TARGET2-Securities: from vision to reality. The Eurosystem’s contribution to an integrated securities market
Speech by Gertrude Tumpel-Gugerell, Member of the Executive Board of the ECB
EU Commission’s Conference on
“The EU’s new regime for clearing and settlement in Europe”
Brussels, 30 November 2006
Ladies and gentlemen,
I would like to thank the organisers of the conference for inviting me to speak to you today. I have noticed the wide range of topics that have been touched upon this morning and will continue to be debated later today, addressing developments in financial infrastructures as well as EU policy issues. In my speech, I would like to mention to you the Eurosystem’s proposal for what we call TARGET2 – Securities, or T2S in short, a new settlement service for securities transactions.
I have organised my remarks as follows. First I will mention the T2S interaction with other EU Commission projects. I will then highlight the objectives of the Eurosystem initiative in securities infrastructure. Thereafter I will outline the potential benefits of T2S for users. Finally I will conclude by mentioning the next steps of the project.
T2S and the interaction with other EU Commission projects
Before describing the details of T2S, I would like to tell you the way I see the interaction between the Eurosystem initiative on T2S and the other initiatives recently taken by the EU Commission, among others the Code of Conduct.
TARGET2-Securities is not a lone-runner in introducing innovation. It is part of a wider set of complementary initiatives to solve the problems relating to integration in post-trading infrastructure. Consequently, TARGET2-Securities shares the same objective as other public initiatives in this field, most notably the Code of Conduct prepared by the European Commission. The common objective is to achieve higher efficiency and lower costs through greater competition. The Code of Conduct pursues this objective through the self-commitment of CSDs to provide price transparency, to facilitate access and interoperability, and to implement service unbundling and accounting separation. TARGET2-Securities does it from an operational angle, in the way that I will later describe.
This is why the European Commission has stated its support TARGET2-Securities from the start. Both initiatives reinforce one another. Indeed, also the European Parliament has also concluded that “until such time as an [integrated settlement] infrastructure may have been introduced, an ECB governance must be put in place”.
Background for the Eurosystem initiative in securities infrastructure
Let me say something about the background relating to the Eurosystem initiative itself. In July of this year, the Governing Council of the European Central Bank announced that the Eurosystem should explore, in cooperation with central securities depositories and other market participants, the setting-up of a new service for securities settlement in the euro area, TARGET2-Securities (which is also sometimes referred to as “T2S”). Since then considerable work has been undertaken by the Eurosystem both internally and in conjunction with CSDs and market participants in different fora to develop this proposal.
To understand the essence of this proposal, one should bear in mind that over the past decade, two trends have been apparent in the development of the European securities settlement infrastructure:
There has been considerable progress in integrating settlement systems at the national level, with the result that in most European countries, there is now just one settlement platform for all types of securities.
At the international level, there have been several cross-border company mergers, which have resulted in bringing CSDs in different countries under common ownership (for example, Clearstream, Euroclear and the CSDs in Sweden and Finland). However, although these mergers have the objective of integrating settlement platforms, progress has been slow.
It is widely recognised that securities settlement systems are comparatively cheaper at the national level than at the cross-border level. While efficiency at the national level has improved, there is still no example of a fully integrated cross-border settlement system in Europe. Barriers remain, in the form of different market practices, legal structures and tax procedures, in spite of the work undertaken by ECSDA to develop harmonized market practices and by the European Commission to address the “Giovannini” barriers. Securities settlement in Europe remains fragmented, with the result that cross-border transactions remain expensive and inefficient.
It is particularly striking that, almost eight years after the introduction of the single currency, the euro area still lacks an efficient, integrated securities infrastructure that would support the operation of a single financial market. A number of studies have been published that quantify the cost of post-trading activities in the EU and in the US. On the other side of the Atlantic, the Depository Trust & Clearing Corporation (DTCC), the US institution in charge of clearing and settlement, is used in the studies as a benchmark for a fully consolidated system. All the studies find that costs are generally higher in the EU compared to the US. This is not surprising given the multiplicity of settlement engines in the Old Continent.
In the EU the number of settlement engines declined from 22 in 1998 to 19 in 2005, and the number of securities central clearing counterparties declined from 14 to 7. The number of securities clearing and settlement systems is still rather high, in particular if we compare it to the significant progress that has been made in the integration of large-value payment systems, with the overall number standing at 4, down from the 23 that existed before the introduction of the euro and the TARGET system.
My description illustrates the difficulty faced by independent organizations in coordinating solutions for integration across multiple countries, and involving many different participants.
In 2007 the implementation of TARGET2, the new system for settlement of large-value cash payments, will present an opportunity for the European securities industry to take a leap forward in the field of securities settlement. TARGET2 will, for the first time, implement a single technical infrastructure across the euro area (and beyond), enabling banks to pool liquidity across different countries. This will make it possible to bring together the payments associated with securities settlement across multiple CSDs. However, the benefit to banks of pooling liquidity cannot be achieved if TARGET2 has to maintain separate interfaces to multiple CSDs.
With the introduction of TARGET2 next year, the operational efficiency generated by a single pool of liquidity that TARGET2 allows will not be fully exploited because of the panoply of interfaces for the many CSDs.
Following its introduction, TARGET2-Securities will allow to fully exploit the potential benefits stemming from TARGET2-Cash, since it will complement the possibility of having a single pool of liquidity with the possibility of a having a single entry point for settlement of securities and to bring on the same platform the cash and securities settlement.
Objectives of the Eurosystem initiative in securities infrastructure
The vision for T2S is simple. It will bring together just the information and functionality required for settling securities transactions. It will provide this as a service to CSDs, which will continue to be responsible for maintaining their relationships with intermediaries, investors and issuers.
The new element of this concept is that the securities accounts of multiple CSDs should be maintained on a single technical platform alongside central bank cash accounts, while all the other functions – notably, the relationship with intermediaries, investors and issuers and the management of corporate actions – remain with the CSDs. While this split is innovative, it is also logical. Settlement is the most standardized process for the CSDs. On the other hand, the relations with intermediaries, investors and issuers are much more heterogeneous, with numerous local variations. It is therefore possible relatively rapidly to achieve integration of the settlement process, while allowing more time for the harmonization of local market practices.
Some market participants fear that by introducing TARGET2-Securities the Eurosystem will eliminate competition in the field of securities settlement. The underlying assumption is that by merging CSDs settlement platforms into a single one, the Eurosystem will create a monopoly. In reality, even if there are many CSDs in Europe today, competition between them is already very limited. The multitude of actors is a necessary but not sufficient condition for competition. In addition, by pooling the settlement function into a single system, the market will benefit from economies of scale. Each CSD will remain in charge of relations to its participants. The only change will be the recourse to T2S resources for settlement services.
The continuing role for CSDs in relation to intermediaries, investors and issuers means that there will continue to be choice and competition in the provision of services. If anything, T2S will increase the possibilities for choice and competition. Participants will be able to choose among multiple CSDs to access a common settlement engine. Issuers will improve the liquidity of their securities by making them directly available to a wider range of investors.
The ability for any bank (including ICSDs) to offer securities settlement in commercial bank money will not be affected. The parallel provision of securities settlement services in central bank money and commercial bank money is a stimulus for central banks to provide efficient services. This is as valid for TARGET2-Securities as it is for TARGET2.
The Eurosystem intends to use its position as a public sector, supranational organization to provide leadership in a way that is impossible for other market participants. Such a role in overcoming sectoral or national barriers in the way of a more efficient market structure is a traditional one for central banks in many countries and consistent with the mandate of the ECB and the NCBs of the Eurosystem.
The potential benefits of T2S for users
As concerns market reactions to the T2S project, at the ECB we have the impression that, while underlining the challenges of such a project, banking communities have generally provided encouraging comments to the project. Other market participants, in particular the CSDs, have understandably manifested some reservations and have asked for more information on how T2S will look like.
To assuage any fears that markets may have on the T2S project, let me mention here the benefits for the markets that we are committing to deliver.
Firstly, cross-border securities transaction settlement can be as efficient as domestic securities transaction settlement. All markets may operate in real-time under the same settlement engine, thus allowing for a faster re-use of securities and central bank money. As a result, T2S will propose the same pricing for domestic and cross-border settlements.
Secondly, competition will be fostered by pooling all securities that settle in central bank money in a single settlement engine accessible via multiple CSDs. At the same time, a decentralised structure is maintained whereby each CSD is responsible for maintaining relationship with intermediaries, investors and issuers, as well as asset servicing.
Thirdly, T2S will encourage CSDs to offer to their participants the opportunity, if they choose, to centralise their securities holdings in one place. This will depend on the readiness of CSDs to hold securities issued in other CSDs. In fact, CSDs will have an incentive to do so in order to improve their competitive position vis-à-vis their participants.
Fourthly, issuers may potentially reach directly a much wider set of investors, while continuing to use the same CSD they are using today, with the same procedures they are using today.
Finally, the Eurosystem and its counterparties will also benefit of this efficiency for using collateral in its credit operations. With cross-border deliveries becoming as efficient as domestic, a new generation of Eurosystem collateral handling procedures could be implemented.
Bringing together the securities accounts of multiple CSDs on a single platform also creates the possibility of a much more efficient cross-border settlement. The bookings for a transfer of securities from a participant in one CSD to a participant in another CSD can be made simultaneously, together with the cash movements. This eliminates the complex (and risky) process of reserving securities and waiting for cash payments in another system before a transaction is final, something that has reduced the attractiveness of CSD links up to now.
You might ask yourself “Is there really no other alternative than T2S?” Such an alternative should be ready to provide a settlement engine that covers the whole euro area both in terms of securities settled and in terms of governance. It should be ready to provide settlement of securities and central bank money in real-time. It would need to be more than an association or alliance: ensuring a way to reach decisions that are binding for all members. It would need to preserve a role for each CSD, while at the same time promoting competition between them, like I have described earlier. We have seen nothing like this taking place so far.
The market process of achieving integration is different. To be effective, it normally involves acquiring a CSD and rationalising the internal processes to reduce costs. This process necessarily takes time. It is slower than the users would want and more painful than the absorbed CSD would want. By co-operating with the CSDs, the Eurosystem wants to achieve this integration in a way that is faster, less painful and at the same time promotes competition.
The problems of fragmentation are wider than the single currency area. We are aware of the demands coming from market participants dealing in various currencies. We are concentrating on the euro, which is the currency for which we are responsible. It would of course be technically possible to include other currencies. We respect in any event that this is a decision for the central banks issuing currencies other than the euro.
For the Eurosystem, T2S is a project unlike any that it has undertaken before, as this project reaches out beyond banks and payments systems, into securities markets. The Governing Council has indicated that the Eurosystem is willing to finance and operate T2S, but it also recognises that it will need the co-operation and commitment of CSDs and securities market participants in general to deliver the service successfully.
Indeed, to get the greatest benefit from consulting market participants, we have announced our intentions to the markets at a very early stage and in a very transparent manner. We have also been very receptive to the markets’ views on the T2S design. Beyond the current consultations with markets, we are looking at ways to enable possible partners to participate in the design and development of the project, in a way that appropriately links the degree of commitment with the level of involvement in decision-making.
For the Eurosystem as a whole this project is wider in scope than any that it has undertaken since the euro was introduced, as this project reaches out beyond payments systems into securities markets. But for National Central Banks it is not uncommon to settle securities. In fact there is a long tradition in this activity, which continues into today in some countries. Still today both the Federal Reserve and the Bank of Japan do it as well as 3 national central banks in the euro area.
The Eurosystem has sufficient expertise to set-up market infrastructures in a multi-country context. For example, TARGET1 was delivered for the start of monetary union in 1999, as was the Correspondent Central Banking Model (CCBM) which to date is still the most widely used procedure for settling securities for central bank credit operations on a cross-border basis. TARGET2 will also be delivered soon. The Eurosystem is conscious of the complexity of the project and intends to co-operate closely with those institutions willing to co-operate.
Finally, my concluding remarks. Let me state once again what in my view are the main benefits of the T2S project:
TARGET2-Securities is expected to provide a significant contribution to increasing the settlement efficiency and the integration of the infrastructure of EU capital markets.
TARGET2-Securities will provide a single platform for settlement of cash and securities legs of all the transactions today effected in the various CSDs. In fact, a single platform will be used for settlement of all domestic and cross-border transactions.
What will be the next steps of the project?
Since the decision by the Governing Council in July this year, there has been a period of informal consultation with the market, which has helped us understand many of the technical issues raised by the proposal. Helped by these consultations, a more detailed Feasibility Study is being prepared, which will be presented to the Governing Council in February 2007. In order to foster further discussion with the markets, I am inviting interested parties from CSDs and banks active in the European Union, together with representatives from banking, clearing and issuer organizations, to a meeting to be held on the 18th and 19th of December this year.
On the basis of the Feasibility Study, I am confident that we, at the Governing Council, will then decide how to take the T2S proposal forward in February 2007. I expect that this decision would include running a formal consultation with market participants on the design of the TARGET2-Securities project, and that this consultation could take place during the spring of 2007.
[Ladies and Gentlemen, I do not wish to delay any further the lunch which is waiting for us. “Food is our common ground, a universal experience.” – let us hope that T2S also becomes a common experience. Thank you.]