T2S Benefits: Whats in a business Model?

By Peter Kepel, Securities Services Consultant and T2S advisor - 3 October 2013

This article describes some tangible T2S benefits, which one can weigh and sell to stakeholders for implementation in the current business model in a short period when having subject matter expertise and applying the right methods. To keep it simple, only two use-cases are described, however, there are of course many. The first benefits analysis, scenario "A" of UseCase1, the benefit of creating a true T2S EUwide settlement and cash process is not fully delivered if the current value chain remains. A benefit measurement "cost", related to the amounts of providers and the level of operational efficiency, only improves if the first goes down and the latter up. A benefit measurement "risk", when relating this to the time an instruction is not settling and the quality of counterparties, would again also only improve if the first goes down and the latter up. "The true benefits of T2S are not fully delivered in the current C&S value chain" When setting a cost benchmark for both scenarios, the cost at "A" will always be higher than "B" due to each actor putting its margin on service delivering to the other. This would even be the case if there was only one actor in each value chain component. Setting a benchmark on risk, due to fewer counterparties in the chain, scenario "B" would always be lower. From a practical point of view, now assuming that scenario "B" of Use-Case1 finds more traction and is implemented by the two trading institutions ("X" and "Y"), the timeline process for a Delivery Versus Payment (DVP) in T2S can have the following process description. At 11AM CET, "X" and "Y do an off-exchange bund future trade for which the middle office application semi-automatically generates settlement instructions to the GC with "High Priority" and "X", the buyer, has earmarked the position as auto-collateral eligible . The GC validates the instruction, and being DCP at the German CSD "Clearstream Frankfurt", immediately sends it off to T2S. Due to the priority of the instructions, T2S settles it in "daytime settlement" and although the buyer does not have cash it still settles due to the auto-collateralization taking place in the

continuous optimization of the on-going T2S settlement cycle. Accordingly, T2S sends out the sese.025 settlement confirmation to the GC, who sends out the respective MT548 to the trading institutions at 1PM CET who can reconcile securities and cash based upon delta or End-of-Day reports from the GC and National Central Bank respectively. At day end, the GC reports the trade to the trade repository and T2S does any re-alignments if needed. Now, for any settlement taking place between parties having an account at a DCP and for which the security is T2S eligible the process does not need to be different than the one above. Even in case the trade is in a non T2S eligible currency, the ICSDs and custodians should be able to settle the cash outside T2S and feedback for conditional settlement in T2S in a matter of minutes if the parties have arrangements in place with them. Clearly, any required regulatory capital, related to counterparties, liquidity or funding will be less at Scenario "B" as funding and liquidity can be done on centralised EU wide cash and securities accounts in a value chain having quicker turnaround times with less counterparties.

One can say that the trick is not only to see how you can enlarge footprint now, but also how to -at the same time- use T2S processes as base for the enlargement to minimize the "throwaway" in the long run. In the second analysis, one can focus on the value chain attribution for the service offered how a customer can still fit his work inside the coming T2S roadmap. For example, Issuance, Investment Funds, Settlement, Cash

Management and Securities Financing are business domains that deserve separate added value analysis, possibly changing the classic asset-and investor servicing businesses product servicing. To pick only one domain, focus is on the fund lifecycle, whereby EU-wide cross-border fund processes are becoming a single domestic process and everything outside EU is considered a cross-border. Again, here the objective is to create a harmonized process in a changed business model, from which to tackle local specifities instead of trying to defend the current model. As such, any Financial Institution (FI) in-and outside the EU who wants to issue and sell funds in EU can appoint a single T2S intermediary. As sub-scenario, one can imagine the fund manager being part of the FI for which an internal securities services department provides the asset management branch of the FI with T2S services. In such case the asset manager can integrate the cash forecast, securities trading and portfolio structuring according to the fund's investment scheme into the same infrastructure through which the distribution takes place. Of course, not all funds can follow the same standardisation and automation, e.g. operational costs for an alternative investment fund will carry higher principal costs than an Exchange Traded Fund due to the complex account, static data and compliance rules that need to be applied. But it is likely that there will be a hybrid model between the current TA and Custody models. From a practical point of view, in the second use-case, one of the objectives for a fund lifecycle is not to have the least costs, risks and quickest turnaround times, but to reach the

largest investor base to maximize sales against least costs and risks. As any EU FI can have a T2S fund distribution account, the issuer can reach any EU investor though a standard infrastructure using (minimum) two intermediaries. The investor buys fund shares at the FIs local and physical branch for which the FI exchanges MT5XX or ISO20022 SETR messages with the T2S Intermediary, who then sends a SESE.023 with the fund specific message items (e.g. UNIT) and a predefined fund account model as first interaction with T2S. If it relates to an ETF, the settlement and reporting can be completed within hours like in the first use-case. If a Net Asset Value (NAV) needs to be applied, the already settlement instructions that were put on hold, can then be modified with the NAV and released for settlement. "One of the objectives for issuing and selling funds in T2S is reaching the largest possible investor base" For both use-cases, one can conclude, looking at the extensive T2S functions implementable on a footprint of a minimum of 24 CSDs, that on the medium to long run current relevant business models will change and in the short run the operating models are being implemented through companywide transformation programs. If in doubt that the Eurosystem will be able to get the T2S objectives it sets out in the beginning, it will use its legislative power to enhance the on-going capital markets regulation and directives. The question is in what timeframe this will happen and how incumbent and disruptive entrants will further change the landscape. This, the actual T2S value attribution and profit measurements, can be subject of an another article. This article is based on public information available on the Internet.