The best of T2S is yet to come

Nearly eight years have passed since TARGET2-Securities (T2S) initially went live with the first set of central securities depositories (CSDs) being onboarded. The overall vision of T2S was nothing less than to revolutionise securities settlement in Europe: reduction of cross-border securities settlement costs and risk, increase in competition among providers of post-trade services in Europe, streamlining of the use of liquidity through single settlement accounts, and increase of financial stability by using central bank money for transactions on the platform.

A couple of years later, reality shows that some expectations were partially too optimistic and not all goals have been fully achieved. The level of cross-CSD settlements compared to total settlements by volume has remained low between 2018 and 2022, increasing from 0.67% of all transactions in 2018 to 1.25% in 2022.

Potential for further efficiencies

The main sources of post-trade inefficiencies can be categorised in three areas: operations, funding and capital. In an everchanging macro-environment and the seemingly entry to a new monetary era, these areas are increasingly challenged by a high interest rate environment, collateral scarcity and ever-increasing regulatory scrutiny of capital and risk management. In 2021, the average daily value of unsettled transactions was at €26 billion. The interest rates for ECB overnight credit rose from 0.25% to 3.75% between March 2022 and March 2023. The interest rate increase leads to an increase in T2S market-wide borrowing costs from €65 million to €910 million. This corresponds to an aggregate cost rise of ~€300 million per 1% increase in interest rate solely for end-of-day activity.

T2S had quite a rocky start with lower volumes and longer implementation than originally projected which meant fees had to be increased in 2019. Since then, we've seen a significant increase in volume driven largely by market activity (44% increase from 2017 to 2022), but unfortunately, we do not yet see a corresponding fee reduction that T2S is able to pass back to customers. T2S is a platform at the centre of market efficiency, which consequently needs to be aware and proactive in providing cost-efficient settlement.

We see an increasingly pressuring monetary policy environment being met by a more prepared than expected banking sector. The Basel Committee on Banking Supervision (BCBS) reports major improvements in bank liquidity risk profiles and capital reserves since 2008 as a milestone in building the resilience of the global banking system. However, a long period of low interest rates allowed debt to build across household and corporate sectors and, in a high interest rate environment, borrowers are facing significant increases in their debt service obligations. Widespread repricing of assets may also create risks for the banking sector. ?

Given the potential for inter-operability that T2S promises to offer, centralising access to T2S via one CSD can impact the profit and loss of market participants through pooled settlement, reduced intraday liquidity requirements, balance sheet netting, use of central bank money and of course simplified operations.

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Changes needed to fully leverage the benefits of T2S

There is a variety of reasons that are keeping market participants from shaping their processes towards adopting the advantages envisioned by T2S, e. g. by adopting the investor CSD model, such as:

·????????Unrealised potential regarding the benefits of adaptations. If a CSD allows its customers to hold securities of another issuer CSD in its books, the CSD acts as an investor CSD. The investor CSD enables its participants and connected clients to access securities other than those for which it itself performs the notary function (i.e. the issuer CSD). This is exacerbated by the fact that in many financial companies, settlement is purely considered an operational activity.

·????????Operational issues and cost considerations complicating the implementation by clients into their operating model and IT infrastructure.

·????????Structural issues of T2S and incomplete adoption of the T2S functionality by CSDs, market participants and service providers which limit the realisation of potential benefits.

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A centralised settlement setup with an investor CSD can provide optimal benefit to a client when all or at least most of the traded securities are available for custody via the investor CSD.

What Clearstream offers to support the market

As the CSD covering over 50% of T2S volumes already, we found our German hub, combined with our extensive link network, to be the natural home for a centralised T2S access and central bank money solution. Since the launch of T2S, Clearstream’s German CSD has established links to 13 T2S CSDs with more links coming up, as well as connections to multiple CCPs and trading venues, to ensure that market participants gain as much efficiency from their T2S as possible.

Moreover, with the SEC recently deciding to move to the T+1 standard settlement cycle in the US in 2024, discussions about such a move in European markets have started as well. Such a shortening of settlement cycles could not only reduce the risk and cost associated with the process but also align European markets with other global markets such as the US, India or China. We agree with market associations that the shortening of settlement cycles would not only put immense pressure on post-trade operations, potentially increasing the risk of settlement fails, but would also require collective industry effort and a broader harmonisation across markets.

Being linked to the domestic CSDs within T2S, Clearstream’s German CSD and its Luxembourg CSD, LuxCSD, are also well positioned to provide a full service for clients upon the launch of the Eurosystem Collateral Management System (ECMS), where we have partnered with Vermeg for a fully-fledged STP collateral management solution. Last but not least, data is a valuable lever that market infrastructures can use to provide added value to their participants, be it through predictive analytics such as our Settlement Prediction Tool and Insights Dashboard or as the golden source for key efficiency information.

Post-trade is quickly becoming a strategic pillar for any market participant, through regulation and an ever-stronger requirement for value creation. We at Clearstream are proud to be at the centre of this innovative process and are looking forward to forming strong partnerships along the way.

For the full article, please go to the Clearstream website.