Target2-Securities, the European Central Bank’s controversial proposal to build a single settlement platform for euro-based securities, would split settlement from custody. Do the proposals go too far or not far enough, asks Frances Maguire.
Target2-Securities would make use of, or link with, the Eurosystem Target2 platform, which goes live next November, to settle the cash legs of securities transactions and provide a single platform for central bank money settlement, for all euro-denominated securities and for all central securities depositaries (CSDs) in the euro area. According to the European Central Bank (ECB), safety of the settlement of euro-denominated securities would be maximised by using the delivery versus payment mechanism, and efficiency maximised by settling cash and securities on the same IT platform.
Unlike the US Fedwire-Securities system, which acts as a fully fledged CSD for government securities, Target2-Securities would not be a CSD but only a settlement platform. The Eurosystem has no intention of dealing with issuers or managing corporate events. Neither does it intend to open securities accounts for the users. All custody activity would remain with the local CSDs, but the CSDs would no longer have to maintain settlement links between them.
Settlement efficiency
One CSD, Clearstream, has reservations about what exactly this means for euro settlement in commercial bank money taking place at international CSDs (ICSDs) in any CSD euro-denominated security.
Katja Rosenkranz, director, product management, custody, clearing and connectivity, at Clearstream, says: “Target2-Securities could improve the efficiency of securities settlement cross border if the ECB manages to harmonise the lifecycle management of settlement instructions across Europe and the finality of securities settlement. It could result in a level playing field for access to central bank money liquidity for all CSDs and could be the nucleus for opening up a fragmented landscape to competition.”
But Paul Symons, head of public affairs at Euroclear, says that there is need for further consultation as early as possible, and as openly as possible. “There is still uncertainty about precisely what Target2-Securities is, how it will work and how many functions it will take away from the settlement systems that exist today,” he says. “Will it end up just doing settlement – purely the transfer of stock against cash for the eurozone – or will it also do a lot of the custody and asset servicing? If it were developed in the way it is currently being portrayed, it would be a unique model among global securities settlement systems. Settlement systems and their users thrive on the economies of scale and scope they get by combining settlement activity with all the asset servicing. That is why all the CSDs do both activities.”
Burden of proof
Mr Symons believes that the burden of proof is on the ECB to demonstrate why this separation of functions is more efficient and more cost effective than the way in which settlement systems have developed in Europe, and globally, over the past 30 years.
Ms Rosenkranz goes further, saying that cost reductions for end users can only be achieved if CSDs are able to reduce their processing cost. “Splitting settlement from the rest of CSDs processes may lead to additional operational complexity,” she says.
ECB director general, payment systems and market infrastructure, Jean-Michel Godeffroy outlined the reasoning behind the proposals at the British Bankers Association in September. He said the feasibility study, which will be completed by the end of February, was exploring the possibility of separating settlement from custody. “For the moment, the answer depends on the reaction of the respondent vis à vis the project. Those who are in favour say that it is possible and easy. Those who are against tell us that it would be very complicated and costly. We will review this question carefully in the coming months. Looking at the strength of the arguments so far presented, I do not expect any ‘show-stoppers’ in this field,” he said.
Scope unknown
Mr Symons also wants to know whether, if the system is mandatory for CSDs, it will also cover systems such as Crest, which is outside the eurozone but settles in euros, in central bank money, across the books of the Bank of England. Similarly, the settlement system in Sweden and Finland settles in an out-currency (non-euro) and an in-currency (euro). Is this going to be permitted in the new Target2-Securities system? “These are important issues for the CSDs and the market to understand,” says Mr Symons. “The danger is that Target2-Securities could increase fragmentation rather than reduce it. By just doing settlement, it creates an additional settlement system in Europe, and another infrastructure, and we think that could add to inefficiency, fragmentation, and cost.”
According to Mr Godeffroy, this is a tricky question that he said he hoped would become irrelevant before it is answered. “If the answer is ‘mandatory’, we will be accused of imposing our solution against the market’s will. If we answer ‘optional’, we open the door to intermediaries’ efforts to maintain arrangements that are sub-optimal for the market but serve better their specific interests. If our project makes sense, I cannot imagine that a CSD could act against the interests of its users, especially if that CSD is user-driven,” he said.
Euroclear’s Single Settlement Engine is already live in Crest and the French market, and will go live in Euroclear Bank before the end of the year. Belgium and the Netherlands will join France on the Single Settlement Engine at the end of 2007, when Euroclear migrates the three Euronext markets on to a single processing solution. In 2009, the Single Platform will be fully introduced to cover all of Euroclear’s markets for custody, collateral management and securities lending activity.
While there is so much uncertainty around Target2-Securities, it is business as usual at Euroclear. But Mr Symons believes there is some concern in the market about the future progress of Europe’s market-practice harmonisation initiatives in view of the uncertainty introduced by the ECB’s Target2-Securities proposal.
Banks go further
For the banks, it seems, the proposals cannot go far enough and they are reported to be putting pressure on the ECB to ensure that duplication is cut down through informal consultation.
According to Mr Godeffroy, the ECB would have preferred to limit the scope of the project to daylight settlement, possibly only for government bonds or assets eligible for the Eurosystem credit operations. “However, preliminary feedback from the market is very clear: banks have no intention of financing the Target2-Securities platform on top of the existing platforms,” he said. “They expect this platform to eliminate the need for any other settlement platform for securities transactions denominated in euros at the CSD level. That is why, if the project materialises, it is likely to cover all euro-denominated securities, for both daylight and night settlement.”
Diana Chan, managing director of Citigroup Global Transaction Services, says that the ultimate efficiency model is a single infrastructure for the EU and that the more the securities settlement platform can encompass, the better it will serve as the basis for consolidation.
“Target2-Securities will initially concentrate on the 12 euro markets with the ECB acting as an umbrella for harmonisation,” she says. “This is a good starting point from which to evolve and it will hopefully provide a catalyst for further consolidation. CSDs have a valuable role to play as long as each market involves different procedures in asset servicing, but Target2-Securities is an excellent opportunity for the market and a first step towards more consolidation and integration.”
Diana Dijmarescu, regional head of securities markets issues at JPMorgan Treasury & Securities Services, says the initial announcement could be a good idea and has potential, provided that a number of very serious issues are addressed. “Are we just talking about a settlement system that would be dedicated strictly to euro-denominated government bonds or only to instruments currently being used in the operations of the Eurosystem; or are we talking about a wider range of instruments, about equities, about all types of instruments that are settling today in the eurozone domestic CSDs?” she asks.
“In terms of services, is it just settlement or more than that? Is this just a first step in a longer-term project that would aim at, ideally, progressing the ultimate consolidation in the European space and indeed replacing the domestic CSDs with a single European CSD?”
Beyond the remit
Ms Dijmarescu believes that the ECB should consider beyond its remit of just the single currency, ideally at an EU level. She believes a single settlement system for Europe that omits the other non-euro currencies of the EU member states, especially sterling, would simply lead to a different kind of fragmentation instead of grasping a real opportunity to progress the process of consolidation in Europe.
“A wider scope would make the project more attractive,” she says. “Today, the post-trading problems in Europe are the fragmentation, the high costs and the barriers that prevent the operation of a single market. If the project was able to deliver more consolidation, and progress the removal of the Giovannini barriers by engaging all the markets, we would be very supportive. But the question is: will the ECB project deliver this, as opposed to creating more fragmentation?”
Crucial time
The next months are crucial: the ECB’s governing council will decide whether or not to proceed with the project based on the results of the feasibility study, and will then begin a formal consultation with the market on the detail. If the project does go ahead, the larger CSDs would lose part of their business while the smaller ones would gain from the economies of scale. The idea of sending transactions via the CSDs to Target2-Securities for settlement has already been ruled out due to the lack of technical justification for such a detour.
As far as the ECB is concerned, the market will benefit from economies of scale, without any meaningful reduction of competition, which will continue to exist between settlement in central bank money and settlement in commercial bank money, and the project will only go ahead if a substantial reduction of settlement fees, both cross-border and domestic, can be achieved.
