Collateral management in a Target2Securities (T2S) Landscape
Hugh Palmer, product manager at Societe Generale Securities Services (SGSS), spoke at NEMA in Dubrovnik about how the bank is helping its broker dealer clients optimise their collateral management processes in a T2S environment.
What is happening?
T2S is nearing the final stages of its implementation after a decade of discussion and planning among the industry and its creator – the European Central Bank (ECB). The ability to settle transactions in European securities on the T2S platform in central bank money is likely to result in lower overall settlement costs for participants. SGSS participated in a study which estimated that operating a single DCA in T2S could result in a reduction of 30% in the cash liquidity required for settlement. This in turn would reduce the demand for collateral. SGSS instigated its T2S project in the first quarter of 2011 and has demonstrated commitment to the initiative. This dedication meant that SGSS is ready for the coming major migration waves, including the all-important ESES markets. This level of preparation is evidenced in its successful migration of its large Italian activity, which transited to T2S as part of the Wave one migration. Moreover, the benefits of T2S will be realised in SGSS’s broker dealer and investment banking client segment.
How will clients benefit?
SGSS acts as clearing member on behalf of a number of brokers of varying sizes. Many smaller brokers are not directly impacted by T2S, but they are dependent on a “post trade service provider” such as SGSS. Most of these smaller clients are, however, more focused on issues such as ensuring their compliance with the Markets in Financial Instruments Directive II (MiFID II). These entities will not manage their collateral in a T2S environment and these brokers do not have the collateral at all required by the ECB as security for liquidity lines. These organisations will look towards their agents to ensure they can manage their liquidity and optimise total margin requirements, using their in-house position or acquiring the needed liquidity through the use of their own collateral pool. This means agents can increase the supply of intraday liquidity to their broker clients enabling them to bolster their volumes.
While T2S and central securities depository’s (CSD) pricing policies will not lead to cost savings, and there are material adaption costs for direct T2S participants, the ability to pool the cash leg of settlement and reduce demand for liquidity and collateral will be a major cost benefit. T2S will also lead to an alignment and automation in the settlement processes across middle and back offices, which again will have cost benefits. Nonetheless, firms need to adopt a holistic approach to T2S implementation and there is certainly not a “one size fits all” methodology.
Investment banks are also likely to benefit from this arrangement. T2S allows them to move from treating settlement in silos or by trading desk into single hub, allowing them to pool liquidity in a single place. In addition, they will have security of settlement as it will be in central bank money. As money is posted in central bank money and not commercial bank money, it carries no risk weighting, which further frees up liquidity. This again is important for banks who are facing Basel III challenges. While a single link into T2S is a positive development, firms need to build systems where they can measure the profitability of each trading desk or unit, and be able to track who is using what liquidity, and when as well as collateral. This analytical process could be quite complicated, but it is something financial institutions should be considering.
The liquidity, financing and collateral benefits accrued through T2S are hard to falter. The T2S project may have high adaption costs across the value chain, which may not be directly recoverable from clients, but it allows firms to reduce the back and middle office costs of settlement. The key benefit, however, is through improved asset and liability management, including more netting through cash accounts. The main advantages SGSS will be felt when the ESES markets (including France) go live on T2S.