Carpe Diem
27 September 2016
Consolo鈥檚 Sarah Nicholson discusses how the recent launch of the third wave of T2S could present the securities finance market with new opportunities for efficiency that should not be missed
Image: Shutterstock
Target2-色花堂(T2S) has been a relatively quiet revolution for securities finance. Perhaps seen as an issue wider than just securities finance, it never the less has the potential to significantly change and perhaps even improve the settlement process for the industry.
The third wave of T2S markets transitioned across on the weekend of 12 September, and with it the numerous core securities lending markets. Wave two only included Portugal and Italy but the latest step brought on France, Holland, Belgium and Luxembourg, meaning that a significant part of the European securities finance market is now trading through this settlement engine. The next wave will commence in February 2017 and includes, among others, Germany, which in itself is one of the largest EU markets to go live.
So from a securities finance perspective what does this mean? Firstly the static data for each participant in the migrating markets has to change, with business identifier codes increasing to 11 digits and this in itself has been no mean feat as generally SSIs for the industry are held independently from the firm鈥檚 main database and each required manual updates, involving operations team manually managing positions and transactions in flight over the transition.
Other aspects of the instruction template have also changed. While the custodians have been very accommodating in managing the process of enriching old-style instructions to meet new requirements, as time goes on client instructions will require amendments and systems will require development to enable this, with many more fields having matching requirements.
However, notwithstanding the potential pain of transition, T2S offers a lot of enriched functionality, some of which seems custom made to reduce risks and improve settlement rates in the lending industry. Functionality such as the ex/cum div indicator could be useful if the market decides to adopt it and may save parties managing the dividend entitlements by amending trade dates, but as a matching field the market consensus is to leave this field blank and continue adjusting trade dates for the time being.
There is functionality that enables you to 鈥榟old and release鈥�, whereby you can match trades but put settlement on hold until such time as you wish to release. This could be utilised to more effectively manage bilateral collateral arrangements: matching loans in one market but on hold for settlement until collateral has been received in another. This could be used to manage cross-border cash and security collateral and put an end to potential daylight exposures.
There is also the ability to link trades, so that one settlement can be dependent on another and is seen by many agent lenders as a solution to the bulk delivery process used, whereby an agent transfers a number of shapes into a single omnibus account and then delivers one shape to the borrower. Issues can arise if a number of transactions are pending to ensure that the receipt and onward deliveries match and some agent lenders see the linking functionality as an obvious solution.
However, borrowers are keen to use other functionality such as the ability to partially settle transactions. On a return leg this would allow a borrower to efficiently return any long positions automatically. All it requires is for the lender and the borrower to flag the matching field on the instruction as accepting partial settlements. Of course, from a lender鈥檚 perspective there is a risk that loans have numerous returns reducing any profitability, but the process has been managed in CREST for years, so agents are familiar with managing the process, and also see the benefit where their client has sold and loan recalls have been required. The automatic partialling could mean that subsequent fails are reduced, and of course, with the Central 色花堂Depository Regulation coming, this could be important.
The general market consensus is that T2S should be bedded down before the market utilises partialling, but with obvious benefits on both sides it is clear that there will be demand to use this as soon as possible and system vendors are already looking at how this can be incorporated. But here鈥檚 the rub: if you use linking on a transaction, you can鈥檛 use partialling. So while one side of the market is building solutions using one function, there may be a growing expectation from the other that a different function will be adopted, and the market can鈥檛 have it both ways (apparently).
Of course, the European Central Bank, which developed T2S, is keen to see it successfully implemented and utilised to its fullest. It is already listening to the market feedback and working out additional functionality or developments that mean the system is more effective.
This will eventually ensure than even where potential conflicts or issues lie, there may be opportunity to influence the next iteration. As a market, we shouldn鈥檛 miss this opportunity to ensure we can maximise the efficiencies T2S can offer.
The third wave of T2S markets transitioned across on the weekend of 12 September, and with it the numerous core securities lending markets. Wave two only included Portugal and Italy but the latest step brought on France, Holland, Belgium and Luxembourg, meaning that a significant part of the European securities finance market is now trading through this settlement engine. The next wave will commence in February 2017 and includes, among others, Germany, which in itself is one of the largest EU markets to go live.
So from a securities finance perspective what does this mean? Firstly the static data for each participant in the migrating markets has to change, with business identifier codes increasing to 11 digits and this in itself has been no mean feat as generally SSIs for the industry are held independently from the firm鈥檚 main database and each required manual updates, involving operations team manually managing positions and transactions in flight over the transition.
Other aspects of the instruction template have also changed. While the custodians have been very accommodating in managing the process of enriching old-style instructions to meet new requirements, as time goes on client instructions will require amendments and systems will require development to enable this, with many more fields having matching requirements.
However, notwithstanding the potential pain of transition, T2S offers a lot of enriched functionality, some of which seems custom made to reduce risks and improve settlement rates in the lending industry. Functionality such as the ex/cum div indicator could be useful if the market decides to adopt it and may save parties managing the dividend entitlements by amending trade dates, but as a matching field the market consensus is to leave this field blank and continue adjusting trade dates for the time being.
There is functionality that enables you to 鈥榟old and release鈥�, whereby you can match trades but put settlement on hold until such time as you wish to release. This could be utilised to more effectively manage bilateral collateral arrangements: matching loans in one market but on hold for settlement until collateral has been received in another. This could be used to manage cross-border cash and security collateral and put an end to potential daylight exposures.
There is also the ability to link trades, so that one settlement can be dependent on another and is seen by many agent lenders as a solution to the bulk delivery process used, whereby an agent transfers a number of shapes into a single omnibus account and then delivers one shape to the borrower. Issues can arise if a number of transactions are pending to ensure that the receipt and onward deliveries match and some agent lenders see the linking functionality as an obvious solution.
However, borrowers are keen to use other functionality such as the ability to partially settle transactions. On a return leg this would allow a borrower to efficiently return any long positions automatically. All it requires is for the lender and the borrower to flag the matching field on the instruction as accepting partial settlements. Of course, from a lender鈥檚 perspective there is a risk that loans have numerous returns reducing any profitability, but the process has been managed in CREST for years, so agents are familiar with managing the process, and also see the benefit where their client has sold and loan recalls have been required. The automatic partialling could mean that subsequent fails are reduced, and of course, with the Central 色花堂Depository Regulation coming, this could be important.
The general market consensus is that T2S should be bedded down before the market utilises partialling, but with obvious benefits on both sides it is clear that there will be demand to use this as soon as possible and system vendors are already looking at how this can be incorporated. But here鈥檚 the rub: if you use linking on a transaction, you can鈥檛 use partialling. So while one side of the market is building solutions using one function, there may be a growing expectation from the other that a different function will be adopted, and the market can鈥檛 have it both ways (apparently).
Of course, the European Central Bank, which developed T2S, is keen to see it successfully implemented and utilised to its fullest. It is already listening to the market feedback and working out additional functionality or developments that mean the system is more effective.
This will eventually ensure than even where potential conflicts or issues lie, there may be opportunity to influence the next iteration. As a market, we shouldn鈥檛 miss this opportunity to ensure we can maximise the efficiencies T2S can offer.
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