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Reforming Cross-Border Payments and Forex Settlement Systems

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Title: Sin t tulo de diapositiva Author: Doraye Rueda Last modified by: Jos Antonio Garc a Created Date: 1/24/1999 9:39:10 PM Document presentation format – PowerPoint PPT presentation

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Title: Reforming Cross-Border Payments and Forex Settlement Systems


1
  • Reforming Cross-Border Payments and Forex
    Settlement Systems
  • Regional Workshop on
  • Reforming Payment and Securities Settlement
    Systems
  • Manama, Bahrain, March 16, 2005
  • José Antonio García

2
Contents
  • Forex settlement systems
  • Key Considerations
  • Risks
  • Current Situation
  • Reducing Forex Settlement Risk
  • Cross-border retail payments
  • International family remittances

3
Cross-border vs. Forex
  • Large-value, cross-border payments generally
    (though not necessarily) related to financial
    market transactions, particularly foreign
    exchange (Forex).
  • On the other hand, Forex market transactions need
    not to imply a cross-border payment
  • Non large-value cross-border payments more
    related to
  • International trade of goods and services
  • Unilateral funds transfers from individuals
    residing in country X to others in country Y
    (Family remittances)

4
Forex Settlement Systems
  • Forex market is the most active financial market
    in the world in terms of total amounts traded
  • Approximately the equivalent of US 4 trillion
    was settled each day worldwide by financial
    institutions by year-end 2004 (gross value, spot
    markets only).
  • Forex markets may entail risks that are relevant
    from a systemic standpoint
  • Credit risk
  • Liquidity risk
  • Legal and operational risks

5
Forex Settlement Systems
  • A sound Forex market settlement infrastructure is
    thus key for several reasons
  • Systemic risk reduction
  • Necessary in order to develop a deeper and more
    dynamic (and, hence, more efficient) forex market
  • The forex market can be regarded as the entry
    point of foreign investors to all other domestic
    financial (and non-financial) markets

6
Credit Risk in Forex Transaction
  • A bank that cannot make the payment of the
    currency it sold conditional upon its final
    receipt of the currency it bought (i.e. under a
    payment versus payment (PvP) basis), faces the
    possibility of losing the full principal value of
    the transaction.
  • Actual exposure when settling a forex trade, it
    is the full amount of the currency purchased
  • Duration of the exposure the exposure lasts from
    the time a payment instruction for the currency
    sold can no longer be cancelled unilaterally
    until the time the currency purchased is received
    with finality.

7
Credit Risk
  • This period may still be followed by an
    uncertain period, which is the length of time
    after the bought currency is due that a bank
    takes to identify whether of not it has received
    the funds (e.g. when working through
    correspondent banks).
  • Durations are a function of market practices,
    differences in time zones and in payment system
    operating hours.
  • Exposures can last from at least overnight and up
    to several days. For trades in a number of major
    currencies, the duration was greatly reduced with
    the launch of CLS Bank.

8
Credit Risk
Settled or Failed
Revocable
Irrevocable
Uncertain
Final Settlement of both currencies
Identification of transactions
Deadline for Unilateral Cancellation
Trading
9
Credit Risk
  • Thus, considering all the above, banks should be
    expected to apply a control process to FX
    settlement exposures that is the same or
    equivalent to the process they apply to credit
    exposures of the same size and duration resulting
    from loans or other formal counterparty credit
    extensions.

10
Liquidity and Legal Risks
  • Liquidity Risk
  • Temporary delays in settlement can expose a
    receiving bank to liquidity pressures if
    unsettled funds are needed to meet obligations to
    other parties.
  • The high dynamism of the Forex market also means
    that a bank will face high opportunity costs if
    it does not receive the currency bought on due
    time
  • Legal Risk
  • In the case of foreign exchange deals, legal risk
    can be complicated by the fact settlement
    normally takes place in more than one
    jurisdiction.

11
The current situation
  • Besides the case in which currency pairs are now
    settled through CLS Bank (to be explained later),
    the current situation and trends in most
    countries are the following
  • Low awareness of the settlement risks involved in
    Forex deals.
  • In many cases, deals and settlement based purely
    on mutual trust. Some banks, however, do
    establish controls as to who their Forex
    counterparties may be, and also set limits on the
    amounts that may be traded with such
    counterparties
  • In some cases there is a centralized Forex
    trading platform. However, in general such
    platforms have no direct links with a settlement
    infrastructure
  • In some countries, the Central Bank is the main
    player (buyer seller) in the Forex market.

12
The current situation
  • Lack of PvP
  • Forex trades among domestic institutions are
    generally over-the-counter (OTC) bilateral
    transactions. The domestic leg usually is settled
    in central bank accounts, while the foreign
    currency leg is generally settled through bank
    correspondents abroad (in most cases in the
    country of origin of the foreign currency).
  • In the vast majority of cases, the two legs of
    the transaction are settled independently one
    from the other. The only assurance that
    settlement will occur is trust in the
    counterparty.
  • The risk of loss of the principal value of the
    transaction due to a failure in settlement
    generally lasts for a few hours when deals
    involve moreless the same time zone, or overnight
    and even a few days if deals involve quite
    different time zones.

13
The current situation
  • Lack of PvP (cont..)
  • In general, Central Banks are concerned about
    managing settlement risks of their own Forex
    transactions and do not pay much attention to
    deals between financial intermediaries.
  • In some countries, the Central Bank holds
    accounts for financial intermediaries both in
    local currency and also in one major foreign
    currency. This could open the possibility to
    settle Forex trades among domestic financial
    institutions under a PvP basis. However, in most
    cases this possibility is not used.

14
Reducing Forex Settlement Risk
  • In 1996 the Governors of the central banks of the
    G-10 countries endorsed a comprehensive strategy
    to reduce risks, particularly systemic risks, in
    settling Forex transactions.
  • A three-track strategy was agreed, providing for
  • action by individual banks to control foreign
    exchange settlement exposures
  • action by industry groups to provide
    risk-reducing multi-currency services and
  • action by central banks to induce rapid private
    sector progress.

15
1. Action by individual banks
  • Increase awareness of the risks
  • Proper measurement and updating of Forex
    settlement exposure (current and future)
  • Establish clear senior level responsibility for
    measuring and controlling Forex settlement risk
  • Treat Forex settlement exposures like other
    credit exposures of the same size and duration,
    and manage them accordingly, for example
  • Establish bilateral exposure limits with each
    counterparty
  • Establish limits (or sub-limits) for exposure
    duration
  • .

16
1. Action by individual banks
  • Revising correspondent banking arrangements
  • Improvements in back office payments processing,
    for example, on-line statements of accounts with
    correspondents
  • Consider the possibility (and costs) of
    implementing settlement assurance mechanisms,
    like pre-funding of transactions or other forms
    of collateral
  • Consider the possibility of implementing
    obligation netting to reduce settlement flows

17
2. Action by industry groups CLS Bank
  • In September 2002 the CLS Bank International (CLS
    Bank) started its Continuous Linked Settlement
    service, settling foreign exchange transactions
    in 7 currencies (the Australian dollar, the
    Canadian dollar, the US dollar, the Euro, the
    Swiss Franc, the Japanese Yen, and the British
    pound)
  • At the time of its launch, CLS had 66 of the
    worlds largest financial institutions
    participating as shareholders
  • It is estimated that CLS banks settles over 80
    percent of the worlds foreign exchange business
    by value.

18
2. Action by industry groups CLS Bank
  • By December 2004 a total of 15 currencies (the
    former plus Danish Krone, Norwegian Krone,
    Swedish Krona, Hong Kong Dollar, Korean Won,
    Singapore Dollar, South African Rand, New
    Zealand Dollar)
  • By December 2004, a total of 58 Member Banks
    (shareholders, with settlement accounts) and 191
    Member customers (third parties sponsored by a
    Member Bank).
  • The CLS Bank is subject to the cooperative
    oversight of central banks involved and it is
    under the direct oversight of the US Federal
    Reserve.

19
2. Action by industry groups CLS Bank
  • Counterparty risk is eliminated through a form of
    payment versus payment (PvP). Liquidity risk is
    not eliminated.
  • Settlement member accounts at CLS Bank
  • Single, multi-currency account on CLS Banks
    books
  • Individual currency balances calculated,
    monitored
  • FX trades settle gross on CLS Banks books
  • Final, simultaneous debits and credits to
    Settlement Members accounts Achieves payment
    versus payment
  • Pay-ins, pay-outs via CLS Bank accounts/RTGS
    systems
  • CLS Bank holds accounts at central bank of issue.
  • Participants funding and defunding of these
    accounts is on the basis of the net amounts in
    each currency of the trades they are settling
    that day.

20
3. Action by Central Banks
  • Encourage timely, market-wide progress
  • For example, cooperation and dialogue with
    private sector to ensure that well-constructed
    multi-currency services are developed
  • Enhance national payment systems
  • For example, extension of operating hours of
    payment systems, to increase the overlap in
    system hours in different currencies

21
Cross-border Retail Payments
22
Todays Picture
  • Customers expect a set of convenient, cheap,
    reliable and predictable instruments to cover
    their most important payments needs
  • face-to-face-payments, one-off and recurring
    remote payments, ATM cash withdrawals
  • While customer requirements are generally met in
    many countries at a domestic level, performance
    in most areas is poor for cross-border
    transactions
  • As recent as two years ago, the average fee
    applicable to retail cross-border transfers in
    the Euro zone was 100 times higher than that
    applicable to comparable domestic transfers

23
Todays Inefficiency
  • A natural explanation
  • with few exceptions (e.g. payment cards), payment
    infrastructures already in place are only
    domestic in terms of their scope, this is, they
    were developed for a monetary zone delimitated by
    national boundaries.
  • Additional issues
  • Payment instruments being used
  • Involvement of a Foreign Exchange Transaction
  • Different risks
  • Supply factors (diversity of service providers)
  • Regulation (including customer protection) and
    Oversight

24
Payment Instruments
  • All over the world, cash continues to be the most
    relevant instrument for cross-border payments in
    terms of volume
  • As for cashless transactions, payment cards are
    the most relevant instrument in terms of volume
  • In the EU, cards account for 83 percent of total
    cashless transactions. In many cases, however,
    cards are not used as payment instruments but
    rather for ATM cash withdrawals
  • Using cards for remote payments?

25
Payment Instruments
  • Cheques still relevant for remote payments,
    especially in less bancarized countries
  • With the payment system technology currently
    available, electronic credit transfers and direct
    debits would appear to be the natural instrument
    for remote payments
  • Until recently, only available through cumbersome
    and costly correspondent arrangements
  • Only in recent years, with the spreading of
    processing and messaging technologies, they are
    starting to become accessible to the average
    individual

26
Involvement of a FX transaction
  • Not necessarily the case
  • Cross-border payments in the Euro area, or
    payments between a dollarized country (e.g.
    Ecuador) and the US
  • In some cases, more than one FX transaction,
    meaning more intermediaries
  • Usually, large exchange rate spreads
  • Interestingly, however, at present cross-border
    transactions between countries that use the same
    currency are not very different in terms of
    overall inefficiency (i.e. high cost) from
    transactions involving two or more currencies

27
Different Risks
  • The risks are actually the same than for domestic
    transactions, although the mix can be quite
    different
  • Increased legal risk
  • Increased operational risk due to intensive
    manual procedures (i.e. lack of interoperability)
  • However, fraud and other security concerns (e.g.
    identity theft) are regarded as the main risks
  • In the case of cards, cross-border fraud is
    approximately 20 times higher than domestic fraud.

28
Supply Factors
  • Increasing demand for cross-border payment
    services with enhanced flexibility, speed and
    geographical outreach
  • Banks have not been able to cope with this
  • Banks strong in urban areas, where they have
    generally well-developed infrastructures and
    where payments involve bancarized sectors
  • Thus, non-banking (or even non-financial)
    institutions have gained an important market
    share
  • Proprietary messaging systems
  • Large distribution networks covering remote
    locations

29
Regulation and Customer Protection
  • Transparency standards are particularly low for
    cross-border payments
  • Several implicit charges that are not disclosed
    to customers (e.g., exchange rate spreads,
    charges applicable to the receiver, etc.)
  • Minimum service levels, which, for example, give
    certainty on the time of accreditation of funds
    to the beneficiary, are practically non-existent
  • It is still costly for customers to foster
    competition through customer research and
    comparisons

30
Oversight
  • Still no consensus that retail systems should
    fall under the direct control of the overseer
  • Additional problems in the case of retail
    cross-border payments
  • Overseeing non-financial payment services
    providers
  • Overseeing the full flow of a transaction would
    necessarily involve two or more national
    authorities
  • A broader and more activist agenda in the
    particular area of retail cross-border payments?

31
What can be done?
  • Improvements through
  • The natural or inertial evolution of
    cross-border payment systems as a result of
    increased economic and political integration
  • The systematic and conscious effort to
    improve/reform retail cross-border payment systems

32
A look at the SEPA
  • In theory, with the adoption of the Euro domestic
    payments and payments between the countries of
    the Euro zone ought to be identical
  • Up to 2002, however, this was not the case
  • High costs when compared to domestic transactions
  • Relatively low STP rates
  • Lack of transparency
  • Poor performance for customers (cost, quality and
    time)
  • For cards, seamless domestic and cross-border
    processing, but significant price differences
    between domestic and cross-border

33
A look at the SEPA
  • The European Commission decided that a drastic
    political solution was necessary. In December
    2001 the European Parliament adopted the
    Regulation on cross-border payments in euros
  • Main features
  • All fees applicable to card and ATM cross-border
    transactions in euros, up to Euro 12,500, must be
    identical to those being applied to domestic
    transactions
  • This same regime would apply to credit transfers
    starting on July 1, 2003

34
A look at the SEPA
  • To comply with this Regulation, the European
    Payments Council approved two key market
    conventions
  • The CREDEURO Convention
  • Establishes a basic bank-to-bank pan-European
    credit transfer that allows banks to give
    guarantees to their customers as regards
    information requirements, execution time and
    remittance information transmitted
  • The Interbank Charging Principles Convention
  • A standard procedure for achieving end-to-end
    certainty in charging methods, and allowing for
    the instructed amount to be credit to the
    beneficiary in full

35
A look at the SEPA
  • Commercial banks have decided on a pan-European
    architecture, the Pan-European Clearing House
    (PE-ACH) as the preferred model for credit and
    debit transfers.
  • In a first stage, the PE-ACH will process credit
    transfers in combination with existing clearing
    and settlement systems
  • Summit of the Americas Commitment to Reduce
    Remittance Costs by at least half by 2008
  • An upcoming Pan-American Payments Clearinghouse?

36
International Family Remittances
37
International Family Remittances
  • International remittances initiated by migrant
    workers are an important source of family income
    in many developing economies.
  • In some cases, remittances represent a very
    relevant percentage of the GDP of the receiving
    countries.

38
Integrating remittances in the reform of the
National Payments System
  • KEY IDEA Remittance services are part of the
    broader retail payment system both domestic and
    cross-border
  • Remittances are cross-border retail payments with
    particular access requirements (on both the
    demand and supply sides)
  • An efficient development of the domestic payment
    system infrastructure is key to reduce costs of
    remittance services
  • The development of payment system oversight is
    fundamental to enhance transparency and reduce
    costs in the retail payment sector

39
Integrating remittances in the reform of the
National Payments System
  • KEY IDEA Remittance services are part of the
    broader retail payment system both domestic and
    cross-border
  • The World Bank is a leading institution in
    payment system development, in particular in
    Latin America through the Western Hemisphere
    Payments and Securities Settlement Forum (WHF).
    In the context of payment system reforms, the
    World Bank has recommended improvements in the
    remittance area since 1999
  • Payment system development projects are a good
    vehicle to address the issue

40
Additional Key Ideas
  • Remittances are part of an individuals access to
    financial services
  • A good remittance product improves value to the
    user in the short term and access to other
    financial products in the long term
  • A good remittance product increases competition
    and moves transactions to the formal sector,
    enabling the formal sector to provide superior
    service
  • There are no standard solutions

41
CPSS/WB Task Force on General Principles for
International Remittance Systems
  • As part of the Sea Island remittance initiative,
    the G7 Finance Ministers and Central Bank
    Governors called for work toward developing
    prudential standards/guidelines for remittance
    services.
  • Some obstacles identified include
  • Lack of physical access to financial institutions
  • Inadequate financial education
  • Inefficient and costly remittance services
    available at financial institutions
  • Regulatory barriers to the provision of
    remittances services
  • Inadequacy of data on remittance flows
  • Lack of guidance on what regulation/supervision
    of remittance service providers is necessary to
    ensure safety and integrity of these services

42
Composition of the Task Force
  • The Task Force is co-chaired by the CPSS and the
    World Bank.
  • Additional Members
  • Central banks of Italy, the United States,
    Brazil, Mexico, the Philippines, Sri Lanka,
    Turkey, Germany, Hong Kong and the European
    Central Bank, as well as the International
    Monetary Fund, the Arab Monetary Fund, the Asian
    Development Bank and the Inter-American
    Development Bank

43
Mandate and scope (I)
  • The Task Force is to develop general principles
    on remittances describing key features and
    functions that should be satisfied by remittance
    systems, providers and financial intermediaries.
  • These principles must be clear and universally
    applicable international standards, its main
    focus being to identify the main characteristics
    of sending and receiving remittances an the
    related infrastructures with a view to improving
    them.

44
Mandate and scope (II)
The Task Force shall pursue the following streams
of work
  • To map and compare the remittance market in
    different countries, as well as the respective
    cross-border arrangements in these countries in
    the form of country reports. This analysis should
    allow the Task Force to define stylized
    structures of remittance systems, and to
    determine Principles that could be applied.
  • To try to identify principles to ensure an
    appropriate level of consumer protection and
    transparency. In this context, the different
    pricing methodologies shall also be analysed.

45
Mandate and scope (II)
The Task Force shall pursue the following streams
of work (cont.)
  • To discuss the appropriate level of access to
    payment systems infrastructure preserving the
    safety and integrity of the infrastructure.
    Appropriate mechanisms for educating the
    remittance agents and operators will also be
    considered.
  • To discuss public policy issues related to the
    remittance market.
  • To discuss the role of the central bank and other
    public authorities in the application of the
    principles.
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