T2/T2S big bang: banks risk exclusion from payment transactions

Payment transactions are invisible and reliable for the general public. But it does not have to stay that way: the biggest current topic that is unknown to the general public is the TARGET2/TARGET2 Securities consolidation, and with it the ISO 20022 migration and a new account model. Banks that cannot deal with this in time are in danger of being cut off from payment transactions – and customers will feel the consequences.

The migration affects all participants in the current TARGET2 system and takes place within the infrastructure of the financial institutions, central banks and the European Central Bank (ECB). Since the migration will happen as a big bang, i.e. simultaneously for all financial institutions in Europe on 21 November 2021, delays at individual institutions may also have a negative economic impact. At worst, complications in the often outdated IT systems or delays in project implementation can lead to exclusion from individual payments if the switch cannot be performed by the cut-off date.

The consequences of a failed T2/T2S consolidation for banks:
  • Exclusion from individual payments with central bank money
  • Exclusion from conducting monetary policy operations, which means in particular:
  • Open market operations cannot be used.
  • Standing facilities cannot be used.
  • The minimum reserve requirements cannot be met.

If an ancillary system connected to TARGET2, such as the SEPA-Clearer, is used for mass payments, the bank would also be excluded from the relevant clearing channels and would no longer be able to process payments.

The consequences are therefore dramatic and practically threaten the viability of the bank itself. The only remaining alternative is establishing a direct connection via another institution. However, it would also have to be decided and planned at an early stage and cannot be done just before November 2021. If this also fails, the bank's future is at risk. Relying or speculating on a possible postponement of the migration would be negligent.

However, the major challenge of the TARGET2 consolidation is not only the redesign of the account structure, but also the technical standardisation of the access for the existing TIPS and T2S systems to TARGET2, as well as the upcoming migration of the message formats.

Future access to TARGET2

The connection to TARGET2 will change. So far, SWIFT's FIN Copy service (called Y Copy mode) is used. In the future, there will be a separate dedicated communication architecture provided by the ECB that will run with the Eurosystem Single Market Infrastructure Gateway (ESMIG) as the central access point to all TARGET2 services. For this access, a Network Service Provider (NSP) that communicates with ESMIG will be required as a new participant.

Message formats

The future speaks ISO 20022, and so does TARGET2. So far, TARGET2 still uses MT messages for communication. The MT messages will be replaced by ISO 20022 messages in XML format (MX), which will be significantly more comprehensive and able to compile more information. The MX messages are not introduced in a like-for-like approach, where it would still be relatively easy to transform MT messages into MX messages; instead, the potential of the new formats will be exploited from the beginning.

This, as well as the complete rearrangement of the infrastructure, means that parallel use or an interim solution with both formats will not be possible.

Taken on too much?

New message formats, new connection channels, new players and new processes – all of it across Europe by one cut-off date. Can that work?

Due to the topicality of the subject, detailed reporting via the central banks is carried out on a strict time schedule. Project milestones are set centrally by the ECB and the achievement of objectives is regularly monitored. Each bank is responsible for its own implementation. Currently, seven participating markets (including Germany) have reported the status yellow, while 18 have reported green. At first glance, this looks as if everything is still going well - but banks that underestimate the consequences and the effort required to be compliant in time are likely to slide from yellow to red faster than they would like.

To keep things interesting, in addition to the TARGET2 consolidation, SWIFT will also switch from MT formats to MX formats. The latter will, however, allow for a four year transition phase during which financial institutions will still be able to use both formats. Given the topical proximity, it makes sense to address this issue together with TARGET2.

The list of tasks is rather long and will tie up the institutions' capacities for the next few years. Executive board members must come to understand this as well. We are not just dealing with a "compulsory exercise" here, but with the sustainability of each individual institution.

Authors: Swaantje Anneke Völkel, Thomas Ambühler
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