The European Central Bank’s TARGET2-Securities (T2S) platform is a significant way towards realising its goal of harmonising securities settlement in the eurozone for central bank money. The platform seeks to reduce the cost of cross-border settlement as markets migrate to the new platform in a series of five waves.

Yet, some in the industry wishing to recover settlement costs have described the second wave migration of markets as “anticlimactic” [Global Custodian, March], given delays by some central securities depositories (CSDs). So, what exactly has the platform delivered so far?

When the European Central Bank began to discuss T2S pricing in 2010, it announced that cross-border settlement within the platform would cost participants 15 euro cents per transaction, plus an additional matching fee of 6 cents, where required. Fees were previously a lot more. “When you start to peel back the layers, cross-border settlement should be cheaper on the T2S platform because the CSDs can be linked together via T2S directly,” says Mike Clarke, Director, Product Management, Global Securities Services at Deutsche Bank. “You no longer have the higher cost of settlement across bilateral links between the CSDs.”

Another difference of T2S is that, in domestic settlement, the CSD that used to provide the full settlement and safekeeping service has now outsourced settlement and matching services to T2S. As a result, CSDs have changed their systems for the most part, by taking away the settlement component, and reducing their settlement fees accordingly. So, the cost of pure settlement is becoming cheaper. “While the settlement cost is not the 15 cents people were expecting, it should still be a reduced settlement fee in the CSD,” says Clarke.

However, the cost of asset servicing in the CSD may increase, since CSDs need to keep the position of record, the links through to registration and various other processes. This requires the CSD to continue to process all of the instruction flows in their systems to build that position of record. As a result, the assets under custody fee may go up.

“For a broker dealer trading flat every day, we’ve seen, and will continue to see, overall fees go down in T2S,” says Clarke. “Given that these clients are focused on back-to-back transactions, and therefore do a lot of settlement, their overall cost will likely fall.” But long-only clients and global custodians, who tend to hold assets for the buy side, are weighted a lot more towards assets under custody than they are towards the settlement volume. “What we may see is the cost model for that client sector changes to such an extent that the external fees rise higher than they have historically been,” says Clarke. “However, until we see full transparency from the CSDs in regards to their pricing schedules, we cannot fully confirm that across the board.

“With asset servicing fees being increased, then depending on how you are balanced between settlement volume and long positions, this can greatly influence whether infrastructure-related fees rise or fall before you get to fees charged by your custodian.”

For some parties, the fee benefits are clear. However, Clarke argues that when looking at cost savings in relation to T2S, parties should not just look at fees. “You have to look at your overall processing costs in the new environment. Just by having a harmonised settlement day, and settlement process at the CSD level, can allow a single operational process rather than multiple different connections.” This should bring a reduction in full time equivalent (FTE) costs.

“Secondly,” says Clarke, “one of the components that became apparent within T2S as it evolved was that institutions could consolidate all of their funding for settlement into a single central bank. So, participants can fund a single account for all T2S markets rather than multiple accounts.”

That way, the overall liquidity need is reduced because money that comes in from a settlement in Germany can automatically be used for a settlement in Italy without having to move cash across locations. This will reduce funding costs in the region.

The harmonisation of the settlement day into an overnight and real-time settlement process complements this liquidity benefit, notes Clarke. In each overnight cycle, an institution’s cash account is only accessed for the net amount they need for what is settling in that cycle. “As a result, the overall amount of liquidity required within that overnight settlement process is reduced,” says Clarke. “We have also seen about 95% of settlement move to this overnight cycle, which has, in turn, reduced the liquidity need over the day during the real-time settlement periods.

“The liquidity benefit means that institutions need less cash or less credit requirement from their agent provider, which, in turn, reduces the amount they need to provision on balance sheet, and this is what liquidity regulations have been driving,” says Clarke.

Another benefit is the real-time links between the CSDs, bringing real-time collateral mobility. Since CSDs have outsourced settlement to T2S, as long as there is a relationship between the CSDs, it’s much easier now for assets to move from a domestic market into a tri-party programme rather than relying on separately bilateral agreed processes between different CSDs. This greater mobility allows clients and counterparties to use a wider range of securities and reduce pressures on higher-grade collateral, leading to cost savings.

“Where the benefits are realised will vary for each client. Choosing the correct post-T2S model is about ensuring the model looks at the full picture, including regulatory needs, FTE reduction and, if necessary, collateral mobility. It’s imperative for institutions to focus on the value-added services needed from their provider,” says Clarke.

“People have to look at their overall business model in order to understand what it is that brings them value from their service providers, and who is best positioned to provide each of their required components. Then it is about understanding how those processes and fee components fit together for the shape of their business.

“Once you understand the value in the services required and understand how that revised engagement model can bring those benefits in the wider European landscape, they can start to quantify those benefits for their organisation,” says Clarke.