In June 2015 one of the most significant steps toward reaching a homogenized European financial landscape was taken when Central Securities Depositories (CSDs) in Europe began migrating to the TARGET2-Securities (T2S) system.

A single platform for securities settlement developed by the ECB, T2S connects European CSDs together for the first time. This will drastically simplify securities settlement in Europe, for example by making settlement between European countries as simple – and cost effective – as domestic settlement.

With cross-border securities settlement in Europe costing four to five times as much as domestic settlement, there is significant savings potential. Yet as Feriz Hasani, Head of Relationship Management Global Custody FI at UBS, points out, taking advantage of T2S is not as straightforward as it would seem.

“The devil is in the details,” he says. “To get the most out of T2S, banks and broker-dealers need to consider the new possibilities in light of the whole securities value chain. They then need to make some important decisions. The answer won’t be the same for all institutions.”

Settling, not servicing

Today, the European securities landscape is made up of a complex network of CSDs and sub-custodians, with banks generally maintaining relationships in each country where they do business. Allowing CSDs to connect directly to each other simplifies the situation, among other things making it possible to take sub-custodians out of the settlement process altogether. The problem is that, while T2S handles settlement, it does not cover post-trade services like dividend processing, tax services, corporate actions and proxy voting. Banks who do not have such asset servicing expertise in-house will need someone to handle these processes, which still vary from country to country.

“While T2S looks good from a distance, taking advantage of it means taking settlement out of the securities value chain,” says Hasani. “But clients still need the related asset servicing. Therefore banks will have to bring things back together at some point. That means extra costs and risks. When considering a new operating model to exploit T2S, banks have to take these factors into account.”

At the crossroads

Hasani says UBS has been carefully studying the situation both in terms of its own business model and its offering. “We have identified four generic operating models, with numerous subversions, we think banks and broker-dealers should consider in the new T2S environment,” he says. “Each has its advantages and disadvantages depending on the type of institution.”

“We can’t emphasize enough that there is no one-size-fits-all solution.”

Feriz Hasani, Head of Relationship Management Global Custody FI

Model 1: Global/Regional custodian

Appoint a global/regional custodian.

For smaller or mid-sized banks – typically serving mostly retail clients – it probably will not make sense to break up the value chain in any significant way. Such banks will want to keep their current setup, which generally means having their global or regional custodian handle both the settlement and asset servicing. T2S does, however, offer some scope for consolidation. While some banks have already gone this route, many still maintain sub-custodians in various countries. That can mean 20 to 30 custody relationships, each with its own contract and service level agreement, proprietary IT connection, different ways of handling daily business interactions, etc. Under T2S, these banks could significantly reduce their network down to a couple of regional custodians, if not one for all of Europe. The banks would benefit from the lower settlement costs passed on by the custodian, who can now efficiently settle through T2S. They would also potentially benefit from better conditions, since by consolidating they are bringing higher volumes. “We think this will be a popular scenario for a large number of mid-sized banks,” says Hasani, “although perhaps not right at the start of T2S. Banks will first look to see how things develop.”

Model 2: Traditional sub-custodian

Keep the traditional sub-custodian network and buy all-in services for each market.

Larger banks whose clients have complex needs may find that these customers prefer keeping the traditional setup with sub-custodians in most major countries. This is due to the ability of the sub-custodians to handle the intricacies of the local environments. Each country has different tax laws, for example. For institutional clients, compliance can be quite complex, requiring local expertise and relationships. Banks with such clients, especially in high-volume markets, may therefore keep their sub-custodian network more or less as it is, perhaps looking to consolidate on one service provider in countries where they now have several. Savings will, however, not be as high. “We spoke to a number of our larger clients about this issue,” Hasani says. “Naturally, everyone is trying to save on operations cost. But many are willing to accept that expertise comes with a price.”

Model 3: Access through one CSD

Settle direct, buy asset servicing from third parties.

For large broker-dealers, however, who typically have high settlement volumes but relatively little asset servicing needs, taking advantage of T2S to go direct to the market through a single CSD can make a lot of sense. Here, the securities value chain is clearly broken up. The broker-dealer has an account directly at T2S through the CSD, and buys all asset servicing capabilities through third parties. “For a typical large broker-dealer with 20 million euros in settlement costs per year, but only five million euros in asset servicing costs, this could be very interesting,” says Hasani. “The broker-dealer could conceivably bring down settlement costs to around five million euros. Asset servicing costs may go up several million euros, and there would be more operational complexity and IT investment, but at the end of the day overall costs could conceivably be cut in half.”

Model 4: Hybrid model

Go hybrid, with relationships with sub-custodians, regional custodians and CSDs.

For larger banks with a broad base of different clients, a hybrid model with a mix of different relationships may be a viable option. Here the bank keeps, and if possible tries to consolidate, its assets in its regional and sub-custodian network, taking advantage of T2S to benefit from lower asset servicing and safekeeping costs thanks to the sub-custodians’ buying power. At the same time, the bank opens an account directly on T2S through a single CSD (the so-called “account operator model”). The bank then actively manages its securities holdings by sending sufficient volume to the CSD for settlement purposes at the beginning of the day, and at the end of the day returning the assets to the sub-custodian/regional custodian, who handles asset servicing. Under the right conditions, this can result in savings both on the settlement and asset servicing side.

Hasani says T2S offers other advantages as well. “Along with settlement savings, it has the possibility to revolutionize liquidity, cash and collateral management,” he explains. “Choosing the right operating model is an important step in helping banks – and their customers – take advantage of this new world.”

Take your pick

With TARGET2-Securities, the securities landscape in Europe is fundamentally changing. Banks can take advantage of these changes by adjusting their business models. According to UBS, there are four basic approaches to choose from.

Model 1: Global / Regional custodian setup

For smaller to mid-sized banks, consolidating sub-custodian relationships could make sense:

  • Settlement in commercial bank money
  • Bank has no direct account on T2S platform
  • Global / regional custodian to provide all-in services
  • Bank to benefit from its buying power

Model 2: Traditional sub-custodian setup

Larger banks with demanding clients may keep their sub-custodian setup and buy all-in services for each market:

  • Settlement in commercial bank money
  • Bank has no direct account on T2S platform
  • Sub-custodian to provide all-in services (traditional setup)
  • Consolidation of all business lines with one sub-custodian/ICSD
  • Pressure on settlement fees

Model 3: Access through one CSD

Organizations with high settlement volumes but little asset servicing needs, like brokers-dealers, can go direct to market through one CSD:

  • Safekeeping and settlement with one CSD
  • Settlement in central bank money
  • Bank has its own account on T2S through a CSD
  • Bank to buy asset servicing from agent banks or regional providers
  • Challenging setup for bank as well as for asset servicing providers

Model 4: Hybrid model

Larger banks with a broad base of clients may prefer a hybrid model, with a (consolidated) custodian network and an account on T2S:

  • Majority of holdings with regional custodian
    (buying power at regional custodian for safekeeping/asset servicing)
  • Direct relationship with CSDs for settlement purposes only (benefit from lower transaction fees)
  • Bank has account directly on T2S
  • Settlement in central bank money
  • Opportunity for account operating model

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