What were the key results from this year’s study on TARGET2-Securities?
Guido Wille: Last year, we worked with PricewaterhouseCoopers to estimate the overall benefits that TARGET2-Securities (T2S) can unlock for the market as a whole. The objective for the study that we commissioned with Oliver Wyman was twofold. Firstly, to break down the benefits for the market into benefits for market players. Oliver Wyman calculated various ranges of euro savings for a generic international broker-dealer, a global custodian, and a European bank. While each real bank has its individual profile, these ranges give an idea to each organisation of the benefits they can extract. Secondly, we wanted to provide more insight into the specific drivers that enable these savings. The study breaks the drivers into four clusters, each with three to four dimensions, and explains the dynamics that create these costs today or will create them in future.
What is important to stress is that many of the costs are either widely absorbed today or are costs that will only materialise in the near future and therefore are often poorly understood. Let me explain this with two examples.
In terms of widely absorbed costs, think of fails that arise because of realignments to move securities from the place of settlement and safekeeping to the place of financing. For domestically traded assets this is a daily process as, today, the large triparty agents do not operate settlement services within the European central securities deopositories (CSDs), as these tend to be the domain of the domestic agent banks. As a consequence, domestically traded assets such as equity and Southern European market fixed income are moved manually between the settlement agents and the sub-custodians of the financing agents, and naturally, fails occur in this process.
While most people understand this reality, few have viewed this as a cost to reduce as there has been no alternative solution to this issue. What the study says is that T2S will offer an alternative, as it will enable the triparty services offered in the international CSD market to be extended to domestically held assets through the investor CSD route facilitated by T2S. This will enable a significant reduction in the fails cost that, today, is unavoidable.
My second example concerns future costs. Many market players rely on uncommitted and unadvised intra-day credit lines for their settlement and very often there are no interest charges for intraday usage of these lines. At the same time, market commentators suggest strongly that regulatory pressures will change this.
First, organisations that offer intra-day credit are under pressure to manage their credit provision more tightly and they will face capital charges where credit facilities are provided on a formalised basis. Second, clients as the users of credit are under pressure to agree these more formal arrangements for their credit lines, because of business continuity considerations and regulatory pressure to assure stability in their liquidity arrangements.
There are now two possible ways to deal with this situation. The simple way is to say, “hey, great, intra-day credit is for free”, and carry on with the current credit model. The second, which the study assumes will become more commonplace, takes a more nuanced and forward-looking approach. It says, “the industry believes that it is likely that, in the future, there will charges for intra-day credit lines, so, if you take no action, you will face future costs, and you can calculate them fairly easily with some basic knowledge of your business and an educated assessment on potential future intra-day interest charges—T2S can help you avoid these future costs”.
Were they the results you expected?
Wille: In broad terms yes, as it has been long been our belief that direct access to CSDs and central banks and the consolidation of cash and securities pools that T2S enables can bring significant benefits to market players. But, of course, it is impressive to see them calculated for realistic business profiles item-by-item, because the level of transparency is much greater now.
What do these results mean to banking?
Wille: They mean that every organisation has a choice. The first option is to look at T2S as something that forces you to migrate to a new series of processes that your provider will adapt as the markets migrate to T2S, and to limit change to these mandatory migrations. Pursuing this option mean that your organisation remains fully functional with a given network and correspondent set up but will continue to face most costs that come with fragmentation, plus those additional costs that will arise because of the market changing in response to regulation.
The second option is to embrace the opportunity and redesign your European securities processing chain, leveraging the potential that T2S provides. Choosing this option will mean that your organisation will, with T2S fully live, conduct business in a significantly cheaper way than with the legacy structure. Oliver Wyman has estimated the difference it makes for each organisation based on three generic cases:
A broker-dealer with €100 billion trading assets and liabilities across major T2S markets could save up to €70 million;
A global custodian with €400 billion in assets under custody across major T2S markets could save up to €50 million; and
A regional bank with €140 billion in securities deposits across major T2S markets with a home market bias could save up to €30 million.
Given these large numbers, it appears that taking no option is a significantly worse option. We expect the large majority of banks will reassess their European post-trade structure, to avoid falling behind competitors who do just that and, in the process of doing so, significantly increase their competitiveness.
T2S has just moved into its user testing phase. Could any implications arise in this phase that could set back the ‘go live’ in 2015?
Karla Amend: The size and complexity of the project, the high number of stakeholders with different business and user profiles, and the interaction between all involved parties could lead to larger testing issues, even those that might set the go live in 2015 at risk.
Therefore, stability and efficiency of the T2S environment and T2S platform right at the beginning of user testing will already be a key factor for a smooth and successful user testing period. Later on, efficiency in handling problems as they occur also represents a key success factor. Procedures need to be in place that efficiently manage all the involved parties and allow quick decision making when required.
It remains a key imperative for all parties to avoid a delay scenario by all means, as the associated cost would hurt everyone. The staggered approach of migrating in several waves provides some flexibility needed in case of test issues. In addition, the migration approach provides slots for stabilisation of the platform between each migration wave.
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