Home-currency payment and settlement services

4.2 Certain home-currency payment and settlement services might be modified or made available to increase the level of support for international settlements. In particular, where they do not currently exist, settlement accounts and intraday final transfer capabilities (i.e. the ability to initiate transfers between accounts at the central bank of issue that become final within a brief period of time) could be made available by central banks to settle home-currency obligations related to cross-border and multi-currency transactions. These central bank services could facilitate the settlement of both gross and net obligations in each currency.

4.3 The rationale for making available certain home-currency services would be to help lower the significant credit and liquidity risks that can arise in the process of settling obligations in multiple currencies. It is important to recognise, however, that the availability of these services would not be sufficient to permit the simultaneous settlement of obligations in all G-10 currencies. Hence these home-currency services could not, per se, eliminate the credit and liquidity risks that exist in the absence of multi-currency DVP capabilities. As described in Section 3, these risks include the potential loss of principal inherent in a non-DVP settlement process. They also include the possible liquidity risk that can emerge if participants refuse to honour their settlement obligations to "suspect" counterparties out of fear of losing principal.

4.4 Recognising that they cannot eliminate the risks associated with non-DVP settlement, certain home-currency payment and settlement services would nonetheless significantly improve the ability of market participants to manage and control these and other settlement risks on both a bilateral and multilateral basis. Without intraday finality, for instance, it is possible that transfers initiated over home-currency payments systems might be cancelled or revoked, and so the ultimate discharge of obligations in such currencies remains uncertain. This uncertainty carries over to the discharge of multi-currency settlement obligations that include those currencies. In light of this uncertainty, which characterises today's multi-currency settlements, the availability of accurate information about when obligations in each currency are finally discharged would enable financial institutions to quantify more precisely and efficiently than they can at present the exposures that may be incurred in the process of settling both gross and netted transactions in multiple currencies. If the level and duration of exposures, such as principal risk, can be quantified more accurately, it should be more feasible (i.e. less costly) for the private sector to implement bilateral procedures and multilateral systems that could monitor and control these exposures in a manner consistent with the Lamfalussy standards.

4.5 The Lamfalussy standards for managing credit and liquidity risk require that netting schemes "should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single net-debit position"(Lamfalussy Report, Part C, page 26). Since settlement obligations remain outstanding until appropriate payments are made irrevocably and unconditionally, a settlement system would need to maintain (i.e. pay for) adequate resources in one form or another to cover the credit and liquidity exposures that exist until all obligations have been finally discharged. In this regard, the use of final transfers in the settlement process could reduce the size and duration of settlement exposures and, hence, could reduce the cost of protecting against these risks.

4.6 Other sources of risk can arise in the settlement process. For instance, if a financial intermediary provides a settlement service which takes the form of collecting and disbursing settlement payments for a multilateral netting system, the clearing house and market participants that make use of this service could be exposed to the intermediary for the full amount of the settlement flows. Accordingly, by using settlement accounts at the central bank of issue, multilateral netting systems could obtain this service without being exposed to private entities.

4.7 Overall, to the extent that the availability of intraday final transfers, settlement accounts and other home-currency services would facilitate the development of sound private sector settlement arrangements, systemic risk would be reduced. Market participants, whether individually or through a multilateral clearing house, would be in a better position to monitor and manage settlement risks. Furthermore, new arrangements, such as multilateral netting schemes that meet the Lamfalussy standards, would bring with them the potential to reduce the size of outstanding settlement exposures.

4.8 It is worth noting that individual central banks could modify or make available home-currency payment and settlement services either unilaterally or on a more coordinated basis. Indeed, many home-currency payments systems already permit intraday final transfers and several central banks plan to develop, or are in the process of implementing, this capability in their large-value funds transfer systems. The combined availability of intraday final transfers and other home-currency payment and settlement services from each central bank could influence the private sector's overall technical and financial ability to develop risk-reducing, multi-currency settlement arrangements for the relevant currencies.

Operating hours of home-currency payments systems

4.9 The operating hours of home-currency large-value funds transfer systems, particularly gross real-time transfer systems, could be extended to increase the level of support for international settlements. At one end of the range of possibilities, a modest lengthening of the operating hours of an individual payments system would reduce its current gap (or increase its current overlap) with the operating hours of payments systems in other countries. Towards the other end of the spectrum (which, in the extreme, could involve the large-value funds transfer systems in a number of countries operating round-the-clock), a major extension of the hours of payments systems in certain countries could result in an operational overlap of most major currencies. Provided that intraday final transfers were available over those systems, such an overlap could support the elimination of the current risks associated with non-DVP settlements by creating the technical ability to conduct a simultaneous settlement of all relevant currencies.

4.10 Simultaneous settlement would eliminate temporal settlement risk. Counterparties could build upon this capability to develop procedures to ensure that payments in one currency will be made if and only if payments in another currency or currencies are made - that is, to create a multi-currency DVP settlement. Without directly linking payments made over different large-value funds transfer systems, however, this assurance would have to come from bilateral or multilateral private sector procedures that would use the available home-currency payment and settlement services during the extended hours of operation. For instance, individual institutions (for both gross and bilaterally netted transactions) or a clearing house (for multilaterally netted transactions) could require, monitor and collect the final payment of daily settlement obligations in each currency over each large-value funds transfer system before disbursing funds in any currency. By creating an operational overlap that would make possible a DVP settlement process, an extension of hours would help support the potential elimination of the credit and liquidity risks associated with the current lack of multi-currency DVP capabilities.

4.11 Individual central banks could also choose to extend the operating hours of their home currency payments systems either unilaterally or on a more coordinated basis. In fact, several central banks are considering moderate extensions of their local payments system operating hours to support domestic markets and settlements. At the same time, many pairs of payments systems already have overlapping hours. Notwithstanding other potential obstacles to achieving multi-currency DVP settlements (e.g. differing local payment arrangements and the timing of finality), such expansions increase the opportunities for the private sector to eliminate or reduce certain international settlement risks by more closely aligning the timing of payments in multiple currencies. As is the case with the availability of home-currency payment and settlement services, the combined effect of the expanded hours of each large-value funds transfer system could influence the private sector's overall technical and financial ability to develop risk-reducing, multi-currency settlement arrangements that would take advantage of the resulting overlap in hours and available services.

Cross-border links between payments systems

4.12 Another possible option might be the establishment of bilateral or multilateral crossborder links between large-value funds transfer systems in conjunction with an extension of their operating hours to increase the level of support for international settlements. In particular, direct operational and informational links could be created that would give participating central banks the joint capability to monitor, control and execute simultaneously final transfers over their respective home-currency payments systems.

4.13 As discussed above, an extension of hours would not, per se, be sufficient to create a DVP settlement. The private sector could develop arrangements to ensure that payments in one currency will be made if and only if payments in all relevant currencies are made. Alternatively, with the additional benefit of cross-border connections between payments systems with overlapping operating hours, central banks could provide this assurance directly. In either case, an extension of operating hours - with or without direct operational and informational links - would help support the potential elimination of the credit and liquidity risks associated with the current lack of multi-currency DVP capabilities by permitting a DVP settlement among currencies with overlapping payments system operating hours.

4.14 In contrast to simply extending home-currency payments system hours, developing and running central bank operational and informational links would require a high degree of bilateral or multilateral central bank coordination and cooperation. Compatible central bank policies, as well as computer systems, software and communications facilities, would be needed (both on a regular basis and when dealing with settlement problems) to provide a multi-currency DVP settlement service.

Multi-currency payment and settlement services

4.15 Another possible option might involve the joint offering of multi-currency payment and settlement services. Multi-currency accounts and settlement facilities might be provided by the central banks of issue through a "common agent". The rationale for developing and offering these multi-currency services would be to support the elimination of the current risks associated with non-DVP settlements by creating the technical ability to conduct a DVP settlement of all relevant currencies at one location.

4.16 In the basic model considered by the Working Group, a central bank controlled common agent could be established to accept deposits in multiple currencies and to facilitate final transfers between these accounts. The central bank common agent would accept private sector deposits denominated in the currencies of issue of the controlling central banks. Deposits with the common agent would, in turn, be fully backed by deposits at the respective central banks of issue (i.e. subject to a 100% reserve requirement); this is to ensure that central banks of issue retain full authority over the process of creating central bank money in their currencies. To guarantee that deposits at the common agent are fully backed by deposits at the central banks of issue, deposits into and withdrawals from accounts at the common agent would require corresponding final transfers between accounts on the books of the respective central banks of issue. Accordingly, the respective large-value funds transfer systems would need to offer intraday final transfer capabilities.

4.17 A variant of this model would involve one or more central banks offering settlement accounts in foreign currencies. The services offered would be similar to those envisaged for the common agent. The central bank or banks playing this role would operate the accounts in each currency in accordance with predefined authority from the central bank of issue. As in the case of the common agent, foreign currency deposits in these accounts would represent deposits at the central banks of issue.

4.18 The purpose of collectively offering multi-currency services would be similar to that of creating an overlap in the operating hours (with or without direct operational and informational links) of the major large-value funds transfer systems: to provide the private sector with the technical ability to achieve on the same value date DVP in the settlement of multi-currency obligations. With multi-currency services this would be accomplished by effecting settlement over operational accounts in each currency held either at the common agent or, in the case of the variant, at one or more individual central banks. In both cases, an important issue is whether arrangements would be in place to provide assurances that sufficient liquidity would be available to complete settlement in the relevant currencies.

4.19 Multi-currency payment and settlement services could be used by multilateral clearing houses, should they be established, and their members to settle net multi-currency obligations. Similar to the situation where an overlap exists in the operating hours of the major payments systems, the actual DVP settlement process (i.e. the debiting and crediting of the relevant accounts) could be managed either by the clearing house and its participants or by the controlling central banks through a common agent. The issues that would arise if these services were also used by the counterparties to individual or bilaterally netted transactions are discussed in Section 5.

4.20 Establishing and operating central bank multi-currency payment and settlement services would require a high degree of central bank coordination and cooperation. Integrated central bank policies and operational links would be needed to create and run a common agent. Furthermore, in setting up and operating the technical and settlement arrangements, central banks would likely need to share confidential information.