Published on October 14, 2014
1. CAPITAL MARKETS ACH EVE MORE WHITE PAPER GETTING READY FOR TARGET2-SECURITIES (T2S): THE TIME IS NOW Tim Garnons-Williams senior business analyst SunGard’s Stream Securities
2. Getting ready for TARGET2-Securities (T2S): the time is now TARGET2-Securities (T2S) is a new European securities settlement engine which aims to offer centralized delivery-versus- payment (DvP) settlement in central bank funds across all European securities markets. Launching in four phases starting in 2015, it is part of a broader initiative to facilitate cross-border trading by reducing the cost of investing in European securities, particularly for participants not domiciled in the country of the securities. Focusing more on the speed of settlement than the method by which trades are settled, T2S will introduce significant changes in terms of the pace of settlement and funding. Agreement on trade details will need to take place at the latest early on T+1 in order for participants to communicate with their settlement agents in time for them to enter the settlement instructions into the T2S system on the evening of T+1. Because clients can be anywhere in the world, funding must be arranged quicker as well. Together with this initiative are other European infrastructure projects, such as the move from a T+3 settlement cycle to T+2 (excluding Germany, which has used T+2 for some years now), and the implementation of synchronization penalties for failing to settle on time. Central securities depositories (CSD), custodians and participants each have unique roles to play in T2S, bringing with them specific needs, impacts and challenges. Now is the time for all these organizations to evaluate their options for T2S, make decisions on participation and service offerings, and implement required technology changes and solutions to address the new settlement environment. 2 Getting ready for TARGET2-Securities (T2S): The time is now The CSDs and global custodians view T2S as an opportunity to offer non-domestic instrument settlements to their participants, as well as differentiate themselves with add-on services such as corporate actions, stock borrowing and collateral management. In the past, they have developed relationships amongst each other to provide such services, opening up the ability to have pool accounts in another CSD. However, the major problem had been offering a DvP solution for transfers between participants in the different CSDs. T2S essentially resolves this issue. Meanwhile, sell-side firms are approaching T2S with caution, as they await clarity on the services that will be available to them and evaluate the cost-benefits of making changes. The size of the organization and in particular, the number of markets in which it participates in directly as a member, will influence its decision-making, particularly about whether to join T2S directly or use its existing agent to handle the necessary communications. Although only the very big players will join directly, T2S will force the major players to go through a deep review of all their back offices, their services, and the models for the services they offer. While the initiative involves a significant amount of technology change for the large players, smaller firms will use other banks or custodians to access clearing and settlement. The main technology concern is the conversion to ISO 20022 messages required by T2S, and whether or not firms using agents will still need to add more fields or codes to their current systems.
3. www.sungard.com/stream 3 Participation options Because T2S is a settlement platform rather than a securities depository, stock must be held in accounts within a CSD. Therefore, a T2S participant must also maintain a custody solution with one or more CSDs, or alternatively, arrange for a global custodian to manage this on its behalf. The CSDs that previously had their own settlement functionality have outsourced the process to T2S, which causes an impact on participants even if they are only trading in their domestic securities. The European Central Bank (ECB) recognizes three types of links to T2S: ›› Direct: The first CSD has an omnibus account in the Issuer CSD, so its participants can hold and trade the securities amongst each other. The cross-border element is transferring stock into or out of the omnibus account to other participants in the Issuer CSD ›› Operated: The first CSD has an omnibus account managed by a third-party custodian participant in the Issuer CSD ›› Relay: The first CSD has an omnibus account in another CSD who has an omnibus account in the Issuer CSD Participating directly in T2S requires the participants to send messages using the new ISO 20022 standard. The vast majority of participants in the securities industry have systems generating ISO 15022 messages, which may drive a technology cost in the change. New functionality offered by T2S will address the 15022 messaging through a combined effort among CSD, T2S and participants. The alternative to direct participation is to go through a CSD such as Euroclear Settlement of Euronext-zone Securities (ESES), Monte Titoli and Clearstream Frankfurt, or an International Central Securities Depository (ICSD) such as Euroclear Bank or Clearstream Luxembourg (Cedel). At the present, some of these organizations are communicating guidance to their participants on the specific functionality they will support using existing messaging to instruct the CSD to put their settlement instructions onto T2S. That said, CSDs, ICSDs and global custodians may require new codes to be entered into the messages to add granularity to instructions to T2S, such as setting priorities, holding messages in a matched state and then releasing them into T2S when ready, permission for partial settlement indicator, and linking instructions for settlement. Brokers and the large European banks are mostly concerned with serving their customers. Their interest lies in reducing risk. Errors in the confirmation process will require fallback positions, such as borrowing funds to deliver stock to the market should a selling client become unable to deliver it to them. Penalties, such as fines and buy-in rules, will become uniform across the various euro markets under T2S, although the specific details have not yet been agreed. It is likely that fines on failed settlements will be swiftly levied, and a buy-in process will commence within five days after the initial failure. The buy-in process is unpredictable and can be quite expensive, and the methods will need to be agreed across different markets, which is driving demand for standardization.
4. The role of CSDs and global custodians Traditionally, investors interested in buying non-domestic securities have had to employ a custodian to hold the stock – either a local agent participating in the CSD where the stock is issued, or a global custodian who manages a network of local agents in a range of CSDs. It is probable that professional investors, such as fund managers and their funds, will always employ a custodian as they provide value-added services and manage the intricacies of shared ownership, such as collecting dividends, reclaiming tax, submitting instructions into the securities infrastructure, and interpreting the responses. According to the European CSD Association, there are 41 CSDs in Europe. Twenty-one will join T2S by 2017, and four will operate as not-for-profit institutions. In order to offer their direct participants a wider range of securities, CSDs will directly compete with global custodians, who have traditionally offered services that have essentially eliminated the burden of customers having to participate in multiple CSDs. The winners will be defined by the add-on services they can offer, mainly corporate actions, automatic stock borrowing and tri-party collateralized services such as repos and loans. Since T2S is only a European solution, investors will need solutions that provide a worldwide reach. Firms can avoid the 20022 messaging issue if their custodians can receive the 15022 messages and convert them to the new standard – a service many custodians are offering. While the CSDs have said they will absorb much of the change and reduce the impact on members, it is not likely that they will be able to avoid the effect on banks’ back offices. 4 Getting ready for TARGET2-Securities (T2S): The time is now The T2S solution may address little regarding the custodial requirements for European securities, at least initially. A CSD can only hold foreign securities if it has developed links with the CSD that manages the issue; however, not every CSD in the T2S fraternity has such links. These links allow a CSD to have a pool account in another CSD, enabling securities to be held within a CSD’s infrastructure without requiring the participant to join the other CSD. A link may be one-way only, meaning that the first CSD may hold another CSD’s stock, but the other CSD cannot hold the first CSD’s stock. At this stage, relationships do not exist between all the CSDs. Consequently, managing stock holdings may still be as complicated as before T2S, although it may improve over time. In cases where the CSDs do not have links, a participant must join the other CSD directly or use an agent to manage the securities on its behalf, representing no change at all from the pre-T2S environment. However, this may evolve over time as the CSDs develop more links, as Euroclear and Clearstream have developed over the years, but at the start of T2S, not enough links will be in place to affect change in participants’ habits. Potentially, consolidation of the CSDs may naturally address the problem.
5. www.sungard.com/stream 5 The issue of messaging Much discussion has revolved around communication message types to transmit directly with T2S. Because the typical market participant will not communicate directly, its depot (global custodian or CSD) will take on responsibility for the new messaging. The market participants and the buy side, who are buying these euro securities, will communicate as they do today with their agents. The vast majority of participants are looking to their CSDs or custodians to handle the 20022 messaging to T2S, which will enable them to continue using their existing 15022 messages. However, this does present concerns to the industry since much of the new functionality for T2S – such as priority indicator (high/normal), hold/release (using PREA), partial settlement indicator, and message linking – does not fit neatly with the existing 15022 messaging. Therefore, each CSD or custodian may come up with its own solution. While some agents to date have been slow to communicate with brokers on how it is going to work, others have begun to communicate with users on utilizing the functionality. Participants and the buy side will need to put pressure on their agents to obtain an explanation in terms of field requirements to determine the development impact should they need to start supporting new data messages. The new T2S addresses several key areas: ›› Market claims and transformations ›› Holding settlement instructions ›› Opt-out of partial settlement ›› Settlement priority ›› Using a common reference for matching ›› Participant BICs (Business Identifier Codes) Depots are approaching the new T2S functionality by allowing their users to opt to use the new functionality by supplying the new indicators or link references on their instructions; or, they can continue to instruct as they do today. In the latter scenario, they would pass on the instructions using the T2S defaults. Participants using vendor solutions should be able to obtain the indicators from their providers to give users the ability to submit the MT530 messages for these various areas. Market claims and transformations CSDs will be responsible for detecting failed settlements and generating claim transactions using a new Payment Free of Delivery message, which essentially is a stock delivery/receipt instruction with a zero quantity. In T2S, market claim transactions will be generated on the basis that all transactions are trades; that is, a late deliverer always owes the buyer the benefit. This means that claims will be raised in the wrong direction for dual leg transactions such as repos, in which the entitlement should remain with the collateral giver or seller. T2S offers “an opt-out of market claims and transformations” indicator which should be used to stop the claims being generated in the repo’s start leg scenario. This settlement transaction condition indicator (NOMC) needs to be reported on the user’s settlement instruction to its depot. This is an “additional matching field” and must also be input by the counterparty to achieve a match. This suggests that the participant should raise a claim in order to obtain the coupon from the counterparty. As a consequence, users’ systems may need to be changed in order to be able to send stock settlement instructions (such as MT540-MT543) with a zero quantity for market claims. Users generally do not want market claims to be settled until the underlying trade has settled, however T2S will not be managing this automatically. To address this, users will be able to link their claim trade to the underlying trade using an AFTE (after) linking instruction, which instructs it to settle at the same time or after the linked trade has settled. Users can trade “out of context” transactions when the instrument involves an ex-date. T2S will recognize these transactions if the special ex (XCPN) or special cum (CCPN) trade transaction condition indicators are reported in the settlement instructions. This is also an “additional matching field” and must also be input by the counterparty to achieve a match.
6. Holding settlement instructions T2S will be responsible for matching settlement instructions between the two counterparties of the trade before it presents them to the settlement process. Users who manage their stock in pool accounts at a depository (in which case the depository is unaware that the stock in an account is actually owned by different beneficial holders) may not want T2S to settle the transaction if the seller does not physically have a holding, as this implies someone else’s stock will be used. T2S offers their users two solutions for this: 1. The settlement instruction can be submitted as a pre-match (PREA) transaction, which means it will be matched but will not be settled until it is released for settlement. This is existing functionality used by some depots like Euroclear France, but will be new to most depots. The release mechanism depends on the depot. Some require a new settlement message to be issued with a link to the previous PREA instruction. Others will use the MT530 to release the original instruction. 2. The sale settlement instruction can be linked to the purchase transaction or stock borrow that will provide the seller with the stock. This instruction can be entered on the sale instruction to the depot or added after submission using the MT530 message. Opt out of partial settlement By default, T2S expects that any settlement instruction can be partially settled in one of its partial settlement runs. Users will be able to remove a transaction from the partial settlement process by submitting an instruction with a no partial settlement indicator. Alternatively, they can qualify partial settlement by specifying a required minimum cash value or quantity. This indicator can be submitted with the original instruction to the depot, or added or changed using the MT530 message. Settlement priority Settlement instructions in T2S will have a standard priority that is defaulted by the system. This can be overridden by the depots supplying higher priorities on the instructions they send to T2S. Users can indicate a different priority by submitting a priority code on their instructions to their depots or by changing the priority using the MT530 message. 6 Getting ready for TARGET2-Securities (T2S): The time is now Settlement instruction matching at T2S T2S will generally match settlement instructions based on the following mandatory fields: purchase sale indicator, ISIN, trade date, quantity, intended settlement date, delivering and receiving parties (identified by BIC codes), delivering and receiving CSDs, currency, settlement amount within a tolerance, and credit/debit indicator for cash. If the Additional Matching fields (that is the opt-out of market claims indicator and the out of context cum or ex indicators) are reported by one side, then the other side must match it, although both sides have the option to leave them blank. T2S also recognizes the following fields as “optional matching fields” in that if both sides input them, the details must match, but if only one side enters one, the instruction will match: the client of the delivering/receiving CSD participant (the buyer or seller) and the accounts of the clients. In addition, the buyer and seller can agree to a reference they will both use on their settlement instructions for matching. If this reference is reported as the “COMM” reference on their instructions, then this will be used by T2S as an optional matching field. Participant BICs T2S requires that any participant in the system is identified by a BIC code. Consequently, in instances of cross-CSD deliveries, participants will need to identify the BICs of their counterparties on their settlement instructions. The depots will be asking their participants to obtain BICs before the implementation of the system in order to use them in their T2S instructions, although they will accept proprietary participant codes in their instructions.
7. www.sungard.com/stream 7 The best way forward for sell-side participants Regardless of the T2S option a participant chooses, electronic trade confirmations, exception management, inventory management, and stock borrowing will become critical components. Electronic trade confirmation maximizes a participant’s ability to agree trade and settlement arrangements with its counterparty as quickly as possible and then be able to send settlement instructions to its agent or direct to T2S with confidence they will match. Such functionalities are available through SWIFT and other methodologies. However, the key issue with which participants should be concerned is exception management. Drawing attention to transactions that are failing enables users to take remedial action quickly. In this process, the system should place an importance weighting on the exception – such as size of deal, time window for settlement, and counterparty – to ensure high priority items are brought to the top of the staff’s work list for immediate attention. Penalties for settlement failures and the need to use assets for funding will encourage participants to manage their holdings across their CSD accounts. Inventory management functionality that can anticipate short positions and transfer long positions where they are needed will help participants avoid fines and provide collateral to support stock and cash borrowing and the requirements of central counterparties. Conclusion The change of settlement cycle under T2S will have a dramatic effect on the securities industry. These infrastructural changes in Europe could potentially have a big influence on the structures that continue to exist. It will force faster communications – particularly of trade confirmations – and greater concentration on exception management, while fines for settlement failures will encourage participants to avoid failure by taking precautionary measures such as borrowing stock. The time is now for market participants to evaluate their participation options and begin asking their agents detailed questions about the support they will provide and what will be required of them in terms of modifying their systems to meet new messaging standards. In addition, firms should begin considering the mechanisms they need in place to reduce risk and optimize their daily positions within the new settlement environment. About TARGET2-Securities What it is: A new European securities settlement engine which aims to offer centralized delivery-versus-payment (DvP) settlement in central bank funds across all European securities markets Who is running it: The IT platform will be built, owned and operated by the European Central Bank (ECB) and 17 national central banks in the euro area (collectively known as the “Eurosystem”) What are its objectives: ›› To integrate and harmonize the currently highly fragmented securities settlement infrastructure in Europe ›› To reduce the costs of cross-border securities settlement within the euro area and participating non-euro countries ›› To increase competition and choice amongst providers of post-trading services When it started: 2006 When it will go live: Based on the latest announcements, the first phase will go live initially in 2015, with the remaining three phases rolled out over two years T2S Onboarding Schedule First phase – June 2015: Greece and Switzerland Second phase – March 2016: The Euronext markets (France, Belgium, Holland and Portugal) Third phase – September 2016: Germany Fourth phase – February 2017: Spain
8. About SunGard’s Stream Securities SunGard’s Stream Securities suite includes the Stream RIMS and Stream Phase3 solutions. It helps financial services firms manage their middle- and back-office operations in an efficient and scalable manner. The Stream Securities suite supports real-time confirmations, allocations and affirmations across multiple asset classes, as well as real-time, order-to-settlement global securities processing. Retail and institutional self-clearing broker-dealers, ECNs, high frequency trading firms, investment banks, proprietary trading firms, fund managers and correspondent clearing firms use the Stream Securities solutions to help them reduce errors and take on new clients more easily. About SunGard Financial Systems SunGard Financial Systems provides mission-critical software and IT services to institutions in virtually every segment of the financial services industry. The primary purpose of these systems is to automate the many detailed processes associated with trading, managing investment portfolios and accounting for investment assets. These solutions address the processing requirements of a broad range of users within financial services, including asset managers, traders, custodians, compliance officers, treasurers, insurers, risk managers, hedge fund managers, plan administrators and clearing agents. In addition, we also provide professional services that focus on application implementation and integration of these solutions and on custom software development. For more information, please visit www.sungard.com/fs For more information, please visit: www.sungard.com/stream Contact us CM.email@example.com Telephone +44 (0) 208 081 2000 Tweet this whitepaper www.twitter.com/SunGardPTO ©2014 SunGard. Trademark Information: SunGard, the SunGard logo, and Stream are trademarks or registered trademarks of SunGard Data Systems Inc. or its subsidiaries in the U.S. and other countries. All other trade names are trademarks or registered trademarks of their respective holders. CM2388
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