What children's literature can teach us about T2S
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One of the many pleasures of parenthood is revisiting children’s literature. In particular, I have rediscovered an affinity with A. A. Milne’s cuddly and philosophical bear, Winnie-the-Pooh.
I recently came across the following passage: “Here is Edward Bear, coming downstairs now, bump, bump, bump, on the back of his head, behind Christopher Robin. It is, as far as he knows, the only way of coming downstairs, but sometimes he feels that there really is another way, if only he could stop bumping a moment and think of it. And then he feels perhaps there isn’t.”
Is that not a perfect analogy of life in the post trade world?
Luckily, from time to time, our heads stop bumping and we do find that better way of coming downstairs.
I fully expect that we will look back at Target2-Securities (T2S) as being one of these ‘great leaps forward’. The harmonisation, security and capital efficiency that it brings will have been well worth the effort – even if our heads have hurt just a little from all that bumping.
While we all need to get through the next few waves and contribute to the European Central Bank’s (ECB) thinking about future projects, there are some more immediate issues that we need to address if T2S is to reach its full potential.
The idea was that the cost of post-trade settlement at Europe’s CSDs would be cheaper once all the CSDs utilised T2S.
Maybe this is hard to achieve because volumes just did not keep growing. But reducing the ‘headline’ settlement cost must surely remain a key objective if the post-trade world is going to contribute as it should to CMU (Capital Market Union). T2S, like many of our businesses, has relatively high fixed costs and low marginal costs. It therefore needs to gain economies of scale and to attract volume. From where I am standing, this volume can only come from four sources: the UK, Switzerland, and the funds and Eurobond markets.
Getting any one of these onto T2S represents a very real challenge. But it should be bumped to the top of the priority list. These markets are necessary to reducing the cost of settlement in Europe.
The second issue surrounds how the CSDs will change their pricing models, and the impact that this might have.
We can expect to see CSDs change their pricing structure to make custody more expensive and settlement cheaper. The re-allocation of fees between custody and settlement is not the only aspect of CSD pricing that we should be anticipating. Some CSDs believe that it is very important that they get more clients to go directly to them rather than through an agent bank. So for the vast majority of financial institutions that choose to access the European markets via an agent bank another concern is that the pricing that CSDs offer becomes unbalanced, disproportionally favouring one client base over another.
We want CSDs to be solid, profitable institutions – and we appreciate that they have had to spend a lot to adapt to T2S. But we need them to be very transparent about their costs and charges, and to engage with the broader industry on this matter.
Next, how will T2S interact with the rest of the market? It is not being introduced to a static post-trade world, but rather to an industry that is dealing with many interconnected issues, often resulting from regulations: UCITS and AIFMD for asset safety; Basel III and BCBS (Basel Committee on Banking Supervision) for liquidity and capital; CSDR (Central Securities Depositories regulation) and CASS (Client Assets Sourcebook) for asset segregation; EMIR for collateral management, to name a few.
Each piece of regulation makes sense in its own right. What we do not know is what their cumulative effect will look like, and what their relationship with and effects on T2S will be.
We need to develop our businesses in accordance with the regulatory environment – but we also need to create real economic value.
T2S will be a success – assuming that all market players keep the overarching goals of T2S in mind throughout this long migration process.
By increasing volumes and decreasing costs, having a fair pricing structure for CSDs participants, and not duplicating investment across our industry, we can ensure the project’s realisation. Overall progress is good and the vision, persistence and hard work of many thus far should be applauded – and needs to be maintained.