Target2-Securities (T2S) will fall short of expectations when/if it launches on schedule in 2015. Rather than rationalising the number of central securities depositories (CSD), it will leave them all intact, at least until market forces take their toll. But that will occur only after they have spent the money to modify their systems to meet regulatory requirements. Given the likelihood of future CSD consolidation, most countries have settled for modifications to existing systems rather than implement entirely new technology.
In a blog post, Ronny Cosijns , a partner in Capco’s Frankfurt office, compared T2S to the single European currency and the Channel Tunnel as another “euro fantasy” that is now reality.
It is “ambitious: a new, bespoke technology solution providing a best-of-breed settlement model” but “no consolidated technology solution was provided in the course of these mergers. This leaves largely the same fragmented pre-merger systems,” he commented.
The goal of T2S is to fully integrate securities settlement across the EU by allowing it to occur in any (CSD) in participating European countries. The T2S IT platform will be operated by the European Central Bank. Four central banks — Spain, Italy, France and the Bundesbank — are building the platform with project management out of Frankfurt, said Cosijns and the platform is now undergoing integration testing.
Industry insiders had expected that at least a few CSDs would combine to avoid the cost of implementing the T2S changes in each country. They still expect some consolidation, but probably not until 2018, after each CSD has already spent a lot of time and money to modify its technology to comply with the new regime.
With 30 CSDs, the market expected that there would be mergers and joint ventures, agreements to avoid doing developments twice, but that hasn’t happened, said Isabelle Olivier, head of clearing and settlement for EMEA at SWIFT.
Two CSDs, in Hungary and Euroclear Finland are replacing their technology with systems from TCS. The Bank of New York has launched its own CSD in Belgium to extend its custody business and keep processes in-house, while JPMorgan has allied with the London Stock Exchange to create a CSD in Luxembourg. Global custodians can probably save on costs by launching their own CSD, but more importantly they will have complete control of settlement, deal with fewer counterparties and be able to launch new services, said one industry expert.
R. Vivekanand, vice president and global head of product delivery at TCS, said the changes at CSDs have mostly been incremental in the way that they have updated their platforms; they have not adopted new technology for many years.
“T2S is a great opportunity to refresh technology and revamp their systems even if they will not go for a big bang.”
This was a technical opportunity, Cosijns said, although one that several observers said will largely be missed, at least for the next several years.
“It is all about technology. The normalisation that T2S will bring at the level of settlements will represent significant technology change, so systems needs to be adjusted. Having the right technology is key to be ready and go further and leverage change to improve services.”
Uncertainty about T2S and the sheer number of projects financial firms are confront have limited the appetite for significant technology upgrades.
Sell-side firms area approaching T2S with caution, said Tim Garnons-Williams, senior business analyst with SunGard’s Stream.
“It is not very clear what services will be available to them and what the cost benefits of making changes will be. The size of the organisation and in particular its international presence (i.e. how many markets does it participate in directly as a member) will influence its decision-making, particularly about whether to join T2S directly or use its existing agent to do the communications for it. Only the very big players will take the first option.”
T2S is more than just a technical implementation project, said Isabelle Olivier, head of clearing & settlement for EMEA at SWIFT. Its goal was to change the vertical silos and national monopolies of CSDs. It was meant to change the equation by opening up the business and force the major players to go through a deeper review of all their back offices, their services, and the models for the services they have.
That said, it does involve a lot of technology change.
SWIFT Messages and T2S
While SWIFT has about a dozen messages in post-trade settlement, in T2S there are about 130 different messages and only 12 are functionally equivalent to SWIFT’s 15022 messages, said Olivier.
“So for those we have implemented off-the-shelf mapping. For the other 118 messages, we have proved a library of those administrative messages and the business rules that pertain to them.”
With T2S, if you send a request for a status update of your settlement instructions, you get a message back in real-time in the message channel, unless the message is over a certain size; then it might come back as a file rather than a message.
“Then you need to reconcile the files with the messages you sent.”
“If you are a direct participant and want to send settlement instructions into T, and have been using 15022, we can provide something off the shelf that does all the mapping to T2s and execute the structural transformation that implements some of the business rules which are cross field validation rules, the things that makes those T2S messages and not vanilla ISO 20022
Firms which have been running on XML have to adapt to ISO 20022 ,which they have heard about but largely avoided, Olivier added. And T2S doesn’t just use plain old 20022, it has some special headers that add another layer of complexity. SWIFT has worked closely with market participants and has developed Connect for T2S which provides a plug and play layer to help customers connect. Ninety percent of customers who will use SWIFT to connect to T2S will use the Connect product, she added.
SunGard’s Garnon-Williams said that firms can avoid the 20022 issue if their custodians can received the older 15022 messages and convert them to the newer standard. This seems to be a service many custodians are offering, he added.
Olivier thinks that some firms underestimated the complexity of connecting, which explains why so many are using SWIFT’s Connect to T2S.
“I think many players thought generating XML was enough. Then they had to turn to us and say we’re not sure we can do the last mile in these specific requirements. They were surprised and running a bit late, so they turned to an off-the-shelf solution.”
“SWIFT itself has been helping some customers making sure they can generate the right message format,” Olivier added. “We have been consulting and working on the middleware layer as well. The typical middleware providers have been supporting other customers and the back office app providers have also been involved.”
T2S has two sides, said Capco’s Cosijns. One level is the CSDs which are similar to the role of real-time gross settlement systems (RTGS) when they rolled out with SEPA.
“With T2S, each market has its own CSD and they will be heavily impacted because they have to toss out the settlement instruction lifecycle manual positioning and booking. all which will be carved and outsourced to this new pan-European platform that the ECB is building.”
Fiona Hamilton, a vice president at Volante, the messaging vendor, said that each country with its own domestic CSD understands the nuances of their domestic market and most are protective of their own infrastructures. Latvia, Lithuania and Estonia each have their own CSDs.
“What would be the upshot of Latvia acquiring the others? There would probably be economies of scale but there are still nuances of how they understand their local markets. The smaller ones understand their local market idiosyncrasies and have made a good business supporting their national clients. The scope of the change project for them is limited to defensively making sure they can carve out those functions and connect their clients with T2S and offer services.”
Since T2S is a highway to other CSDs, its costs should be as low as intra CSD costs.
“Not many CSDs are able to manage that change to connect with others,” said Capco’s Cosijns. “They have underestimated the impact. Adding to that change are scope extensions of reference data to cover 24 other markets’ securities from a technical view — and that does not seem to be on the radar now.”
National CSDs — Slated to go the way of national flag carriers?
Hugh Cumberland, solution manager at Colt Technology, thinks inevitable turf wars will lead to winners and losers.
“CSDs could go the way of national airlines,” he said. “I remember time when there were flag carriers for every country in Europe. It was a matter of national pride rather than commercial sense — you had to have a flag carrier. That doesn’t apply any more — the rule of competitive free markets has taken over so now the biggest carrier in the UK is EasyJet. The ECB, quite rightly, has said that’s [national pride] is no longer a good enough reason to be in existence. You have to apply services on a common platform across Europe where other CSDs will compete with you. The ECB was intent on introducing competition into the CSD market.”
He thinks that some CSDs will have to leave the business because they won’t be financially sustainable.
“I think there will be an orderly retreat. They are all regulated bodies and have to satisfy their regulators that they are fit for purpose and appropriately capitalised going concerns. The inevitability is that one or two may have to exit.”
CSDs in smaller countries are most at risk.
Vivekanand, commented in a video on the company’s site that smaller countries will face problems as liquidity shifts to T2S.
“I expect there will be consolidation because not all of them will be able to survive over the next 5 to 8 years, especially in countries where a lot of liquidity moves to T2S, “ he said. Competition will result in quite a few falling away.” Some will survive only by providing settlement in the local market or offering other services. In something of a stretch to find a use for a CSD in a small country, he suggested that they could follow a model from India, where depositories handle data for the national identity program. However, while national IDs are new in India, European countries already have numerous identity programs with broad reach, from national IDs, voting registrations, passports and drivers licenses.
Rowena Romulo, managing director and global head of direct custody and clearing at JP Morgan, told a Mondo Visione conference that having 40 CSDs in Europe results in massive duplication. She suggested two or three would be plenty. [The European CDS Association says there are 41 CSDs in Europe, 21 will join T2S by 2017 and four operate as not-for-protift institutions.]
“When any CSD can settle any of the eligible securities around T2S, you might ask where that leaves the local custodians, who might feel the threat of disintermediation,” Cumberland noted.
Implementing T2S is supposed to occur in four waves, starting in 2015 and extending to 2018. The reluctance to make major investment has three major causes. The first is that financial services firms are swamped with new regulatory requirements and struggle to add any big new commitments.
Second, T2S has been delayed in the past and some aren’t certain that 2015 will be a hard deadline.
“To be honest, that’s a good questions,” said SWIFT’s Olivier of the 2015 launch date. “We have been hearing some concerns, but there is no official statement from anyone. I have heard of one country that is not ready and is trying to find ways to do the minimum to avoid penalties, although it is a minor country in term of volumes.”
Some firms are wary of the whole initiative, said Colt’s Cumberland, and are doing the absolute minimum.
“They realise that this potentially will not be a market for them and they might have to find some other role. Some bigger organisations are saying they would really like to invest in a smart new platform. For them it is not a question of the investment, but what else they have on their plate. Europe is currently riddled with new regulatory requirements and competitive challenges, so some of the bigger guys will patch systems, cobble things together and get something working. Then maybe once it is live and in 2018, when we have gotten through all the four waves, they will look at refresh and renew.”
The other side of T2S, said Capco’s Cosijns, is the role played by the banks. The big ones are connected to several of the larger markets; smaller players will use other banks or custodians to access clearing and settlement.
“While the CSDs said they will absorb a lot of the change and reduce impact on members, if you look at the detailed specs the CSDs are publishing, it becomes clear they will not be able to avoid impact on the banks’ back offices.”
Colt’s Cumberland has been surprised that no big vendors have become predominant in the market for systems and services for T2S.
“It’s been a very diverse market, and we haven’t seen one player come to the fore and dominate, and that’s unusual. I think probably the geographical diversity has helped that, along with the time scales. We are going live over a three-year period and over four different waves, while organisations are looking for [financial] results this year and next.”
IBM have been reasonably present but haven’t come out with any big wins, he added, while Capco have been doing their usual good job in consultancy.
“I have seen a really frugal attitude from participants, probably related to the time this project runs. It started in 2006, and if you had employed 25 consultant at the beginning with go live in 2018, you'd run out of money. In addition, there have been a lot of questions over whether it would happen at all, which probably dissuaded a lot of tech players, maybe sending them off to opportunities in regulation where certainty is a lot clearer.”
Cumberland added that he doesn’t think firms are taking a long-range view of their strategy, asking where they should be in five years, or breaking down their silos, or which silos they should break down.
He expects some surprises to come from players who haven’t gone public with their strategies.
“The real game will be around value added services, a lot of which T2S won’t touch — things like corporate actions or collateral management. Right now it is almost a phoney war, where players are waiting for people to show their hands and declare their real intention.”
Some of the problem may arise from internal politics, said Volante’s Hamilton.
“I think the silos are often down to the internal politics of the org rather than whether it is physically possible to implement tech which goes across those silos. We still see lots of those silos where front doesn’t talk to mid and back office, and that is just one asset class.” A decision to break through the silos has to be taken pretty high up in the organisation to be successful, she added.
By Tom Groenfeldt, freelance financial industry Journalist.