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WHITE PAPERMigration to the ‘TARGET2 - Securities’ (T2S) PlatformForeground: August 2013

The year 2012 saw 23 Central Securities Depositories (CSDs) in Europe signing up to join the T2S platform. With this the T2S project has moved from concept to reality.

T2S is conceived as a centralised settlement engine for the CSDs. It is expected to provide an efficient automated platform to European CSDs for clearing and settlement of all securities within the respective countries and across borders. This is expected to provide a competitive market to the participants with many benefits including price transparency and reduced settlement costs. T2S migration is expected to take place in four distinct waves between 2015 and 2017 to ensure a smooth transition.

Some of the achievements and milestones crossed are:

• Setting up of a governing structure

• Signing of the framework agreement with 23 CSDs

• Finalising of the network service providers

• Development of the core T2S system, which is ready for the testing phase

• Denmark National bank’s signing up to allow settlement of securities in Danish Krone to usher in multi-currency settlement possibilities

In parallel, other initiatives are underway to strengthen the project, including:

• Comprehensive CSD regulation to harmonise the business across countries in the EU region

• Integration of Target2*1 with T2S

• Integration of CCBM*2 with T2S

*1 RTGS system for common payment and settlement infrastructure, a forerunner of T2S.

*2 Correspondent Central Banking Model: Single platform for domestic and cross border collateral management

This paper looks at the T2S project from the perspective of what is required to ensure a smooth transition in the following order:

• The rationale of T2S

• Building blocks

• The T2S process

• Benefits of T2S

• Questions and Challenges

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Rationale of T2S

Eurozone, the economic and monetary union (EMU) of the member states of the European Union, has been initiating various measures to unify the market place. In parallel, consolidation at the exchange level and mergers between CSDs have taken place. However, cross border transaction costs have continued to be high. Cost escalation can be attributed to disparities existing within various market places in the Eurozone. These can be clubbed under legal, fiscal and technical areas. Such disparities have become obstacles for a single competitive European market.

Steps to address these issues include Target2 and CCBM and finally T2S.

T2S will offer real-time Delivery versus Payment (DvP) settlement across borders, being one of the largest infrastructure projects launched by the Eurosystem so far. This provides a single pan-European platform for securities settlement in central bank money.

There will be a single interface between CSDs and T2S for settlement of cash and securities through an integrated single IT platform. T2S participants can continue to have their securities account with one or more CSDs and a dedicated cash account with their nationalised central bank. The dedicated cash account will be used for T2S settlement. This cash account will be again linked to the participant’s cash account with TARGET2 or any other non-euro central bank account. Thus, T2S provides an integrated model for settlement.

While trading is attractive, the not so glamorous settlement process is the more expensive side of the market place and so provides more scope for savings. One of the expected benefits of T2S is cost reduction for cross border settlement. T2S aims to bring down cross border transaction costs many fold. While cost reduction had been the initial goal, over a period of time, other benefits have been identified. These are discussed later in this case study.

In comparison to the US market the EU settlement landscape is highly fragmented. T2S aims at reducing the layers and making the settlement process simpler, efficient &cost effective.

European market: Current Settlement landscape

Source: ECB

UNITED STATESEUROPE

NYSEBMEGroup

DeutscheBorse

MTFs c.g.Chi.x / Turquoise LUSE

NaadaqOMX

NordleNasdaq

NSCCEMCFEurexClearing

lberclear

Clear-stream

BankingFrankfurt

Clear-stream

BankingLuxemb

VP InterBolsaCSD

NCBxSNB

... ... ...

LCH. Clearnet SALCH.

Clearnet Ltd.

Euro-CCPClearing

Cashsettlement

Securities Settlement and Asset Servicing

Trading

DTCCSISEuroclear

BE FI FR NL SEUK&IE

MonteTitoli

FED

FICC

MTFs e.gBATS

Euro-Next

PT. BE,FR. NL

LondonStock

ExchangeBorsa

ItalianaSIX

Group

Cassa DiComp

SIX.xClear

Target2

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European market: Proposed settlement landscape

Source: ECB

T2S, along with TARGET2, is expected to integrate the European market and make Europe a better place to invest.

Building Blocks

Ahead of T2S and in parallel many measures were undertaken to make this integration a reality:

• Harmonisation of practices, legislation and regulations across the European Union

• Introduction of the European Market Infrastructure Regulation (EMIR) to regulate OTC derivatives, central counterparties and trade repositories, as part of the worldwide effort to reduce counterparty risk and operational risk

• Review of the Securities Law Directive and the Central Securities Regulation by the European Commission to address the legal differences

• Review of the “Code of Conduct for Clearing & Settlement” by Exchanges, CSDs and CCPs

The T2S project covers entire Europe – both the Eurozone as well as other European nations. Thus, the project is envisaged as a multi-currency settlement platform.

T2S is expected to eliminate many of the “Giovannini barriers” relating to market-practices, legal issues and tax procedures. The settlement platform offers centralised processing of settlements cutting out multiple CSDs and Banks interacting with each other.

The T2S Process

In the T2S environment, CSDs will eventually cease to maintain systems of their own. This move is expected to be gradual. In the initial stages, CSDs will continue to maintain their own systems, simultaneously utilizing the services of T2S for the cross border settlements and subsequently for domestic settlement as well.

The Future Landscape with T2S

One integrated settlement process(domestic and cross-border)

One technical platform used byCSDs for securites settlement

Market Participants

dire

ct a

cces

s

Custodians

TARGET2-Securities

CSD A CSD B CSD C CSD x

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CSDs T2S

Maintain client security position in T2S. Each client account in T2S will be linked to a CSD

Legal relationship with client (participants) Legal relationship with CSDs

Provide core depository services including Maintain dedicated central bank money accountcorporate action for the participants

Handle national requirements such as taxation, Provide DvP settlement irrespective of which CSDregistration and regulatory reporting or National Central Bank is involved in the settlement process

Provide for direct or indirect connectivity to their Provide for connectivity to CSDs to transmit theirclients to input settlement instructions to T2S settlement instructions and receive reports

Some interesting winning features of T2S are:

• Real time gross settlement in central bank money

• Optimized gross settlement – sophisticated algorithms to achieve DvP while providing for netting benefits

• Auto collateralization

• Liquidity optimization

• Real time link between market participants’ T2S dedicated cash account with its main RTGS cash account(s) outside T2S at the central bank

• Direct connectivity for participants as an option

Birds-eye view of T2S

T2S

Optimisationof

settlement

Settlementand

realignment

CSD A accounts

Securities

CSD A

CSD B

CSD C

NCB A

NCB B

NCB C

Validation and matching

CSD B accounts

CSD C accounts

NCB A accounts

NCB B accounts

NCB C accounts

Source: ECB

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Benefits of T2S

The harmonisation of settlement through a single platform is expected to yield many benefits:

• Reduced settlement cost

• Significant benefits through efficient collateral management – CCBM

• Consolidation of back office operations leading to straight through processing possibilities

• Competition leading to gains in pricing and service quality

• Reduced counter party and settlement agency risk

• Standardisation of processes leading to: - Improve trading activity - Enhance liquidity, leading to lower cost

• Increased efficiency in collateral management – freeing up capital for better deployment

• Increased liquidity leading to: - Larger pool of investors - Better capital raising programs

Addressing these challenges including a successful migration of the CSDs will be crucial to T2S fulfilling its goal.

Percentage of volumes migrating to T2S

1009080 4 WAVE

3 WAVE

70605040302010

0

22/0

6/20

15

28/0

3/20

16

12/0

9/20

16

06/0

2/20

17

Source: ECB

Questions and Challenges

The huge transition that would take place, when the CSDs move their accounts to T2S and fully outsource their infrastructure needs, would pose some interesting questions, situations and challenges.

• How will CSDs amortise the cost of the new infrastructure and transition the domestic settlements into T2S? While the ultimate goal is to move all business to T2S, there will be an intermittent phase when the CSD will run parallel infrastructure. This means a spike in costs initially, which would be absorbed over a period of time when the old systems are retired

• Some shakeups would be seen with smaller entities merging with larger ones and diversifying as a way to remain competitive

• The United Kingdom and Norway have not joined the program. The projected cost-benefit is based on volume assumptions. Any decline in the actual business flow could impact the cost benefit proposition

• With the onset of large technology changes, it is imperative that the systems and interfaces are meticulously tested to avoid glitches that could reverberate across the European Union

T2S Finale

T2S Finale is on the last leg of its journey to integrate European Market’s development of core functions. A majority of the non-core functions have also been completed. With this the crucial phase of testing and migration has commenced. Testing of the system i.e., functional testing is nearing completion and end to end testing is in progress for core functions.

The next part of the final phase will be user testing across the market and preparatory work for this has already commenced. All actors have a crucial role to play in this i.e., CSDs, Banks, Participants and T2S itself. As this is a mega project, these entities will require the support of resources experienced in Testing and Migration activities.

Migration phase itself is planned in waves to avoid market disruption. There will be in all four waves with the first wave commencing in 2015 and the final completion by 2017, with target dates clearly stated.

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General Principles of T2S

Principle 1: The Eurosystem shall take on responsibility for developing and operating T2S by assuming full ownership.

Principle 2: T2S shall be based on the TARGET2 platform and will therefore provide the same levels of availability, resilience, recovery time and security as TARGET2.

Principle 3: T2S shall not involve the setting-up and operation of a CSD, but instead will serve only as a technical platform for providing settlement services to CSDs.

Principle 4: The respective CSD user’s securities accounts shall remain legally attributed to the CSD.

Principle 5: The T2S settlement service will allow CSDs to offer their participants at least the same level of settlement functionality and coverage of assets in a harmonised way.

Principle 6: Securities account balances shall only be changed in T2S.

Principle 7: T2S shall require participating CSDs to be designated under the Settlement Finality Directive (SFD).

Principle 8: T2S shall settle exclusively in central bank money.

Principle 9: The primary focus of T2S shall be settlement services in euro.

Principle 10: T2S shall be technically capable of settling in currencies other than the euro.

Principle 11: T2S shall allow users to have direct connectivity to its platform.

Principle 12: The participation of CSDs in T2S shall not be mandatory.

Principle 13: All CSDs settling in euro central bank money shall be eligible to participate in T2S.

Principle 14: All CSDs connecting to T2S shall have equal access conditions.

Principle 15: All CSDs connecting to T2S shall do so under a harmonised contractual arrangement.

Principle 16: All CSDs connecting to T2S shall have the same calender of opening days and harmonised opening and closing times.

Principle 17: T2S settlement rules and procedures shall be common to all participating CSDs.

Principle 18: T2S shall operate on a full cost-recovery and not-for profit basis.

Principle 19: T2S services shall be compatible with the principles of the European Code of Conduct for Cleaning and Settlement.

Principle 20: T2S shall support the participating CSDs in complying with oversight, regulatory and supervisory requirements.