If T2S is the answer, what’s the question?
The purpose of the European Central Bank’s T2S project is ill-defined and taking so long to deliver that it is being pushed aside by other projects.
Speaking on a panel at the Swift Business Forum in London, Warren Alsop, head of network management and market infrastructure at Bank of America Merrill Lynch, compared the project to the computer Deep Thought in Douglas Adams’ 1979 book The Hitchhiker’s Guide to the Galaxy: asked for the answer to the meaning of life, the universe and everything, it comes up with “42” and a bigger computer has to be built to work out what the question is.
“I don’t think people understand the question behind T2S,” said Alsop. “We need to find the question. What are you trying to achieve? Are you trying to support an ETF that is multi-listed? Or to provide safer, cheaper markets? It’s a combination of all of these that will provide the benefit. A factor such as collateral on its own is not the answer to life, the universe and everything.”
T2S is the European Central Bank project to harmonise Europe’s clearing infrastructure and make it more efficient. Begun in 2006, the project is now expecting the final wave of implementation to take place in 2017. The project has a significant political aspect, as it is seen as a means of driving European integration. Mario Draghi, president of the ECB, described T2S earlier this year as the necessary platform for setting up a single European market for securities services.
However, some market participants have expressed concern that the project is taking so long to deliver that it is in danger of being marginalised by banks in favour of more pressing priorities.
“The fact that this project has taken so long has raised a lot of questions at high level,” said Philippe Castelanelli, global head of network management for HSBC Securities Services. “Getting the buy-in from chief executives and heads of each division has been a big challenge. T2S has implications everywhere – in asset management, on the broker side, for custody and so on – but the retail side has been more questioning about the benefit.”
The reason for that reluctance can be partly attributed to the fact that around 95% of investment made by retail investors in the UK was directed towards UK stocks, according to Castelanelli, who added that this made T2S relatively unappealing for retail clients. In response, HSBC created a post-trade market committee, which examined all the business lines affected by T2S. The committee carried out an analysis of the opportunities presented by T2S and its effects on liquidity. Eventually, this led to unexpected synergies. “Every business line should be empowered and responsible for implementation,” he added.
The effects of T2S will, it was agreed by the panellists, be far-reaching. Alex Dockx, T2S program director at JP Morgan pointed out that T2S will affect cash as well as securities. It will have an impact on liquidity management, he said, and will also have an inter-linked effect together with other regulations such as Basel III, which affects collateral. But the danger of this complexity is that it may disguise other, deeper problems.
“T2S is just a platform,” said Dockx. “It’s not going to solve a shortage of collateral. It’s not going to solve problems with settlement. T2S will provide the infrastructure but we need to be very careful to calibrate settlement and not throw away the baby with bathwater. We need to propose a workable but also efficient regime rather than have a technical piece of regulation imposed on us which could turn against us.”
One of the questions facing financial institutions is how to handle Europe’s central securities depositories, which play a key role in Europe’s post-trade infrastructure and therefore in the T2S project. One option is to adopt direct connectivity to the CSDs. However, Bank of America Merrill Lynch has decided not to take that approach, on the grounds that the bank prefers to wait until the migration is more complete. HSBC has taken the direct participation route in seven markets, but the bank has said it will take a ‘wait and see’ approach in relation to the other markets. The dilemma is between acting early and taking on both a bigger risk and larger potential reward, or acting later and cutting both risk and the potential benefit, according to Dockx.
“Not everything is known,” he said. “It requires a lot of independent analysis. But the sooner you start to do things the bigger the rewards. We decided that given the scale of the project we didn’t want to take too much risk during migration. It’s still a year away. But we didn’t want to be last and wait for 2018 either. So we will insource liquidity management for T2S in the second wave. We are taking a flexible strategy that could shift forwards or backwards.”
Other questions surround more fundamental aspects of the project. T2S is relatively poorly understood by international investors, especially in regions such as Asia. Although the ultimate aims of the project include goals such as making it easier for a German company to issue rates in another European country, the level of harmonisation that would be required to make such a step practical remains some distance away. Although T2S is intended to bring down costs for banks that can then be passed on to the end investor, so far very few CSDs have published tariffs detailing the actual cost reduction, and it remains unclear to what extent larger institutions will be able to reduce the number of agent banks they will use. More radically, some participants even question whether the European Central Bank is best placed to run the T2s project at all.
“Despite all the work that has been put in place, it’s ultimately not up to the ECB to decide,” said Castelanelli at HSBC. “It is in the hands of others. I don’t know how this will end. I don’t think the ECB’s role is to provide infrastructure. Will they transfer it to someone else? We need to work together because it’s in our common interest to ensure T2S happens.”