TARGET Services of the European Union
The TARGET Services are a number of services developed and operated by the Eurosystem which ensures the free flow of cash, securities and collateral across Europe. The following are the currently available services.
- TARGET2-Securities (T2S)
- TARGET Instant Payment Settlement (TIPS)
The following paragraphs discuss each of these services in brief.
Before the new term TARGET2, the service used to be called as "TARGET", which stands for "T
ross Settlement E
ransfer System". It was a real-time gross settlement system (RTGS) for the Euro. This service started soon after the introduction of the Euro currency. It was created by linking together the different RTGS structures of the member countries. This decentralised system was not very efficient, though it served its purpose, and was expensive. It was replaced in 2008 by the current system named "TARGET2".
TARGET2 is designed as a single centralized service. It is owned and operated by the Eurosystem. The following are some of the features of the system.
- It handles only Euro currency.
- All transactions are processed and settled in central bank money i.e. money held in an account with a central bank.
- It processes transactions relating to both bank-to-bank and commercial transactions.
- More than 1,000 banks use the TARGET2 system either on their own behalf or on behalf of their customers
- The system supports the implementation of the European Central Bank's (ECB) monetary policy.
Being an RTGS system, the submitted transactions are processed one by one on a continous basis in central bank money (money held in an account with the central bank). All transactions are processed with immediate finality and irrevocability. The efficiency of an RTGS system depends on the cost and speed of transactions and availability of liquidity. The system provides some features such as liquidity management, payment priorities, timed transactions, liquidity reservation facilities, limits, liqudity pooling and optimisation procedures. These features have been briefly discussed below.
Liquidity Management (also commonly known as Intraday Liquidity Facility in RTGS parlance) is a service provided to the participants of the RTGS system to overcome short-term fund requirements for settlement purposes. Sometimes, participants of the system may need to process some RTGS payments but their account with the central bank may not have sufficient money. In such a case, the central bank can lend the money (usually on intra-day basis) to help settle the transactions. Without this short-term lending support, the intended payments cannot be processed and it can result in a grid-lock in the system. The grid lock here refers to a scenario where some banks will not process their transactions unless they receive funds from other banks, which does not help the free and fast movement of money, which is an essential requirement for a modern economic system.
All RTGS systems have built-in liquidity management features.
The members of the system can assign a priority while processing a payment transaction at the Member Interface before releasing the transaction for processing by the system. This helps the members to manage priorities and also liquidity management at their end.
Timed transactions is also referred to as "Queuing". Members can process future dated transactions. Such transactions are placed in a Queue and settled on the date and time specified.
As discussed above, liquidity management is an essential feature in an RTGS system because without it there can be a grid lock in the system. However, availing the liquidity management facility provided by the central bank comes at a cost. Banks would prefer to do their own liquidity management, at first, and avail the intra-day liquidity facility of the RTGS system only if required. There are two common strategies adopted by banks - 1) Balance-Reactive Gross Settlement (BRGS); and 2) Receipt-Reactive Gross Settlement (RRGS). A discusson on these topics is beyond the scope of this article. We shall discuss them in a separate article
. The TARGET2 system allows BRGS method. Under this method, a bank sets a threshold balance for its account. If the balance falls to this threshold, then it reserves that liquidity for making urgent payments; any non-urgent payments it wishes to make are queued until the balance is back above the threshold, which happens when it receives incoming payments from other banks.
TARGET2 sets minimum and maximum transaction value limits for processing. These are modified over period of time.
Liquidity Pooling and Optimisation
This features allows banks to pool liquidity within a group to view and use their liquidity, irrespective of the account on which it is held. This helps to pool liquidity and helps in efficient liquidity management.
Types of participants in TARGET2 system
All banks of the EU Member States can be a part of the TARGET2 system and settle their transactions in Euro. Other financial institutions can also connect to TARGET2 via participating central bank. The following options are available in the system.
Any financial institution established in the European Economic Area (EEA) that holds an RTGS account in central bank money in TARGET2 can send and receive payments on its own behalf or on behalf of its customers.
A financial institution established in the EEA that sends and receives payments via a direct particpant in TARGET2.
Branches and subsidiaries of a direct participant in the EEA that are authorised to channel payments through the accounts of the direct participant.
A correspondent of a direct participant that holds a Bank Identifier Code (BIC), irrespective of its place of establishment.
TARGET2-Securities is the securities settlement platform in the EU. Trading in securities is followed by settlement of securities and cash (changing hands), a process called as securities settlement. The Delivery vs Payment (DvP) method is commonly used for securities settlement, under which the delivery of securities is made only if the corresponding payment of cash is made, or vice-versa. This method mitigates settlement risk. To make this method work, a robust settlement insfrastructure is required; T2S is the platform in EU that facilitates this simultaneous exchange in a safe and secure way.
Before T2S, if a person in Portugal wanted to buy some shares of a German company trading in Germany, he/she would have to engage in an elaborate cross-border settlement procedure. This was expensive and complex because the settlement procedures of both Portugal and Germany could be different and he/she has to keep in mind the different settlement practices in both these countries. T2S provides a single common platform using which settlement can be done on the basis of harmonized rules and practices of all member countries. This means cash and securities can now be exchanged as if it were done locally. T2S changed the user experience of cross-border settlement and made dealing in securities across the EU very simple.
Currently, about 20 European countries are using this platform. The cash leg of the settlement is settled using the TARGET2 platform, which settles in central bank money. The securities leg of the settlement is settled by crediting or debiting the accounts with the Central Securities Depositories (CSD) that are linked to the T2S platform.
How does the system work?
If a person wants to trade in cross-border securities, he/she needs to open an account with a market participant. The use of T2S platform is voluntary. Market participants can use the T2S platform, Euroclear or Clearstream services, or settle them internally. There is a bridge between Euroclear and Clearstream and both are connected to T2S (we shall discuss this aspect in some other article in future)
If the market participant wants to settle securities transactions using the T2S platform, it should maintain a securities account with one of the CSDs connected to T2S and a dedicated cash account with one of the central banks connected to the platform. These accounts live side-by-side on a common platform. Once instructions to T2S are given, the settlement instructions coming from CSD and the bank are matched by T2S. If matched, then they are settled on a DvP basis through simultaneous debits and credits to the cash and securities accounts.
Note: Market participants will need to connect to T2S via the technical interface of their CSD or Central Banks. It is not the other way round.
Advantages of using T2S
T2S was designed to integrate trading in securities across the EU on a common platform. The following are some of the advantages.
- it makes it easy for investors to buy securities in other EU countries
- it reduces the cost of cross-border settlement
- it increased competition among the providers of similar service in Europe
- It helps in pooling collateral and liquidity. This means no bank will now need to keep the money in various locations (different accounts or countries). They can keep it at one place. This increases liquidity.
- It reduces settlement risk and increases financial stability
Settlement in currencies other than Euro
Currencies other than Euro can be used for settlement in T2S if the central bank of that non-Euro currency country is connected to T2S. Currently, Danish Krone is available for settlement. A currency participation agreement need to be entered into for this purpose.
List of CSDs currently connected to T2S
The following is the list of CSDs connected to T2S.
||Bank of Greece Securities Settlement System (BOGS)
||Centralny depozitar cennych papierov SR, a.s.
|Narodny Centralny Depozitar Cennych
||Clearstream Banking AG
||Depozitarul Central S.A
|National Bank of Belgium Securities Settlement System (NBB-SSS)
||Euroclear France and ID2S
||Iberclear - BME Group
||KDD - Centraina klirinsko depotna druzba, d.d.
||Kozponti Elszamolohaz es Ertektar Zrt
||Malta Stock Exchange
||Monte Titoli S.p.A
||SIX SIS Ltd.
||VP Securities A/S
END OF MY NOTES