No 4 (June 96/Juin 96/Juni 96)

A proposal for a Directive aimed at reducing `systemic risk' in payment systems has been put forward by the European Commission. The risk in question is that the bankruptcy or failure of one participant in a payment system, and its resulting inability to pay up its own obligations when due, will have `knock-on' effects leading to the bankruptcy of other participants. The proposal sets out guidelines for both domestic and cross-border payment systems as regards settlement finality (definition of when a payment order becomes final) and collateral security (the guarantees lodged by payment system participants in case they are unable to meet their obligations), thus providing a minimum legal framework for payment systems in the EU.

Payment netting means that payments between participants are set off against each other so as to obtain only a net credit or debit position. It reduces the size of credit and liquidity exposures incurred by market participants and thereby contributes to the containment of systemic risk, on condition that the net amounts obtained by netting are legally valid. However, one can only be sure that a cross-border netting arrangement between banks located in different Member States is valid if the netting scheme has a well-founded legal basis under all relevant juridictions. This is not currently the case in a number of Member States. Therefore, under the proposed Directive, Member States would have to ensure that payment netting was legally enforceable and binding on third parties, even in the event of insolvency proceedings.

The Directive also includes rules for payment systems which are not based on netting but on gross settlement systems (where each payment order is settled individually in real time as it arises during the day).

The proposed Directive would also exempt payment systems from national rules giving retroactive effect to the insolvency of a participant in a payment system, such as the zero-hour rule. Such retroactive effect allows the liquidator of an insolvent institution to challenge payment orders which have already been introduced into the payment system, thus leading to the unwinding of the settlement operation. This unwinding is highly disruptive and can lead to systemic risk.

The same is true for revocation of payment orders. Revocation of a large payment order in a payment system during the settlement process, could lead to systemic risk. The Directive would therefore bar revocation of payment orders after the moment contractually fixed by the payment system participants.

The insolvency of a participant in a payment system, insofar as it concerned its dealings with the payment system, would be governed by the insolvency law of the country where the payment system was located, according to the proposed Directive. This would avoid conflicts of law and the ensuing legal uncertainty and thus facilitate cross-border participation in payment systems.

Collateral security is pledged by the participants in a payment system in order to secure its exposures against the other participants. When collateral security is provided in a cross-border arrangement, its realisation in case of default of the pledging participant can be hindered by conflicts of law which may either weaken the collateral security or even render it unenforceable. In order to ensure collateral security to be realised immediately and in priority over all other creditors in the case of a default (so as not to jeopardise the liquidity of the other participants in the system, i.e. to avoid systemic risk) the proposed Directive would require that the collateral security be insulated from the effects of the insolvency law of the defaulting participant.

This protection would also cover collateral constituted for monetary policy purposes. This would contribute to developing the necessary legal framework in which the future European Central Bank may develop its monetary policy.

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