The financials of T2S

One of the crucial workstreams in the coming months, which is of high interest to all stakeholders, is pricing. In particular, how much will T2S charge for standard delivery-versus-payment (DvP) settlement?

Our ultimate goal is for T2S to be one of the lowest cost settlement platforms in the world. We will achieve this by exploiting the huge potential for economies of scale that still exists in Europe. In 2008 314 million transactions were settled by the CSDs that have signed the T2S Memorandum of Understanding. If this number of transactions were settled on a single platform rather than being spread out over almost 30 platforms, it would be possible for T2S to achieve a level of settlement efficiency similar to that of the United States, which already has a centralised clearing and settlement infrastructure.

Our ultimate goal is for T2S to be one of the lowest cost settlement platforms in the world.

Of course, to decide on the eventual pricing, three crucial pieces of information are required: the overall tariff list for the various services that T2S will charge for, the total cost of building and operating T2S (the “total cost of ownership”) and the expected future settlement volume during the first few years of T2S in operation. Given the Eurosystem’s requirement for full cost recovery, the “pricing equation” shown below must eventually balance.

The first piece of the equation is, in relative terms, by far the simplest: in addition to standard DvP settlement, we need to decide what different types of services T2S will provide and charge for and how these services will be priced relative to standard DvP settlement. This tariff structure will include, for instance, other types of settlement, such as delivery free of payment and conditional settlement on delivery, as well as other services such as reporting and querying fees. The aim is to ensure that the tariff structure is transparent and extremely simple to understand. In this regard, discussions are taking place with the market to obtain feedback. One tricky issue still to resolve is how to charge for queries: even though the visual output of a query may only be a small table, it may have consumed large amounts of computer processing power.

T2S is expected to stimulate a greater trading volume by fostering harmonisation and competition.

The second part of the equation is much more difficult to establish, but still manageable: how much will T2S cost to build and operate during the amortisation phase from 2013 to 2020? Given the need for full cost recovery, the total cost of ownership will be a key driver for pricing. The 4CB have made an initial proposal to the T2S Programme Board, and an internal task force, chaired by T2S Programme Board member Anders Reveman, has been established in order to identify the main cost drivers and thereby seek to further reduce overall costs, in particular “operational costs”.

The third piece of information required is possibly the most difficult of all, and no one has a precise answer: what are the expected settlement volumes for the period between 2013 and 2020? Coming up with an answer to this question would truly require a crystal ball, as there are so many factors working in different directions. Prior to the financial crisis, settlement volumes had been increasing, on average, by around 10-15% per year. However, since then, the latest data have shown a decrease in volume by around 15%. It is not known when settlement volume will resume its upward trajectory and what the new growth rate will be.

T2S will deliver settlement services at a lower price than is currently available in Europe.

Despite the uncertainty, there is general consensus on the main driving factors. In a recent T2S information session in Luxembourg, I chaired a panel discussion on expected future settlement volumes. The panel agreed that there is expected to be a positive influence on future settlement volumes arising from the dynamic effects of T2S itself, in particular because it will stimulate a greater trading volume by fostering harmonisation and competition and overcoming cross-border barriers in the European post-trading market infrastructure. Another positive factor would be the potential for further growth in algorithmic trading in Europe. Algorithmic trading, which aims to overcome minor market inefficiencies through automated trading programmes, has expanded strongly in Europe in recent years, but there is still further scope for growth to reach the same level as in the United States. More efficient settlement through the use of T2S would provide a further stimulus for algorithmic trading. At the same time, there is also a trend towards more trades being cleared by central clearing counterparties (CCPs). This trend may have been further strengthened by the financial crisis, as the use of CCPs helps to reduce counterparty risk. The increased use of CCPs would tend to reduce settlement volumes because they net transactions between their participants.

To conclude, I would like to reassure you that, despite the complexities and uncertainties, T2S will deliver settlement services at a lower price than is currently available in Europe. The proposal for the eventual price structure, making clear the various assumptions, will be presented to the T2S Advisory Group in its future meetings for feedback and endorsement. And ultimately, pricing will be one of the core elements of the Framework Agreement to be signed by the CSDs committing to use T2S. I am sure we will be revisiting the issue of pricing in a future article in T2S OnLine.