An agreement to improve interoperability between Euroclear and Clearstream has hit some rough patches over the past year or so, but projects to improve the bridge linking the two international central securities depositories (ICSDs) and to achieve tri-party settlement interoperability (TSI) between Euroclear, Clearstream and Eurex Clearing appear to be on track in a two-phased approach.
Back in July 2013, Eurex Clearing, Euroclear Bank, Clearstream Banking Luxembourg, Clearstream Banking Frankfurt, and the European Repo Council (ERC) signed a memorandum of understanding (MoU) around TSI , primarily for Eurex to extend its settlement locations for its secured funding market GC Pooling with Clearstream to include Euroclear and to be processed across multiple collateral management systems.
Since then, these firms have had 10 full-day workshops to figure out what is required to make this happen. "And the conclusion from all those parties, even if there was a commitment at the level of the MoU to deliver this by end-2015, was that this was largely underestimated in terms of complexity, because there are multiple operational and processing layers impacted,” says Edwin de Pauw, director, head of product management at Euroclear.
“First of all, there are complexities at the level of clearing and exposure management. Also impacted is tri-party collateral management itself. Furthermore, there are impacts on the settlement systems and the bookings, because of the inter-entity settlement flows between the ICSDs (international central securities depositories). And then not to be underestimated, the large impact in terms of reference data, because those collateral management systems depend on a variety of data feeds to determine collateral eligibility and perform valuations. Together, those entities came to the conclusion that the target date of end 2015 was unrealistic.”
Bridging the gap
When looking at the technical requirements for this project, it also became clear that a major roadblock was the state of the bridge between the ICSDs, which is an electronic communications platform that facilitates the settlement between counterparties in Clearstream Banking Luxembourg and Euroclear Bank. While repairs of a sort have been made over the years, there have not been any significant improvements since 1993.
Thus, the ICSDs needed to improve the bridge before implementing TSI, and as De Pauw explains, some people outside these organisations thought the improvements to the electronic bridge between Clearstream and Euroclear had the same timelines as the originally intended improvements to TSI.
“Even if the impact is on the four layers, the focus moved to the settlement layer, and so that's where I think the confusion came from," De Pauw says.
The projects are closely linked, though, and the work toward more efficient interoperability is also closely intertwined with TARGET2-Securities (T2S), both in the need to have an efficient environment for transactions taking place outside of the central bank environment, and in terms of why the project timeline has been pushed out. The timing of T2S means that the ICSDs, particularly Euroclear who goes in Wave 2 rather than Wave 3 like Clearstream, have had to devote more resources to that project and don’t have enough capacity to deliver on bridge improvements.
For the bridge, the two ICSDs concluded that the improvements for settlement turnaround and settlement deadlines could be delivered by the end of 2016 or early 2017.
Yet earlier this year, the ERC said it was not happy with the target date and asked Euroclear and Clearstream to revisit the timeline.
“Generally, under the watchful eye of the ECB (European Central Bank), we pushed for a faster delivery [of the bridge improvements],” says Godfried De Vidts, Chairman of ICMA’s ERC. “Those discussions resulted in the ECB report published in July on repo inefficiencies, where it was mentioned we should get interoperability and the bridge improvement before the first launch of TARGET2-Securities.”
However, Euroclear and Clearstream hit some bumps trying to agree on the roadmap for improvements, and when the ERC asked for an update at the end of June 2014, the parties had reached a stalemate.
“Because we were at a stalemate, myself and senior staff at ICMA had a meeting with senior executives of Euroclear, Clearstream and Eurex Clearing where we asked them to reconsider, because this is a really vital piece of the architecture for Europe,” says De Vidts.
In August, a report in Financial News noted there was a breakdown in talks between Euroclear and Clearstream, and while the ICSDs refuted this notion, the fact that the discussions were placed more in the public spotlight perhaps provided the necessary push.
“After the Financial News article all parties realised that we had to do something,” says De Vidts. “There was already an agreement but the article did help keep the momentum going.”
A new path forward
"What the ERC came back with was to say we need better interoperability between the ICSDs earlier, and even if it's not the full solution, can you consider introducing an interim step before implementing the full solution,” says De Pauw.
"We now came to the conclusion that we will improve the settlement interoperability between the ICSDs in a first step for September 2015, where we will reduce the turnaround time in the afternoon by approximately 50%."
Today, users typically have to wait an hour or more to do a back-to-back trade between Euroclear and Clearstream, whereas after the improvements in the first phase are complete, it will take a little more than half an hour. As for the cash settlement deadlines, EUR, USD and GBP will extend from 1pm to 3pm, with an optional window extended from 3pm to 5pm.
This work toward extending the settlement deadlines could improve financing in the Eurozone.
“As time goes by, as more and more people start to use tri-party, you see that the cracks in the construction become much more visible,” says De Vidts. “We found that one institution had cash in one ICSD and another had collateral in the other ICSD; but of course, if the inter-ICSD cutoff time is early in the afternoon, this basically stops financing in the afternoon of the same day. Well before the crisis you had the move from unsecured to secured lending, so when banks wanted to square up long positions of cash at the end of the day but they couldn’t find counterparties who were short cash in the same ICSD, some banks had to dump excess cash into the ECB, of course because it was safe, but also because it was technically impossible to effect delivery versus payment over the bridge.
“There is interoperability in equities now in central counterparty clearing but not in fixed income. If we could create the momentum and the technical possibilities to link banks with collateral to banks with cash between both ICSDs over the bridge, we could actually create something that would decrease the funding tension in the Eurozone. That’s why we came up with interoperability in tri-party in the ICSDs that we have been discussing for the last couple of years.”
The second phase
As part of their agreement, Euroclear and Clearstream will take the second step toward TSI by implementing further bridge improvements after T2S.
“The second phase will be the full solution where the turnaround time will be on average between 15 and 30 minutes, and we will be able to push the deadline for euro and sterling to 3.30pm, and U.S. dollar to 5pm, and then the optional window to somewhere after 6pm,” explains De Pauw. “The second phase is still targeted now for somewhere near the end of 2016 or early 2017. The first phase will be September 2015, because between end-2015 and mid-2016, we will be very engaged in the migration toward T2S.
“You don't want to introduce any, even slight risk of not being ready to connect to T2S, and so you don't want to run concurrent testing or parallel system changes, and that's where for phase two of the bridge, we have not concluded on the exact date, because Euroclear's critical timing is March 2016 and Clearstream’s is September 2016.”
However, Clearstream’s public position indicates that T2S is not a deterrent for making the bridge improvements.
“From a Clearstream perspective we consider bridge enhancements to be fully in line with our strategy and want to see this topic evolve much faster,” says Marc Robert-Nicoud, member of the executive board of Clearstream responsible for strategy. “At Clearstream, we are completely committed to make these changes happen. We set aside budget for them, we have the product organisation in place, and are ready to meet the target of making significant improvements to the bridge by the agreed delivery date in 2015.
“We have been very quick to align the delivery of these improvements with our T2S developments and we assume that the other parties to the MoU did the same. Effectively what is on the table now is very consistent with what we have been proposing since 2012. So it's just a matter of making sure that all the parties can contribute what is needed for this to happen. We are ready and committed to make the necessary investment, but we cannot do it alone.”
Still, T2S is delaying the second phase of bridge enhancements, and thus the parties have proposed a mid-2017 implementation for the TSI improvements.
“It doesn't make sense to provide a TSI solution prior to T2S being live...Because the relevant markets for TSI is ESES connecting to T2S in March 2016 and CBF connecting to T2S in September 2016, we think that mid-2017 is the right timing,” says De Pauw.
Euroclear, Clearstream and Eurex Clearing have also been consulting with the major repo banks to validate the need of TSI, as they do not want to invest in the project if the demand isn’t there. But these banks do appear to think the requirement still exists. Even after T2S goes live, there will likely still be a need to connect these liquidity/collateral pools at Clearstream and Euroclear for commercial bank money.
“In a way, one can understand the delay in the final delivery,” says De Vidts. “Of course it's not optimal, but at least we have some progress…I'm partly pleased.”