How Can Banks Prepare for Migration to TARGET2?
The Eurosystem has decided to implement the second generation of its large-value payment system, TARGET, in order to bring further harmonisation and additional services to users. The launch of the new system, called TARGET2, is planned for November 2007. TARGET2 will mark a significant change in the processing of large-value payments in euros, as it will be based on a single shared platform (SSP), whereas the current organisation relies on the interlinking of 17 national real-time gross settlement (RTGS) systems. Potentially 10,000 participants will be affected. In addition to the technical changes needed to connect to the future system, they will face structural evolution in their organisations. In order to ensure the success of such a complex and large migration, what do banks and central banks need to do?
TARGET came into being with economic and monetary union (EMU). Two main objectives were assigned to the system when it began operations on 1 January 1999:
TARGET has fully attained these two objectives and is now the ‘backbone’ of euro area market infrastructures. With average daily transactions amounting to a value of €2,100bn, TARGET is one of the three largest payment systems in the world, along with the FEDWIRE system and CLS.
TARGET was created on the basis of the national RTGS systems of the European Union Member States, which were linked (‘interlinking’) via the SWIFT network. This approach was motivated at the time by the imperative need for TARGET to be operational as from the first day of EMU. However, the counter side of this is that TARGET is based on a concept of minimum harmonisation, which limits the system’s ability to contribute to European financial integration.
TARGET2 will mark a significant change in the processing of large-value euro payments. It will be based on a SSP, which is being developed and will be operated by a group of three central banks (3CB), namely the Banque de France, the Deutsche Bundesbank and the Banca d’Italia.
With TARGET2, the Eurosystem will contribute to European financial integration while keeping business relationships between national central banks and users decentralised. Its development has been driven by four principles:
The SSP, on which TARGET2 is based, will enable real-time, integrated monitoring of the liquidity position in all RTGS accounts of a credit institution, or even a banking group, across Europe. Thus, multi-country banks will be able to manage the activity of their branches and subsidiaries from a single point and to centralise their cash management, which will include liquidity involved in the settlement of ancillary systems – as settlement of these systems will be performed over RTGS accounts after a transition period (maximum four years after TARGET2 goes live). They will be able to optimise their internal organisation for payments in euro, for example by centralising payment flows and liquidity management under a unique access platform and a common ‘group of accounts’.
It is expected that TARGET2 will contribute to the harmonisation of the business practices of its users and can therefore be seen as a stimulus for further consolidation. Indeed, TARGET2 is expected to help concentrate internal processes (such as treasury and back-office functions) and promote the harmonisation of ancillary systems interfaces throughout Europe.
Among other comparable high-value payment systems, TARGET2 will be the one that offers the most comprehensive and efficient optimisation and liquidity management tools. Nevertheless, a participant will benefit fully from these mechanisms only if it relies primarily on TARGET2 for the processing of its operations and for optimising its intraday liquidity, by issuing its operations as soon as they are ready to be submitted, without retaining them on its participant platform because waiting for the needed liquidity to become available.
Twenty European countries will be using TARGET2 from the outset, which means that about 10,000 participants (1,000 direct and 9,000 indirect) will use TARGET2 to initiate payments on their own or on their customer’s behalf, and close to 53,000 entities worldwide could be addressed via TARGET2. Consequently, the change from 17 national RTGS systems to one centralised platform is a real challenge.
The idea of a European ‘big bang’ has been discussed and discarded, as the overall risk is considered to be too great. On the contrary, the migration to TARGET2 will be carried out by ‘country groups’ (see figure 1 below), allowing TARGET users to migrate to TARGET2 in different waves and on different predefined dates.
Each wave will consist of a group of central banks and their respective national banking communities. The number of migration groups will be limited to four. TARGET users will only be allocated to the first three groups, while the fourth one will be reserved for contingency purposes.
A central bank and its whole community will migrate simultaneously. Two main migration models have been identified, with obvious business implications in opting for one or the other model:
For example, as Banque de France has decided to allow the French banking community to reap all the TARGET2 benefits as soon as possible, it will dismantle all its current systems at the time of the changeover, which means that its migration to TARGET2 requires all participants’ readiness to join the SSP at once.
In contrast, in Portugal, where the current RTGS system will be kept largely untouched, and all changes required to migrate to the SSP are at the central bank’s level, participants’ readiness should not be a critical issue.
Table 1: Migration Groups
19 November 2007
18 February 2008
19 May 2008
15 September 2008
|Reserved for contingency|
From the outset of the project, the Eurosystem has clearly defined all the stakeholders and assigned to them roles and responsibilities, being highly transparent on the governance of the project:
Within each national banking community, there are some players without whom the migration to TARGET2 could not be envisaged, owing to the systemic risk this would entail or to the negative impact it would have on the smooth functioning of TARGET. These players can be central banks, credit institutions, ancillary systems or even third-party providers. Consequently, the readiness of such critical players should be one of the main criteria for the final decision of a national community to migrate. This is particularly true for countries that have adopted the so-called ‘migrate all at once’ model.
As a first step, central banks identify their critical players, based on the ‘migration model’ chosen. Once this identification has been done, the second step consists in involving them more actively in the migration project, to monitor their preparations more closely and possibly to envisage fallback arrangements to settle their transactions once their central bank has joined the SSP.
After a phase of acceptance testing, during which the participating central banks will check that what has been developed by the 3CB complies with the initial requirements, the Eurosystem will launch a user testing phase of several months (six months for the first window, 11 for the third window). To meet the objective of a smooth transition to the new TARGET2 system and environment, it will aim to verify that all involved parties:
In order to do so and to contribute to an efficient and effective testing organisation, the testing strategy defined by the Eurosystem will:
After each testing phase, a test report summarising the outcome of that phase will be prepared by the involved central bank(s). Each test will have to be assessed against the pre-defined criteria as ‘successful’, ‘partially successful’ or ‘not successful’. For each test with the results ‘unsuccessful’ or ‘partially successful’, this report will indicate its level of criticality, the proposed workaround (if any) and the proposed action plan in view of its resolution. The general objective of the user tests is to give sufficient confidence to level 2 that TARGET users are able to make use of the application in the production environment and that the whole system is sufficiently reliable, that the procedural framework is operationally stable and that central banks’ staff is sufficiently trained.
A national banking community will be ready to migrate if, and only if, the following conditions are met:
Four user testing phases are foreseen as illustrated in Figure 1.
A specific tool has been developed by the Eurosystem to support the user testing phase: the TARGET2 Test Related Information System (T2TRIS) is a web-based application designed to facilitate coordination and communication between all stakeholders. The T2TRIS is available to all TARGET2 users via the ECB’s TARGET2 website, and provides them with all information relevant to the preparation, planning, actual performance of and reporting on TARGET2 user testing activities.
For 9,000 of the 10,000 TARGET users in Europe, internal preparation should be rather light, as they will be indirect participants and will rely on their direct participant. However, for the remaining 1,000, the migration to TARGET2 is not a simple enhancement or a new release to an existing system. It will have a deep impact on organisations. They need to address strategic choices, business decisions and operational issues as well as technical problems. This is particularly true for banks with multi-country presence.
For a multi-country bank group, TARGET2 can deeply affect the group’s organisation, as it calls for a reassessment of the number of central bank accounts in euro, the model for the minimum reserves constitution, the repartition between direct and indirect participation within the group, the potential use of alternative payment systems, the commercial relationships with other banks, and access to and participation in the numerous ancillary systems (cash, securities and foreign exchange) which will settle in TARGET2. TARGET2 will be at the centre of the euro payments world; that is why preparation of these multi-country players needs to be timely, comprehensive and thorough, supported by rigorous testing.
Given that TARGET2 will replace France’s two large-value payment systems (Transferts Banque de France (TBF) and Paris Net Settlement (PNS)), the French banking community worked intensively, even before the end of 2002 public consultation on TARGET2, on defining its requirements with regard to the future system.
This enabled it, in addition, to play a very active role right from the start of European banks’ work on TARGET2. The French community’s migration to TARGET 2 represents a strategic risk: it is a collective and complex operation which is similar to a national big-bang. The migration concerns a large number of players, and its schedule does not allow for any delay: the user tests began in May 2007, and changeover to TARGET2 is in February 2008.
In addition, other major changes will be implemented at the same time in the field of payments, securities settlement and collateral management. In fact, the French securities settlement system, RGV2, will migrate to the new Euroclear platform ESES in November 2007, whereas the unique French Retail Payment System, SIT, will be replaced by a totally redesigned system, CORE, towards the end of 2007. Meanwhile, Banque de France, answering a demand from the French banking community, is taking advantage of TARGET2 as well as a new French legal framework for financial collateral arrangements, to change its guarantee management mechanism. Therefore, the ‘collective’ and ‘big bang’ aspects of this operation require strong coordination, which is achieved via well-defined project structures and plan.
At the strategic level, the TARGET2 project is regularly monitored by the highest representatives of the French Banking Federation. The monitoring was based on work carried out by a special task force led by the Centrale des reglements interbancaires (CRI), which liaises with the European banks’ TARGET Working Group.
At the operational level, the French financial community’s work on migration to TARGET2 is led by Banque de France and based on a ‘migration’ committee, assisted by a technical group, which liaises with the Eurosystem’s working parties on TARGET2.
The project plan aims to set the rules of the coordination; it defines mainly the following:
In addition to the coordination of the work stream, Banque de France makes sure to circulate the information that allows all financial market players to lay the groundwork for their migration to the new system. This information is disseminated mainly via the Banque de France website (www.banque-france.fr, ‘Payment and securities settlement systems’ bookmark, under TARGET2), but also via regular functional workshops, publication of an information letter on TARGET2, and e-mail exchanges for ad hoc queries.
Migrating to TARGET2 is at the same time an opportunity and a challenge. This is an opportunity for banks and central banks to rationalise their organisation of euro liquidity management, which will allow financial benefit only if they consider the migration to TARGET2 as a real reorganisation project and allocate sufficient resources to it. This is also a challenge for them, as the deadline for the launch of TARGET2 has to be met by all, whatever the workload needed to reach it. Consequently, the migration process from TARGET to TARGET2 has to be carefully planned and coordinated at all levels – Eurosystem, central banks and participants – and a thorough and comprehensive user testing campaign will take place for more than six months. Good cooperation between the owners of TARGET2 and the participants all along the project will be a critical factor in the successful launch of the system and its acceptance by users.