T2S roll-out: opportunities and challenges for users (part 3)
In September 2017 TARGET2-Securities (T2S) became fully operational with the final migration wave, in which Iberclear Spain and the central securities depository (CSD) from Estonia, Latvia and Lithuania joined the platform. This marked a milestone in a ten-year journey, but also the beginning of a new era for T2S. New markets will join the single platform after the final migration wave – such as Národný centrálny depozitár cenných papierov, a. s., which joined in October this year – and new currencies like the Danish krone will also bring new possibilities.
But how has T2S changed the securities market in Europe? Has it brought the integration and opportunities which we set out to reach a decade ago? To find out, we held a series of interviews with market participants. We invited them to share their views on T2S and, in particular, the opportunities and challenges it has created.
This interview with Alex Dockx, Executive Director at JP Morgan is a continuation of the interview series started in June this year, when we spoke with Stephen Lomas, Head of Market Policy Global Transaction Banking at Deutsche Bank, and Marcello Topa, Director EMEA Market & Policy Strategy at Citi, about the opportunities and challenges ahead for the post-trade industry from the user perspective as well as the transformation of the post-trade industry in Europe following the arrival of T2S.
Continuing in this direction, we asked Mr. Dockx what he considers to be the biggest opportunities and challenges for users of T2S?
T2S offers a great opportunity for international banks to obtain direct access to a pan-European settlement platform in central bank money, following a single set of harmonised rules. This allows for a reduction in the cost of settlement and liquidity management, and minimises intermediary risk. Within J.P. Morgan, we are in the midst of executing a strategy to establish direct accounts in the main T2S markets, insource settlement activity, and centralise liquidity and collateral management in central bank money. This programme is conducted across different business lines within our Corporate and Investment Bank.
This being said, there is still a lot of work to do on further harmonisation of standards and rules, especially in corporate actions, tax and collateral management, before the full benefits of T2S can be realised. Another challenge is the ability to switch efficiently between the T2S platform and other platforms, such as the ones of the two international CSDs, which operate in commercial bank money.
A variety of initiatives are ongoing within the T2S community to analyse and address these challenges. The recent report published by the European Post Trade Forum, to which a large number of industry experts (including J.P. Morgan) contributed, also highlighted a number of these barriers, with a clear set of priorities and recommendations. The European Commission is currently conducting a consultation on them within the framework of the capital markets union (CMU) initiative. It is crucial for the further success of European post-trade and for T2S that these barriers are tackled.
So, even though T2S is now fully operational, there are still challenges ahead. Mr. Dockx, what is your view on cross-CSD settlement? We often hear that T2S has not been able to trigger an increase in the level of cross-CSD settlement in Europe. Do you see this as a challenge to its success?
There is a tendency to assume that low levels of cross-CSD settlement reflect a lack of cross-border investment into Europe, but the two are actually quite different.
The current low levels of settlement activity between different CSDs in T2S are mainly caused by the fact that most firms are settling their activity through local accounts in each issuer CSD (i.e. the home market), and this for reasons of efficiency, history and cost. This is compounded by the fact that most on-exchange trading and clearing activity is also conducted locally. All of this generates a large volume of intra-CSD settlement activity on T2S between firms, but not necessarily cross-CSD settlement.
Custodians and investment banks have used this home market set-up to offer efficient cross-border investment and settlement access into T2S to their international client base, and bridge the barriers created by a lack of harmonisation between different markets.
Cross-CSD activity is mainly driven by the desire to use a consolidated account in a chosen T2S CSD (the “investor CSD” access model), which then serves as a hub for cross-CSD settlement with other T2S CSDs. The success of this access model depends to a large extent on the ability of investor CSDs to provide a level of service, cost and connectivity equivalent to the issuer CSD connectivity. It also requires market participants, including CCPs and exchanges, to offer this option to their clients, and market practice and market authorities to work towards removing some of the barriers mentioned above. Lastly, the operational and technical set-up remains quite complex, especially on the asset servicing side, given the absence of further cross-border harmonisation in this area. For these reasons, J.P. Morgan has chosen to implement a model where we connect directly to the issuer CSD for our custody business. Other lines of business, however, are looking at solutions to establish collateral pools, for which an investor CSD access model is an attractive proposal.
In short, low levels of cross-CSD settlement are not a sign of low levels of cross-border investment in T2S, and therefore are not a yardstick against which to measure the success of T2S in attracting investment into EU markets. T2S has the technical functionality to perform cross-CSD settlement and it is now up to market forces to remove the remaining obstacles and to make best use of it. We should hopefully see an uptick in cross-CSD volumes as a result over the coming years.
It has often been said that T2S give investors easier access to Europe. As a bank with a large presence outside Europe, do you expect that we will see an increase in investment into Europe by non-European investors due to the existence of T2S?
Needless to say, the availability of a pan-European settlement platform such as T2S helps in lowering the barriers to, and costs of, conducting post-trade activity in Europe. However, there are many other important factors that drive appetite for investment into Europe: a stable political and regulatory climate, attractive companies, a deep and liquid capital market, growing economies, benign interest rates and an openness to innovation, etc.
Post-trade has an important role to play in providing that investor-friendly climate, and this has been recognised as well by policy-makers. As mentioned, the European Commission is focused on removing the remaining barriers to a single market for capital, particularly for cross-border investment, as part of its CMU programme. Together with key post-trade regulations, such as the European Market Infrastructure Regulation (EMIR) and the CSD Regulation (CSDR), T2S provides a key foundation for a single capital market.
Europe has been successfully leading international harmonisation efforts, such as with the shortening of settlement cycles to T+2 in the run-up to the launch of T2S, and these have since been emulated by the US and Asian markets.
If the good progress in harmonisation and innovation in the EU post-trade markets can be maintained, the appeal of Europe as a trading and investment location for international investors can only grow as a result. As a firm that provides investors with access into Europe, J.P. Morgan is fully supportive of all these initiatives, and we will continue to be actively involved in driving these efforts forwards.