While the European Central Bank (ECB) might score top marks for unleashing its Target2 Securities (T2S) concept to unsuspecting droves of bankers last summer, its “back of a cigarette packet” economic analysis behind proposals to build its very own cut-price securities settlement system has appeared very much as a fait à compli to industry.
Commentators even suggested that a “coach and horses” could be driven right through the ECB’s own calculations. Turning up the heat in February, the European Central Securities Depositories Association (ECSDA), a trade association of 42 settlement bodies, wrote a letter to the ECB urging a delay to the T2S project.
Slashing costs
The ECB’s plan – a centralised engine hub built and backed by the eurozone central banks – would potentially slash cross-border settlement costs by around 90 per cent for some 13 European markets of the eurozone. Many industry watchers question the validity of the numbers, have criticised a lack of detail and insufficient market consultation in the ECB’s proposal, plus the hurried approach.
“The T2S feasibility study is insufficient to serve as the basis for a committed decision at this stage,” comments Joël Mérère, ECDSA chairman in the association’s eight-page letter to the ECB.
Mr Mérère adds: “The ECB has been making a growing number of statements relating to the scope, feasibility, budget and pricing for T2S – and even its impact on European GDP – with a degree of firmness and certainty which cannot be justified at such an early stage of the proposal.”
For some it amounts to public authority control of the settlement processing function in euro currency in 13 European national territories.
It also begs the question: should the UK remain outside the eurozone for the next seven to eight years, what impact will the T2S platform (slated for 2013) have on the City of London, given that so many big international banks are located within the ‘Square Mile’? As for certain Nordic territories, there will still be cost implications from having to connect to a new system in order to facilitate cross border securities settlement in euros.
The London Investment Banking Association (Liba) is trying hard to understand what the terms of ECB’s proposal might actually be and what it intends to deliver. Privately its sees potential for “significant” damage as well as good.
One banking ‘industry insider’ familiar with the situation argues: “There are some very serious issues that have not been analysed, which could effectively ‘hobble’ the market.”
“Suddenly to try to nationalise and standardise - effectively forcing everybody through a tiny pipe - with all this complexity and richness…at a time when everyone is going through a rapid stage of product differentiation and all kinds of new requirements, could be extremely costly,” the source says.
A voice of reason has been heard from the Economic Council of Finance Ministers (Ecofin). After reviewing the T2S concept at a meeting in January, Ecofin forthrightly indicated that the ECB should delay its decision for similar reasons put forward by the ECSDA. At a second meeting on 27 February, the finance ministers said they needed from the ECB a more elaborated business case, clear information on how T2S would comply with EU competition policy, the intended governance structure and more to understand what T2S is expected to achieve and exactly how the ECB has arrived at its conclusions.
Pushing back decision
Accordingly, the final decision from the ECB Council is expected to be pushed back to the summer or even later.
In a doomsday scenario for Europe’s central securities depositories (CSDs), another banking analyst says: “What might be left of the CSDs [after T2S in 2013] might be so costly as to be no longer economically viable.”
There is concern that if the settlement ‘piece’ is removed from CSDs, they might be compelled to raise tariffs to their end customers for their other services. And, while there are no CSD consolidation moves on the table presently, one CSD spokesman said T2S could become the “catalyst that sparks further consolidation”.
The ECSDA also suggests that with the objectives of T2S to “promote use” of central money, if T2S proceeded it would rapidly promote a high degree of internalisation and concentration within the books of a smaller number of Europe’s largest local custodian banks.
That the ECDSA asserts would lead to a “migration” of settlement activity to commercial bank money that today (on a domestic basis) is largely in central bank money both for domestic and cross-border transactions.”
The ECDSA’s members, while expressing concern over the governance and legal aspects of the T2S project, highlight a “blurring” of the ECB’s role. “The [ECB] proposal risks a blurring of responsibilities between the accepted role of the ECB as a public authority and its proposal to become a monopoly supplier of IT-infrastructure for CSDs regarding their settlement services to the securities industry,” Mr Mérère states.
While the ECB received written responses from banks and CSDs of 13 national markets, the two international CSDs, two European banking associations (ESBG and EACB), several central counterparties and stock exchanges, many think the ECB wants to ram its decision home irrespective of any concerns raised. Might they have a point?
In a 38-page response to the T2S questionnaire, the Euroclear group commented on the creation of new market inefficiencies arising from the project, said: “Splitting DVP [delivery versus payment] settlement from asset servicing and safekeeping creates a new source of inefficiency.”
“While it is not unusual in CSDs for settlement platforms to be technically distinct from corporate actions platforms, no market operates these platforms under separate governance in different entities…let alone under different legal systems,” adds Pierre Francotte, CEO of Euroclear SA/NV.
That said, while Euroclear broadly agrees ‘conceptually’ with the objectives and principles of T2S - the reduction of cross border settlement costs - they argue a strong case for greater information and study. Like Deutsche Boerse’s Clearstream in Luxembourg, Euroclear is also not able to “reconcile” the purported savings of the project to be used and what benchmark has been used to compare with the existing market initiatives to reduce settlement costs.
Collectively the ICSDs and CSDs make a call for the ECB to engage in substantially more ‘true’ market consultation – in a similar vein to what the European Commission pursued before arriving at its ‘Code of Conduct’ in post trade, which probably saved years over implementing a directive.
In the event of the T2S single platform arriving, each of the CSDs in the eurozone would connect to T2S, as a single access point. The end customer of a CSD would continue to send their instructions to their respective national CSD (for instance, Euroclear France, Clearstream Frankfurt, Italy's Monte
Titoli), rather than processing those settlement instructions on their own systems. The CSDs would then send these instructions to the T2S platform for processing. Results would then be relayed back to the CSDs for additional action.
But T2S will not embrace the services of custody, collateral management and securities lending provided by CSDs. For many CSDs operating on thin margins, providing only these services could put them under financial stress.
The ECB claims that T2S will deliver €300m to €350m per annum in savings as a result of creating a single settlement platform. However, what it does not do is remove any of the existing processing platforms in the CSDs - but adds another. That effectively increases fragmentation.
Loss of synergy
Is it really more efficient to separate the two processing functions: Settlement from everything else? This could lead to a loss of the synergies claimed by the ‘Eurosystem’, the body responsible for implementing T2S for the ECB.
In relation to the Eurosystem’s slashing of settlement costs by 90 per cent, as touted under T2S, is that fact or fiction? Many do not know. Experts would have been scratching collective heads at how an ‘average’ €0.28 (c.$0.36) charge levied on the CSDs by the ECB for settling a euro-denominated cross border securities transaction using T2S was arrived at.
The ECSDA in particular has “deep concerns” at the way in which the ECB has compared its notional average IT processing costs per T2S transaction of 28 euro cents in 2013 with the settlement fee of the CSDs in 2006. The ECB’s assertion that the total investment cost for all the eurozone CSDs combined would be €172m is described by ECDSA as “far too simplistic”.
Yearly savings among the CSDs have been estimated to €85m, a figure that has been based upon the annual reports of the CSDs and the assumption that IT costs can be reduced by 50 per cent. But this ignores fixed operating and overhead costs for the CSDs.
Referencing data on the ECB’s website, this charge does not include CSD connection costs that the CSDs would need to charge their clients for accessing T2S and other charges that the CSDs would need to charge the end investor. (The latter are for the related services they provide before and after the client’s transaction is processed on the T2S platform).
Current cross-border settlement charges within Europe are said to range from about €5 to €20 per transaction, depending on the number of intermediaries involved. At Euroclear Bank, cross-border settlement costs as little as €0.50 per transaction when the two counterparties are both clients of Euroclear Bank.
And, when Euroclear completes its single platform consolidation and market-practice harmonisation programme in 2010, expectations are that cross-border transactions within any Euroclear group markets will cost the same as for domestic trade settlement. At this stage the ICSD does not know what the tariff will be in 2010 nor in 2013.
However, Euroclear expects €300m in annual savings will be delivered upon completion of the 2010 platform consolidation for Euroclear Bank, the ICSD, and its five markets of Belgium, The Netherlands, France, the UK and Ireland. (Hypothetically, if this initiative was stretched across western Europe, the savings figure might be in a range of €700m to €800m, purely as a comparison). Within the €300m p.a. figure is included an estimated €140m to €180m from a reduction in transaction fees due to internalisation (i.e. no need for intermediaries)
Judith Hardt, secretary general of Federation of European Securities Exchanges (FESE) in Brussels, says: “I guess the assumption of the ECB is that there has been a market failure and hence that the public sector should step in. This view might not be universally shared, but many people are making substantial amounts of money due to fragmentation of markets.”
The FESE Secretary General adds: “Right now it’s very difficult to get a clear-cut view on who is right and who is wrong in this debate in what looks very much like a huge re-nationalisation of CSDs.” Fear too of the US DTCC moving into European markets could also be a factor driving behind T2S events.
“There was some momentum for the ECB…but right now it’s stalling a bit,” adds Mrs Hardt. “People have woken up to the fact that they may lose local power, since too many firms are living off market inefficiencies.” And, ultimately she thinks liquidity could be “siphoned out” of certain markets.
