T2S (TARGET2-Securities) is a new European securities settlement engine which aims to offer centralised delivery-versus-payment (DvP) settlement in central bank funds across all European securities markets. The project was initiated in 2006 and is currently under development. Based on the latest announcements it is scheduled to go-live in 2015. The fundamental objective of the T2S project is to integrate and harmonise the currently highly fragmented securities settlement infrastructure in Europe. It aims to reduce the costs of cross-border securities settlement within the euro area and participating non-euro countries, as well as to increase competition and choice amongst providers of post-trading services. It will therefore be a critical step forward in the creation of a single market in financial services in the European Union, fulfilling one of the goals of the Lisbon agenda. The IT platform will be built, owned and operated by the European Central Bank (ECB) and 17 national central banks in the euro area (which are collectively known as the “Eurosystem”). Technical details of the project are available at the ECB T2S project website.
Historically, financial market infrastructures in Europe were created to meet the requirements of national financial markets. In most cases, there were one or two dominant players at each stage of the value chain: typically only one stock exchange for trading, possibly one central counterparty (CCP) for clearing and at least one central securities depository (CSD) for settlement. Furthermore, each of these national infrastructures was primarily designed to manage securities that were denominated in the national currency.
Today, despite the introduction of the euro over ten years ago, the provision of post-trading services (i.e. clearing and settlement) remains heavily fragmented along national lines. For example, there were still 19 central CSDs operating in the euro area in 2009, and almost 40 in the 27 countries of the European Union (EU).
This situation is clearly not optimal for a single currency area or for the EU, as it encourages each country’s financial market to remain domestically-oriented. Investors continue to invest mostly in domestic securities, and as a result the euro area financial markets as a whole cannot fully benefit from the risk diversification and competition benefits that arise from having a single currency.
The US was in a very similar position to Europe several decades ago, with a fragmented trading and post-trading infrastructure. The inefficiencies of the US system eventually forced the US government to intervene resulting in a high degree of consolidation. The US now has a very streamlined trading and settlement environment, with the Depository Trust & Clearing Corporation (DTCC), responsible for the clearing and settlement of all equities and corporate bonds, and the Federal Reserve System responsible for government bonds.
The EU authorities have so far not resorted to such dramatic steps. The initiatives taken up to now have focused on removing the barriers to competition between national market infrastructures so as to let market forces work their magic. Market forces would determine the optimal market structure, whether this is a single monopoly provider, as in the US, or multiple providers. The two most important initiatives from the European Commission are the “Markets in Financial Instruments Directive” (MiFID) and “Code of Conduct for Clearing and Settlement”. T2S is intended to complement these existing initiatives by boosting competition, increasing price transparency and harmonising existing practices across Europe. Settlement has traditionally been the domain of national CSDs, so it was difficult for a CSD in another country to gain access to these securities. By creating a pan-European platform, T2S aims to break down the barriers between national markets in a way which could not have been achieved by the MiFID or the Code of Conduct on their own.
Organisation and decision-making
Since its beginning the T2S project has benefited from the strong involvement of CSDs, banks, financial market associations, public authorities and other interested parties. The main T2S stakeholders are CSDs, CCPs, investment banks, commercial banks active on the securities market and national central banks. The Eurosystem – the owner, developer and future operator of T2S – is at the core of the T2S organisation and decision-making process and ensures that all T2S developments are fully transparent and in line with the needs of the market. The ECB's Governing Council, the main decision-making body of the Eurosystem, is the ultimate decision-maker on T2S. The Governing Council assigned the daily management of the T2S project to the T2S Board, which has the mandate to implement T2S in time, within the budget and according to what market participants need. The project stakeholders contribute to the T2S project mainly via two bodies, the Advisory Group (AG) which ensures that T2S meets needs of the market and the CSD Steering Group (CSG) which is responsible for articulating and coordinating the views of participating CSDs within the T2S Governance. The CSG can give its advice and make resolutions on any issue related to T2S and in particular on issues related to the FA and its schedules, issues of major interest for T2S (pricing, risk, etc.) and the prioritisation of change requests. The AG is composed of around 80 senior experts from central banks, CSDs and the banking community. The CSG is composed of participating CSDs, i.e. the ones that have signed th T2S Framework Agreement, and users. The two main bodies are supported by their sub-structures, which assist in the preparation of both technical/functional specifications and the legal framework of the T2S platform.
Settlement is the final stage of the process of buying and selling securities, in which ownership of the securities is transferred from seller to buyer and funds are transferred from buyer to seller. A safe and efficient settlement infrastructure is crucial if financial markets are to work properly. Central bankers realised this after the stock market crash of 1987, which saw a huge backlog of transactions not being settled in time and caused huge uncertainty in financial markets about whether the banks would receive their securities or not. It eventually resulted in the revolutionary push towards all CSDs adopting so-called “delivery-versus-payment”. Delivery-versus-payment means that funds are transferred only if the corresponding agreed value of securities is also transferred. It is the safest form of settlement and eliminates the risk that a bank transfers funds to another bank to pay for a security, but does not receive the security because the other bank has gone bankrupt in the meantime.
Traditionally, each country’s CSD has been responsible for carrying out the settlement of trades in its domestic securities (e.g. German government bonds are settled in the German CSD, French government bonds in the French CSD etc.). This however creates problems if an investor wishes to buy securities that are normally settled in another country (i.e. a German investor which wishes to buy French government bonds). The investor would need to ask a local French bank to help settle the transaction with the French CSD. A report produced by Alberto Giovannini, who was chairing a group looking at the obstacles to cross-border clearing and settlement in Europe, showed that such a cross-border transaction would normally involve around 11 intermediaries (compared with only 5 for an equivalent domestic transaction) and the sending of a minimum of 14 electronic messages.
The T2S platform is intended to be a single place to settle almost all securities being traded in Europe, eliminating the former differences between a domestic and cross-border transactions. A French government bond could be settled in the German CSD as easily as a German government bond. T2S is designed to be an extremely secure settlement system. First, it will use the delivery-versus-payment method. Second, it will settle individual trades in “real-time”, rather than grouping them all together and netting the outcomes between the various participants. Third, it will settle only in central bank funds.
T2S will be fully integrated with TARGET2 the real time gross settlement (RTGS) system operated by the Eurosystem - and with other, non-euro RTGS systems, for the processing of the cash leg of the transaction. For the securities leg, the T2S platform will settle via the securities accounts of connected central securities depositories (CSDs).
T2S will also make use of state-of-the-art settlement techniques, cherry-picking the best practices of all national CSDs. Building a completely new IT system from scratch has the advantage of not being burdened by the requirements of legacy systems. The level of settlement efficiency in T2S will therefore be extremely high and the level of liquidity needed by banks to settle their transactions will be significantly reduced compared to at present. This will have benefits for financial stability and the efficiency of banks’ collateral and liquidity management.
The idea of a T2S settlement platform was initially proposed in July 2006. In July 2008, after two years of consultations with the market, and after building a strong level of support, the ECB’s Governing Council committed to build the platform. The development and operation of T2S, coordinated by the ECB was assigned to four central banks of the Eurosystem – those of France, Germany, Italy and Spain. The support to build the T2S was subsequently confirmed by a memorandum of understanding (MoU) signed in 2009 between the Eurosystem and 28 European central securities depositories (CSDs). The MoU provided the basis for the negotiations of a formal contractual agreement between the CSDs and the Eurosystem. According to the project timetable, the T2S platform should be operational in 2015.
One of the objectives of T2S is a reduction in the cost of settlement in Europe, in particular for cross-border transactions which are on average at least 10 times more expensive than domestic. The Eurosystem has already announced its aim of settling standard delivery-versus-payment transactions at a lower cost than any other current domestic settlement platform in Europe.
The T2S settlement platform is also a step towards a single market for financial services, thus supporting the Lisbon agenda, which is aimed at making the EU the most competitive economy in the world. The T2S project will be a catalyst for further harmonisation of post-trading practices and regulations across Europe. Significant progress in this direction has already been made by the T2S subgroups, composed of industry experts, on harmonisation of instructions management and settlement processes, as well as on the processing of corporate actions on unsettled transactions.
Overall, it is assumed that as a result of reduced settlement costs, increased competition and greater harmonisation, T2S will have a positive impact on European economic growth. The lower cost of settlement, and potentially for other post-trading services, will be passed on to investors. Reduced transaction costs will encourage investors to buy more securities in Europe. Furthermore, by making it easier and less costly to access cross-border securities, investors could benefit from more diversified bond and equity portfolios and issuers would have the access to a more diversified investor base. This dynamic process will generate more efficient securities markets, eventually leading to a lower cost of capital for companies, so that they can invest more, generate more jobs and boost economic growth.
The T2S platform may also have a positive impact on financial stability, which is particularly important given the financial market turmoil that has been experienced in the last years. In particular, it may reduce the risks that still affect the settlement of cross-border transactions and could help to optimise banks’ collateral and liquidity management. Additionally, by fostering greater efficiency and integration of European financial markets, T2S may lead to greater diversification and sharing of risks, adding to the stability of the whole system.