James Rundle: The Gray Debate Around T2S

Question marks around Target2–Securities (T2S), the planned pan-European settlement platform, operated by the European Central Bank (ECB), have hovered over it since the project’s conception in 2006. Some thought it was a pipe dream, initially, but over six years later it’s still very real, and it is certainly happening. Created to provide harmonized delivery-versus-payment settlement in central bank funds, for most European securities, the first wave of migration to the system is scheduled to begin in 2015, with three subsequent waves thereafter.

What’s remarkable is that some people still don’t think it will happen at all. These may be the die-hards, but the ECB has confirmed that the software has been completed, and is currently undergoing testing. The ECB has selected industry banking cooperative Swift, along with payment processor SIA, and telecommunications provider Colt, to provide value-added networks. Large custodian banks have begun to assess their connectivity, and other large sell-side firms have begun their own strategic moves toward adapting to the new environment. BNY Mellon, for instance, recently launched its own central securities depository (CSD). These are not the hallmarks of a project with an uncertain future.

Changing Models
Asking whether it will happen, therefore, is the wrong question. Jean-Michel Godeffroy, director general at the ECB and chair of its T2S board, said as much during a recent candid moment at Sibos 2013 in Dubai this year. Frankly, he’s right, and it’s alarming that some businesses have yet to consider the potential impact that T2S will have on their technology and their business models.

Without sugarcoating it, under the new regime, it seems likely that smaller CSDs are going to go under. Their settlement functions are being outsourced to T2S, and they don’t have either the scale or the resources to expand into other areas that the larger international CSDs or custodian banks do so well, such as managing collateral or asset servicing. As if this weren’t enough, T2S is now being positioned as a political pawn in the wider game of European integration. In five years, according to Godeffroy, national CSDs will not exist. They will be European in outlook and operation, or they will not survive.

Unique Challenge
This presents a unique challenge to the CSDs in question, which are in the position of finding their central, perfectly legal business model being stripped away by a central bank. Do they consolidate with one another, regionally, to try and form an entity that can fight in a heavier weight class? Do they look to merge with larger CSDs, or be bought out, for their regional expertise? Or do they throw in the towel? Whatever the choice, it will require a lot of technical work.

When debates become duller, it means that the topic itself is reaching convergence and that the industry’s various constituents are reaching consensus.

Choosing to stay the course, however, may not be impossible. The ECB is putting certain cost stabilizers in place that might allow smaller CSDs to survive, for a time. But then, there is the cost of connecting to T2S, upgrading middle and back-office infrastructure to handle standardized messaging, and other post-trade necessities that will be electronic in nature. Contending with newer breeds of CSDs, set up by those with deep pockets, is going to be problematic.

Dull Is the Aspiration
During the T2S debate at Sibos, some panelists and the moderator, Aité Group’s Virginie O’Shea, remarked that it seemed everyone was basically in agreement. When debates become duller, one suggested, it means that the topic itself is reaching convergence and that the industry’s various constituents are reaching consensus. Those who are still dithering on T2S would be wise not to take this lightly.