Why is T2S so important for the fund industry?
The funds industry in Europe is facing a number of exciting challenges which are set to reshape the current distribution model as we know it.
At the top of the agenda is T2S: a long-term project to create a more efficient cross-border investment process across European financial markets.
European authorities have other large-scale regulatory changes in the pipeline, such as the Markets in Financial Instruments Directive 2 (MiFID 2) and, in the longer term, the Capital Markets Union (CMU). All these initiatives are aimed at making Europe more attractive, namely by increasing market transparency, enhancing investor protection, and reducing costs related to settlement.
Countries within the T2S scope correspond to 68% of the European fund business1. As T2S aims at making cross border investments easier, it is likely that investors will systematically ask for settlements in T2S – which are expected to be cheaper than today’s settlements – and thereby leading to significant impacts on investors and asset managers alike.
Investors will only need to have one account in one CSD - the Investor CSD - to have access to all T2S eligible securities; and funds will only have to be issued in a unique CSD - the Issuer CSD – to be accessible to investors settling in T2S. This set up enables investors to have access from a single account to any T2S fund wherever it is issued within T2S markets.
In 2015, T2S first became a reality with five Central Securities Depositories migrating onto the settlement platform. Wave 2 took place in March, adding two more. By mid-2017, a total of 23 CSDs in 21 countries will have joined T2S.
Two models for central administration of fund distribution co-exist in Europe, each with their own set of benefits and challenges.
Centralisation directly in the fund’s register (Luxembourg, Ireland): The investor directly opens an account at the transfer agent of the fund. With this set-up, the fund’s register clearly identifies the account owner, and the acceptance process by the fund can be easily managed. On the downside, the registration process is costly, and the settlement is processed bilaterally.
Centralisation within a central depository (Germany, France): industrialised through a DVP settlement between CSD participants. In terms of transparency, the fund may struggle to identify the investor or the distributor behind the CSD participant. When distributed in various CSD’s markets, a fund must be sub-issued in each CSD and needs to appoint a local issuing agent. The latter centralises orders from the CSD participants, executes them at the central administrator, manages the fund sub-issuing account in the CSD, and performs the settlement.
The real way that T2S is changing the game is by introducing new settlement capacities for distribution within the geographic scope of T2S - thereby increasing CSD competition.
The new distribution model will progressively be designed to combine the benefits of the register and the CSD models. It is also meant to fit with global distribution needs, as many funds are distributed outside of Europe where a register model persists.
In the upcoming hybrid model, funds might need to appoint a T2S issuing agent to progressively replace the local issuing agents. The T2S issuing agent will collect orders and manage the sub-issuing account in the T2S environment. In order to simplify distribution oversight and reduce registration costs, in some cases, the central administrator may take on the role of the T2S issuing agent.
One of the industry’s challenges is to identify investors, intermediaries or distributors behind the transactions through the T2S framework.
Some countries have already implemented market practices in order to identify transactions in a CSD environment. Such practices, known as order marking, associate each transaction with a code, which helps the fund company identify the source of the order. It allows the issuing agent, appointed by the fund, to perform ex‑ante controls on each transaction.
In France, a distributor’s referential, known as a “BIC1” – an approved SWIFT and EFAMA standard – lists around 2,000 distributors across Europe with proven efficiency (98.9% of orders are ear-marked). Such a market referential may be envisaged for the broader scale of T2S in case of subscriptions, redemptions or switches.
However, transfers of shares between CSD accounts are not reported ex-ante to the fund or to its issuing agent. The existing process – a periodic reconciliation with positions held in the CSDs’ books – enables ex-post position adjustment. Extending the order marking to transfers could be an option worth investigating, in order to create conditions for efficient distribution oversight within T2S.
The industry is currently drawing up the blueprint for new fund distribution models to benefit from the efficient processes of T2S while complying with MiFID requirements and increasing distribution oversight duties. It faces many complex operational challenges to be able to ensure easy access to global investors and simplify the identification process.
Rather than a big bang for fund distribution, we foresee a progressive evolution over several years. With our local expertise in both registrar and CSD models, BNP Paribas Securities Services is contributing to the dialogue in the main European fund jurisdictions on T2S and MiFID, with a desire to support the increased industry competitiveness and investor protection that these initiatives promote.
1 Source: EFAMA Quarterly Statistical release - 4th quarter 2015