is talking to markets in Asia and beyond about selling on some of the T2S technology platform. If buyers were found in Asia, the US or Latin America or the Middle East, this could facilitate subsequent links between Europe and countries in these regions.
In general, though, it is important not to overestimate the benefits beyond Europe. When you are talking about global organisations, the complexity of unpicking services that have become bundled – or achieving cooperation between competing infrastructures – is considerable.
Even for us in Europe, simply requiring CSDs to come together and outsource settlement to a single outsourced technical platform, will still present challenges. T2S needs to be a success with its current scope, and so long as it is, others will want to join it or leverage its technology.
What priorities should the industry now focus on to extract maximum benefit from T2S for the end investor?
Ray: A lot of unseen progress is being driven through the legion of other working groups within the ECB governance structure devoted to activities other than settlement itself, such as harmonisation of asset servicing.
Legislation could play a role here, but it can be a relatively slow and blunt instrument. A better driver for this type of improvement is the industry’s own work to generate and apply standards, and the ECB and its working streams are doing hugely valuable work here in driving these.
In general, the industry must adapt to create efficiencies and cost reductions for all participants in the settlement chain, by improving and adding to existing business models.
A couple of things, in particular, need to happen for the industry to lead this: first, greater partnership in relationships – between client and client, client and provider, provider and provider – many of which have traditionally been competitive; second, a larger degree of specialisation, where firms are focusing on what they do best – be that asset servicing, collateral management or depositary functions.
There will be some areas where greater opportunities exist for CSDs and others where asset servicers are an advantage.
But the key is that the playing field must be level. This is a necessary condition if the industry is to find its way to the most effective model for the end investor.