T2S roll-out: opportunities and challenges for users (part 1)
The roll-out phase of the TARGET2-Securities (T2S) project is moving fast towards completion, with the final wave of central securities depositories (CSDs) set to migrate to the platform on 18 September 2017. With the wave 4 migration having taken place in February 2017, T2S is now processing about 90% of the total transaction volume expected at the end of full migration and more than 500,000 securities transactions are being settled on the platform every day!
By providing market participants with a pan-European securities settlement service, T2S has made cross-border settlement easier and more efficient. T2S has not only integrated securities settlement in Europe, it has also created the momentum to press forwards with the harmonisation of post-trade activities, complementing the European Commission’s efforts to build a capital markets union.
With T2S nearing full operation, we invited users to share with us their views on how T2S has transformed the post-trade ecosystem. What has changed for the participating commercial banks in Europe following the roll-out of T2S? And what are the main challenges ahead?
In this first part of the interview with T2S users, we spoke with Stephen Lomas, Head of Market Policy Global Transaction Banking at Deutsche Bank, to get his view on the major opportunities presented by the roll-out of T2S and the main challenges ahead for the post-trade industry from the user perspective.
Let us start by asking you how T2S has changed your business model and what opportunities you see emerging as T2S evolves?
We have seized on T2S as a real business opportunity to change how we interact with clients and how we offer services. Some major clients are now considering handling settlement themselves within the more harmonised T2S environment, while others may choose to use their own direct access to a T2S central bank for cash processing. In this context, as a multi-market custody service provider, we have devised ways we can unbundle our services and still provide value to our clients where they continue to require local market services and expertise, in areas such as asset servicing, tax and the local regulatory environment.
T2S is not happening in a vacuum; the industry is also going through a period of significant regulatory change in Europe. We are using the opportunities presented by T2S, and combining these with the value-added services that we provide, to help our clients adjust to the changing regulatory and market-infrastructure landscapes.
Deutsche Bank has evolved its business model in a number of ways. Firstly, we have developed a single technical access point to T2S so that we can become more efficient in the new environment, and at the same time enable our clients to operate under one legal contract covering all T2S markets; this structure still allows for an operating environment in which there are people on the ground in each location. Secondly, we have componentised our services, allowing clients to choose only those services that are of value to them; they can still buy everything from Deutsche Bank, or pick certain modules – and we have unbundled pricing accordingly. Thirdly, we work actively with our clients to understand any regulatory or business-related “pain points” they have in the European environment and find the correct account structure and service model to fit their requirements.
As well as closer financial market integration, T2S is changing the securities market, bringing both opportunities and challenges. According to a recent whitepaper published by Deutsche Bank, some areas, including collateral and liquidity optimisation, still require more work in the post-T2S environment. Stephen, what is your view on this? What should be addressed so that banks can reap the maximum benefit from T2S?
T2S brings a lot of benefits in terms of collateral and liquidity optimisation. You can now use a single commercial bank or central bank cash account across the T2S region, allowing real time offsets in euro across markets; this reduces the volume of euro liquidity required for intra-day settlement. T2S enables common usage of the overnight cycle, operating on a net basis and reducing the liquidity required overnight; however, only if the volume of overnight settlements can be increased will this further reduce the amount of liquidity required on an intra-day basis. The usage of partial settlement again maximises the usage of liquidity by delivering available inventory more effectively. Auto-collateralisation is also a cost effective way for those with central bank access to create additional liquidity. Furthermore, the real-time settlement links across the T2S platform and the fact that triparty providers have a direct connection to the platform allow for a more efficient mechanism for delivering collateral from local markets to triparty programmes.
That said, it would be helpful if the ECB/4CB and the CSDs could develop additional platform-reporting tools to better manage these processes. Also, the T2S cash forecasts do not yet include all information on corporate actions or on exchange-trading activity. T2S is a great step forward, but cannot in itself answer all the collateral and liquidity needs of clients; collateral requirements are not limited to T2S markets, and need to be considered in a global context. Similarly, we need to view client credit exposures, collateral provision and liquidity usage from a commercial perspective across the whole customer relationship, not just in relation to T2S markets. Clients are looking to work with providers who can bring the most beneficial aspects of T2S to their operating models, but who can also help them look beyond T2S to address their overall requirements as efficiently as possible.
Looking further to the future, technological innovation is driving rapid change in the financial industry, and the post-trade landscape, in particular, is considered an area where new technologies could have a significant impact. Distributed ledger technology (DLT) is among the new solutions with great potential. A DLT task force made up of market experts on financial innovation and cyber security has been created by the Advisory Group on Market Infrastructures for Securities and Collateral (AMI-SeCo) to explore the impact of DLT on the post-trade industry. Stephen, as Chairman of the DLT task force, could you give us an update on its progress? Could DLT offer solutions to some of the persistent challenges the financial sector has faced for years?
The AMI-SeCo and the Harmonisation Steering Group (HSG) have given the DLT task force the mandate to consider various aspects of potential technological change, and how this change could impact or influence T2S as well as the wider post-trade integration agenda over time. We have been working on a report to be presented mid-year. We have received valuable contributions from all task force members, and I trust that the report will prove informative and provocative – although it is unlikely to answer all open questions and will probably lead to further work.
Distributed ledger technology may in future help resolve some of the industry’s long-term issues, but before DLT solutions are more widely adopted within the post-trade world, or within the EU’s wider capital markets infrastructure, a number of conditions need to be met: establishing the legal nature of digital currencies and the information stored in digital ledgers; developing standards for interoperability; and creating a cohesive regulatory position on DLT applications, among other things. This will involve a great deal of work and time, but the potential benefits seem to be large and visible enough to be worth the effort.
The future of the post-trade industry looks challenging indeed, but also exciting! We would like to thank Stephen for this insightful conversation. Read the second part of the interview where we speak to Marcello Topa, Director EMEA Market & Policy Strategy at Citi!