T2S

T2S (TARGET2-Securities) will be the future IT platform for the settlement of almost all bonds and equities that are traded in Europe. The project was initiated in 2006 and is currently under development. It is scheduled to go-live in 2013. The fundamental objective of the T2S project is to integrate and harmonise the currently highly fragmented securities settlement infrastructrue in Europe. It will reduce the costs of cross-border securities settlement within the euro area and participating non-euro countries, as well as increase competition and choice amongst providers of post-trading servicers. 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 other 16 national central banks in the euro area (which are collectively known as the “Eurosystem”). Specialists who are interested in the technical details of the project should refer to the ECB T2S project website.

Logo of the T2S Project

Background

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-orientated. 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. There are important history lessons to be learnt from what happened in the United States. The US was in a very similar position to Europe several decades ago, with a fragmented trading and post-trading infrastructure. The efficiencies 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 will significantly 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 will significantly 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 the very beginning, the T2S project has benefited from the strong involvement of CSDs, banks, financial market associations, public authorities and many 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 Programme 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 Contact Group (CCG) which prepares the legal framework of the project. The AG is composed of around 80 senior experts from central banks, CSDs and the banking community. The CCG is composed of the central banks and CSDs. 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.

T2S Governance

The governance structure of the T2S project is characterised by the strong involvement of the market and all interested parties. The main T2S stakeholders are central securities depositories (CSDs), users (e.g. 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 governance and ensures that all T2S developments are fully transparent and in line with the needs of the market.

The ECB Governing Council, the main decision-making body of the Eurosystem, is also the ultimate decision-maker on T2S. The Governing Council assigned the daily management of the T2S project to the T2S Programme Board, which has to implement T2S in time, within the budget and according to market needs. The project stakeholders contribute to the T2S project mainly via two bodies, the Advisory Group (AG) – which ensures that T2S meets the needs of the market - and the CSD Contact Group (CCG)– which prepares the contractual framework of the project. 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.

Technical details

Settlement is the final stage of the process of buying and selling securities. Although most people are generally aware of what traders do when they buy and selling bonds and equities, what happens after that is often overlooked or assumed to be a formality. But this is far from being the case. 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 cash is 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 cash 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 (i.e. German government bonds are settled in the German CSD, French government bodns 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 famous 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 an 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 will dramatically change all that. It will 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 will 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 money. Central bank money is the safest cash asset as central banks cannot go bankrupt.

Another advantage is that T2S will be fully integrated with TARGET2 the real time gross settlement (RTGS) system operated by the Eurosystem - and with other, non-euro RTGS, for the processing of cash payments. 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 substantial benefits for financial stability and the efficiency of banks’ collateral and liquidity management.

See also

• TARGET2
• European Central Bank

External links

• T2S page on the ECB website

References

• T2S brochure