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.
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”. Maybe provide a link to Mifid and Code of Conduct in Wiki (as you did to settlement and euro area above) 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.
Within the T2S platform the transactions will be settled in central bank money and linked to TARGET2 (real time gross settlement system operated by the Eurosystem) or other, non-euro RTGS. For the securities leg, T2S will settle via the securities accounts of connected central securities depositories (CSDs). Both legs of the transaction will be performed in Delivery versus payment (DvP) mode, i.e. the security will only be delivered to the buyer if, and only if, the cash is delivered to the seller. Thus the risk that one party to the transaction will not deliver is, in theory, excluded. In principle, T2S should become a single IT platform for settling almost all traded securities in Europe, eliminating any differences between the settlement of domestic and cross-border transactions. It is also assumed that, T2S will lead to the horizontal integration, across Europe, of the most fundamental part of the securities infrastructure value chain: settlement.
The T2S project was officially launched by the Governing Council of the European Central Bank (ECB) on 17th July 2008. The development and operation of T2S, coordinated by the ECB was assigned to the four members of the Eurosystem – the central banks of France, Germany, Italy and Spain. The will to build the unique European settlement platform was confirmed by a Memorandum of Understanding signed in 2009 between the Eurosystem and 28 European central securities depositories (CSDs), which provided the basis for the formal contractual agreement between project participants. According to the project timetable, the T2S platform should be operational in 2013.
Core Functionalities
The most important functionalities of T2S will include:
Real-time gross settlement in central bank money: T2S will provide real-time Delivery versus payment (DVP) securities settlement in central bank money. According to this concept, the transfer instructions for both securities and cash are settled on a trade-by-trade basis, with final transfer of the securities from the seller to the buyer (delivery) occurring at the same time as final transfer of the cash from the buyer to the seller (payment). Additionally, in order to further decrease settlement risk, the cash leg of the trade is settled in the books of the central bank.
Optimisation of settlement: T2S will use sophisticated optimisation algorithms to achieve exceptionally high levels of settlement efficiency. The settlement could be optimised among others through detection of simultaneous transactions’ chains, using technical netting or allowing partial settlement.
Auto-collateralisation: T2S will provide efficient auto-collateralisation functionality, extending a service which was previously only available in a few European countries to all users of T2S. Auto-collateralisation enables a transaction to be settled by automatically triggering the provision of intraday credit from the central bank, which gets as collateral either the securities that are being purchased (collateral-on-flow) or by other eligible securities available in the market participant’s securities account (collateral-on-stock), with prioritisation given to the use of the former.
Optimisation of liquidity: Optimisation of liquidity within T2S will be possible due to services based on a link between a market participant’s T2S dedicated cash accounts and its main RTGS cash accounts (outside T2S at the central bank).
Technical direct connectivity: Market participants will get the possibility, conditioned upon the consent of their CSD (the contractual relationship remains between the market participant and its CSD) to “connect directly” to T2S, routing their settlement instructions directly to the T2S platform rather than via a CSD.
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.
Reasons for T2S
In its principles, T2S should allow to overcome still existing fragmentation on the post-trading market in Europe. The most important, and most direct, benefit of T2S will be a significant reduction in cross-border settlement fees. T2S aims to achieve this result by processing cross -border and domestic transactions in the same way, and therefore at the same cost. Consequently, T2S settlement should replace today’s very complex methods involving processing in several central securities depositories (CSDs) and intermediaries.
As a European project, T2S is also a step towards a single market for financial services, creating a “domestic” market for the settlement of European securities, directly and indirectly removing many of the “Giovannini barriers” to cross-border clearing and settlement.