26 April 2010

T2S currency participation agreement

T2S is not only a platform for settlement in euro: it can also be used to settle transactions in other currencies.

T2S is not only a platform for settlement in euro: it can also be used to settle transactions in other currencies. This is enshrined in the “general principles” of T2S, which form the cornerstone of the project. This openness to other currencies was strongly welcomed by the ECOFIN Council. Enabling multi-currency settlement on T2S not only increases settlement volume, which in turn helps reduce prices for all participants, but also brings us closer to achieving our single market objectives. It certainly makes it more straightforward for a Central Securities Depository (CSD) from a non-euro area country to join T2S if its national currency is also in T2S. So far, three non-euro area central banks – Danmarks Nationalbank, Norges Bank and Sveriges Riksbank – have formally indicated that they are willing to enter into negotiations for their currency to be settled in T2S, and a number of other non-euro area central banks are following developments closely.

Of course, T2S only settles in central bank money. For a central bank to outsource the settlement of its currency to T2S is a rather sensitive decision. Among other things, this is because a central bank needs to be able to maintain full control over its currency for monetary policy and financial stability purposes. However, outsourcing settlement is not an entirely new concept for central banks: for example, Banque de France and Bank of England have been outsourcing the settlement of their currency to their national CSDs for many years. Furthermore, in the case of T2S, any concerns over outsourcing can to some extent be assuaged by the knowledge that the platform will be operated by a group of fellow central banks, the Eurosystem.

The key legal instrument for regulating the inclusion of the non-euro currencies will be the Currency Participation Agreement

The key legal instrument for regulating the inclusion of the non-euro currencies will be the Currency Participation Agreement (CPA). Along with the Framework Agreement, which is in the process of being negotiated with CSDs, the CPA will be one of the key pillars supporting the T2S’s legal structure. The preparation and eventual signature of the CPA by non-euro area central banks is therefore a very important milestone for the T2S project.

Some preliminary discussions on the CPA have already been taking place with a group of experts from non-euro area central banks. However, the formal negotiation of the agreement is due to start soon with the setting up of a dedicated task force, composed of legal and technical representatives from the non-euro area central banks and the Eurosystem. The timetable for the preparation and signature of the CPA is still rather fluid, but it will approximately mirror the timetable of the Framework Agreement. We are therefore aiming to have the agreement ready for signature by autumn 2010.

Although we are only at the very beginning of negotiations, I can say that they have so far been very smooth. After all, central bankers do have a certain mutual understanding of each other’s concerns. However, it is already very clear that one of the trickiest issues to resolve will be governance.

To some extent one can compare the governance issue to a relationship between two best friends who have known each other for many years.

To some extent one can compare the governance issue to a relationship between two best friends who have known each other for many years. One of the friends has recently built and paid for a fantastic new house for his family. The house not only has a state-of-the-art architectural design, but also the most up-to-date energy-saving technology, and its furnishings are elegant but simple so as to avoid unnecessary clutter. It is even big enough that it has enough space for the best friend’s family to live there as well, and the owner has offered that they move in together. This way they can both benefit: the friend can enjoy living in a modern, energy efficient house, and the owner can have some help with paying off the mortgage.

But moving house, of course has a number of transaction costs, and sharing a house can sometimes lead to disagreements, even between best friends. For example, they know that they are both non-smokers. But it is still possible that in a few years’ time one of them may start smoking. Of course, as a last resort the friend knows that he could always decide to move out, but in our context this would really be a very expensive option, to be avoided in all but the worst case scenario.

Governance can be ignored 99.9% of the time, but when you need it, you really need it

An effective governance arrangement between the friends sharing the house, as with T2S, would enable the parties to amicably and fairly resolve their differences if and when they arise. As one of the non-euro area central banks said at a meeting, governance can be ignored 99.9% of the time, but when you need it, you really need it. Of course, the owner of the house is likely to be reluctant at first to cede control over decision-making for a property that he took the risk to finance. But, at the same time, if he wants his friend to move in he will need to give some ground.

The recent report submitted to the T2S Advisory Group by the “Task force to explore a separate legal entity” helped to identify some of the key concerns of both the non-euro area central banks and the Eurosystem, and explored some potential solutions for a future governance arrangement. Further discussions will take place in the coming months, and we are very confident that we will come to a mutually beneficial conclusion.