Target to Securities

February 17, 2016
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By Abhinit Kumar.

Financial market is known for its constant changes. Since its inception, it has seen many changes in terms of financial reporting to regulators, risk or the way client’s assets are managed. Post Lehman collapse, the industry has seen one of the biggest changes in the way how derivatives markets are managed and how banks can indulge in proprietary trading under Dodd-Frank.

And yet again there is a new change being brought in the way securities trades will be settled in the euro zone knows, as introduced in finance courses in India, as Target to Securities (T2S).

T2S is in fact a new European securities settlement engine which will allow delivery-versus-payment (DVP) settlement in funds across all European securities markets much in similarity to DTC market in United States. It is expected to go live in 2015.

Reason for introduction of T2S is that currently all the securities trade in euro zone settle differently and authorities now want to make it more uniform settlement process.

In the past, European financial market was created to meet the requirements of national financial markets. In most cases, there were one or two dominant players at each stage of the value chain: typically only one stock exchange for trading, possibly one central counterparty (CCP) for clearing and at least one central securities depository (CSD) for settlement. Furthermore, each of these national infrastructures was primarily designed to manage securities that were denominated in the national currency.

Despite the introduction of the euro over a decade ago, the provision of clearing and settlement remains heavily dependent on domestic settlement.

Investors still trade mostly in domestic securities and in domestic currency. This does not provide an optimal settlement process in the euro zone and due to which the risk is still concentrated and not diversified which arise due to single currency.

So initially even United States was in a very similar position long time back, with a fragmented trading and post-trading infrastructure. The inefficiencies post trading system eventually took its toll and US government had to take measures to consolidate this fragmented. The US now has a consolidated trading and settlement environment, with the Depository Trust & Clearing Corporation (DTCC), responsible for the clearing and settlement of all equities and corporate bonds, and the Federal Reserve System responsible for government bonds. Very soon investment banking courses and training across financial courses,  MBA etc will need to start including this topic into their content to provide learners and readers with first hand information.

The EU authorities though have so far not taken any such dramatic steps. The initiatives taken up to now have focused on removing the domestic settlement process. Market forces would determine the optimal market structure, whether this is a single provider, as in the US, or multiple providers. The most important initiatives from the EC are the Markets in Financial Instruments Directive (MiFID) and Code of Conduct for Clearing and Settlement.

T2S is intended to complement these existing initiatives by improving competition, better price transparency and also improving current practices across Europe. Settlement has traditionally been the domain of national depositories, so it was difficult for a depository in another country to gain access to these securities. By creating a pan-European platform, T2S aims to improve these challenges between national markets in a way which could not have been achieved by the MiFID or the Code of Conduct on their own.

Also, with introduction of T2S in the school of investment banking is expected to get boost with more job opportunities getting created across operations.

 

Current workflow structure

Steps Involved

1-IB will execute trade with brokers

2-At the same time they will contact their custodian bank to provide trade details

3-Custodian will then inform clearing broker to ensure trade matching and settlement is done by them.

4-Both executing broker and clearing broker will match the trades and ensure settlement is done.

5-It is currently the job of clearing broker that trade matching is done on domestic exchanges and inform of any disparity.

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New workflow structure

Steps-

1-All the steps remain same as per the old structure, but the clearing broker will not be part of the trade settlement process.

2-Custodian and Executing broker will directly be involved and settle the trade via new platform.

3-This will then ensure that trade can settle without the involvement of domestic exchange and improve cross border settlement process in EURO currency.

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