new standards on asset servicing and liquidity management

This document was produced for the client's internal use. Circulation, citation or reproduction aiming for deployment outside of the client’s organization is therefore prohibited without the prior written approval of Be Consulting, Bluerock Consulting or targit GmbH. This material was provided as written support for oral presentation: It is therefore not exhaustive without the accompanying verbal commentary.

T2S: NEW STANDARDS ON ASSET SERVICING AND LIQUIDITY MANAGEMENT Claudio Anfossi, Director, Head of Securities Competence Center, Be Consulting, Milan Peter Peschek, Managing Consultant, targit GmbH, Vienna

Post-Trade Forum, Vienna, September 11th, 2014

BE CONSULTING & TARGIT GMBH 2

T2S: NEW STANDARDS ON ASSET SERVICING AND LIQUIDITY MANAGEMENT

• Impact on Global and Local Custodians

• Changes on Asset Servicing

• Liquidity Management will not be the same anymore – an Overview

• Securities and Cash Financing becoming strategically important


WHO? - MAIN T2S STAKEHOLDERS

12 ottobre 2012 Copyright © 2012 Claudio

Anfossi

CSDs (Global)

Custodians (Local)

Custodians Asset Managers Investors

CSDs CCPs Trading Venues Brokers/Dealers Investors

Custo

dy

Sett

lem

en

t

Custody & Settlement Value Chain


KEY EXPECTATIONS

Key Issues Key Expectations

IMPROVE LIQUIDITY

MANAGEMENT

REDUCE SETTLEMENT

COSTS

HARMONISE SETTLEMENT PROCESSES

•Enable financial intermediaries (banks, investment firms, etc.) to settle all securities transactions performed in the Eurozone by using a single account, with significant advantages in terms of liquidity management

•Significantly reduce the settlement costs for cross-border transactions and align the cost of domestic transactions

•Harmonise practices and standardise the settlement processes in the different countries, by fostering innovation and competition

•Create a technical standard (based on a new platform), for the settlement of securities transactions, both at a domestic and at cross-border level

•The new T2S platform will be managed at a European level and will interact with local CSDs (Central Securities Depositories) and single intermediaries

•The first T2S “clients" are CSDs

•T2S is not mandatory, but offers strong business and operational opportunities to "first movers"


FROM EXPECTATIONS TO IMPACTS

Expectations

Reduce the current fragmentation of securities settlement infrastructure in

Europe

Harmonize settlement services in Central Bank

Money (CeBM)

Reduce costs of cross-border securities settlement to

domestic level

Increase competition among providers of post-trading

services and break up monopolies

Support to EU Financial Services Action Plan and contribute to removal of

Giovannini Barriers

Reduce risks

Promote lower overall collateral requirements,

reduce collateral costs and improve liquidity

management

Impacts


T2S: CHANGE IN BUSINESS MODEL?

It is widely believed that the introduction of T2S, as a single shared platform (SSP) that provides outsourced settlement services to national CSDs, will mainly impact the latter and, in particular, to the ones that decided to join it.

There is a large consensus on the fact that T2S would affect the current market positioning of all intermediaries currently operating in the Eurozone: global custodians but also local agent banks as well as Central Counterparties (CCPs) not to mention trading venues and asset managers.

In order to remain competitive they should all take critical decisions as if to stay in the securities business or not and, if yes, how to comply with the new business framework.

In brief, they should assess their current business model in relation to the new scenario and, if necessary, think about adopting a brand new one.


Anfossi


GLOBAL CUSTODIANS


Anfossi

All potential models have pros and cons. All of them imply investments costs in addition to those already planned. All of them lead to a shift of the current structure of costs and revenues.

As the majority of them work through local entities that offer them agency services, they will be geared to reduce the number of current local providers; this solution will imply that they have to plan additional

costs to insource skills and know-how.

The few large operators that can be considered as truly global (i.e. those that act directly in any, single, financial center with their own organisation) will probably plan, in the long term, to rationalise the

number of CSDs they work with. In the short term, they would probably decide not to change the current business model based on direct membership.

As for CSDs, T2S represents a mix of opportunities and threats for global custodians. So we can state that there will be a number of different business models able to fit with the various different scenarios that

can be drafted. Some of those models may also overlap with the ones of other T2S actors.


LOCAL CUSTODIANS

12 ottobre 2012

T2S could have significant implications on the sub-custodians (or local custodians), smaller local operators which normally act as a local agent for global custodians. Even in their case, it could be necessary to rethink/refine the business model in order to keep the current competitive position. This will imply new investments and their operating costs will rise in the medium term.

In addition, not all sub-custodians will be able to cope with the new challenge: they are fully aware about this issue that explains why a high percentage of sub-custodians expressed a negative opinion on T2S. The fragmentation of European markets was, in fact, the key to their success so far.

Concerns also arise from the fact that there is a significant probability that the national CSDs in T2S may extend their operating scope to local custody services (in particular in the field of management of corporate actions, taxation, etc.) .. Such an event would hardly be counteracted by the local custodian who would lose not only revenue but also the fundament of their business.

In fact, there would be space for only a few operators who can aspire to the role of single point of access to a country involved by T2S and the ideal candidate is surely represented by the national CSD. The most likely consequence is, in the medium term, a consolidation of local operators or their conversion to the role of traditional commercial banks.


ASSET SERVICING - WHERE DO WE STAND RIGHT NOW?

The CASG has noticed that as we move closer to T2S migration, the situation becomes clearer and implementation problems (expected and unexpected) have emerged in some markets, moving their status from YELLOW or GREEN to RED.

how many implementation problems are still undiscovered ?!?


SPECIFIC MARKET ATTRIBUTES (1/2)

What are Market Specific Attributes - MSA’s: Defined by the CSDs on their static data object that can be added to following objects: - Securities account - Party - Security

The CSD can apply following actions - Accept - Reject - Put on hold

These rules will be applied to following transactions: - Settlement Instructions - Settlement Restrictions - Realignment Instructions - Auto-collateralization instructions


SPECIFIC MARKET ATTRIBUTES (2/2)

Without sufficient knowledge of each CSD’s rules it is difficult to ensure that T2S cross-CSD settlement will be smooth (T2S Programme Office, April 2013)

CSD A CSD B

Client X at CSD A

Client Y at CSD B

Investor CSD

Client X at CSD A

Client Y at CSD B

CSD A CSD B

DVP Transaction

Realignment

RVP Transaction

MSA rule on Investor CSD level

• Client X and Client Y are sending instructions to CSD A and CSD B

• T2S matches these instructions and sends status advice

• On settlement date, T2S attempts to build the realignment chain and hits the rejection rule

• T2S cancels the instructions

What’s the impact on market claims and transformations?


CASH DISTRIBUTIONS

Due to T2S CA Standards, all cash distributions should be handled via dedicated cash accounts – DCAs. As of today, we already know that not all markets will fully comply with this rule when T2S goes live. Example Germany:

• Cash distributions for Government bonds will be booked to DCA’s at the beginning of the overnight batch

• All other cash distributions will be booked to T2 accounts in batch mode (netted payments)

• Payments could be forwarded to DCAs via liquidity bridge


BUYER PROTECTION

All T2S markets have indicated that they will implement manual buyer protection in their respective markets. This means the responsibility lies with buyers and sellers and not the CSD. Local market groups have to assure that respective procedures will be defined.

but there is still a long way to go!!


MULTIPLE TECHNICAL ISSUER CSDS

Securities from non-T2S markets could have different technical issuer CSDs which requires realignments outside T2S

T2S

Technical Issuer CSD A

Technical Issuer CSD B

Subcustodian A

Client A Client B

Subcustodian B

NON-T2S CSD

Realignment

Realignment

• The client instructs a technical issuer CSD

• Each technical issuer CSD could have different sub-custodians in the local market which needs to be instructed

what are the consequences to - Corporate Action processing? - Creation and processing of market

claims and transformations?


LIQUIDITY MANAGEMENT IN T2S KEY FEATURES (1/2)

T2S is a securities settlement system in central bank money only; this means that it exclusively relies on the cash settlement platforms managed by national central banks that, in the case of the Eurosystem, is represented by the TARGET 2 platform (T2)

The model adopted by the Eurosystem for the delivery-versus-payment (DvP) settlement of securities and cash is called "integrated" in the sense that both securities and cash positions are managed on the same platform (T2S); in regards to the cash positions, they will be handled through special accounts called T2S Dedicated Cash Account (or DCA)

Therefore, DCA are considered as central bank money accounts opened in the books of a national central bank (CB) to banks settling cash positions on their own behalf and/or on behalf of other entities

A DCA holder shall be allowed to hold one or several T2S dedicated cash accounts in Euro or a non-Euro currency. Every DCA can exist in one currency only and T2S shall not perform/facilitate any currency conversion

T2S acts as an ancillary system to the RTGS system and a DCA shall start with a balance of 0 at the start of the business day and repatriate all the remaining balances at the end of the same day through a process called "automated cash sweep“


LIQUIDITY MANAGEMENT IN T2S KEY FEATURES (2/2)

Sophisticated Credit Limit Management

Central Bank Auto-collateralisation

Client Auto-collateralisation

Multiple Liquidity

Provider tool

Liquidity Monitoring


LIQUIDITY MANAGEMENT IMPACTS

While the impacts of T2S on settlement processes were largely stressed and analysed, the ones on liquidity management are very often underestimated

In fact, T2S will dramatically change the way cash is managed by banks for securities settlement purposes and, in general, will affect liquidity management policies and processes of banks’ treasurers

The new scenario will have business, organisational, operational and technological impacts on many areas of banks and the extent of these impacts is influenced by a number of key factors:

Geographical perimeter of a bank’s business (local vs. global)

Clients typology and dimensions

Level of process automation

National CSD decisions related to corporate actions management (in vs. out of T2S platform)

Access strategy to T2S (DCP vs ICP)

Etc.


LIQUIDITY MANAGEMENT KEY BUSINESS AREAS IMPACTED BY THE IINTRODUCTION OF T2S

Treasury

Settlement

Custody

Reporting / Compliance Static Data Risk & Control

Custody Administration

Liquidity

Management

Client Service & Support

Corporate Actions

Tax

Claims & Comp.s

Proxi Voting

Trading

Services &

Client

Support

Core Middle-

& Back-Office

Ancillary

Middle- &

Back-Office

Other

Trading On-Exchange

Instr

uctio

n -

Report

ing

Trading OTC

Collateral

Management

Securities &

Cash

Financing

ILLUSTRATIVE

Business will be significantly impacted by the new scenario:

On one hand, pushing for changes in organisations and operations and for service offer enlargement

On the other hand, creating new opportunities


Custody & Settlement

Reporting / Compliance Static Data Risk & Control

Client Regulator

y

Audit Tax

Securities Currencies

Parties Accounts

Risk Mgm Credit

Control G/L

Market Ops

P&L Acc.ng

Position

Management

Clearing &

Settlement

Collateral

Management

Exceptions Management

Transaction Management

Cash

Management

Margin

Management

Reconciliatio

ns

Treasury

Funding

FX Mgm

Client Service & Support

Sales CRM Help Desk

Asset Servicing

Corporate

Actions Tax

Claims &

Comp.s

Research &

Portfolio

Analysis

Securities Lending

Cash Financing

Proxi

Voting

Pre-Matching

Security

Trading

Services &

Client

Support

Core Middle-

& Back-Office

Services

Ancillary

Middle- &

Back-Office

Services

Other

Services

Trading

Com

munic

atio

n Inte

rfaces

LIQUIDITY MANAGEMENT MAP OF MAIN T2S IMPACTS ON A STANDARD IT ARCHITECTURE ILLUSTRATIVE

Where the bank uses market standard applications and the vendors are committed to adapt them to T2S, the economic impact of the investments will be substantially the same in all cases (DVP vs. ICP)

What will determine the major impact differences will be the update/development of “custom applications" interfacing those of 'external' parties (CSD, NCB, custodian, Eurosystem, etc.)





• Liquidity Management will not be the same any more – an Overview

• Securities and Cash financing becoming of strategically importance


SECURITIES AND CASH FINANCING BECOMING OF STRATEGICALLY IMPORTANCE

“At the moment, the buzzword in the market is ‘collateral’.

• We are seeing considerable growth in secured borrowing. Also the future legislation on CCPs and OTC

derivatives (EMIR) will require more margining. All regulatory initiatives point to the greater demands for more

high-quality collateral. T2S will enable banks to make very significant savings in collateral when settling securities

transactions.

• T2S will eliminate the need for banks to hold multiple buffers of collateral in depository systems across Europe.

Banks will have the possibility to have a single buffer based on their entire European business. A single pool of

assets and liquidity automatically nets the short and long positions between various countries. A single

settlement engine, central bank auto-collateralisation, a harmonised schedule, and many other features of the

T2S platform, will also enable banks to reduce the amount of collateral that is left idle.”

• Gertrude Tumpel-Gugerell’s keynote speech at the ECB’s conference on “Securities settlement in 2020: T2S and beyond”,

Frankfurt, October 4th, 2011

In July 2013, J.P. Morgan announced that its collateral management business has selected London Stock Exchange

Group (LSEG) to provide settlement, custody and asset servicing services through a new CSD that LSEG established in

Luxembourg.

J.P. Morgan confirmed that this development is in response to EMIR, which requires margin and default

contributions posted to CCP to be held, when possible, with a securities settlement system. CCPs will be

expected to comply with this requirement when they obtain authorisation under EMIR.

12 ottobre 2012


Total value of securities used as collateral in the financial system worlwide was estimated to exceed €10 trillion

However, this value represented only a small portion of total assets of global banking system which is estimated to be around € 70 trillion

COLLATERAL: A HUGE MARKET …

12 ottobre 2012

3%

49%

2%

44%

2%

Trading with CCPs

Market-securedfunding

OTC derivativesmargining

Settlement

Central-banks-secured fundings


… OF A MORE AND MORE PRECIOUS RESOURCE …

12 ottobre 2012

Retail and wholesale payment systems (within SEPA and

Target 2 contexts) will necessarily evolve and

unsecured (i.e. not collateralised) interbank

deposit markets would be gradually replaced by

guaranteed ones. Financial institutions aiming to keep their competitive

positions in the new scenario will have to define strategies aiming to integrate cash and

securities in order to optimize risk and profitability

management.

Banks will look for more efficient collateral and risk

management tools that, being integrated with payment and

compliance processes, are able to work in a proactive

way instead of simply reacting to market inputs.

The recent financial crisis has exacerbated the relation

between efficient management of collateral and its impact on capital adequacy

needs of European banks.

Following completion of a capital exercise, the European

Banking Authority (EBA) determined in 2011 that the

aggregated shortfall - corresponding to a minimum

Core Tier 1 ratio at 9% - exceeds over € 100 billion

In T2S, thanks to its auto-collateral functionalities, banks may be able

to reduce their average daily cash or credit requirements during peak

settlement periods


… THAT IS BECOMING MORE AND MORE SCARCE …

12 ottobre 2012

On September 6th, 2012, in order to increase collateral

availability for the Eurosystem’s liquidity-providing operations,

the ECB Governing Council decided to suspend the

application of the minimum credit rating threshold in the

collateral eligibility requirements.

The suspension applies to all outstanding and new assets of marketable debt instruments issued or guaranteed by the

central government, and credit claims granted to or

guaranteed by the central government, of countries that

are eligible for Outright Monetary Transactions or are under an EU-IMF programme.

The Governing Council of the ECB has also decided that

marketable debt instruments denominated in currencies

other than Euro, namely US-Dollar, Pound Sterling and the Japanese Yen, and issued and

held in the Euro area, are eligible to be used as collateral

in Eurosystem credit operations.


… DUE TO MANAGEMENT INEFFICIENCIES

Current way of managing collateral shows some inefficiencies both internal (i.e. related to the specific business model of each market actor) and external (i.e. determined by the fragmentation of markets and platforms): these inefficiencies are estimated at about € 4 billion per year, of which about 10% originating from processes of over-collateralisation.

12 ottobre 2012


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new standards on asset servicing and liquidity management

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