TARGET2 - SECURITIES: INITIAL ASSUMPTIONS AND QUESTIONS

Transcription

1 PSSC/2006/352 FINAL 10 August 2006 TARGET2 - SECURITIES: INITIAL ASSUMPTIONS AND QUESTIONS Introduction TARGET2-Securities (T2S) is a possible new service of the Eurosystem with the aim to achieve efficient settlement of securities in central bank money in one single technical platform (i.e. an integrated model ). CSDs would be invited to participate. It is envisaged T2S would cover only the settlement function whereas other CSD functions (such as safekeeping, custody, administration, corporate actions) would remain with the CSDs. T2S, like TARGET2, will settle only in. This document is the follow-up to the meetings which the Eurosystem held with CSDs and a limited number of banks on 19 July to discuss TARGET2-Securities (T2S). It was agreed then that each National Central Bank (NCB) would hold further meetings in order to achieve greater coverage and pursue discussions in further depth. This questionnaire is directed to market participants (e.g. banks, CSDs, CCPs, stock exchanges and other trading platforms) and is expected to guide the discussion in these national meetings. NCBs will report the outcome of these national meetings to the ECB by 11 September 2006, after which the ECB will prepare a consolidated document for a second Eurosystem meeting with CSDs and market participants scheduled for end-september This document consists of: - A set of initial assumptions on the scope of T2S services based on the feedback provided by CSDs and banks on the 19 July meeting. - A set of questions to market participants based on the assumptions above. 1. Initial assumptions on TARGET2-Securities scope of services Market participants are invited to express whether the assumptions below are in line with their expectations and are encouraged to present alternatives. Deutsche Börse Group Response

2 No parallel settlement with CSDs: Once T2S is fully deployed, no division of settlement activity is expected between T2S and CSDs: neither in time (day/night) nor by type of asset (debt/equities). We would like to understand in more detail what exactly this means for euro settlement in CoBM taking place at ICSDs in any CSD euro denominated security, before making a final statement on this assumption. Gradual deployment: The T2S will probably be implemented in a phased manner. In this respect, we interpret the market s priority to be the daylight DVP1 settlement of debt securities. Phased implementation leaves market participants and CSDs with parallel processes, which may result in additional cost. Additionally phased implementation increases risk, i.e. if an implementation by security type is chosen, split liquidity may harm overall settlement efficiency and increase operational risk. Settlement frequency: Real-time settlement with optimisation mechanisms will be offered (DVP model 1 and FoP). The business case for offering batch settlement will be investigated. Selfcollateralisation facilities will be offered. RTGS settlement is efficient for low volumes and same day activities, especially for repo transactions, but is vulnerable to blockages due to transaction chains and due to peak cash needs. Next day (t+1-3) settlement, especially of equity transactions or settlement of cheapest to deliver bonds for future contracts, is typically high volume and benefits from batch processing and its netting algorithm that reduces transaction blockages and funding requirements. Moving equity business into RTGS settlement may significantly impact overall settlement efficiency, especially during certain periods of the day time processing when the bulk of CCP transactions are settled. We would like batch settlement to be in scope. We agree that self collateralisation is an efficient instrument to reduce funding requirements and should be in scope. Nature of participation: Service offered to CSDs (directly) and their participants (indirectly). We support the set up of CSDs being directly linked and market participants indirectly, as this will minimise impact on the CSD notary function, allow validation checks on the eligibility of a security for settlement, ensure the record keeping is always correct at the CSD level with regards to information on matching and settlement, and will allow the processing of intraday corporate actions. User Committees: User committees will be established to ensure the involvement of CSDs and their participants. We would favour a set up where CSDs, as users of the system, and market participants are part of these committees. Cost and pricing: Investment and running costs to be covered by fees. T2S would make no pricing distinctions between what are now domestic and cross-border transactions. Fees would be levied on the participating CSDs on the basis of a published fee schedule. CSDs would apply their own fee 2

3 schedule to their customers. This should translate for end-users in lower prices for the sole DVP settlement service in central bank money, thanks to the economies of scale allowed by the recourse to T2S for the provision of that service. The goal is clearly to ensure lower settlement service prices for participants. However, if the settlement services and infrastructure are retained by the CSD, costs cannot be reduced. Only through a CSD decommissioning applications/systems and reducing staff will the cost reductions be achieved. 2. Questions to market participants Market participants are invited to provide their views on the open questions below and raise any further questions they might have. Scope of assets and services - Do you agree TARGET2-Securities should cover the settlement in central bank money of all debt instruments and equities in euro? Or would you prefer CSD platforms to continue to offer settlement of securities in central bank money for some assets (e.g. non-eligible assets for Eurosystem credit operations; batch settlement)? A scenario where all CSD settlement takes place on T2S has the potential to reduce the costbase by as much as is possible. The extent to which CSDs continue settlement will determine to what extent settlement liquidity is split, and to what extent economies of scale are reduced on both T2S and the CSDs. - Would you expect T2S to cover also the settlement of euro bonds? The Eurobond market is a highly international market with participants (investors and issuers) from beyond the eurozone markets. It exclusively settles in CoBM on the two ICSDs, in many currencies in addition to the euro. The market place for settlement of Eurobonds is highly efficient, and prices for settlement in either of the ICSDs or between them are low. It is unclear why there would be a need to include this market in T2S. CoBM settlement is required for large numbers of non-eurozone participants and for settlement in non-euro currencies. Including Eurobonds de-nominated and settling in euro into the scope of T2S would result in destroying a very efficient market segment, splitting its liquidity between settlement in euro and other currencies. Additionally we would like to get more information with regards to no parallel settlement between T2S and CSDs. Would this mean forcing CoBM settlement into CeBM settlement? - Is it absolutely necessary to complement the T2S service with other CSD services (e.g. collateral management services; securities lending services) or can the provision of these services remain at the CSD level (CSDs could be considered as users of T2S for these 3

4 services)? Based on our initial assumption that CSDs would be directly linked to T2S and would provide the services to the market participants, we would expect these services to remain at the CSD level. - On the assumption that equities will settle in T2S, is there a business case for equities (or other assets) to settle in real-time (DVP1 with optimisation mechanisms)? Or should also the possibility to settle in batches be provided? From a CCP perspective and with regard to equities settlement multiple batches are sufficient. For collateral provision and substitution, real-time processing is strongly requested. For certain fixed income products such as specific repo transactions, real-time processing is a key requirement. - Do you believe T2S should offer facilities for matching and release/blockage of instructions? For certain securities, should T2S have a connection with another platform (e.g. trading platforms) which would do the matching? The current facilities and interfaces of the local CSDs need to be covered, especially in a cross border scenario. Matching and release/blockage of instructions need to be offered. Trading platforms only do trade matching, but do not do settlement matching and validation; therefore there is no need to link T2S with trading platforms. - Should T2S offer the same opening times as TARGET2? This is aligned with activities to address Giovannini barrier 7. Within these same opening times there should be an orderly close down of settlement; with a final optional settlement period that should be reserved by participants for transactions assisting cash management (e.g. repos). Stock exchanges and CCPs - What specific issues are relevant for CCPs as participants in CSDs which are on the T2S platform? o Efficiency of settlement process, as the CCP has responsibility for settlement and incurs risk o Efficiency of securities lending o One technical interface to all European CSDs o Harmonized processing timing o Harmonized corporate action processing and interfaces o Real-time provision and release of collateral o Harmonized rules and regulation with regard to e.g. ownership transfer and registration processes, taxation issues etc. 4

5 - What specific issues are relevant for stock exchanges and trading platforms which either clear via a CCP or directly settle in a CSD? For Stock Exchanges, the ability to perform bulk transaction processing of T+1-3) transactions efficiently, and the efficiency of sameday processing. Non- settlement in the euro area and settlement outside the euro area - Does your CSD offer settlement services in currencies other than? If yes, what is the relative weight of these securities (in relation to total custody and total settlement volumes)? What type of securities are they and in which currencies are they denominated? What could be the alternative for these non- denominated securities once a CSD joins T2S (knowing that T2S will operate only in )? Yes, the CSD offers settlement services in currencies other than euro. As the issuer CSD for securities denominated in foreign currencies it has to continue supporting these securities. Currencies include the Canadian Dollar, US Dollar, Pound Sterling, Swiss Franc, Czech Krona, Swedish Krona, Danish Krone, Mexican Peso, Norwegian Krone, and the South African Rand. The CCP is linked to CSDs that offer settlement services in other currencies than euro, and for T2S to operate only on euro basis is not acceptable from a CCP perspective as this implies a multiplication of different systems to handle different currencies that should definitely be avoided. The ICSD offers settlement services in 40 currencies other than euro. They represent approximately one third of total custody and one-fifth of settlement volumes. Both the CSD and ICSD would have to continue to offer settlement in non-euro currencies. - What could be the solution for denominated securities settled in non-euro area CSDs? T2S needs to link up with non-euro area CSDs, and other CSDs that the European CSDs are currently linked with; e.g. SIS, DTCC, CrestCo. 5

6 Account structure - For T2S to offer cross-border settlement which of the following basic options (or which combination of options) do you deem more feasible: (a) Users who wish to be able to settle a given type of asset open a securities account in the CSD issuing that asset; (b) CSDs participating in T2S open reciprocal accounts (links), so that users need only maintain an account with their local CSD; (c) Users settling assets issued in a CSD where they do not have a securities account designate a local custodian Option (b) is the only option offering cross border settlement. Market participants should have the possibility to settle without the need for re-alignment of positions even though they keep specific securities outside the issuer CSD. Alternative (c) should be available as well, as local custodian services remain relevant for certain participants even when T2S is in place, and option (a) is of course always possible. - What is the most feasible securities account structure in T2S? To what extent are sub-accounts for wholesale customers (to omnibus accounts of participants) needed for the monitoring and efficient processing (transmission of instructions) of wholesale customers transactions? In countries where a direct holding structure is in place, what would be the optimal level of aggregation? T2S account structures will need to support CSD processes, as otherwise there will be profound impacts on the level of the markets: both CSD custody and notary functionality and additionally the systems of participants. For example, account structure facilities such as settlement routing accounts ( Reg-Ueber and Abweichendes Depotkonto ) are important for stock exchange transactions and the transaction bank community. - As a potential user of T2S, would you prefer the payments associated to securities transactions to be credited / debited (a) directly on your TARGET2 RTGS account/special purpose TARGET2 RTGS account with the usage of all TARGET2 control and monitoring tools (ICM), (b) on a dedicated account within T2S (linked to the RTGS account) possibly with the usage of ICM tools? From a DBAG perspective the question is relevant but is more significant to market participants. Corporate actions - Let us assume T2S settles continuously (i.e. day and night) and after the end-of-day securities are repatriated to the issuing CSD. How much time do you believe is needed by the issuers, 6

7 the paying agents and the CSD to conduct their functions (custody, corporate events )? Is there a specific period during which these functions must be performed?: The processing of elective corporate events will require intraday real-time position updates, as will securities financing and collateral management. - Which corporate events are processed on the basis of an intraday position (i.e. knowledge by the CSD of the end-of-day position is not sufficient)? What would be the requirements of CSDs for processing corporate events intraday? Information is required on an ongoing basis in order to provide timely information on both future and ongoing income and corporate events, as well as timely updates. Some impacted categories of elective corporate events: - Exdate events where rights are generated e.g. o Choice dividends o Subscription offers - Non-Exdate events where the securities must be blocked or surrendered o Exchanges o Put options o Meetings/ votes Communication - What are your preferences in terms of communication protocols and communication network? Communication should be standardised according to SWIFT ISO standards. In terms of communication network we would envisage a cost efficient direct connection between T2S and the participating CSDs. - What role should CSDs play in the routing of settlement instruction to T2S? Based on our initial assumption that CSDs will be directly linked to T2S and market participants indirectly, CSDs would route instructions to T2S and market participants would remain to use the infrastructure of their home CSD. - For CSDs: What are your preferences in terms of communication with regard to the mirroring of accounts at the beginning and the end of the day? Is there a need for real-time communication during the day between CSDs and T2S? There is a clear need for real time communication between CSDs and T2S to perform position keeping, allowing corporate action notification and processing and equally importantly securities lending and collateral management services. 7

8 - What information would CSD participants wish to have available from T2S (a) throughout the working day on a real-time basis; (b) at the end of the day? CSD participants will need real-time life-cycle information throughout the day. Especially from a CCP perspective this information has to be available in real-time as for risk management purposes it is required. Timing / Priorities - What timeframe would you consider realistic for the Eurosystem to launch TARGET2- Securities (considering the difficulties you expect will be encountered)? T2S would have to be implemented within 3-4 years in order to (i) achieve level playing field early and (ii) remove uncertainty that results in a backlog of investments and respective lack of innovation / service improvements in the settlement area. - Do you see any problem in a phased implementation (e.g. certain services to start earlier than others or a phased country migration)? As mentioned previously, a phased implementation leaves market participants and CSDs with parallel processes which may result in additional cost. Additionally phased implementation increases risk, i.e. if an implementation by security type is chosen, split liquidity risks harming overall settlement efficiency and increases operational risk. Impact on CSDs (only for CSDs to answer) - What are the incentives / disincentives for CSDs to join T2S? We appreciate that T2S could be the nucleus for opening up a fragmented landscape to competition. We consider it could be a base for ongoing product and service innovation, increasing the competitiveness and attractiveness of European capital markets. We still need to better understand how T2S would change the business dynamics. The extent will be determined by the scope of T2S which is currently subject to many open questions, and many potential issues. A key incentive would be if the end-to end costs to participants can be reduced, and innovation made faster and cheaper. If there are liquidity splits reducing market efficiency, highinvestment requirements, high uncertainty, and reduced economies of scale these will be disincentives. - What is the amortisation period of the settlement platform currently used by your CSD? What about the investment cycle? Has your CSD initiated further investments to improve the current 8

9 platform? Have investments been made to build a future platform? By when will these investments be amortised and at what rate? We implement service and product developments to further improve the efficiency of the market on an ongoing investment cycle. T2S implies that both amortised and ongoing investments would have to be adapted to T2S, requiring additional investments. If there is an investment freeze in the interim period leading up to T2S, there is a likelihood that the resource capacity will shift to other responsibilities, compromising the ability to adapt to T2S. - What would be the cost savings for CSDs in joining T2S and not having to develop a settlement platform themselves? The scope and impact of T2S and the requirements to perform the custody functions will determine the degree to which investments are required for T2S, and any potential long term savings. There will be no cost savings unless there is a decommissioning of services and infrastructure at the CSD. - How would T2S affect the links among CSDs of the euro area? How about the links with CSDs outside the euro area. T2S would make obsolete most existing CSD links for settlement purposes. As most of the existing links are not efficient due to their limitation to FOP settlement, we consider this a clear improvement of CSD interoperability. However, CSD links will still be required, as the notary function and custody remain with the issuer CSD, in particular in case of account structure option (b). Links to CSDs outside the euro area are not addressed by T2S and need to be maintained independently. Potential obstacles - What are the main obstacles you see for this project to materialise? 1. Different legal and regulatory rules and processes in the local markets. 2. High effort for consultation of all impacted members in the respective local markets. 3. High implementation costs to substitute existing infrastructure by a European wide solution. 4. Risk that partial coverage of processes, instruments and currencies will bring only very limited benefits to the members or create an additional burden due to the duplication of processes. 5. Location of securities: 9

10 The location of the position of record, and the timing of transfer of ownership should be legally verified in light of the CSD keeping the notary function and T2S performing settlement. There may be implications for national legislations relative to securities and CSDs. 6. Drivers of end-to-end efficiencies o Direct/indirect access If there is direct access by market participants, CSD information requirements will still need to be supported to allow the notary function, custody and other activities. Direct access by participants would be in addition to their retaining an access to the CSD required for Non-T2S instruments and non-t2s activities (custody, securities financing). o Transaction lifecycle CSDs have the contractual relationship with participants, and the notary role. CSDs will need perfect information on transaction statuses in order to perform Custody, collateral management and lending services. This implies real-time settlement feedback. This implies in the case of direct access, transaction receipt, matching and settlement information will still need to be recorded at the CSD level in real-time, i.e. duplication. o Settlement For securities settling on T2S, at least the booking component of current settlement engines will need to continue to operate to reflect T2S results. The grounds for determining which securities go to T2S and which do not is an open question, and there may be national legal conditions that influence this. Full settlement would need to continue for products not settled on T2S, examples of which might be registered shares, exchange traded foreign securities, European Energy Exchange transactions, "Streifbandverwahrung" etc. Keeping settlement with reduced numbers of transactions would impact economies of scale on the CSD level. The impact of changing to interfaced settlement for residual processes will need to be identified. CSD efficiencies from settling across instrument types, from the use of custody proceeds for settlement and from the availability of optimisation and securities lending should be examined. 10

11 The peak load requirements generated by Stock Exchange transactions (T+1-3) should not be underestimated, and are currently handled in batch processes using netting. o Custody, securities financing Real-time positions are required to generate notifications. Many settlement processes would need to continue for the processing of corporate action and income events, for booking registered shares, and to support securities financing (lending and collateral management) products. o New issues The initial booking would need to continue on the CSD to allow the notary function. If this is separated from a distribution on T2S there would be implications for the CSD cash liquidity requirements. The issuance process and the extent to which T2S is involved in the primary market is an open point. National practices will not necessarily harmonise. o Adaptations to T2S A major area of uncertainty is account structure, which could be a profound driver of changes for the CSD and market participants. Existing systems and processes will need to be adapted in order to handle the T2S process. The cost of these changes to connectivity, settlement, custody, would be significant, even assuming major changes due to account structure are not required. Securities financing systems will probably require a major re-work. Multiplying out the cost of adaptations by the number of CSDs implies significant cost. 7. Business case premises It is generally accepted that clearing and settlement is an activity with large economies of scale. On a national level these economies of scale are already at work. Cross-border settlement costs are considered to be expensive, but represent a lower volume. A positive overall business case for T2S must demonstrate that the end-to-end costs of holding securities and settling domestic and cross border transactions will be cheaper. This in turn implies that that there must be process efficiencies and cost savings on the CSD level that at least compensate for the investment and running cost of settlement using T2S. 11

12 T2S itself would normally be subject to economies of scale. The decision of CSDs to use T2S will determine the unit cost of T2S settlement. The inclusion of EUR denominated Eurobonds on T2S seems incompatible with the crosscurrency efficiencies of the Eurobond market, and would be a challenge to the Noneurozone customers. 8. Timing of T2S implementation The duration until T2S implementation and the conditions prevalent for CSDs will be of key importance to how these are positioned. Uncertainty, or drawn out implementation risk acting as a brake on the development of CSDs in response to market demands. There is a risk that innovations will not be generated, as the business cases for development will be difficult to justify. Even assuming that the CSDs can justify the expense of retaining the capacity needed for T2S implementation during an interim period, there is a probability that the expertise would be dispersed, with people finding other responsibilities. 9. Innovation and governance Future developments by any CSD may need changes within the T2S environment. The prioritisation of work and the division of development costs will be a tricky governance item. Handling the cost and impact of mandatory changes in national legislation will be complex. The regulatory framework will need to be defined for the operations of T2S relative to national laws. - Do you see any problem in separating the platform that provides settlement services (T2S) from the custody and other services that will remain to be provided by the CSDs? Would you identify any legal obstacles in your country that would have to be removed for T2S to provide instantaneous finality? Yes. See above - Do you see any internal constraints (organizational, technical or financial) which could hamper the connection of your institution to T2S? There has to be a business case for connecting to T2S 12

13 - What prerequisites would you point out in terms of harmonisation? No reply at this stage. 13