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TARGET2-Securities

TARGET2-Securities: reviewing project design and release schedule


Financial Services Research Q3 2011

The ECB highlights two key activities during 2011 that will shape the future evolution of the T2S project. One is the finalisation of contractual agreements with CSDs and central banks. The second is the completion of the User Detailed Functional Specifications (UDFS). Bob Currie analyses the implications of these important stages in the T2S programme
We are now past the halfway point in the Eurosystems design to release a centralised platform for settlement of euro-denominated, and some non-euro, securities. Originally proposed in May 2006, the first wave of CSDs (Monte Titoli in Italy, Depozitaral Central in Romania, and the Bank of Greece Securities Settlement System,

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the Greek CSD for government securities) will join T2S in its first migration wave, scheduled to begin in September 2014. Other CSDs that commit to the project will migrate in two subsequent migration waves, with a contingency wave in place that will be activated only if one or more CSDs cannot migrate on schedule (for background on the projects origins and evolution, see FSR, Q2 [July] 2007, pp 34-51; FSR, Q3 [Oct] 2008, pp 32-47; FSR, Q2 [July] 2010, pp 40-57). Jean-Michel Godeffroy, Chairman of the T2S Programme Board, reports that negotiations around the Framework Agreement the contract that defines the rights and obligations of the Eurosystem, as developer, owner and operator of the T2S platform, and the CSDs, as its primary counterparties and clients are progressing well and are now close to finalisation. Detailed discussions around key aspects of the contract have been ongoing throughout 2011, with the T2S Advisory Group and the European Securities and Market Authority (ESMA) offering feedback on its content. The ECB Governing Council expects to present the finalised Framework Agreement to the decision-making bodies of the CSDs in October 2011 with an invitation to sign before the year end. Discussions around the Currency Participation Agreement which governs the relationship between the Eurosystem and non-euro area central banks that will make their national currencies available for securities settlement in T2S are going on in parallel. The Currency Participation Agreement will be presented to non-euro area central banks in October, enabling those wishing to commit their currencies to support CeBM settlement on T2S to sign by the end of 2011. The ECB highlights that intensive and constructive negotiations around this issue have been ongoing with Danmarks Nationalbank, Sveriges Riksbank, Norges Bank, the Swiss National Bank, the Bank of England and the Central Bank of Iceland. The User Defined Functional Specifications (UDFS) offer a detailed description of the services that T2S will offer to users,

Philippe Ruault,
Head of Product Management, Clearing, Settlement and Custody, BNP Paribas Securities Services

providing the framework for implementation of the user requirements which were officially frozen in February 2010 (see FSR, July 2010, op. cit.). The T2S Advisory Group (AG) has subsequently highlighted some changes that it views to be necessary for the smooth operation of T2S. It has been accepted both by the AG and the T2S operator (Banco de Espaa, Banque de France, Banca dItalia and Deutsche Bundesbank, collectively known as 4CB, responsible for the functional and technical design and implementation of the T2S project) that adoption of these changes will present a significant strain on the current project timetable. However, the AG has made it clear that the implementation of these requests is essential to the efficient functioning of T2S, even if these place pressure on the proposed delivery schedule. A further step in the T2S project development is to establish the connectivity channels through which market participants will link to the T2S platform. The T2S Programme Board announced earlier in 2011 that T2S stakeholders will be able to link to T2S either via a value-added network or via a dedicated link. The selection process for the appointment of up to two value-added network providers was initiated in July, with Banca dItalia managing the RFP process. Discussions surrounding the selection process for a dedicated line provider are ongoing and are likely to be finalised during the autumn of 2011. With regard to message communication, the Eurosystem has backed ISO 20022 standard messaging from an early stage in the T2S project design. ISO 20022 standard messaging is the perfect solution for T2S, notes the ECB, as the standard applies to all business areas falling within the scope of T2S, as well as end-to-end transactions, thus enhancing straightthrough processing and market efficiency. It predicts that by the start of T2S operations in 2014, much of the financial community will have adopted ISO 20022 standard messaging, with the T2S community at the forefront in driving use of the ISO 20022 standard for securities transactions.

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Framework Agreement: an invitation to sign


T2S Programme Manager Marc Bayle indicates that during the past two years, CSDs and the Eurosystem have dedicated considerable effort to negotiating the T2S Framework Agreement and its schedules. We feel we are on a very good track even though there are a few issues remaining such as the detailed conditions for Eurosystem liability, the specific rights of CSDs and the Eurosystem in the T2S governance, and some technical details on Service Levels and on User Testing, he says. Nevertheless we are confident that these issues can be solved before the legal documentation is submitted to the ECB Governing Council in October and subsequently offered to the CSDs for their signature (see further in this issue, pp 18-24). The T2S Project Office provided a detailed update on the consultation process and steps to finalise the Framework Agreement in the most recent Advisory Group meeting. Paul Bodart, Executive Vice President and Head of EMEA Operations at BNY Mellon Asset Servicing, indicates that many of the planning issues that were awaiting clarification during the first half of 2011 have now been resolved to the satisfaction of key participants. Discussions continue around the levels of liability that will be borne by the Eurosystem, as owner and operator of the T2S platform, and CSDs as the outsourcing party. As infrastructure entities with relatively limited capital, CSDs have sought reassurance regarding the maximum levels of liability to which they may be exposed resulting from technical or operational failure at the T2S platform. ESMA has been involved in the consultation process and many AG members are confident that this issue will be addressed in the available timeframe. The CSDs are in the final stages of negotiation with the Eurosystem and considerable progress has been made in recent months, reports Jan Lemeire, Director heading up the Target2-Securities team as part of Euroclears Product Management division. However, there are still important issues to be resolved relating to, among other factors, project governance, liability, service

levels, and the testing and migration. A series of meetings has been arranged for coming weeks to give further consideration to these issues. Under the current schedule, it is planned that these deliberations will be concluded by mid-September. The ECB Governing Council will review the Framework Agreement during October and is expected to approve a final version. This will then be presented to CSDs with an invitation to sign in December 2011. Do CSDs have the information that they require to sign the Framework Agreement? In many respects we do, responds Mark Gem, Head of Business Management and Executive Board Member at Clearstream. The pressing issue for CSDs is whether we feel comfortable with the contractual terms set out in the Framework Agreement. The contractual relationship between a CSD and the Eurosystem will differ significantly from a standard outsourcing arrangement under private company law with ultimate control over the project governance remaining with the ECB Governing Council. Technical aspects of the settlement process will be outsourced to T2S, but CSDs will bear full responsibility towards their clients for ensuring that settlement obligations are discharged effectively. CSD participants will contract directly with their CSD and will have no direct contractual relationship with the Eurosystem. The Framework Agreement consists of two parts: the actual framework agreement; and the related schedules. KAS BANK Senior Business Consultant, Business Architecture & Design, Aletta Oostenbrug, indicates that necessary conditions are now in place for CSDs to sign the Framework Agreement, though discussions on liability and governance are still ongoing. One issue that remains problematic for CSDs is that decisions around product enhancement will be made by the ECB Governing Council. This is unlike the governance structure in any ordinary outsourcing arrangement where the outsourcing party plays a major role in product enhancements and why outsourcing under T2S has been labelled outforcing by some observers. Another factor that is still under discussion is the preparation of multi-CSD key

Goran Fors,
Global Head of Custody Services, GTS Banks, SEB Merchant Banking

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performance indicators (KPIs). Oostenbrug notes that most CSDs would prefer to have single CSD service level agreements (SLAs) in place. Liability issues are still to be finalised, especially the liability cap that the Eurosystem sets in place which will be somewhere between 50-100m for all CSDs on aggregate per calendar year. Though we havent discussed this with the CSDs yet, as they are preoccupied with discussions with the Eurosystem, we assume that in the case of a liability cap the CSDs will change their terms and conditions towards their users and try to put the same caps in place towards us, says Oostenbrug.

fully in discussion around crisis management particularly relating to contingency provision in case of disconnection of service and regarding connectivity considerations for directly connected participants.. Philippe Ruault, Head of Product Management, Clearing, Settlement and Custody at BNP Paribas Securities Services, is confident that many of the outstanding issues can be resolved in the timeframe available and that CSDs will be a position to sign the Framework Agreement in line with the November schedule. One point of concern is that the planning and consulta-

One issue that remains problematic for CSDs is that decisions around product enhancement will be made by the ECB Governing Council. This is unlike the governance structure in any ordinary outsourcing arrangement where the outsourcing party plays a major role in product enhancements and why outsourcing under T2S has been labelled outforcing by some observers.

In KAS BANKs view, users should be involved more fully in refining the Framework Agreement, given that they will experience the repercussions either through their amended contracts with the CSD or in their daily operations once T2S is up and running. One area where we believe we should be more involved is in reviewing the Change and Release Management schedule, says Oostenburg. Users have been involved in setting up the user requirements for T2S but so far have been largely excluded when it comes to debating the changes. This also raises questions around competition, given that CSDs will enter into competition with custodians when T2S is released (see further, FSR, Q3 2008, p 43ff). Whereas CSDs have been given opportunity to influence changes in the T2S functionality and release schedule, custodians have so far been granted limited input into this process. Alongside this, KAS BANK believes that end users should be involved more

tion process for T2S has taken longer than was originally anticipated. As a result, the time available to CSDs and users to complete systems adaptation and testing has been compressed. There will be little room for slippage prior to the first phase of the project implementation in Sept 2014. BNP Paribas Securities Services will also connect directly to the T2S platform via direct technical connectivity arrangements. However, Ruault believes that there is still some need for clarification regarding the contractual details that will sit around direct connectivity arrangements. Technically we will interface with the T2S platform as a direct connectivity participant, he says. However, we will continue to contract with the CSD. As a user, we would welcome opportunity to set service level agreements in place with the T2S operator and to secure greater clarity regarding the level of liability that will be borne by the Eurosystem.

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User Defined Functional Specifications


The User Defined Functional Specifications (UDFS) offer a detailed description of the services that T2S will offer to users, providing the framework for implementation of the User Requirements Document. The UFDS can be seen as a bridge between the internal architecture of the T2S platform and the users view of the system, explains Banque de Frances Thierry Belet, a member of the 4CB team responsible for the design, build and operation of the project. The UFDS provides the comprehensive information around which T2S actors will be able to bring their business applications in line with what is required

The UDFS document provides a toolbox of options, outlining the functions that will be offered by the T2S platform, observes BNP Paribas Philippe Ruault. However, users await further detail regarding how these functional specifications will be applied in different markets and how CSDs will adapt their systems. BNP Paribas has prepared a budget plan to guide the next steps in our technical preparations, but we need to be clear how this UDFS toolbox will be utilised in each market before we can implement this next set of changes, he says. As a major global provider of asset servicing, BNY Mellon has committed significant resources to reviewing the draft

The UDFS document provides a toolbox of options, outlining the functions that will be offered by the T2S platform. However, users await further detail regarding how these functional specifications will be applied in different markets and how CSDs will adapt their systems.

by the T2S application-to-application interface. From a functional design perspective, the UDFS provides an opportunity for those behind the T2S project to ensure that the design will allow users to fulfil all their business needs. Banca dItalias Massimiliano Renzetti elaborates, explaining that, in a nutshell, the UDFS describes all the services that T2S provides to the diverse categories of T2S actors and a detailed description of how each T2S service is to be used. In doing so, the UDFS adopts a neutral approach and does not focus on a specific market or a given business or technical framework. Market participants have been encouraged to read and comment on the UDFS from their own individual standpoint, sharing their views on how well they will be served by each specific set of T2S services that they intend to use.

Framework Agreement, UDFS and other key project documents. For smaller CSDs and financial institutions, however, it has been difficult to provide feedback on this huge body of documentation. Paul Bodart notes that within the CSD community, Clearstream and Euroclear are leading the consultation process. Monte Titoli and Iberclear are also actively involved, while smaller CSD with less available resources have been more selective. So too this has been the case within the bank and brokerdealer communities, where the largest groups have been most active in shaping the consultation process. BNY Mellon Asset Servicing has reviewed the draft UDFS document in detail and forwarded its comments to the T2S Programme Office at the ECB. We were comfortable with many of functional specifications outlined in this draft UDFS document and we identified

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few concerns that we believe need to be addressed, comments Bodart. The time window made available to users to share their feedback has presented some concerns, however. Euroclears Jan Lemeire explains that preliminary draft UDFS was published in March 2011 and market participants have had only a couple of months to review the document and provide feedback. Publication of this pilot version has been a first step in enabling CSDs to refine their project planning budget estimates. However, the cost-benefit analysis may be impaired by the delivery of stable requirements in October 2011 only and this has forced Euroclear to base its calculations mainly on the preliminary specifications mapped out in the less detailed T2S User Requirements Document. It is with the release of the UDFS at the end of October 2011 that we will have the required stable information to steady the adaptation and migration costs and to ensure that the service scope delivered by the T2S operator aligns with what we expect as a future outsourcing party, he comments. With this UDFS delivery date in mind, the CSDs are expected to finalise their feasibility assessment based on the UDFS by Q3 2012, which is 6-9 months after contract signing is expected to take place. As a consequence, the estimated cost for CSDs to adapt to T2S may still shift substantially after a firm contractually binding commitment is made. Goran Fors, Global Head of Custody Services, GTS Banks at SEB Merchant Banking, underlines the point that the UDFS is a huge document. As a securities services provider, we have limited resources that we can commit to analysing these functional specifications in detail, he says. Thus, as a market we have attempted to digest the main details outlined in this document and to provide our feedback through national user groups. As direct holdings markets, a specific concern for the Nordic countries is how the segregated investor account structure employed at the CSD will be accommodated by the T2S framework and how this will impact the daily business of issuers, investors and account operators. The cost

Paul Bodart,
Executive Vice President and Head of EMEA Operations, BNY Mellon Asset Servicing

implications will be important: for instance, how high will be the costs of data realignment between the T2S platform and each CSD? And what implications will this have for the total cost of settlement applicable to the CSD participant? Goran Fors notes that there appears to be wide consensus across the Nordic region that for purely domestic transactions installation of a T2S platform will result in an increase in the cost of settlement. For cross-border trades there may ultimately be some cost reduction. The pressing question for our markets is whether an increase in short term costs (including systems adaptation, testing and migration costs, higher cost for domestic settlement) is justified in the name of a more efficient cross-border settlement infrastructure that will allow us to become integrated more fully in the European settlement and asset servicing landscape, says Fors. FSR asked Goran Fors how end users have reacted to these cost dynamics. It has been difficult to get institutional investors, asset management companies or retail investors fully involved in the planning debates surrounding the T2S platform, he says. This is perceived to be too far from their daily business for most to develop a clear position regarding these questions. It appears unlikely that short-term increases in settlement cost for domestic transactions will be passed on to the end investor and thus much of this additional cost will need to be absorbed either by the CSD or CSD participants. We have canvassed feedback from the bank and broker-dealer communities in the four Nordic states and views appear to be divided with those providers that support high levels of cross-border activity inevitably the most enthusiastic about benefits that T2S may deliver. T2S Programme Manager Marc Bayle informs us that, owing to the size and the importance of the UDFS, the T2S Programme Board was aware from the beginning that the users will need a substantial amount of time and effort to become acquainted with its content. Accordingly, the T2S Programme Board took the decision to involve the market at an early stage in the UDFS process. With this in mind, three in-

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terim and incremental versions of the UDFS were made available to users one year in advance of the official market consultation. However, despite this early involvement of the market, the T2S Programme Board considers that the number of institutions that have responded to the market consultation is low at about 22 and that those who have responded were focusing on the generic parts of the UDFS rather than the detailed technical aspects that are the key substance of the document. This potentially suggests that further detailed analysis of the UDFS is still pending from the market.

CSD adaptation
The ECB notes that the most vibrant discussions that took place in the T2S Advisory Group meeting in Budapest on 30 June and 1 July related to how CSDs would reshape their infrastructures for T2S. Discussions need to take place between each CSD and its users to agree on the form of adaptation that is most suitable for the CSD in question with a view to meeting the needs of the market and fostering a competitive position within T2S. Henk Brink, Head of Client Services, Clearing and Settlement at KAS BANK, confirms that there has been fierce discussion regarding how CSDs should restructure for the release of T2S. CSDs say that its not simply a matter of decommissioning their settlement systems but rather of re-shaping their systems to adapt to the T2S environment, he comments. Many of these CSDs seem convinced that decommissioning will not be possible for more than 20 per cent of their settlement infrastructure. Although we have no detailed knowledge of all the underlying CSDs IT structures, it strikes us that this discussion keeps popping up. If we remember correctly, this opinion was voiced strongly by ECSDA back in 2006. Within the user community, there is some apprehension that the cost of CSD adaptation will be passed on to them through a hike in fees. Users must insist that CSDs do not raise their fees for domestic settlement and that they are not asked to finance investments that improve the CSDs positions to compete with custodians, contends Brink.

For Euroclear, a fundamental requirement when adapting its infrastructure is that there must be no deterioration in the service levels that Euroclear CSDs extend to users when securities settlement is outsourced to the T2S platform. This is essential to our committing to the project, states Jan Lemeire. The ECB has always presented T2S as an initiative that will increase the competitiveness of European capital markets, resulting in a sizeable reduction in the cost of cross-border DvP settlement. Specifically, it notes that the creation of a centralised settlement platform to replace multiple settlement platforms currently maintained by Europes CSDs will generate cost benefits by enabling CSDs to decommission large parts of their existing infrastructure. However, on the basis of most CSDs own detailed evaluations, Lemeire proposes that the opportunity for CSDs to decommission existing systems is extremely limited, given that only lean settlement functionality is outsourced to T2S and all other core services will remain on the CSDs existing platforms. More broadly, Lemeire predicts that the benefits of T2S are likely to be minimal for users that are supporting low levels of cross-border settlement activity. Though T2S promises to reduce the cost of crossborder settlement which is dependent on lifting domestic market barriers (e.g. legal, technical) to allow for an efficient crossCSD settlement capability in T2S it is unlikely to generate similar cost reduction for purely domestic business. On the contrary, this may increase the cost of domestic settlement at least during a certain period of time after T2S goes live. Cost savings are expected mainly to come from further harmonisation of market practices and lifting of barriers, market consolidation, increased competition, as well as reduced liquidity needs in euros, he says. In preparing for the launch of T2S, BNP Paribas Philippe Ruault believes it important that CSDs take on board harmonisation proposals prior to adapting their systems. It makes no sense for CSDs to cut and paste their current way of operating into a T2S environment. A number of industry bodies, including the T2S Harmo-

Henk Brink,
Head of Client Services, Clearing and Settlement, KAS BANK

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nisation Steering Group, are working to eliminate inconsistencies in market practice across member states (see below p 36ff). Ruault believes these harmonisation efforts must be accommodated as CSDs adapt their infrastructure in preparation for T2S. This Harmonisation Steering Group has a broad and complex agenda to tackle but we have been encouraged by the priorities that have been outlined, adds Ruault. This includes steps to define ISO 20022 messaging for T2S, to identify remaining barriers to cross-CSD settlement, to harmonise schedules for the settlement day, and to promote legal harmonisation around settlement finality and the rules applied to CSDs when outsourcing service functions.

taking place within the CSD community, observes Bodart. Many of these 27 CSDs tell us that they are planning to link to the T2S platform and to adapt their infrastructure in order to operate as an independent provider of depository services in a T2S Europe. However, we see little evidence of CSDs discussing potential mergers, platform sharing arrangements, or other initiatives to ensure that they have a competitive future in a T2S environment. Through our eyes, it appears that CSD consolidation is inevitable. However consolidation seems to be moving more gradually than anticipated. When T2S is launched and leading CSD groups extend their capability as investor CSDs, business will migrate from

The preliminary draft UDFS was published in March 2011 and market participants have had only a couple of months to review the document and provide feedback. Publication of this pilot version has been a first step in enabling CSDs to refine their project planning budget estimates. However, the cost-benefit analysis may be impaired by the delivery of stable requirements in October 2011 only and this has forced us to base our calculations mainly on the preliminary specifications mapped out in the less detailed T2S User Requirements Document.

BNY Mellons Paul Bodart suggests that there is little benefit for Europes securities services industry from having 27 CSDs each building an individual connection to the T2S platform. It is important that CSDs take this opportunity to review and adapt their business models and to capitalise on the synergies offered through outsourcing lean settlement to the T2S platform. In the banking sector, sub-custody and clearing providers particularly smaller sub-custodians that support client business in only one market have been forced to reconsider whether they have a future as a standalone entity. Following this analysis, some banks have sought opportunities to sell their custody business; others have explored the possibility of entering into partnership arrangements with another provider. Curiously, at the current time we see little evidence that a similar process is

those CSDs that are less efficient and flexible in their service delivery to those that are more so.

Multi-market coverage
Clearstream is rolling out a pan-European service that will enable clients to draw on the benefits of CSD, ICSD and agent bank services in a T2S environment. It will partner with local institutions in developing this service sometimes with agent banks, sometimes with other CSDs, depending on their service capability. At earlier times, we took the view that single market agents would be consigned to history with the release of T2S, as would many smaller CSDs, comments Mark Gem. Now, I am less firm in this conclusion. If we factor in the transaction flow coming from domestic investors, and we recognise that many local banks also have a strong retail presence in their domestic

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markets, it seems possible that their future may be more secure than we once assumed. For banks that are servicing mainly domestic customers, the release of T2S will have only limited affect on their ability to distribute services to this domestic customer base. One implication that T2S may have for this community, however, is that it is likely to trigger market consolidation, leading ultimately to the emergence of local champions. What does the future offer for multimarket providers in a T2S environment? Clearstreams Gem estimates that there are 4-6 organisations some of which are international banks, some CSD groups that will be in a position to construct a competi-

from the specialist product set that we offer, including global collateral management and securities lending. With T2S on the horizon, BNP Paribas Securities Services is making preparations to establish this type of centralised booking engine. It has been developing a new settlement and custody platform since 2008 and has now invested more than 250m in this project. With this in place we will offer a centralised booking model for settlement, allowing us to support a clients settlement and asset servicing across multiple markets via a single cash account and a single securities account, accessed via a single contact point into our multi-direct custody and clearing (MDCC) network,

There appears to be wide consensus across the Nordic region that for purely domestic transactions installation of a T2S platform will result in an increase in the cost of settlement. For cross-border trades there may ultimately be some cost reduction. The pressing question for our markets is whether an increase in short term costs (including systems adaptation, testing and migration costs, higher cost for domestic settlement) is justified in the name of a more efficient cross-border settlement infrastructure that will allow us to become integrated more fully in the European settlement and asset servicing landscape.

tive pan-European offering with the release of T2S. None of these organisations are holding a full deck of cards in terms of the product sets that they offer. As a CSD/ICSD group, Clearstream offers pan-European asset servicing, but it does not make business sense for this organisation to establish a bricks and mortar sub-custody network across multiple European locations. In contrast, the multi-market asset servicing specialists have a strong branch network in place, but typically lack the glue that brings this together. No multi-market custody and clearing provider in Europe currently supports its multi-location offering via a centralised processing engine, says Gem. With this in mind, Clearstream will partner with specialist sub-custody providers across our European network in order to extend a full multi-market asset servicing capability, while also enabling customers to benefit

Financial Services Research Q3 2011

explains Philippe Ruault. The objective is to realise new operational efficiencies and economies of scale by leveraging the benefits of the T2S platform. Work on this centralised booking model is now well advanced and builds on the custody platform that BNP Paribas has developed to support MDCC activity in ESES markets. BNP Paribas Securities Services is also evaluating how it will support the asset servicing requirements of direct technical connectivity participants in a T2S environment. One overarching question is how it will access the data required to support delivery of custody services when it does not directly receive the clients settlement flow. One potential option is that it will offer sponsored access to the T2S platform, whereby DTC customers will route transactions to T2S via BNP Paribas systems.

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BNY Mellon Asset Servicing will take advantage of direct technical connectivity options under the T2S project, enabling it to route transactions for settlement directly to the T2S platform. In some EU markets in which it supports sizeable transaction volumes and assets under custody for instance Germany, the Netherlands and the UK BNY Mellon will meet its asset servicing requirements through its own in-house capability. In other locations, its strategy will be determined on a market by market basis dependent on its levels of business activity and the complexities presented by local market practice and regulation. In Slovenia, for example, where we support 10-15 transactions per week, it does not make sense for us to make significant changes

these issues for attention, identifying which must be resolved prior to the launch of T2S, which can be addressed over a longer timeframe, and what actions are required from key stakeholders (CSDs, central banks, market regulators, CSD participants...) in order to push through necessary reforms. Within the HSG, we have made it clear that the development of a sophisticated T2S settlement platform within a non-harmonised market environment will deliver only limited benefit to the industry, he says. The benefits of automation are diminished in an environment that remains complex and beset with exceptions from market to market. Harmonisation and simplification of market practice are important to delivering operational benefits and cost savings. We

In the banking sector, sub-custody and clearing providers have been forced to reconsider whether they have a future as a standalone entity... Curiously, at the current time we see little evidence that a similar process is taking place within the CSD community. Many of these 27 CSDs tell us that they are planning to link to the T2S platform and to adapt their infrastructure in order to operate as an independent provider of depository services in a T2S Europe. However, we see little evidence of CSDs discussing potential mergers, platform sharing arrangements, or other initiatives to ensure that they have a competitive future in a T2S environment.

Financial Services Research Q3 2011

to our existing business strategy with the release of T2S, says Paul Bodart. We have a good sub-custodian in place and our existing arrangements meet our settlement and sub-custody needs effectively. In other markets, we may continue to make selective use of a sub-custodian to support elements of our asset servicing.

recognise that harmonisation will also facilitate competition, enabling new entrants in sectors where, until now, legislative barriers or non-standard market practice has constrained their freedom to operate. Euroclears Jan Lemeire indicates that the Harmonisation Steering Group has played an important role in the context of T2S in identifying areas that require harmonisation. The next step is to construct a strategy for achieving these harmonisation goals. The Cross-CSD Settlement Task Force was established in late 2010 to identify where harmonisation is necessary and where market practice needs to be amended in order to ensure that cross-CSD settlement takes place efficiently via T2S. Given that a primary rationale for creating T2S was to improve the cost efficiency of cross-border settlement, this harmonisation

Harmonisation agenda
In this context, harmonisation remains important in setting in place the conditions through which T2S can bring optimum benefits to the market. Paul Bodart is encouraged that the T2S Programme Board has recognised this and has been working hard during late 2010 and early 2011 to identify the factors that make cross-border settlement difficult. As a Harmonisation Steering Group member, Bodart explains that the Groups task has been to prioritise

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work is important to the success of the T2S project. Without this, the CSDs business case for outsourcing settlement activity to the T2S platform may be at risk. The fact that a steering group has been created solely to address harmonisation issues highlights the critical role that harmonisation plays in T2S becoming a success, observes KAS BANKs Henk Brink. The HSG has compiled a list of harmonisation issues and it has flagged up those which need to be addressed most urgently. However, amendments to legislation at EU level will be required to push through some of the reforms that are necessary. Therefore the final results will, in part, be dependent on how fast EU legislation is implemented and how far reaching this legislation proves to be (for example around settlement finality, location of securities accounts, EU settlement discipline, EU settlement cycle, free choice of place of issuance).

through to a date 10 years in the future? The Governing Councils pricing decision is a response to market participants request in the Advisory Group for a pricing commitment in order to get stability for their adaptation planning, responds Bayle. A pricing commitment extending so far into the future is rather unusual and we note that some market participants in the posttrading business change their fee schedules rather frequently, sometimes several times a year. But T2S is a unique project and we acknowledge the need to fix certain parameters in advance. The pricing parameter is certainly a key one. It is noteworthy that equal prices will apply for all CSDs that outsource lean settlement to T2S; no discounts will be given for participants taking larger volumes in T2S. A consensus was reached within the CSD community some time ago that each CSD should pay the same. Initially there was some divergence of opinion regarding how pricing should be structured, explains Euroclears Lemeire. Typically, smaller CSDs wished to have a fixed price per settlement given their relatively low volumes; whereas Europes larger CSDs recognised an advantage in having tiered pricing with discounts offered for higher volume. Ultimately Euroclear CSDs are rather comfortable with an arrangement whereby equal prices will apply for all CSDs, says Lemeire. With this pricing structure in place, we may still be in a position to offer pricing discounts to our customers, given that the T2S settlement fee constitutes only one component of the overall settlement fee charged to customers, he says.
Financial Services Research Q3 2011

Price structure
The ECB Governing Council has now released a fee schedule for T2S services, with the DvP settlement at T2S fixed at 0.15 per transaction for the period Sept 2014 to Sept 2018, subject to specified conditions. Achieving a very low price has always been a key objective for the Eurosystem to ensure that future settlement in Europe will become as cost-efficient as possible, indicates T2S Programme Manager Marc Bayle. To provide greater certainty to the market regarding how much T2S will charge, the Governing Council has set in place a pricing guarantee of 0.15 per DvP instruction for the first four years of T2S in operation. This Governing Councils decision was made entirely on the basis of the full cost recovery principle, which requires balancing T2S costs with expected T2S revenues over the eight year amortisation period for T2S (for further detail, see pp 18-24 in this issue). In parallel with the above, the ECB Governing Council has made a commitment not to increase T2S fees by more than 10 per cent between 2019 and the end of the cost recovery period in September 2022. But this is some time ahead. Given the volatile economic conditions prevailing currently, is it prudent to offer a price guarantee

Mark Gem,
Head of Business Management and Executive Board Member, Clearstream

BNY Mellons Paul Bodart indicates that for CSDs to make a binding legal commitment to the T2S project, it is important that they have certainty around the price structure. Prior to signing the Framework Agreement, CSDs have sought assurance about pricing and service levels and requested greater transparency around the project governance. Thus, the Eurosystems decision to offer a stable price over a 7-8 year period is critical to the success of the project. For Bodart, the ECB has been conservative in arriving at its 0.15 per transaction fee

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for lean settlement. We expect T2S to deliver significant cost savings for crossborder settlement and, as pricing falls for cross-border transactions, we expect market participants to increase their levels of cross-border trading activity, he says. Drawing parallels with the US, the headline settlement price at DTCC has fallen 80 per cent over the past decade and the volume of transactions has risen 30 fold over this period. Against this background, Bodart believes that the Eurosystem has been cautious regarding its timeframe for amortisation of investment cost. So too, the ECB has been conservative in its volume projections for non-euro currencies, identifying at an early stage that the Bank of England and Swiss National Bank were unlikely to commit to the project and thus excluding GBP- and CHF-denominated securities settlement from its projections for non-euro currencies. As we have noted, the fee schedule published by the Governing Council is based on a number of assumptions. It is predicated on continuous volume growth through to the end of the amortisation period. Also, the Eurosystem has taken the assumption that 20 per cent of non-EUR settlement volumes in Europe will go to T2S. Given current uncertainty in global markets, Euroclears Jan Lemeire believes it is too early to predict whether either assumption will be borne out in practice. In the wake of the global financial crisis, settlement volumes in the EU have been subject to phases of expansion and contraction and we have not seen continuous volume growth for a number of years. Settlement volumes for non-euro securities will be subject to similar market volatility and will also be dependent on which central banks make their national currencies eligible to support central bank money settlement on T2S through signing the Currency Participation Agreement. Ultimately, according to currently available information, Lemeire estimates that the ECB will need to recover approximately 900 million in costs over the seven year amortisation period. Roughly half of this applies to the cost of developing the platform, which the Eurosystem expects to recover within this seven year period. The remainder relates

to running cost of the platform and other operational overheads. Throughout the projects evolution, the Eurosystem has attached great importance to the fact that T2S fees will be very low compared with todays settlement fees. For cross-border business it has predicted that settlement fee reductions may be up to 90 per cent of current levels and the objective is to offer settlement fees that are lower than those currently found in any national market. However KAS BANKs Henk Brenk believes it unlikely that the initial goal of a 90 per cent reduction in settlement fees will be realised. The ECB has effectively given up on its initial stand of driving for this 90 per cent reduction in fees for cross-border settlement, he says. Now the ECB claims that it may not be cheaper from the beginning but we will get there in the end. T2S is a project which is heavily dependent on economies of scale. The problem with predicting the future, notes Brink, is that unexpected events keep popping up, as illustrated by high levels of uncertainty in global markets in recent years. As users, we are not yet fully convinced that we will realise the predicted cost savings and speaking to the CSDs in private this doubt seems wide spread, he says. The fact that the UK is out is obviously is a pity from an economy of scale point of view, given that this accounts for 30 per cent of all european transactions. The ECB states that their projections already exclude UK participation. For Clearstreams Mark Gem, one delicate finesse that has been played in selling the T2S business case has been to encourage stakeholders to compare the 0.15 fee charged for the lean settlement function delivered by T2S with the aggregate charge that a user pays to settle a trade. Users may contrast this 0.15 fee with the 2 integrated price that they pay for settlement today and believe this represents a major cost saving. But the two figures are not directly comparable. One relates to a CSDs cost of processing via the T2S platform; while the other relates to a CSDs aggregate cost of delivery.

Jan Lemeire,
Director heading the T2S team, Product Management division, Euroclear

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Financial Services Research Q3 2011

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Similarly, Euroclears Lemeire suggests that one needs to treat with some caution the 0.15 headline settlement fee per side proposed by the Eurosystem for DvP transactions settling on T2S. This relates to the lean settlement fee charged by the T2S platform per transaction. However, additional costs need to be factored in to arrive at the full cost of settlement applicable to each instruction. Trade matching costs are not included within this 0.15 figure, for example; and additional charges will apply for reporting and information services. Moreover, this 0.15 fee is applicable for overnight settlement only and higher charges will be applied for transactions settling during daytime.

able to reinvent itself and to identify new opportunities for growth in a T2S world, these cost concerns will be substantially allayed. But this opportunity is open to relatively few CSDs. For others, the question in many cases is whether they offer a limited product targeted at a relatively narrow domestic constituency of users. Indeed, the ECBs Jean-Michel Godeffroy observed in a recent conference presentation that it is important to find a business case that will make T2S attractive for market participants that engage in limited cross-border investment activity. Mark Gem observes that in the German market, for example, over 70 per cent of the equities

One delicate finesse that has been played in selling the T2S business case has been to encourage stakeholders to compare the 0.15 fee charged for the lean settlement function delivered by T2S with the aggregate charge that a user pays to settle a trade. Users may contrast this 0.15 fee with the 2 integrated price that they pay for settlement today and believe this represents a major cost saving. But the two figures are not directly comparable. One relates to a CSDs cost of processing via the T2S platform; while the other relates to a CSDs aggregate cost of delivery.

Domestic finances
With the release of T2S, Mark Gem anticipates that the leading investment banks will take steps to exploit the benefits of this centralised settlement platform as soon as these become available. Global custodians may take a little longer to finalise their strategies, waiting to see how the landscape develops before making major network decisions. The implications of harmonisation discussions will have a crucial bearing on this process. At Clearstream, we are confident that we are well placed to capitalise on these opportunities, he says. In CBF, we have the largest euro-area CSD in terms of settlement volume and we bring to customers a wide array of specialised services via the ICSD. But even for Clearstream the migration and adaptation costs presented by T2S are intimidating. For a CSD group such as Clearstream which is

deposited in CBF are held domestically. For this community, the virtues of T2S are far from obvious. For BNP Paribas Securities Services, the preliminary fee schedule that has been outlined for T2S is broadly in line with the banks expectations though this is predicated on a number of assumptions and it is too early to judge whether these will be borne out in practice. The pricing outline that has been laid on the table is acceptable from a BNP Paribas standpoint and we will pass these benefits fully to our customers, says Philippe Ruault. In turn, the centralised booking model that we have developed will offer will allow us to deliver further efficiency benefits to the customer. A priority is that the ultimate price that users will pay to settle a transaction in a T2S environment is lower than the price

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of settlement currently. There has been some speculation that the cost of domestic settlement may actually increase in a T2S environment, he adds. However, domestic settlements represent a major share of overall transaction flow in Euronext markets and in many other EU jurisdictions and it is vital that the T2S platform delivers cost reduction both for domestic and cross-border transactions. Can this be achieved, FSR asked Philippe Ruault? That is still to be established, he responds. Several CSDs have raised concerns that the cost of domestic settlement will rise in a T2S environment; and have indicated that there may be need for CSD participants to meet some of the cost of systems adaptation and the higher overheads attached to domestic settlement. Again, we are firm in our view that T2S must deliver cost reduction for both domestic and cross-border settlement and we must work together with the Eurosystem and with CSDs to create a business model that realises this objective.

avenues through which they can reduce the cost of domestic settlement. BNY Mellon believes it important that CSDs adapt to this changing environment and it anticipates that plans from the European Commission to review CSD legislation (for example, under the Securities Law Directive and EMIR] will provide additional stimulus in this direction.

Currency participation agreement


The Currency Participation Agreement, governing the relationship between the Eurosystem and non-euro area central banks, will be finalised in parallel with the Framework Agreement prior the end of 2011. At this point, it seems likely that Danmarks NationalBank will commit to making DNK liquidity available to support settlement in T2S, thereby enabling VP Securities to participate in T2S to settle EUR and DNK denominated securities. T2S Programme Manager Marc Bayle explains that as early as 2009, when VP

Within the user community, there is some apprehension that the cost of CSD adaptation will be passed on to them through a hike in fees. Users must insist that CSDs do not raise their fees for domestic settlement and that they are not asked to finance investments that improve the CSDs position to compete with custodians.

Financial Services Research Q3 2011

Some CSDs have indicated that the cost of domestic settlement may rise initially after the release of T2S. But, for BNY Mellons Paul Bodart these projections have in many cases been advanced by CSDs that have, as yet, made limited attempt to restructure their business models (through platform sharing for example) or to capitalise fully on the synergies offered through outsourcing lean settlement to T2S. With this static approach, it is perhaps unsurprising that they have been unable to identify

Securities signed the Memorandum of Understanding for settlement in T2S in euro as well as in Danish kroner, Danmarks Nationalbank made known its intention to make Danish kroner liquidity available in T2S. He believes that the constructive negotiations which have been ongoing for more than a year with the central banks of Denmark, Sweden, Norway, Switzerland, the UK and Iceland, give it strong reason to believe that the three Nordic countries and Iceland will sign a Currency Participation

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Agreement and thus formally commit their currencies to support T2S settlement. He is confident that the Swiss market will realise the substantial benefits of T2S for its market, while the UK market is likely to adopt a wait-and-see approach at this juncture. Bayle also underlines that the price commitment that the Eurosystem has undertaken (see p 23) is based on a 20 per cent contribution of non-euro volumes. This threshold, he suggests, will be more than fulfilled with the volumes generated by the three Nordic markets. In a largely fixed-cost driven endeavour like T2S, any additional volumes will be to the benefit of the entire T2S community, he says Explaining Danmarks Nationalbanks decision to support T2S settlement in Danish kroner as well as euro, Hugo Frey Jensen, Governor of Danmarks Nationalbank, indicates that todays cost of cross-border settlement is disproportionate to that of domestic settlement. The Danish market has been positive about T2S since it was initially proposed and supports T2S objective to establish a trans-European securities settlement system in which cross-border transactions can be settled as efficiently as domestic transactions. Cheaper crossborder settlement would benefit both Danish investors and issuers, particularly bond issuers. The Danish market, which represents the largest component of the Danish securities market, is sizeable even by international standards with market turnover of 4.75 bn during 2010 and market value 543 bn. Against this background, VP Securities, the Danish CSD, has declared its intention to participate in T2S in both euro and kroner. In turn, Danmarks Nationalbank has committed to making liquidity available in kroner for settlement in T2S. KAS BANKS Aletta Oostenbrug points out that discussions in preparation for the CPA have been taking place mainly with central banks in the UK, Switzerland, Iceland, Norway, Sweden & Denmark. However, policy makers in other countries such as Poland and Hungary that are likely to adopt the euro at some point in the future are also giving consideration to their strategies. These might wait until they have adopted the euro before committing

to T2S or they may choose to enter T2S with their local currencies before that, says Oostenbrug. The Bank of England has decided not to commit and the Swiss National Bank also appears to have serious doubts. We feel that for these markets (eg UK, Switzerland) it is easier for them not to join than for smaller countries, which might be forced to join at an earlier stage in order to stay attractive for foreign investors. At present, however, the economic and political situation in the eurozone is precarious and this might influence decision making.

Time schedule
Jean-Michel Godeffroy has underlined on a number of occasions recently that we are now past the mid-point in the T2S project design and remain well on track to go live in September 2014. But does this represent a viable timetable for completing outstanding design, testing and launch commitments? All recent T2S deliverables have been achieved on time or even slightly ahead of schedule, responds T2S Programme Manager Marc Bayle. Thus we are on track and we have delivered and agreed a detailed plan with CSDs on how to implement T2S by September 2014. In the last meeting of the AG, there were requests that changes should be made to T2S functionality and the 4CB had strong concerns that this may lead to tensions in the timetable. The AG nevertheless insisted on having these changes implemented and the T2S Programme Board is currently evaluating the timing implications this may have (see p 24). The launch timetable remains challenging for the T2S project team, for CSDs and for their users, believes Euroclears Jan Mereire. There is extensive work to be done on each side to ensure that CSDs will be in a position to commence testing in January 2014 and for migration to begin for the first wave of CSDs in Sept 2014. As we have noted, the final UDFS will only be released in October 2011 and CSDs will then be given only limited time to analyse their content prior to deciding whether they will sign the Framework Agreement

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by the year end. A range of connectivity issues are still to be finalised, with the selection process to appoint a network service provider to deliver value-added connections only launched in July. We should not underestimate the amount of work that remains to be done in order to ready the T2S design for testing and, ultimately, to migrate 30 or more CSDs onto the T2S platform, says Lemeire. This is a major implementation that will also bear considerable project risk. Clearstreams Mark Gem has no doubt that the T2S user testing that is to be completed between January and September 2014 will be a challenging process. Stakeholders need to be preparing them-

ment of a connectivity provider. CSDs will not release the project budgets before the Agreement has been signed and users are dependent on CSDs. If there are any further significant delays in finalising these issues then it is likely that the September 2014 target for the first Phase of CSD migration will not be met, she says. Besides that we still feel the user testing period is quite limited for such a large project. One T2S AG member told FSR that, for many observers, T2S is a project that attracts public enthusiasm but private scepticism. One finds few market participants, at least outside of the UK, that are questioning publicly the benefits that T2S will bring to the market. But in private conver-

The ECB has been conservative in arriving at its 0.15 per transaction fee for lean settlement. We expect T2S to deliver significant cost savings for cross-border settlement and, as pricing falls for cross-border transactions, we expect market participants to increase their levels of cross-border trading activity... the Eurosystem has been cautious regarding its timeframe for amortisation of investment cost. So too, it has been conservative in its volume projections for non-euro currencies, identifying at an early stage that the Bank of England and Swiss National Bank were unlikely to commit to the project and thus excluding GBP- and CHF-denominated securities settlement from its projections for non-euro currencies.

Financial Services Research Q3 2011

selves for these commitments at an early stage, rather than focusing narrowly on the business issues that have largely consumed their time over the past five years. As the technical content and contractual arrangements are finalised, market participants will need to refine their strategic approaches and product content in order to maximise the advantage that they can reap from the project. It is true that the September 2014 date is still on Jean Michel Godeffroys mind, responds KAS BANKs Aletta Oostenbrug. However, it will be a very close call and there is little room left in the current plan for any more unforeseen issues. Currently on the critical path are the signing of the Framework Agreement and the appoint-

sations, some remain sceptical regarding the T2S business case, its governance and its release schedule. The CSDs in particular find themselves in an awkward position within this debate, with limited freedom to question the initiative. Among other factors, the timeframe allocated for testing and migration is central to the concerns of many CSDs. Will the testing windows be long enough to eliminate any potential problems? Is there sufficient time to complete any corrective coding that might be necessary? For this T2S stakeholder, there is an unspoken fear that the project has a strong political dimension with the Eurosystem committed to the proposed migration schedule regardless of some important questions that remain unanswered.

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