Northern Trust and T2S part 2

As we looked at last week, Northern Trust mapped out its response to T2S very early on, meaning that it had everything in place for when the pan-European settlement platform went live on 22 June.

The fact that T2S is a settlement platform only has made it difficult for Northern Trust to promise clients early reductions in transaction costs. "Asset-servicing costs are higher than transaction costs, and they have not changed at all," says Andy Osborne. "In fact, we had some very interesting discussions with our potential asset–servicing partners, as we and they tried to work out how to unbundle asset-servicing from settlement as a sub-custody service.” Shareholder registers and corporate actions data, for example, continue for now to be controlled by local issuer CSDs.

This bifurcation of settlement and asset servicing will persist until T2S assumes the asset-servicing functions as well. Justin Chapman is sceptical that this will happen soon. Despite the efforts of the Giovannini Group at the turn of the century, and of working groups of the ECB and the issuer CSDs in the run-up to the launch of T2S, corporate actions information alone is still too country-specific to be processed successfully at a supra-national level. "What you may see is the erosion of the ability of domestic CSDs to maintain these services at the domestic level," predicts Chapman. "So they may start to share platforms, or adopt standards, or consolidate."

He agrees that consolidation is likely to be triggered by the portability of issuer activity under the Regulation on Settlement and Central Securities Depositories (CSDR). "If large corporate issuers do start to shift, it will throw the entire European CSD space up into the air," says Chapman. "The biggest corporate brands in any country might choose to stay with their national CSD but, equally, it could become a competitive segment if they decide that returns to shareholders are more important than national loyalty." He adds that, if issuers do start to shift their business to a new class of emergent pan-European CSD, it sets a challenge for the asset-servicing agent to keep up.

Chapman thinks the emergence of pan-European CSDs will increase once swap clearing, which is mandatory under the European Market Infrastructure Regulation (EMIR), starts. This is because clearing is at present a largely broker-to-broker business, whereas EMIR will draw asset managers (and eventually end-investors) into centralised clearing. "If we get more asset management flows into CCPs, it could be a catalyst for change," he says. "Under EMIR, CCPs have to hold their collateral at a CSD, so the logic for a CCP holding T2S-eligible collateral is to appoint a pan-European CSD to hold all of its assets, so they can be posted to all sorts of purposes across the euro-zone."

In fact, one reason Chapman welcomes T2S is its contribution - through the auto-collateralisation service that allows users to pledge eligible collateral in one market against exposures in another - to more efficient collateral management. He adds that T2S creates a safer as well as a more efficient environment, not only through auto-collateralisation, but by reducing the settlement timetable, speeding up reporting of settled trades, and reducing the consumption of credit as well as collateral by making settlement more reliable. "If you get more reliable settlement, clients can use their own funds, so there is less credit required, and a consequently reduced impact on the capital ratios of the custodians," explains Chapman. "From the point of view of the market, that probably amounts to a higher return than a reduction in the cost of settlement."

That is just as well, since Northern Trust not only downplays the prospect of immediate cost savings. The banks also believes material savings in cross-border settlement costs from T2S will not emerge for quite some time. The celebrated 15 cents advertised by the ECB does represent a decline in cross-border settlement costs that run up to 400 basis points under current conditions, says Chapman, but it is merely the starting point. Further charges are levied for functions too essential to successful settlement to escape, such as matching and allocation.

“The designers of T2S were originally trying to compete with the United States, and get total costs of settlement down to 50 cents a trade, or less. There is some way to go before it gets to that, but once the cost of the investment in the infrastructure is recouped, T2S should in the end create efficiencies. There will definitely be a lag before the benefits come through, though. They should be visible by 2018 at the earliest."

One reason the benefits will take so long to materialise is that the custody industry as a whole is thought to have invested at least the same amount in T2S as the ECB, which adds up to €1 billion apiece. Northern Trust spent its share of that sum on a variety of adjustments necessary to support its clients through the transition to T2S. Although the bank is ISO 20022-compliant, many of its clients are not, so it has had to retain the capability to translate messages into ISO 15022. “We service over 2,000 fund managers, and the level of technological sophistication varies widely,” explains Andy Osborne. “We have positioned ourselves to support all of them.”

Insulating clients from ISO 20022 included investing in the T2S-specific messages and testing the reliability of connections to the new system. The bank also chose to invest in insulating itself from any slippage in the T2S transition timetable in particular markets by forging connections to every market in the first wave anyway.

Further investment has gone into assessing the strength of the potential settlement connections and asset-servicing capabilities in the 13 euro-zone markets where Northern Trust transaction volumes are less material. "We have to protect our clients' interests, wherever they are active," says Chapman. "Through waves one, two and three we have conducted full assessments of our agents to check their level of readiness, and what investments they need to make in new technology, because we did see a number of agents withdraw from the market."

Oddly, for a platform designed to harmonise market practices, T2S implementation still comes in particular flavours in each market. “Each market that comes on to T2S has a different nuance, in terms of matching, affirming, confirming, holding, processing and reporting messages to and from the global custodian, the broker and the sub-custodian,” says Chapman. “So we have to test functionality and bandwidth thoroughly as each wave comes onto T2S from 2015 through to 2017, including Euroclear and our agent bank in each market. In any cross-border trade, we have to ensure that T2S and the CSD as the settlement location are always aligned on which CSD will actually hold the asset, because it is our buy-side client, and not the broker, that determines the destination. T2S means delivering safely four or five new markets a year, including avoiding the cost of buy-ins for failure to deliver under the CSDR. It is a big investment of time and money.”

That investment needs to be recouped before prices can fall. Chapman is confident they eventually will, and does not shrink from the implications of that reduction, when it does arrive. "T2S is good for the market," he says. "It is underpinning the evolution of the European marketplace into a much more competitive and open landscape. We are very supportive of the ECB initiative and what it is trying to deliver, which is a reduction in the cost of one segment of the transaction chain - namely, settlement." This, coupled with the operating model opportunities T2S provides Global Custodians when overlaid with the CSDR, will ultimately foster an environment with increased asset safety, transparency and liquidity, making the T2S investment worthwhile.”

Tags: T2SNorthern TrustCSDSettlementCSDRECBEurope