Target to Securities

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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 assets are managed. Since the Lehman Brothers collapse, the industry has seen one of the biggest changes in the way derivative markets are managed and how banks can indulge in proprietary trading under the Dodd-Frank Act.

More recently, there is yet change being brought to the way securities trades will be settled in the Euro zone known as Target to Securities (T2S).

T2S is a new European securities settlement engine which will allow delivery-versus-payment (DVP) settlement in funds across all European securities markets much like DTC markets in United States.

T2S was introduced to standardize the settlements process across the many nations that make up the Eurozone. Currently all the securities trade in Eurozone settle differently and regulators now want to make the settlement process more uniform. T2Sis expected to go live in 2015.

In the past, the 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 Eurozone. Due to this, the risk is still concentrated and not diversified which arise due to the single currency.

Even the United States was in a very similar position a long time back, with a fragmented trading and post-trading infrastructure. The inefficiencies in the post trading system eventually took its toll and the US government had to take measures to consolidate this fragmented system. 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.

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, providing better price transparency and improving current practices across Europe. Settlements have 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 mitigate 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.

Current Workflow Structure:

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.

New Workflow Structure:

1-All the steps remain the 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.

Very soon investment banking courses and training across financial courses, MBA etc will need to start including this topic into their curriculum to provide learners with first-hand information. Also, with the introduction of T2S, careers in investment banking are expected to get a boost with more job opportunities getting created across IB Operations. Learn more about T2S and the settlement process in our comprehensive financial course called CIBOP (Certified Investment Banking Operations Professional).