Choosing how to connect to T2S was a straightforward decision for HSBC. The fact that the bank has otherwise left its existing arrangements untouched for the time being reflects the nature of a project that is at its beginning rather than its end.

Operationally speaking, HSBC Securities Services is ready for T2S. HSBC Trinkaus & Burkhardt, the German subsidiary of the bank, has already contracted to establish a direct connection to the new pan-European settlement platform. But the bank is still evaluating the wider consequences of such a far-reaching infrastructural change."T2S is obviously a catalyst for change in Europe, but we do not see the impact of that change being confined to Europe," says Gina Slotosch, head of global custody product at HSBC Securities Services in London. "We see T2S as part of a series of regulatory and infrastructural changes. Viewing T2S in isolation does not give you the right picture."

The impact of T2S certainly ranges wider than mere settlement. One obvious micro-impact, for example, is the spur the new platform has given to the adoption of the ISO 20022 standard, which is the only messaging language the European Central Bank (ECB) will accept from T2S users. HSBC Germany have invested in the necessary ISO 20022 functionality, while HSBC Securities Services as a global custodian will continue to deal with its sub-custodians via ISO 15022 messages. "The ISO 20022 conversion is amongst the biggest development costs we have incurred," says John Worden, global custody manager at HSBC Securities Services. "It is a cost to the business to adapt to the new format, even though the content of the settlement messages will for the time being remain the same."

But a far more important impact of T2S, says Gina Slotosch, is on the market for collateral. She thinks the strategies of market participants are driven by collateral considerations. By allowing them to collateralise exposures in any one euro-zone market with assets held in any other euro-zone market, T2S has created the first genuine opportunity for banks, brokers and fund managers to run European assets as a single pool of collateral. Since they face obligations under the European Market Infrastructure Regulation (EMIR) to post margin to central counterparty clearing houses (CCPs), this has the potential to save market participants a great deal of money in collateral movements.

Importantly, EMIR insists CCPs keep the collateral they receive at a CSD. This has created an opportunity for CSDs, shorn by T2S of their core settlement revenues, to compete with custodians. "Because counterparties can settle positions through T2S and hold positions centrally, it is possible to create a single pool of collateral simply by holding all your positions at a single CSD," explains John Worden. He expects CSDs to compete for assets by offering higher yields on cash collateral and more efficient (or more speculative) collateral transformation trades to turn ineligible assets into CCP-eligible collateral. However, Gina Slotosch believes the idea of collateral pooling will appeal mostly to institutional investors and fund managers that are not natural holders of the cash needed to meet CCP margin calls. "Institutional investors and fund managers are focused on asset pools, while banks and broker dealers are focusing on cost reductions in the middle and back office," she says. On that score, collateral management efficiencies apart, T2S is likely to be disappointing. Though the cost of cross-border settlement is expected to fall, domestic counterparties will face the additional cost of 15 cents per side, plus extra charges for trade matching and allocations, on top of existing fees. In other words, national CSDs are likely to increase rather than decrease fees once T2S goes live. “Initially, T2S will add a layer of cost," says Slotosch. “It is only over time, as the new infrastructure beds down and efficiencies are sought, that we might see some changes.”

Henry Raschen, Head of Regulatory Engagement at HSBC Securities Services, warns that the costs are unlikely to fall significantly until T2S has recovered the investment in building its settlement platform, and the volumes of transactions it settles have increased markedly. It will also take time for some national CSDs to accept defeat in their search for additional revenue to replace the core settlement income T2S is aggrandizing. As national CSDs disappear, logic dictates that the cost of domestic settlement will fall in line with the lower cost of cross-border settlement. But Gina Slotosch argues the benefits will not be felt until the process is complete. “Even if there are fewer CSDs in Europe, what benefit does that bring to me?” she asks. “I still have the same cost per transaction. The whole infrastructure needs to be more consolidated to make it more efficient for me. Until we get there, we will have a higher cost."

She expects the process of consolidation to be complex as well as prolonged. "The business model of the CSDs will change dramatically," says Slotosch. "There will be winners and losers.” What will trigger consolidation, she agrees, is the freedom of issuers to choose their CSD. This right, granted via the Central Securities Depositories Regulation (CSDR) that accompanies T2S, empowers corporate issuers to switch their issuance business to the CSD that offers the best combination of price, service and (country) rating. Though the decision is not as straightforward as CSDR implies - the CSDs that attract the majority of the business will still have to respect the company and securities laws of the domiciles of the issuers – the transfer of issuer business will exacerbate the loss of core settlement revenues to the point that some CSDs will be forced to retire from the field.

In other words, the loss of issuer business, coupled with the diminution of settlement revenues, is the likeliest spark of consolidation of CSDs. In the meantime, CSDs are obliged to link and hold accounts with one another to enable their users to settle trades in multiple markets. This investment, which is unlikely to help CSDs in smaller markets survive, is expensive but essential. Because T2S offers settlement services only, the movement of assets from sellers to buyers has still to be recorded by the national CSDs into which the securities were issued in the first place. "The need for these links arises out of the fact that T2S provides matching and settlement but it does not carry out custody," explains Henry Raschen.

This also means that global custodians such as HSBC Securities Services have to maintain sub-custodians in each euro-zone market to service those assets, in terms of corporate actions, income collection, proxy voting and tax reclaims. HSBC Securities Services is leaving unchanged its euro-zone sub-custody network – unlike some of its competitors, the bank does not have an extensive proprietary network in Europe, offering services in Germany, Greece, and the United Kingdom only. “We are leaving our network exactly like it is,” says Slotosch. This is almost certainly a temporary compromise. Other global custodians are considering taking on the asset-servicing task in-house. One has said it will settle transactions in-house, and announced the appointment of a single European asset-servicing agent to support their needs in the various national markets [see “COOConnect Guide to T2S: Northern Trust"].

The two international central securities depositories (ICSDs), Clearstream and Euroclear, are developing services that address the bifurcation of settlement and asset-servicing directly enough for banks to outsource both jobs. The ICSDs own CSDs that allow them to settle transactions in central bank as well as commercial bank money, and are developing pan-European asset-servicing capabilities that will enable their clients to dispense with sub-custodians altogether. They have already positioned themselves successfully as the natural home of pan-European collateral pools too, giving them a further advantage. “Their potential offerings are interesting, says Slotosch. "But we want to see how things pan out before committing ourselves to a particular course of action."

One prediction that can be made with confidence is that asset-servicing will be driven by settlement information. This is because it has to be. "The removal of the settlement piece leaves the asset-servicing piece, and the risks associated with asset-servicing, to be done separately," says John Worden. "Local laws,, regulations and market practice were a barrier to moving asset-servicing into a standardised T2S environment, and they are still there. In practice, you cannot actually separate settlement and asset-servicing. You have to know the book, either via drop copy messaging, or a mirror to reflect what exists, so you can calculate the entitlement. You need to know the book to do the corporate actions.” Sub-custodians cannot collect income, for example, without knowing who owns what on the record date.

Two other predictions can be made with equal confidence. One is that the bifurcation of settlement and asset-servicing is in the long term unstable, and that they must one day be united. The second is that the number of CSDs in Europe will fall, perhaps to the point at which there is only one. “Having umpteen CSDs around Europe, even if they have lost all their settlement activity, means you have still got to carry the costs of their systems, staff and buildings,” says Henry Raschen. “It is obviously inefficient to duplicate activity in such a way and, although you must watch the concentration risk, it makes sense to bring them together. The question is how.” Gina Slotosch knows her preference already. “The perfect scenario would be to have a single CSD for Europe, with custody, settlement and asset-servicing in one place,” she says. “Right now, however, we are on a journey towards that goal, and we are not there yet.”

The recognition that T2S is a beginning rather than an end allows the HSBC strategists to resist the temptation to speculate about how soon the pan-European settlement platform will expand its reach into asset servicing, and mutual fund settlement as well. “However the consolidation of CSDs is done, it will require huge investment in automation, and the harmonization of company and securities laws across Europe,” says Henry Raschen. “Once that is done, then we can talk about consolidated, centralized settlement and asset-servicing. In the meantime, let us just get some more countries on to the T2S settlement platform. That would be a good start.” Gina Slotosch agrees. “Look at how long it took T2S to come to market, the many delays that it experienced during its development, and how the current implementation schedule stretches several years into the future,” she says. “To look much beyond that is difficult. In my opinion, it would be wiser to widen the number of countries that use T2S before taking on any additional service functions.”

Dominic Hobson