Target2 will bring more than a single platform for the real-time gross settlement systems in the EU, it will add enhanced euro liquidity management services for euro payments, reports Frances Maguire.
In May 2008, the Eurosystem’s Target2 will replace the decentralised technical structure of the current Target system with a single technical platform, and a single pricing structure for domestic and cross-border payments in Europe.
Phased implementation will begin in November 2007 and Target2 will provide cash settlement services in central bank money for all kinds of ancillary systems, including retail payment systems, large-value payment systems, foreign exchange settlement systems, money market systems, clearing houses and securities settlement systems, as well as for the commercial banks.
However, Target2 will go further than just replacing the current infrastructure. A number of enhanced liquidity management services, such as prioritisation of payments, liquidity reservation, definition of sender limits and active queue management are being built into the system.
Jean-Michel Godeffroy, director, general payment systems and market infrastructure, at the European Central Bank (ECB), says: “The current Target system is, on the one hand, a success in so far as it has become the standard for processing large-value payments in euros. The system supports the implementation of the single monetary policy of the ECB and has greatly contributed to the reduction of systemic risk in payments systems due to the processing of very high value payments in real-time in central bank money.
“On the other hand, the system has a number of shortcomings, mainly related to its decentralised technical architecture, which the Eurosystem intends to overcome with Target2. In particular, with Target2, we will provide a harmonised level of service at a single price structure to the Target participants, independent of the country in which they are located. Target2 will also meet new demands from users, for example in terms of an efficient management of liquidity. Last but not least, due to the implementation of a common technical platform, Target2 will benefit from economies of scale and will cut costs for the Eurosystem and Target users.”
Direct participants will be able to submit and receive payments on their own behalf or on behalf of other institutions via the payment interface. There will be three different payment priorities and it will be possible for participants to reserve liquidity for urgent and highly urgent payments, as well as to dedicate liquidity for the settlement of ancillary systems. Participants will also be able to define bilateral and multilateral sender limits, and actively manage their payment queues (for example, by changing the priority or the order of queued transactions).
Timed transactions
Also, Target2 will take into account the increased time-criticality of payments, particularly in the context of continuous linked settlement (CLS), by making it possible to submit timed transactions. It will also enable better pooling of intraday liquidity, by allowing eurozone participants to group individual real-time gross settlement (RTGS) accounts held with different eurozone central banks and pool the available intraday liquidity for the benefit of all members of the group of accounts. Each member can then make payments from its own account up to the sum of available intraday liquidity on the accounts in the group.
Unlike the current operational day for Target, Target2 will start the new business day in the evening of the previous day. The night-time window will enable the overnight settlement of the different ancillary systems in central bank money with finality, and will support cross-system settlement during the night. The ECB believes that the night-time window will generally increase the efficiency of night-time settlement and will favour initiatives such as cross-system delivery versus payment.
Overnight settlement will have no impact on users because there will be adequate technical and operational tools available in Target2 and the ancillary systems to run night-time settlement smoothly without involving banks’ liquidity managers. Banks can choose whether or not they want to participate in overnight settlement and the Eurosystem may implement restrictions on night-time settlement through operational procedures at a later stage.
“Due to the new functionalities that Target2 will offer, in terms of real-time information services and liquidity management, major players will probably reassess the internal organisation of their payments business to make the best use of Target2,” says Mr Godeffroy.
Infrastructure adaptation
The commercial banks that are directly connected to the current Target system will need to adapt their internal infrastructures to the specifications of Target2. It will help that in almost all countries participating in Target, the banks are already using Swift to connect to the system via their national central banks. But banks will have to undergo intensive testing activities by the end of next year and are most likely to migrate to SwiftNet Phase 2 at the same time.
Pierre Etienne, head of treasury and liquidity forecasting at BNP Paribas, says that, although the bank is having to upgrade its payment systems and reorganise liquidity management in the short-term, the single system will mean lower billing in the longer term. “At present, there are 16 different systems in terms of liquidity aspects and processing and a set of functionalities in each local system. Tomorrow, we will have only one system and an amortisation of all those functionalities,” he says.
“While Target is a real-time payment system, it is also the link between a commercial bank and its central bank so when you process the end of the day reserve management or make a cash withdrawal, this is still done on local basis. With one system, all these local processes, procedures, regulations and infrastructures will have to be harmonised by the national central banks.”
Access points
Today, part of the liquidity is in each system within Target. BNP Paribas has about 20 direct access points in 10 countries. In Target2, the banks will have several options. They can keep these direct access points or centralise their liquidity and save some liquidity by netting payments.
A third option that is being proposed is to have a group of accounts so that multi-country banks can keep the account but merge, on a real-time basis, all the positions in those accounts. Mr Etienne says: “This option will also optimise the liquidity we have in the system. We think that this option will free up some cash liquidity for banks.”
However, because of phased migration, BNP Paribas will have to build an intermediary solution. Then, there is a four-year transition period for the central banks in order that ancillary systems do not all migrate at the same time. “If anything, this is harder because the commercial banks cannot anticipate when the central banks will move. Such a long transition period could actually be more of a problem than a solution for multi-country commercial banks,” says Mr Etienne.
Lining up to receive
The challenge for banks is to reorganise their euro liquidity management infrastructures to take advantage of the new features in Target2, as part of a larger restructuring because Target2 will not simply replace the current system, but will offer banks the opportunity to manage euro liquidity more efficiently.
Martine Brachet, head of interbank relationships at Société Générale Group, believes one of the greatest benefits of Target2 is the intraday liquidity pooling facility. “Euro liquidity will be managed on a single virtual account instead of separate independent pots of liquidity within the eurozone,” she says. “The SG Euro treasurer will benefit from a fully consolidated vision of its liquidity within Target2 and from a liquidity transfer facility to move liquidity between the different SG Group RTGS accounts and home accounts. These new facilities will help banks to save their euro intraday liquidity.”
Target2 participants will benefit from consolidated account information, and access to real-time online information and liquidity control measures. Urgent messages, such as system broadcasts from central banks and warnings concerning timed payments, will be displayed automatically on screen. Direct participants will be responsible for their own liquidity management and able to provide a link for other institutions to connect as indirect participants, offering them additional services.
Alignment opportunity
Christian Westerhaus, head of payments strategy and infrastructures at Deutsche Bank in Frankfurt, believes that Target2 is an opportunity to align internal processes. “Target2 gives multi-country banks the opportunity they need for process harmonisation and centralisation in the individual payment business in the euro area. The clear aim is to have only one point for investing, one point for maintaining systems and directories and one intraday liquidity position,” he says.
However, Mr Westerhaus is also keenly aware of the complexity that this poses and what can realistically be achieved in the time left. “The outlined alternatives for the connectivity of entities show that there are different degrees of centralisation,” he says. “With each alternative, additional benefits can be gained but with each alternative, complexity increases, as does project risk. These complexities have to be managed for a variety of countries within a very short time and in parallel to Sepa [Single Euro Payments Area]. This is the challenge for the Target2 project of each multi-country bank.”
It is estimated that about 22 national central banks will participate in Target2 by the end of the transition period – that includes the 10 countries that joined the EU in 2004. The move from interlinking domestic systems to having a single system will greatly affect the way commercial banks operate. But only if they reorganise their payment and liquidity operations will they get the full benefit of the new features.
