Europe's infrastructures for securities settlement have always been fragmented. As a remedy for this, the Target2-Securities project (T2S) was launched in 2007 with the aim of reducing the barriers to cross-border security settlement in Europe. Almost ten years later, T2S went live: since June 2015, five Central Securities Depositories (CSDs) have been on the platform, including the domestic Italian CSD Monte Titoli. The platform currently settles around two million transactions per month and seems to show more and more resilience. A Monte Titoli executive stated, at the Clearing and Settlement conference in March this year, that there have been "no major issues" since the first weeks of operation and that the ECB was a "fair and responsive" service provider. This is promising, looking ahead at the remaining 80% of the settlement volume still to be migrated to the platform.
T2S Wave 2 went live at the end of March, and no issues have been reported so far. There are no questions anymore regarding whether T2S will happen or not—it's here and it works. The next step is now to understand how it will transform the ecosystem in the coming years and how new technologies such as blockchain may be incorporated to it.
The ECB is also already looking ahead at integrating T2S and Target2 (T2), a platform for payment in Euros. On the agenda are, among other things, a collateral management module for Eurosystem operations, merging the T2 Single Shared Platform with T2S, and providing an instant payment component. In other words, another big project coming!
How could T2S affect the fund industry?
There have been discussions in the past about investment funds and whether, on the new T2S platform, some or part of the volume settled by Transfer Agents (TA) will be done instead by CSDs in Euros / central bank money. Because TA and CSD models respond to different needs, they will coexist for a while as long as there are multi-currency, multi-jurisdiction requirements. The CSD model has been used for years in France and Germany for domestic distribution and these local models will also be ported on to T2S. Thus, whether or not there will be a single model is no longer a question—there will be multiple ones. The TA model is flexible and portable, which has many advantages, whereas the CSD model is industrialised and scalable, which is the better choice if reducing cost is a main driver.
The following chart characterises the different models in the post-T2S world:
What T2S brings ultimately is not a change to the way CSDs distribute domestically, but a change to the way cross-border distribution can be envisaged across Europe, since the ecosystem will be deeply modified once true competition kicks in. The loss of settlement revenues, the newly introduced competition, and the technical facilitation brought by "CSD linkages" will attract CSDs to an area where custodians and global custodians were previously masters of the game. Leveraging on their international CSD ("ICSD") experiences, the big European CSDs will evolve towards being investor CSDs and service not only domestic assets but foreign ones, extending their inbound and outbound networks to aggregate assets and counterparties. Thus, the lines between traditional asset servicers and infrastructure players will be increasingly blurred. Today's distributors might not be the ones of tomorrow. TAs will face increased competition for the processing of subscriptions and redemptions, as well as for register-keeping.
Down the road
Subscribe today, get your units in three to five days. At a time where settlement cycles have been brought to T+2 thanks to CSDR, fund units settlement still lags behind due to NAV and cash frictions. With instant payment and blockchain being the buzzwords of the year, it's easy to picture the disruption potential in Luxembourg's investment fund business if you look at the transformations that have already begun in the clearing and settlement industry. Will T2S be part of this equation? One step at a time, Luxembourg's fund industry needs to face the changes, but more importantly to assess what's coming and to reflect on how it needs to evolve to remain competitive.
The Association Luxembourgeoise des Fonds d'Investissement (ALFI) has launched working groups to examine T2S's impact on the fund industry by looking at different aspects (cash, issuance, and others). It is currently preparing a paper, which KPMG Luxembourg has contributed to, with a publication date set for September 2016. Watch this page for updates.
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