Northern Trust and T2S part 1

Northern Trust surprised its competitors by announcing how it would manage the transition to T2S a good nine months before the first markets joined the new settlement platform on 22 June 2015. Its solution was a practical one, which recognises the fact T2S is essentially a settlement platform. It combines direct access to T2S settlement services, with a single asset-servicing agent. To access central bank money at the ECB, Northern Trust is using its full bank branch in Luxembourg to enter the euro-system via the Banque Centrale du Luxembourg.

"We are happy to be leading from the front on this," says Andy Osborne, senior vice president, global head of network management at Northern Trust in London. "T2S changes the dynamics of how settlement business is done in Europe and we wanted to ensure we protected our clients from the risks of that, while ensuring they would enjoy the benefits as well. Other banks are now adopting similar models to ours, so it seems to be the way the business is moving."

Northern Trust is certainly in the vanguard of the banks that planned for the coming of T2S. On 25 September 2014 Northern Trust announced its strategy for T2S long before most other custodian banks had even decided what theirs was. It consists of an investor central securities depository (CSD), in the shape of Euroclear France, supported by Deutsche Bank as a single, pan-European asset-servicing agent.

The early announcement was the fruit of a planning process which had begun five years earlier. The ambition of the planners was to work out how the bank could turn the impending change in the European settlement infrastructure to the advantage of itself and its clients. "Regulatory change always creates a lot of work, but it also always creates a lot of new business opportunities," says Justin Chapman, the senior vice president who heads the market advocacy and research group at Northern Trust.

Back in 2009, the obvious opportunity was to change how the bank connected to markets in the euro-zone. At the time, Northern Trust had a conventional sub-custody network, supplemented by accounts at Clearstream and Euroclear to settle and hold Eurobonds bought and sold by its buy-side clients. The challenge was to predict what needed to change once T2S was in place.

"We conducted a lengthy study that aimed to predict what a post-T2S Europe would look like," recalls Andy Osborne. "Once we had worked out what we thought it would look like, we had to decide how we would operate in that environment." The result of all of this cogitation was an outline of the model Northern Trust announced in September 2014. The next step was to choose the partners needed to implement it: an investor CSD and an asset-servicing agent.

Choosing the investor CSD was a straightforward contest between the three institutions widely expected to survive the inevitable consolidation of CSDs: Clearstream, Euroclear and Monte Titoli, the Italian CSD owned by the London Stock Exchange. The apparent oddity of working through Euroclear France as the investor CSD is easily explained: Euroclear has built its CSD infrastructure around its operation in France.

"Euroclear is providing the technical connection to T2S, and allowing us to open accounts at their depository," explains Justin Chapman. "We are managing our own accounts, and doing all our own settlement activity, so they are not acting as a settlement agent for us in any way. Thanks to the historic consolidation of sub-custodian banks in Europe, finding the right asset servicing agent also reduced to a choice of three: BNP Paribas Securities Services, Citi Direct Custody and Clearing, and Deutsche Bank.

Northern Trust is alive to suggestions that it eventually chose Deutsche Bank chiefly because the German sub-custodian does not compete with it for global custody mandates, unlike Citi and BNP Paribas, but Chapman dismisses the idea. "The decision point was on the narrowest of margins," he says. "We had very strict criteria on the operating model that we felt we could work with and all of the organisations that tendered could meet them. We could have got comfortable with any of the three organisations, but in the end we had to make a decision, and it was finely balanced."

The key considerations were which asset-servicing agent would work best with a global custodian such as Northern Trust (as opposed to, say, a global investment bank) and which would work best with Euroclear. The German bank could also support Northern Trust in the six euro-zone markets that account for the bulk of its European volumes: Belgium, France, Germany, Italy, Netherlands and Spain. In fact, Northern Trust had already divided the six markets between BNP Paribas and Deutsche Bank well ahead of its final choice of Deutsche Bank as its T2S asset servicing agent in September 2014.

Andy Osborne, who is responsible for selecting the sub-custodians Northern Trust works with around the world, adds that the choice of Deutsche Bank is a strategic partnership. “One of the challenges you face as an early adopter is that you have to choose from what is available at the time," he says. "We are confident what we have chosen has longevity. But once we get beyond the initial phases of the transition to T2S, Euroclear as well as Deutsche Bank are going to have to prove themselves, and they will be judged by the same criteria we use to manage any other sub-custodian. In five years' time we will be reviewing them in the usual way. Once T2S has settled down, we will drop back into a business-as-usual perspective on T2S, as a market in which we need a service provider."

For now, however, Deutsche Bank is gradually absorbing all of the euro-zone business of Northern Trust. Since that choice was first announced, Northern Trust has worked to consolidate its sub-custody business with the German bank. Italy and Spain were switched from BNP Paribas to Deutsche Bank immediately after the September 2014 announcement, and France will follow in November this year. Italy was the most important market to transition, not just because it is large, but because the country was in the first wave of markets scheduled to move on to the T2S platform on 22 June 2015.

Uncertainty about the stability of the platform that Monte Titoli - the London Stock Exchange-owned Italian CSD – has built, meant doubts about whether the country would join on 22 June or later were impossible to dispel. "Uncertainty about the transition timetable persisted until very late in the process," says Osborne. "That was unfortunate, because we needed practical, pragmatic decision-making by the European Central Bank (ECB) to minimise the impact on the downstream conversions." Monte Titoli ended up joining T2S on 31 August.

How will those “conversions” work in practice? In a classic sub-custody arrangement, the sub-custodian would act as the gatekeeper to the CSD, settling trades and servicing the assets of the clients of global custodians such as Northern Trust through their own omnibus accounts. By controlling the accounts at Euroclear France directly, Northern Trust will exert a greater degree of control.

Importantly, in the light of the promise from Andy Osborne to return to a business-as-usual management of service providers once T2S has bedded down, controlling the accounts at Euroclear France also makes it much easier for Northern Trust to change their asset-servicing provider. "Asset-servicing is a sub-set of a sub-custody service," as Osborne explains. "Separating it from settlement, which we will now control ourselves, changes the nature of the relationship.”

It certainly does. The ability to service assets hinges on access to accurate settlement information. Since T2S forces banks to divide settlement from asset servicing, Northern Trust has had to build what Justin Chapman calls a “single pipe” to share settlement information with Deutsche Bank simultaneously. "Deutsche Bank has to work with the issuer CSD at the local level in each market where it is servicing assets, so they have to mirror what is held at the investor CSD level, which could be different from what is happening at the issuer level," says Chapman. "They have the ability to consolidate the assets of an investor in the euro-zone as a whole, but need to remain granular at the issuer CSD level."

Next week we will bring you part 2 of our look at Northern Trust and its steps to embrace to T2S. 

Tags: T2SNorthern TrustSettlementCSDCSDREuropeECB