(The information in this article was updated on December 11 to reflect the European Central Bank’s new changes to the T2S migration timetable).
When first envisioned in 2008, Target2 Securities (T2S) was hailed by the European Central Bank as a single settlement platform to reduce the post-trade processing costs associated with domestic and cross-border European securities trades.
Fast forward seven years later and fund management firms — the intended beneficiaries of the lower costs — don’t seem to be paying much attention to the new operating platform launched in June. Instead, they are delaying getting serious about preparing until the end of the staggered implementation by European securities depositories in 2017, according to a study just released by global consultancy Capco.
For the laggards, that may turn out to be inefficient and costly. Among the challenges: T2S relies on a new means of matching and linking transactions, its own version of ISO 20022 message types, and new harmonized settlement cycles and deadlines.
Several relationship management directors at global custodian banks contacted by FinOps Report insist they have been discussing the merits of T2S with clients and, while declining to be specific about their talks, report that customer reaction has been positive. If that is the case, why aren’t the fund management firms they service doing more to get ready?
Although Capco’s study of about two dozen asset managers didn’t specify the reasons, a dozen operations managers at fund management firms say they have plenty of reason not to jump the gun. Apparently, they haven’t bought the rhetoric. They either haven’t seen the benefits yet, doubt they will have any or simply have too many regulations on their plate to worry about a deadline in 2017. Those include UCITS V, MiFID, EMIR, Basel III, and Solvency II to name a few.
“We’re still uncertain about whether the platform will reduce settlement and other processing costs,” one operations manager in the London office of a global fund management firm tells FinOps.”We’ve heard a lot of promises about lower fees and collateral management efficiency, but we haven’t heard of anyone experiencing it so far,” says one operations manager in the London office of a global fund management firm.
If the European securities depositories don’t have to handle settlement functions any more, they will presumably pass along the savings onto brokers and custodian bank members who will pass them onward to their fund management customers. Those service providers will also forward the benefits of T2S’s standardized settlement and post-trade processing procedures as well as auto-collateralization capabilities downstream. Or so the theory goes.
Will those direct cost and other benefits ever materialize? Perhaps not as much or quickly as fund managers may hope. Change doesn’t come cheap. For one, European securities depositories and their direct members will be spending over US$1 billion by some estimates to adjust to T2S.
“Many asset managers may see new unbundled pricing models from their service providers, but uncertainty still remains as to whether the benefits of T2S will be passed on from the custodians,” says Alan Philpot, managing principal for Capco in London. There could even be a tradeoff, he believes. Asset managers might see a reduction in settlement fees as well as collateral optimization and higher intraday liquidity. However, they might be charged more for other non-settlement related services such as income and dividend processing and tax reclamation as well as accessing intraday liquidity.
T2S has yet to onboard Europe’s largest depositories. The depositories of Malta, Romania, Switzerland, and Greece’s national bank did manage to start using T2S in June with Italy’s Monte Titoli opting to postpone its migration until the end of August. However, it is Euroclear’s announcement that its national depositories in France, the Netherlands and Belgium will delay their migration to T2S from March 29, 2016 that has clearly raised concerns about when and even if T2S will ever reach critical mass in message traffic. If it doesn’t, it can’t continue to offer reduced settlement fees.
Euroclear’s postponement for its trio of depositories will apparently have a domino affect on others. A new migration plan, just posted on the ECB’s website shows that because Euroclear’s depositories in France, the Netherlands and Belgium will be onboarded on September 12, 2016, Clearstream Banking Frankfurt must wait until February 6, 2017 to onboard. Germany’s central securities depository had been set to use T2S on September 12, 2016. Likewise, Spain’s Iberclear and Euroclear Finland will need to postpone their linkages from February 6, 2017, the original final wave of T2S, until September 18, 2017.
Fund management firms may imagine they can afford to wait before they prepare for T2S, but maybe they should think twice about that. Although they will not have to link directly to T2S, they will still be affected by the new business strategies taken by the global custodians who are either directly linked or linked through membership in national European depositories and face growing competition from those market infrastructures.
The changes will affect not only how much fund managers will have to spend on services, but also how they will have to re-engineer their middle and back offices, cautions Philpot. Only 20 percent of the asset managers surveyed by Capco were planning to switch to the new ISO 20022 message formats used by T2S and less than 10 percent are preparing for the workflow changes. Only 30 percent had prepared for changes in cash management.
Global custodians are taking three approaches to T2S. Some have said they will link directly to T2S and reduce the number of agent banks they use in favor of either providing some of the value-added services such as corporate actions processing, proxy voting, securities lending and borrowing, collateral management and tax reclamation on their own, while others will retain their current arrangements. Yet others will rely on a combination of international securities depositories and local agent banks to do the same post-trade work.
“The timing of the flow of settlement and other instructions will vary depending on which business model the global custodian uses,” explains Philpot. “If the fund manager decides to keep the same global custodian, its technology and operations staff will need to prepare for any change rather than wait until the last minute, when it could be either cost-prohibitive or error-prone.”
One more reason that fund management firms might want to focus now: their network managers, operations managers and technology managers may want to negotiate their fees, services, post-trade workflow procedures and IT requirements with their global custodians before the situation becomes urgent. Having the tough talks now could even turn into a blessing in disguise. If the fund management firm decides it doesn’t like the custodian’s terms it still has time to switch banks before the full range of T2S changes are enacted.
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