Europe’s Target2Securities: On Target or Not?

Will T2S launch as scheduled?

Nine years after the European Central Bank proposed the initially controversial idea of launching a single centralized settlement platform for domestic and cross-border European securities transactions, the plans to launch might have hit a snag.

It wouldn’t be the first time, but this time it would be at the 11th hour. The reason? No one is talking. In fact, the ECB appears to be  distancing itself from public statements made a member of the T2S board of directors, Paul Bodart, who suggested there is uncertainly as to whether the system called Target2Securities (T2S) will go live on the scheduled date of June 22. The board will decide on May 25 whether the system is ready to go, he said at a May 6 event hosted by the Association for Financial Markets in Europe (AFME).

T2S is the European central bank’s ambitious project to reduce fees for settling domestic and cross-border transactions and make investing across the continent as seamless as investing across the US. First discussed in 2006, T2S has undergone multiple delays in planning and implementation — the latest in 2013, then in 2014 — largely related to governance and technical issues.

At least part of the delay was caused by concerns of central depositories how the impact on their business and revenues if the settlement and depository functions were moved to the T2S platform. The ECB finally managed to get 30 central European depositories on board, but whether or not T2S can deliver on its utopian promises remains to be seen. The anticipated reduction in fees is dependent on volume, and no one knows if sufficient volume can be generated and when.

The European depositories that have signed on to use the T2S system have faced major operational and technical adjustments. They need to decouple their settlement systems from other operating applications, link to T2S, and only hope they can generate enough fees from other asset-servicing activities, namely securities finance and collateral management, to justify the change. Such a scenario puts them in the uncomfortable position of losing home-court advantage over other depositories and even competing directly with their largest members — custodian banks.

The ECB may have thought of this new Darwinian landscape as a means of eliminating laggards and breeding innovation. Securities depositories and custodians having to make massive changes privately might not share the enthusiasm, although they have publicly put on brave faces, insisting they are ready for change. What’s more, implementation of T2S depended on adoption of the recent European legislation requiring them all to harmonize their operating procedures and more importantly set fines and penalties for participants failing to meet a two-day settlement cycle.

Given the complexities, the ECB opted for a multi-phased migration approach so that the largest depositories aren’t connecting to T2S concurrently. June 22 represents the first wave — with Switzerland’s SIX Securities Services, Italy’s Monte Titoli, Malta’s central securities depository, Romania’s central securities depository and Bank of Greece’s settlement system going live on T2S that day.

How Stable is Stable

If one is to believe a report published by Reuters about Bodart’s keynote address at the AFME event, there is some reason for concern. “The situation is still not at the level of stability that the board is expecting. We cannot launch a platform that is not stable enough,” he was cited as saying.

Bodart, who held executive positions with BNY Mellon, including heading the bank’s asset servicing operations in Europe before retirement in 2012, has been active in the T2S initiative since 2007 and a board member since 2012. In his speech at the AFME gathering, he went on to suggest that a delay until September was still possible without affecting the second and third waves of European securities depositories, going live on schedule. However, any postponement past September would put the subsequent timetables in jeopardy. Clearstream’s Frankfurt operations as well as the depositories in the Euroclear family in France, Belgium, the Netherlands, will be among those in the second and third wave.

Despite Bodart’s very public comments, the ECB is playing it close to the vest. An ECB press officer would not elaborate on what Bodart had to say, instead referring FinOps Report to the most recent issue of the ECB’s T2S bulletin. An article by Medhi Manaa, T2S program manager, reports success of a recent “test rehearsal” for the migration weekend in June, but mentions potential remaining obstacles in warning that “the final stage to go-live will require the utmost effort of the Eurosystem and the community.”

There will be two more migration weekend tests before the end of the month, as well as the start of business day testing on May 18. That date is seven days before D-day, the day the board will decide whether the June 22 timetable will go ahead as scheduled.

Business day testing simulates operations with all T2S users. Previous testing for the first wave uses has included included bilateral testing with each central securities depository (CSD) and its country’s central bank, and then multilateral testing where each CSD tests its settlement processes with other CSDs and central banks. In April, each CSD extended its testing activities with other CSDs and central banks to include the CSD’s participants.

Although each testing event has reportedly illuminated minor issues subsequently addressed by T2S or the participants, there is no public evidence of any problem substantial enough to hold up the launch. One industry source involved in the testing tells FinOps that there was no problem linking any depository to the T2S platform. “There has been some talk about potential problems with the actually settlement– the exchange of cash and securities on the part of T2S itself,” he says.

No News is Good News 

When asked, depositories scheduled for the June launch gave no indication they expect a postponement. A spokesman for Malta’s depository says, “We are going ahead with our plans for a June 22 launch.”  A spokesman for SIX Securities Services says, “ECB has clarified its position and as far as we’re concerned, it is business as usual for us and our clients.” Michalis Michalopoulos, member of the T2S and director of government financial operations and accounts for the Bank of Greece, emailed FinOps Report that “no delay has been communicated.”

The London Stock Exchange, parent of Italy’s Monte Titoli, and SWIFT, one of the two network providers, selected by the ECB to connect depositories to T2S, wouldn’t discuss the matter. Romania’s central depository did not respond to an email seeking comment.

Regardless of whether the launch is delayed, there is no doubt plenty of nail-biting happening right now. The combination of big infrastructure technology, dedicated communications links, specialized message formats, and do-or-die performance requirements with regulatory and legal liabilities attached add up to a launch date that may become a floating point, especially for the first wave of participants.

Embarrassing as a launch postponement might be, especially after all the previous delays, it’s clearly preferable to an international settlement platform that almost works.