An Investor's Guide to T2S

After nine years of planning, the first stage of a major new pan-European infrastructure project went live in June this year. Target2-Securities (T2S), whose logo is “settling without borders”, is an initiative of the Eurosystem (the European Central Bank and the central banks of the eurozone member states).

What is T2S and what do investors need to know about it?

What is T2S?

T2S is a project designed to rationalise and harmonise Europe’s system of securities settlement.

Currently, the region’s post-trade network of clearing houses and securities depositaries resembles a badly designed electrical junction box.

For historical reasons, trades conducted on different national exchanges have been handled by a complex network of intermediaries, with a variety of commercial and central banks involved in the final leg of the settlement cycle (the exchange of cash for securities). This proliferation of middlemen has led to increased costs and risks.

Source: ECB, “Settling without Borders”, 2009.

According to the ECB, in the past a typical cross-border transaction in the EU cost 10 times more than a domestic equity trade, and involved as many as 11 intermediaries and 14 instructions between trading parties. Post-trade costs are also significantly higher in Europe than in the US, where equity trades pass down a single chain (to NSCC and DTCC), wherever they take place.

T2S will rationalise European post-trade processing by introducing a single set of rules and standards for securities settlement. T2S also makes the final leg of the settlement cycle safer: all trades will be settled on a gross basis, delivery versus payment and across the accounts of the central bank, rather than via commercial banks.

Who’s part of T2S?

T2S is taking place in four waves (the diagram below shows the dates on which different European central securities depositaries—CSDs—are due to sign up). Although eligibility for T2S is not confined to euro member states, one major European CSDs whose business is largely non-euro has decided not to join—Euroclear UK and Ireland, the UK securities depositary, has so far stayed out of the initiative (however, Euroclear’s CSDs in Belgium, Finland, France and the Netherlands are joining).

Source: Monte Titoli T2S Handbook.

What does T2S mean for investors?

A lot of the mooted benefits of T2S for investors are likely to accrue over time. As an infrastructure exercise, T2S is intended to make the functioning of capital markets more seamless and to decrease the cost of capital for securities issuers.

However, according to Marcus Ruetimann, COO of asset manager Schroders, investors can already identify three clear gains from the initiative.

“Greater competition should lower operating costs; collateral becomes more mobile as T2S provides a global platform for global custodians and CSDs; and thirdly settlement costs should fall,” Ruetimann said in an interview with Thomas Murray.

For example, T2S allows a market participant to finance a bond purchase via an intraday repo with the central bank, using the bond as collateral, both in the participant’s domestic market and in another T2S CSD.

And clients can net off a sale in one European CSD off with a purchase in another, much reducing the client’s overall liquidity needs.

Unsurprisingly, T2S will increase competition amongst CSDs: investors will be able to hold assets at any CSD they want from among T2S members, resulting in a likely consolidation in the number of European CSDs over time.

Another effect of T2S is to blur the lines between the CSD and the global custodian. As CSDs’ revenues from securities settlement decline, they will be forced to change their business models, developing ancillary banking services and moving more directly into competition with custodians. And as global custodians’ sub-custodian networks also see a decline in settlement-related fees, there is likely to be a substantial consolidation in this layer of the post-trade chain.

“Rather than choosing the best-in-breed in each local market, as in the past, following T2S global custodians are looking at rationalising their networks of agent banks,” says Steve Merry, director at Thomas Murray IDS.

What should you ask your custodian about T2S?

For investors considering their post-T2S strategy, a useful starting point is to ask their custodian bank how it is preparing for the infrastructure change and what opportunities T2S creates.

By design, T2S should enhance collateral and liquidity management across European securities markets, benefiting investors. Many global custodians are seeking to connect directly to the T2S platform via accounts with local market CSDs, although they may still use local agent banks to offer additional asset servicing for clients.

“Investors can ask their custodians what the efficiency benefits of T2S are, what changes they are making to their sub-custody model and how this will impact clients, and what reductions they can expect in overall settlement costs,” suggests Thomas Murray IDS’s Steve Merry.