Europe’s post trading landscape is about to experience a dramatic change this year with the introduction of Target 2 Securities (T2S), the result of greater regulatory pressures on collateral management. The initiative aims to reform the post-trading industry
by providing a single pan-European platform for securities settlements in European Central Bank (ECB) money.
The first phase of T2S will go live in June 2015 and will be the first step towards establishing a fully integrated capital market without international borders. In this reformed market, it is envisaged that T2S will bring a reduction in settlement times,
costs and credit risk. T2S should also improve collateralisation practices, allowing banks to centralise collateral assets into a single pool; reducing the need for multiple funding accounts. This should help collateral managers have a more holistic view on
where collateral is held and improve liquidity levels.
The approach to the settlement of transactions remains disparate across clearers. T2S will seek to increase netting efficiency, but the netting of trades is often conducted at a legal level and we will have to wait to see whether T2S will help counterparties
refine their netting agreements with custodians and clearers. For example we are already seeing LCH Clearnet working with the Italian CSD and T2S to eliminate bond shaping.
The challenge for T2S is whether these benefits can be maximised while attempting to overcome the barriers that have traditionally prevented efficient cross border securities trading.
The ECB identified 15 specific barriers which exist between the different EU countries. They relate to tax, legal and technical jurisdictions and are known as the ‘Giovannini barriers’. T2S has been introduced to help reduce these barriers.
Although not directly related to the ‘Giovannini barriers’, repo tracking is another area that could present challenges. T2S does not recognise the ‘near’ and ‘far’ leg of a repo trade, and repo tracking will not be available on the platform. The onus will
lie with the CSDs / ICSDs / participants to recognise when the transaction is part of a repo trade and perform the full manufacturing process involved in settling the transaction.
It remains to be seen whether CSDs / ICSDs and T2S will develop a single harmonised approach that ensures a consistent treatment of repo transactions across all markets.
The objectives of T2S have been well received and are widely supported across the industry. However, the practicalities of achieving greater harmonisation will remain challenging. It is one thing to get participants to comply with settlement requirements
within T2S – but more difficult to overcome the tax and registration challenges for different countries as this requires new political laws being passed.
I expect the first phase of this year’s introduction to be a cautious affair and the integration of the Italian market with T2S will inform the industry of any potential teething issues. The impact of T2S will be more significant in 2016 with the introduction
of larger markets to the platform. We will then be better placed to evaluate the initial success of T2S in its aim of harmonising post trading activities.
T2S will not immediately eliminate the barriers that currently exist. What we can say with confidence is that T2S will start to enable the difficult and challenging process of reducing and eventually eliminating these barriers.