Over the last two years, 22 central securities depositories in 20 markets have migrated to TARGET2-Securities (T2S). Like it or not, the platform, which aims to end fragmentation and lower the cost of cross-border settlements in Europe, is here to stay. The consensus in the industry is that only those players who have significant scale will connect directly to T2S and become 'Directly Connected Participants' or DCPs. A number of global custodians and international central securities depositories are doing just that. Their vision is to offer a single connectivity point to all T2S markets, enabling them to rationalise their existing network costs over the long term.

To achieve this vision, however, such institutions must determine how to manage their asset servicing in order to offer a full service custody solution across all T2S markets from a single access point. The traditional asset servicing model across Europe has always assumed that the local sub-custodian holds the positions locally and existing technology platforms have evolved to support this model. 

Since DCPs settle all transactions centrally, in the new T2S world, they now have to copy transactions to the local asset servicing partners operating in each local market, thereby creating virtual position balances. For the sub-custodians who wish to act as local partners to DCPs, this new asset servicing model requires both operational and technology changes. 

In this model, the sub-custodian operates as a slave to the DCP in asset servicing mode and the "normal" business process is turned on its head whereby the client of the asset servicer is now the master of the positions recorded at the local sub-custodian. The key roles of the asset servicer remain the tracking of Corporate Action (CA) activity and notifying the DCP of these events. This still involves the receipt and processing of CA messaging from the central securities depositories (CSDs) and the processing of elections, but this is typically on the settled balance only. The asset servicer must therefore also identify market claims and transformations on pending trades. 

Once identified, these have to be advised to the DCP in order for them to be instructed as trades to settle in T2S under normal settlement processing routines and not within the normal Corporate Action messaging set. This includes cash dividends settling as Payment Free Of Delivery (PFOD) within T2S. Whilst the asset servicer is the provider of the CA event details and the claims / transformation information, they have no real stock or cash positions in their accounts and can only update the replicated positions (even if they are directly created from Corporate Actions) until confirmed by the DMP as settled. 

In order to act as a local partner to DCPs for asset servicing under T2S and to undertake their traditional sub-custody function, European sub-custodians need a custody technology platform that is capable of operating in two distinct processing modes simultaneously: one to support the traditional sub-custody model where they hold positions locally; and the other to support the provision of asset servicing to DCPs where they do not hold the positions or transactions in the local market. In many cases, this involves the sub-custodian upgrading its post-trade technology infrastructure to service the two distinct client types and service levels. 

There's no question that T2S is shaking up the asset servicing market across Europe. As DCPs look to mature their T2S offering, they will continue to seek sub-custodians who can offer superior technology coupled with local expertise to manage their local asset servicing capabilities. This new model presents operational and technology challenges for sub-custodians, but also revenue opportunities. Those sub-custodians who are first-movers in making the necessary upgrades to their post-trade technology infrastructure will be best positioned to take a share of the available revenue stream and carve out an important role for themselves in today's post T2S market.

Thomas Cullinan, Director of Information Mosaic Client Solutions, IHS Markit

S&P Global provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.