ECB’s Target2-Securities: Message Transformation Morass? (Updated)

This article has been updated to include comments from Incentage provided after its initial publication. 

Question: When are ISO 20022-compliant message types not like any ISO 20022 message types that are currently in use?

Answer: When they are the messages used by the European Central Bank’s Target2 Securities (T2S) platform to communicate with European securities depositories and global custodian banks.

Sound confusing? It is.

And even more so, because the 20022 message standard, introduced in 2004 and promoted by global financial messaging giant and network operator SWIFT as the replacement to the 15022 standard, has not exactly won universal adoption among the capital markets firms. Acknowledging market resistance to recoding or replacing legacy systems to use the new standard, SWIFT has continued to support both protocols, while specialized vendors and the network provider itself offer “coexistence” solutions to translate between 20022 and 15022 to ease the difficulties for firms that must send and receive in both standards.

For the European central securities depositories, banks and other directly connected parties to T2S, updating to 20022 is no longer an option but an absolute requirement. To communicate with T2S, they will be using variations developed by the ECB of about 12 of the familar ISO 20022 message types. The adaptations of settlement instructions, confirmations, statements, and status updates have more restrictions on the useable data fields, their content and cross-field validation logic. In addition, there are more than 100 brand new 20022 message types used by the T2S system, all of which have been published by the ECB.

The ECB’s rationale in choosing the new 20022 standard over the more commonly used 15022 is understandable. Given that the XML- based 20022 not only carries more  information and more types of post-trade business instructions, it also will be future-proof.

Risky Business

But in taking ISO 20022 one step further, the ECB is also taking a big gamble. Its goal for T2S to eventually reduce the costs for investors to settle domestic and cross-border transactions might not pan out, or not as quickly as it hopes. European securities depositories and custodians will be connecting through one of two-value added networks approved by the ECB — either SWIFT or a joint initiative between Italian technology giant SIA and network provider Colt. That’s the easy part.

The hard part: T2S’s ability to reduce pricing is entirely dependent on traffic.  That traffic will come at a high price for market infrastructures and financial firms directly linked to T2S who are now forced to make either system enhancements, completely rebuild, or replace back-office systems designed to generate 15022 messages. If that weren’t enough, European securities depositories and custodians, which might have historically enjoyed a symbiotic relationship, will likely be competing head-on now once the depositories outsource their settlement functions to the T2S platform.

The clock is ticking: European securities depositories, which have agreed to outsource their settlement functions to the ECB’s T2S, will be connecting in one of four timeframes: June 2015, March 2016, September 2016 and February 2017. The first wave are in their final testing stage now. The ECB has also planned on a fallback date of May 2017 for any European depository which fails to connect as scheduled.

All this urgency to deal with the new connections and new 20022 messages doesn’t even include the complex challenge of providing straight-through processing services to clients that are unlikely to change their 15022-oriented back-office systems just because Europe’s new central settlement utility runs on 20022.  What do the fund managers think? Ten fund operating managers contacted by FinOps Report say they are worried about whether market infrastructures and mega custodians will be able to translate their current legacy ISO 15022 message formats and proprietary formats into the new T2S version of XML-based ISO 20022 messages in time.

“Given that the T2S ISO messages aren’t the same ones which flow through the SWIFT network and there are so many new ones to follow, there are obviously risks for the depositories, the custodians and for us,” says one global fund management operations director. “Our global custodian is in the third wave, and they’re putting out nice-looking marketing material, but we haven’t really talked about how things are going to change for us.”

Fund managers are apparently not the only ones concerned about potential glitches with message transformation. So is Volante Technologies, a popular provider of message transformation technology, has  warned of the difficulties in complying with the T2S message types. Volante unveiled a T2S Message Accelerator in 2013 which, the company says, could make it much easier for market infrastructures to translate T2S messages back and forth between 15022 and 20022 formats. It also handles all of the new data workflow challenges.

So why aren’t European securities depositories and global custodians running to license the new product? Alas, as Fiona Hamilton, Volante’s regional head of Europe and Asia, bemoans, “They may be waiting until the last minute to get ready for the new message types, or they may think their back-office technology providers will automatically upgrade their systems to take into account the new T2S ISO 20022 messages.”

Bad idea. And here is why, explains Hamilton in a white paper she authored last year which was published by London-based BISS Research. As a rule of thumb, the European securities depositories and global custodians rely on ISO 15022 messages at best. Should back-office systems need to be recoded to address the changes, it won’t be enough that they can handle standard 20022 financial messaging. Where the ISO 20022 messages are completely new or specific to the T2S process, they will have to be created largely from scratch.

The ECB does want to be accommodating, so it has offered a set of coexistence rules to allow for interoperability between 15022 and 20022 messages. However, that is only where functionally equivalent fields and elements exist. Even so, the translation between 15022 and 20022 messages is not the responsibility of T2S. It will be sending and receiving its own 20022-compliant messages, and it is on the shoulders of the directly connected parties to handle the transformations. “It can cause real problems in mapping incoming data if it is larger than the target field or contains characters that are invalid in ISO 15022, but allowed in ISO 20022,” writes Hamilton.

Do It Yourself

Another leading provider of transformation technology, Trace Financial, has also seen a surprising lack of interest in its T2S solution for multiple standards and specific T2S message types, which is also offered by SWIFT.  John Murphy, managing director for Trace, points out the larger infrastructure organizations are waiting for the later migration waves to link with T2S, while press reports suggests they are doing the work in-house. “There are understandable reasons like the changes required involve more than just transformation in messaging; for many the processes will also involve change,” says Murphy.

Felix Huber, chief executive of Incentage, yet another message transformation provider, is a bit more optimistic when it comes to European securities depositories relying on vendor-provided T2S messaging solutions, but is far more pessimistic on global custodians embracing their benefits.

“We have the impression that central securities depositories are thinking more out-of-the-box these days, whereas global custodians are leveraging their existing IT infrastructure and squeezing a bit more functionality out of their current message infrastructures,” he says, citing Switzerland, Luxembourg and Denmark’s depositories as users of his software for T2S messaging functionality.

One reason for the different stance: the change in business roles and practices represented by T2S is may be felt most keenly by the depositories, and is “lowering the barriers to radically re-think, modernize and really looking at the messaging challenges ahead,” says Huber. Now that core settlement functions are being outsourced, facility with messaging standards may become a critical differentiator as they face stiffer competition with each other and custodians.

As for the do-it-yourself approach of many global custodians, tinkering with existing infrastructure may turn out to be a short-sighted approach. Systems designed for 15022 messaging are not programmed for the flexibility and variability of the 20022 message types. The results may turn out to be dangerous, warns Huber. “The price for not investing in a solid messaging architecture might be drastically increasing complexity that is difficult to manage, slows down adoption of new requirements, and will be very expensive in terms of operational costs.”

What are some European securities depositories doing? Keler, Hungary’s central securities depository which is scheduled to migrate in the third wave, is fully aware that it is currently not T2S compliant but hopes to be when it switches over from its proprietary technology platform to the BaNCS solution from Tata Consulting in August 2015. “We won’t be linking to T2S until September 2016, which should give us enough time to do the necessary testing with SIA-Colt, the ECB and our members,” says Peter Csiszer, director of strategy for the Budapest-based depository which is one of a handful using the SIA-Colt operated network to link to T2S.

Communicating with T2S aside, just what will depositories do about communicating with each other and member firms? The answer: a lot of transformation work. “We plan to continue using ISO 15022 messages and proprietary message formats to communicate with our members and will use ISO 15022 messages to communicate with other depositories,” says Csiszer. “We suspect other depositories will do the same.”

Hamilton’s advice: don’t leave anything to chance. “The key to connecting to T2S will be adhering to all of the ECB’s rules and restrictions. There will be significant testing required and a large amount of coding work,” she cautions.