Proposal for a European Parliament and Council Directive on settlement finality and collateral security
Date: 1996-05-30
Institutions: European Commission
Subjects: European Monetary System, credit guarantee, credit institution, financial solvency, payment

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I  COMMISSION OF THE EUROPEAN  COMMUNITIES 

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Brussels,30.05.1996 

COM(%)  193 final 

96/0126 (COD) 

Proposal  for a 

EUROPEAN  PARLIAMENT  AND COUNCIL  DIRECTIVE 

ON SETTLEMENT FINALITY AND 

COLLATERAL SECURITY 

(presented  by the Commission) 

EXPLANATORY  MEMORANDUM 

I.  Background 

The present  proposal  for a directive  is the result  of a process which  can  be summarised  as  follows: 

The  Lamfalussy  Report  of  19901 highlighted  the important  systemic  risks inherent  in payment  systems 
which operate on  the basis of one or more legal types of payment  netting1.  The Commission's  attention 
was  drawn  to  these  matters  by  one  of  its  advisory  committees  on  payment  systems,  the  Payment 
Systems Technical  Development  Group. 

In  its  March  1992  working  document3,  the  Commission  noted  that  certain  features  of  the  law  in  a 
number  of  Member  States,  together  with  the  differences  between  Member  States'  laws  relating  to 
payment  systems  in  general,  were  a  source  of  uncertainties  and  risks.  This  view  was  endorsed  by  the 
Committee  of Governors  of the central  banks of the EC4. 

Work  began  on  these  issues  in  a group  of  government  legal  experts  and  central  bank  representatives, 
chaired  by the  Commission, early  in  1993. The first  phase of the  work  has consisted  of establishing  an 
inventory  of  the  legal  situation  in  the  areas  of  payment  netting  and  settlement  finality  in  all  Member 
States,  which  has  led  to a more  precise  identification  of  these  problems.  An  extensive  study5,  ordered 
by  the  Commission  and  delivered  in  February  1994,  supported  these  preliminary  conclusions.  A  first 
consultation  hearing  with the European  Credit  Sector Industry  was held  in the spring of  1994. 

In a second  phase  (since  1994) different  solutions  have  been discussed  and  examined  within  the  group 
of  government  experts.  They  are  listed  under  point  II.3.  A  second  consultation  hearing  with  the 
European  Credit  Sector Industry  was held  in October  1995, which  confirmed  the overall  validity  of the 
approach. 

In  the  light  of  this  process,  the  Commission  has  reached  operational  conclusions,  in  particular  as 
regards the questions pertaining  to. settlement  finality  and  collateral  security.  It therefore  considers  that 
a  directive  should  be  proposed.  No  operational  conclusions  have  been  reached  relating  to  securities 
settlement  systems. These issues remain, however,  under consideration  within the Commission.  It may 
be necessary  to make a further  proposal  covering these issues in the  future. 

Overall  assessment 

The  Commission  Strategic  Programme  for  the  Internal  Market  clearly  identified  the  establishment  of 
effective  cross-border  payment  systems  as  one  of  the  few  requirements  that  still  need  to  be  met  to 
ensure  the  functioning  of  the  Internal  Market.  This  requires  modernisation  of  systems,  which  affects 
both  central  banks and  commercial  banks, and consequent  investment  on  the part  of the  industry.  This 

Report to the Governors of the central banks of the Group of Ten countries, Basel, November  1990 

For the purposes of the present  Proposal, "payment netting" means the conversion  into one net claim  or one net 
obligation of claims and obligations resulting from  payment orders which an institution  either issues or receives, 
with the resuit that only the net claim can be demanded or the net obligation  be owed. 

"Easier cross-border payments: Breaking down the barriers", SEC(92)621 final  of 27 March  1992. 

"Issues of  common  concern  to  EC Central  Banks  in  the  field  of  payment  systems",  by  the  Ad  Hoc  Working 
Group on EC payment systems, September  1992. 

The  iaws  on  credit  transfers  and  their  settlement  in  Member  States  of  the  El J:  Report  for  the  European 
Commission  (IXi  XV), Wilde Sapte - Brussels, February  1994. 

A 

process is already under way. Moreover a number of the large value payment systems which primarily 
serve  the  domestic  market  in  their  countries  are  increasingly  gaining  member  banks  from  other 
Member States. 

The legal  issues which are the subject of the present proposal  have an important underlying  influence 
on  the  design  of  the  necessary  systems  and  linkages,  both  those  which  are  specifically  conceived  to 
transmit  payments  across  borders  and those  which  have  a  "cross-border  membership".  The  resolution 
of these  issues  will  provide  a  valuable  foundation  of  certainty  and  serve  to  minimise  legal  risks  of a 
systemic  kind, as well  as the costs which  such risks entail. 

The  need  for  action  in  this  domain  is  all  the  more  urgent  as  progress  is  made  towards  full  Economic 
and  Monetary  Union.  The  European  Council,  meeting  in  Madrid  on  15 and  16 December,  has  stressed 
that  the payment  system's  infrastructure  needs to be in place  so as to ensure  the  smooth  functioning  of 
an area-wide money  market  based  on the single  currency. 

II.  Subsidiarity  assessment 

1. 

What  are the objectives of the directive, having  regard  to Community  obligations? 

The principal  objectives  are  threefold: 

• 

• 

• 

to  reduce  legal  risks  associated  with  participation  in  payment  systems,  as  was  pointed  out  in  the 
Lamfalussy  report  of  1990, in particular  as regards the  legal validity  of netting  agreements  and  the 
enforceability  of collateral  security; 

to ensure that  in the  Internal  Market  payments may be made free  of impediments, thus  contributing 
to  the  efficiency  and  the  cost-effective  operation  of  cross-border  payment  arrangements  in  the 
European  Union; 

by  taking  into  account  collateral  constituted  for  monetary  policy  purposes,  to  contribute  to 
developing  the  necessary  legal  framework  in  which  the  future  European  Central  Bank  may 
develop its monetary  policy. 

The present directive  also 

• 

• 

leads  to  further  integration  of  EC  banks  in the  domestic  payment  systems  of other  EC  States.  The 
directive  therefore  supports  the  free  movement  of  capital  stated  in  Article  73B  to  73G  and  the 
freedom  to provide  services under Article  59 of the Treaty; 

contributes  to the preparation of the third stage of EMU, for which  efficient  payment  mechanisms 
are indispensable. 

2. 

Does the action  envisaged  stem from  an exclusive competence  of the  Community? 

Exclusive  competence:  Article  100A, in conjunction  with Article 7A. 

3. 

What arc the possibilities  of action available  to the  Community 

A number of alternatives were  considered: 

First,  the  minimalist  approach  of  developing  a  solution  within  the  current  state  of  the  national  laws 
was examined.  The question  in that  context  was to examine whether  it was possible  to design  a  model 
contract  which  could  be used  by members of a payment  system  and  which could  remedy  the  problems 
concerned.  This approach  was rejected  for two reasons: 

•  This  solution  concerns  only  the  parties  to  the  contract,  while  it  is  necessary  that  third  parties  be 
legally  bound.  This  is  illustrated  by  the  following  case:  a  Country  A  bank  participates  in  a 
multilateral  netting  system  with  a central  settlement  agent  in Country  B. The  Country  A  bank  goes 
bankrupt.  In that  ease, the creditors  -or the  liquidator-  of the  bankrupt  Country  A bank,  attempting 
to recover  part  of their claims against that bank, are  likely  to challenge  the netting  agreement  under 
Country  A  law,  since  that  law  may  not  necessarily  recognise  multilateral  netting.  If  such  action 
were successful,  it could jeopardise the whole netting  system. 

• 

Insolvency  law  contains  so-called  "ordre  public"  rules  which  can  overrule  contractually  stipulated 
provisions,  liven  if a payment  system  agreement  stipulated  that  in case  of  insolvency  of a  member 
the  payment  orders  introduced  before  the  moment  of  pronouncement  of  insolvency  proceedings 
cannot  be  unwound,  a  zero-hour-rule  e.g.,  as  it  exists  in  a  number  of  Member  States,  would 
overrule  that  contractual  arrangement.  Consequently,  unwinding  could  happen,  with  potentially 
far-reaching  and  damaging  consequences  for the payment  system  concerned. 

A  second  possible  solution  consisted  of  the  private  international  law  approach,  under  which  it  is 
possible  to  agree  that  a  payment  system  established  under  the  laws  of  Country  A,  a  country  whose 
commercial  law  recognises  netting  and  whose  bankruptcy  laws  do  not  interfere  with  the  proper 
operation  of  payment  systems,  would  be  governed  entirely  -  including  all  its  members  from  EU 
countries  - by  the  laws of country  A.  Whether  Member  State  B's  law  recognises  the  finality  of  netting 
applicable  to  bank  B, or  whether  that  State's  insolvency  law  has  provisions  "d'ordre  public",  like  the 
zero-hour  rule,  would  no  longer  be  relevant.  Such  an  approach  did  not  in  the  final  analysis,  however, 
prove  to  be  attractive.  If  chosen,  it  would  mean  that  the  courts  in  every  Member  State  would  in 
principle  need  to be  in a position  to  interpret  and  apply  the different  branches  of  law  (commercial  law, 
insolvency  law, etc.) of all other  Member  States. Such a solution, at least when  standing  alone,  seemed 
unnecessarily  cumbersome. 

A  third  possibility  was  to  recommend  to  the  Member  States,  without  any  binding  obligations,  the 
necessary  modifications  in  their  laws.  This  approach  has  some  procedural  attractions  in  largely 
bypassing  the  EU  legislative  process  but  it would  not  substantially  assist  the  governments  of  Member 
States, who would  still have to  draft  and  implement  any  necessary  legislation.  From  the point  of  view 
of  the  financial  institutions  and  payment  systems,  the  solution  would  lack  transparency  and  legal 
certainty.  Any  slight  advantage  of  proceeding  in  this  way  was  felt  to  be  outweighed  by  the 
disadvantages. 

Therefore,  as  explained  in  detail  in  section  I above,  a binding  instrument  is  now  deemed  both  timely 
and  necessary. 

4. 

Is  uniform  legislation  necessary  or  is  a  directive  setting  out  the  general  objective  and 
leaving  implementation  thereof to the Member  States  sufficient? 

Uniform  legislation  is  not  necessary.  A  directive  setting  out  the  general  objectives,  as  they  are 
outlined  hereunder,  is  sufficient. 

Section  I of  the  directive  deals  with  the  scope  of  the  directive  and  defines  the  necessary  terms; 

Section  II  of  the  directive  lays  down  the  general  principle,  the  objective  of  which  is  to  ensure  that 
payment  netting  is  made  legally  enforceable  under  all jurisdictions  and  its  effects  binding  on  third 
parties; 

Section  III  provides  for  the  irrevocability  of  payment  orders  in  accordance  with  the  rules  of  the 
payment  system  concerned; 

Section  IV of the directive  lays down the general  principle, the objective  of which  is to : 

• 

• 

ensure  that  insolvency  proceedings  or any  other  rule or practice  do nol have a retroactive  effect  on 
the rights and obligations  of participants. 

determine  which  insolvency  law  is  applicable  to  the  rights  and  obligations  in  connection  with 
direct  participation  in  a  payment  system  in  the  event  of  insolvency  proceedings  against  a 
participant  in that payment  system. 

Section  V  of  the  directive  lays  down  the  general  principle,  the  objective  of  which  is  to  insulate 
collateral  security  from  the effects  of the insolvency  law of the Member  State of a failed  participant. 

These  provisions  set  out  the  general  objective  pursued,  thus  leaving  implementation  to  the  Member 
States;  where  appropriate,  institutions  are  free  to  determine  the  precise  contents  of  these  general 
principles. 

III. 

Detailed  commentary  on the articles 

Article  1 

This  Directive's  main  goal  is  to  reduce  the  systemic  risk  associated  with  participation  in  Payment 
Systems.  There  was  a general  consensus  that  this  directive  should  have  the  widest  scope  possible.  To 
this  effect, 
the  directive  covers  cross-border  payment  systems  as  well  as  domestic  systems. 
Furthermore,  it applies to the following  two  categories: 

•  EC  institutions  which  are  participants  in  third  country  payment  systems  and  collateral  security 

constituted  for  such a payment  system 

•  Third  country  institutions  which  participate  in  an  EC  Payment  System  and  the  collateral  security 

constituted  in favour  of that payment  system 

The inclusion of the first category  in the directive's  scope implies that the benefits  of this  Directive  are 
extended  to third  country payment  systems as far as their EC participants  are concerned.  Third  country 
payment  systems as such are of course not covered  by the directive, but their participants  are insofar  as 
they are EC institutions  within the meaning  of Article 2 (i). 

As far  as the  second category  is concerned, the essential  interest of its inclusion  in the directive's  scope 
lies  in  the  fact  that  it  makes  it  possible  to  insulate  collateral  security,  pledged  by  a  third  country 
institution  in an EC Member  State, from  a possibly  universal  insolvency  law of that  third  country. 

Finally,  with  a  view  to  the  establishment  of  the  future  European  Central  Bank,  the  pledging  of 
collateral  security  will  increasingly  be  cross-border.  The  same problems  arise  in  that  respect  as  in  the 
case of  the pledging  of  collateral  in  the  framework  of  payments  systems.  Therefore,  the  scope  of  this 
proposal  has  been  extended  to  collateral  security,  pledged  in  connection  with  monetary  policy 
operations. 

Article  2 

"institution"  has  been  given  a wide  scope,  so  as to  include  not  only  credit  institutions  in the  sense  of 
the  first  Banking  Directive,  but  also  investment  banks,  giro  and  postal  banks  and  any  other 
undertaking which participates directly  in a payment  system. 

"payment  order"  means  an  instruction  given  to  carry  out  a  transfer,  be  it  credit  or  debit,  by  a  book 
entry  on the accounts of a credit  institution  or of a central  bank. On the accounts  of a credit  institution, 
since  it  is  this  type  of  payment  system  which  calls  -from  a  public  policy  standpoint-  for  the  kind  of 
protection  which this Proposal  for  a Directive  provides  for.  On the accounts of a central  bank,  is added 
to  anticipate  the  foreseeable  development  of  real  time  gross  settlement  facilities,  which  necessitate 
movements on the accounts of the Central  Banks. 

"payment  system"  is  defined  widely,  so  as  to  include  systems,  regardless  of  whether  they  settle  on  a 
gross or net  basis  and  of whether  they  are based  on multilateral  or  bilateral  arrangements. Of course, a 
federation  of payment  systems in itself is also covered  by the directive. 

Article  3 

Many  payment  systems,  handling  very  large  payments  ("large  value")  or  smaller  values  ("retail") 
depend  on the technique known  as netting^ or set-off.  "Payment netting"  is the conversion  into one net 
claim  or  one  net  obligation  of  claims  and  obligations  resulting  from  payment  orders  which  an 
institution  either  issues  to  one  or  more  other  institutions  or  receives  from  one  or  more  other 
institutions,  with  the  result  that  only  the  net  claim  can  be  demanded  or  the  net  obligation  be  owed. 
This  has  the  effect  of  reducing  greatly  the  number  of  settlement  transactions  required  to  process  a 
given  number  of  payments.  Instead  of  settling  each  payment  order  individually  as  it  arises  during  the 
day the banks  involved  in a netting  agreement  settle once by paying  (or receiving)  a single net  balance 
to (or from)  the other members  of the  system. 

The  legal  enforceability  of  a  netting  operation  with  institutions  from  different  Member  States 
ultimately  depends  on  the  law  of  the  Member  State  of  origin  of  these  institutions.  In  a  number  of 
Member  States  netting,  especially  multilateral  netting,  is  not  enforceable  under  the  current  state  of 
legislation.  If the  liquidator  of a failed  participant  in a payment  system  were on  that  basis  to  challenge 
the  netting,  this  would  mean  that  he  could  repudiate  the  net  settlement  debt,  arrived  at  by  netting. 
Instead  he  could  insists  on  payment  to him  of  all  the  individual  underlying  amounts  originally  due  to 
that  institution.  As  for  the  amounts  due  from  the  failed  institution,  they  will  be  claims  on  paper  in  the 
insolvency  proceedings  and  unlikely  to  be  met.  This  phenomenon  of  repudiating  the  debt  and 
accepting  the  amounts  originally  due,  is  called  cherry-picking.  The  consequence  of  cherry-picking  is 
serious  disruption  in  the  payment  system  at  best,  at  worst  the  payment  system  might  break  down 
(systemic  risk)  and  cause  in  turn  the  inability  of  other  members  in  the  payment  system  to  meet  their 
obligations (knock-on  effect). 

Therefore,  Article  3(1) provides that netting is legally enforceable  and binding  on third  parties, even in 
the  event  of  the  opening  of  insolvency  proceedings,  insofar  as  the  payment  orders  have  been 
introduced  into the payment  system  before  the opening of insolvency  proceedings. 

Article  3(2)  specifically  focuses  on  the  cases  in  which  a  participant  who  realises  that  bankruptcy  is 
becoming  inevitable,  introduces  payment  orders  into  a  payment  system  before  the  declaration  of 

From the legal point of view, "netting" in this sense  is the same technique as is the subject  of the proposal  for a 
directive on contractual  netting. However the latter deals with  unmatured  obligations, netted on a bilateral  basis 
only,  whilst  the  present  initiative  concerns  payment  streams  netted  bilaterally  or  multilaterally.  Both  types of 
netting differ  markedly from  the concept of position netting, as used in the Capital Adequacy Directive. 

insolvency  in order to remove assets to the detriment of the creditors. Therefore, this article  confirms 
that the directive does not shield fraudulent  payment orders from  invalidation. Such invalidation  will, 
however, not be permitted to occur through the unwinding of the netting operation, something that the 
directive aims to avoid at all costs, but rather outside the payment  system, or indeed  in a subsequent 
netting cycle (via a reverse order). 

Article 4 

It is commonly agreed that the possibility of a significantly  large payment being revoked  can generate 
systemic risk, if the revocation occurs during the process leading to settlement  in a payment  system. It 
would be unacceptable, on the other hand, to disproportionately  limit thé freedom  of operation and the 
freedom  of contract  of the various  parties to a payment  system  in attempting  to reduce  or  minimise 
this risk. 

Thus, having recognised that revocation might otherwise lead to an unwinding of settlement. Article 4 
(1)  precludes  the  revocation  of  a  payment  order  after  a  contractually  agreed  time,  not  only  by  the 
parties  to  the  payment  system  agreement,  but  also  by  third  parties,  e.g.  a  sub  participant.  This 
prohibition  is  important  not  only  in  the  case  of  netting,  but  also  in  the  case  of  real  time  gross 
settlement arrangements. 

This does not mean, of course, that a payment order which was not due by the originator, but has been 
introduced into the payment system, is forever  lost to him. Article 4(2) confirms  that, if the originator, 
i.e. a customer,  has a right against the  beneficiary  to reclaim an amount that has been  introduced  into 
the  payment  system,  such  a right  is not  cancelled,  but  will  only  have  to  be exercised  outside  of the 
payment system, or by a reverse payment operation in the next netting cycle. 

Articles 5 and 6 

Irrespective  of  whether  a payment  system  operates  on  the  basis  of  netting  or  gross-settlement,  the 
different  insolvency  laws in the different  Member States cause further  problems, where rules "d'ordre 
public" included in these insolvency laws would lead to the possibility of cherry-picking, with its very 
damaging consequences, as described above. 

This is the case for the so called "zero-hour" rule, which gives retroactive effect  to the pronouncement 
of insolvency. A consequence of this rule is that payment orders introduced after  zero hour of the day 
of pronouncement of insolvency of a participant in a payment system but before the pronouncement of 
the insolvency, could be challenged  by a liquidator  of an insolvent  institution.  The latter would then 
be in a position to insist on payment to him of all the individual underlying amounts originally  due to 
that institution. As for the amounts due from  the failed  institution, they will be claims on paper in the 
insolvency  proceedings  and unlikely to  be met.  In order to avoid this possibility,  Article  5 provides 
that insolvency proceedings do not have retroactive  effect. 

There  may,  however,  exist  other  provisions  "d'ordre  public",  beyond  the  so  called  zero-hour  rules, 
which can potentially  lead to cherry-picking.  This is why  Article  6 has been designed  as a catch-all 
provision,  which  is to cover all  those cases which  have not been  identified  but  are believed  to exist. 
Therefore,  Article  6 states that  "in the  event  of  insolvency  proceedings  against  an  institution  which 
participates directly in a payment system, the rights and obligations arising from or in connection with 
participation in that payment system, shall be determined by the insolvency law of the country where 
the  payment  system  is  located."  In  practice,  Article  6  does,  of  course,  not  imply  that  a  separate 
insolvency proceeding has to be opened  in the Member State of location of the payment  system. The 
insolvency  of a member  institution  would  continue to  fall  under the  insolvency  law  of the  Member 
State where that  institution  is established,  as is currently  the case. If the  liquidator,  however,  would 
wish  to  draw  on  insolvency  provisions  "d'ordre  public"  to  challenge  a  payment  made  through  the 

payment  system,  he  would  have  to  apply  the  insolvency  law  gJl.lk* MuilheL Staleol" location  of  the 
payment  system.  This  approach  has  the  advantage  that  the  parties  in  a  payment  system  only  have  to 
examine  one  insolvency  law,  namely  the  insolvency  law  of  the  Member  State  of  location  of  the 
payment  system,  instead  of  having  to  examine  and  attempt  to  reconcile  the  insolvency  law  of  the 
Member  State  of  origin  of  every  single  participant.  This  would  contribute  to  reducing  costs  and 
eliminating  legal  uncertainty. 

Article  7 

Finally,  the  directive  addresses  the  problems  associated  with  collateral  security  which  supports 
participation  in payment  systems, on  a cross-border  basis. Its objective  is to avoid  a situation  where in 
the  case  of  insolvency  of  a  participant  in  a  payment  system,  the  insolvency  law  of  that  participant's 
Member  State  would  not  recognise  the  validity  of  collateral  security  constituted  in  another  Member 
State.  Article  7(1)  therefore  provides  that,  in  the  case  of  insolvency  of  a participant,  the  rights  of  the 
pledgee  shall  not  be  affected  by  the  insolvency  of  that  participant.  This  rule  is justified  for  public 
policy  reasons.  Vast  sums  are  transferred  through  the  payment  systems  on  a  daily  basis:  if  one 
member  were  not  able  to  meet  its  obligations  and  the  collateral  could  not  be  realised,  this  could  -in a 
worst  case  scenario-  have  disastrous  consequences  for  the  payment  system  as  such,  causing  no  less 
than  the collapse  of such  a system,  with a devastating  knock-on  effect  in  financial  markets. 

It  should  be  pointed  out  that  this  Proposal  does  not  alter  the  rule  of  law  applicable  to  collateral 
security.  This  remains,  as  is the  current  situation,  the  law  of the  Member  State  where  the  collateral  is 
located,  in accordance  with  the principle of lex rei  sitae. 

In its second  paragraph,  Article  7 provides that  in the case of a universal  third  country  insolvency  law, 
the  effects  of  that  law  do  not  extend  to  the  rights  of  the  pledgee  in  connection  with  participation  in a 
payment  system  or  in  connection  with  monetary  policy  operations,  if  that  collateral  security  is 
constituted  in a Member  State. 

DRAFT PROPOSAL FOR A EUROPEAN PARLIAMENT AND 

COUNCIL DIRECTIVE ON SETTLEMENT FINALITY AND 

COLLATERAL  SECURITY 

THE EUROPEAN PARLIAMENT AND THE COUNCIL OF THE EUROPEAN UNION, 

Having regard to the Treaty establishing the European Community, and in particular Article 100A 
thereof. 

Having regard to the proposal from the Commission, 

Having regard to the opinion of the European Monetary Institute, 

Having regard to the opinion of the Economic and Social Committee, 

In  accordance  with  the  procedure  laid  down  in  Article  189b  of  the  Treaty  establishing  the 
European Community, 

Whereas the Lamfalussy  report of 1990 to the Governors of the central banks of the Group of Ten 
Countries  demonstrated  the  important  systemic  risk  inherent  in payment  systems  which  operate 
on the basis of one or more legal types of payment netting, be it bilateral  or multilateral,  on the 
one  hand;  whereas  the  reduction  of  legal  risks  associated  with  participation  in  real  time  gross 
settlement  payment  systems  is  of  paramount  importance,  given  the  increasing  development  of 
these systems, on the other; 

Whereas  the  reduction  of  systemic  risk  regards  in  particular  the  finality  of  settlement  and  the 
enforceability  of  collateral  security;  whereas  collateral  security  is meant to  comprise  all  means 
provided  by  a  participant  to  the  other  participants  in  the  payment  system  to  secure  rights  and 
obligations  in  connection  with that  payment  system  including,  among  other  means,  repurchase 
agreements,  insurance  contracted  by  a  participant  in  a  payment  systems  for  the  benefit  of  the 
other participants; 

Whereas, by ensuring  that payments and movement of capital  may be made free  of impediments 
in  the  Internal  Market,  the  present  directive  contributes  to  the  efficient  and  the  cost-effective 
operation  of  cross-border  payment  arrangements  in  the  European  Union;  whereas  the  directive 
thereby  follows  up  the  progress  made  towards  completion  of  the  internal  market,  in  particular 
towards the freedom  to provide  services and liberalization  of capital movements, with a view to 
the realisation of economic and monetary union; 

Whereas the present directive is intended to cover payment systems of a domestic as well as of a 
cross-border nature; whereas debit as well as credit transfers  are covered; whereas the directive is 
applicable to EC payment systems and collateral security constituted by their participants, be they 
EC  or  third  country  participants,  in  connection  with  participation  in  these  payment  systems; 
whereas  the  directive  also  covers  EC  institutions  which  participate  in  third  country  payment 
systems; whereas financial flows are increasingly taking place on a world-wide level; whereas EC 
institutions  and EC payment  systems thus are bound to establish  and maintain  close  operational 
links  with  third  country  payment  systems  and  to  participate  in  them;  whereas  it  is  essential, 
therefore, that the cross-border relations between EC institutions and EC payment systems on the 
one hand  and  third  country  payment  systems  on the other  are addressed  and  facilitated  by  this 
directive with a view to avoiding  impediments for  EC institutions to participate  in third  country 
payment  systems arising from  a of lack of legal security; whereas efficient  EC payment  systems 
are  vital  for  the  Internal  Market  and  cannot  operate  properly  without  links  to  third  country 
payment systems because financial markets are inextricably connected with one another; 

J 

Whereas  the  directive,  by  covering  collateral  security  provided  in  connection  with  monetary 
policy operations, assists the EMI in its task of promoting the efficiency  of cross-border payments 
with  a view  to  the preparation  of the third  stage of economic  and  monetary  union  and  thereby 
contributes  to  developing  the  necessary  legal  framework  in  which  the  future  European  Central 
Bank may develop its monetary policy; 

Whereas the purpose of the present directive is to ensure that netting is legally enforceable  under 
all Member States' jurisdictions and binding on third parties; whereas the purpose of the directive 
is also to ensure that payment orders cannot be revoked after a contractually agreed time; whereas 
the directive aims at securing that insolvency  proceedings do not have a retroactive effect  on the 
rights  and  obligations  of  participants;  whereas  the  present  directive  furthermore  aims  at 
determining  -in  the event  of  insolvency  proceedings  against  a participant  in  a payment  system-
which insolvency law is applicable to that part of the insolvency which the rights and obligations 
in connection with direct participation in that payment system are; whereas the present directive 
finally  intends to insulate collateral security from the effects  of the insolvency  law applicable to 
the failed participant; 

Whereas  the  present  Directive  also  applies  to  the  relationship  between  an  institution  and  a 
member  of  a  payment  system  which  transfers  the  payment  orders  of  such  institution  to  the 
payment system, given that this relationship can be considered in itself to be a separate payment 
system; 

Whereas the adoption of the present directive constitutes the most appropriate way of realising 
the above objectives; whereas the present proposal is nessary to realise these objectives and does 
not go beyond the goal of realising these objectives; 

HAVE ADOPTED THIS DIRECTIVE: 

/. SCOPE and DEFINITIONS 

Artkk ]-SWJK 

The provisions of this directive shall apply to : 

(1)  any EC payment system operating in any currency and the ECU and to collateral  security 

provided in connection with participation in such a system. 

(2)  any  EC  institution  which  participates  directly  in  a third  country  payment  system  and to 

collateral security provided in connection with participation in such a system. 

(3)  collateral security provided in connection with monetary policy operations. 

/fe 

For the purpose of this directive : 

Artkk  2- Définitions 

(a)  "institution" means any undertaking as defined  in Article  1  of Council Directive 77/780/EEC 
including the institutions set out in the list in Article 2(2) thereof, which participates directly 
in  a payment  system,  and  any  other  undertaking  which  participates  directly  in  a  payment 
system; 

(b)  "direct"  participation  means  participation  in  a payment  system  entailing  responsability  for 

settlement; 

(c)  "EC institution" means any institution which has its registered office  in a Member State; 

(d)  "third country institution" means any institution which is not an EC institution; 

(e)  "payment order" means any instruction to place at the disposal of a final recipient an amount 

of money by means of a book entry on the accounts of a credit institution or a central bank; 

(I)  "insolvency  proceedings"  means  any  measure  which,  for  reasons  of  impending  or  actual 
inability  to  meet  financial  obligations,  is  pronounced  by  a  judicial  or  administrative 
authority  for  the  benefit  of  a  collectivity  of  creditors,  and  which  precludes  from  making 
payments or disposing of property; 

(g)  "payment netting" means the conversion  into one net claim or one net obligation  of claims 
and  obligations  resulting  from  payment  orders  which  an  institution  either  issues  to  one or 
more  other  institutions  or receives  from  one or more other  institutions, with  the result  that 
only the net claim can be demanded or the net obligation be owed; 

(h)  "payment  system"  means  any  written  agreement  between  two  or  more  institutions  for 

executing payment orders; 

(i) 

"EC  payment  system"  means  a  payment  system  located  in  a  Member  State.  A  payment 
system shall be deemed to be located in the Member State the law of which has been chosen 
by  the  institutions  which  participate  directly  in  that  payment  system.  In  the  absence  of 
choice,  the  payment  system  shall  be deemed  to be  located  in  the  Member  State  where the 
settlement takes place; 

(j) 

"third  country  payment  system"  means  any  payment  system  which  is  not  an  EC  payment 
system; 

(k)  "monetary  policy  operation"  means  an  outright  (spot  and  forward)  buying  and  selling 
operation  in  the  financial  markets  or  such  an  operation  under  a  repurchase  agreement,  or 
lending  or  borrowing  of  claims  and  marketable  instruments,  whether  in  Community  or  in 
non-Community currencies or in precious metals, by a Member State Central Bank or by the 
future  European Central Bank; it also means the conduct of credit operations, by a Member 
State Central Bank or by the future  European Central Bank, with credit institutions  or other 
market participants, with lending being based on adequate collateral; 

M 

(!) 
"collateral  security"  means  all  assets,  provided  for  the  purpose  of  securing  rights  and 
obligations potentially arising in a payment system or provided to Member State Central  Banks or 
to the future  European Central Bank in connection with monetary policy operations. 

//. FINALITY of PAYMENT NETTING 

Artkk  3-Payment Netting 

( 1 )  Payment netting is legally enforceable and shall, even in the event of insolvency  proceedings 

against any institution  which participates directly in a payment  system,  be binding  on third 
parties,  provided  that  the  payment  order  was  entered  into  the  payment  system  before  the 
opening of insolvency proceedings. The moment of entrance shall be defined  by the rules of 
that payment system. 

(2)  Any rule on the setting aside of contracts and transactions entered into before the opening of 

insolvency proceedings, shall not lead to the unwinding of the netting. 

///. REVOCA TION of PA YMENT ORDERS 

Article 4-Revocation 

( 1 )  A payment order may not be revoked either by an institution which participates directly in a 
payment  system  or  a  third  party  as  against  the  other  direct  participants  in  that  payment 
system  after  the  moment  defined  by  the  rules  of  that  payment  system.  This  rule  applies 
notwithstanding the opening of insolvency proceedings. 

(2)  Any right which the originator of a payment order might have to a refund  shall be exercised 

without prejudice to paragraph 1. 

IV. NON-RETROACTIVITY and APPLICABLE INSOL VENCYLA W 

Article S-Non-Retroactivity 

Insolvency  proceedings  shall  not  have  retroactive  effects  on  the  rights  and  obligations  of  an 
institution  in  connection  with  direct  participation  in  an  EC  payment  system.  Any  other  rule  or 
practice which has a retroactive effect  shall be superseded. 

Article 6-Applicable Insolvency Law 

In  the  event  of  insolvency  proceedings  against  an  institution  which  participates  directly  in  a 
payment system, the rights and obligations arising from  or in connection with direct participation 
in  that  payment  system,  shall  be  determined  by  the  insolvency  law  of  the  country  where  the 
payment system is located. 

V. INSULA TION of the RIGHTS of the PLEDGEE 

from  the EFFECTS of the INSOLVENCY of the PLEDGER 

Article 7-Insulation from the effects of insolvency 

(1)  The rights of a pledgee in connection with liabilities of one participant to one or more other 
participants  in  a  payment  system  or  the  rights  of  monetary  authorities  to  whom  collateral 
security  has  been  pledged  in  connection  with  monetary  policy  operations,  shall  not  be 
affected  by  the  opening  of  insolvency  proceedings  against  the  pledger.  The  collateral 
security  shall  be realised  for  the satisfaction  of rights  in connection  with participation  in a 
payment system or with monetary policy operations with priority over all other creditors. 

(2)  Where  a  third  country  institution  constitutes  collateral  security  in  a  Member  State  in 
connection  with  participation  in  an  EC  payment  system  or  in  connection  with  monetary 
policy  operations,  the  rights  of  the  pledgee  shall  not  be  affected  by  the  opening  of 
insolvency proceedings against that third country institution. 

VI. FINAL PROVISIONS 

Article  8 - Implementation 

(1)  Member  States  shall  bring  into  force  the  laws,  regulations  and  administrative  provisions 
necessary  to comply with this Directive before  31 December  1998 at the latest. They  shall 
immediately inform the Commission. 

(2)  When Member States adopt these measures, they shall contain a reference to this Directive 
or  shall  be  accompanied  by  such  reference  at  the  time  of  their  official  publication.  The 
procedure for such a reference shall be laid down by the Member States. 

(3)  Member States shall communicate to the Commission the text of the laws, regulations and 
administrative  provisions which they adopt in the field governed by this Directive. In this 
Communication  Member  States  shall  provide  a  table  of  correspondence  showing  the 
national provisions which exist or are introduced in respect of each article of this directive. 

Article  9 - Report to the European Parliament and the Council 

A3 

No later than three years after the date mentioned in Article 8(1), the Commission  shall present a 
report  to  the  European  Parliament  and  the  Council  on  the  application  of  this  Directive, 
accompanied where appropriate by proposals for its revision. 

This Directive is addressed to the Member States. 

Article 10 

Done at Brussels, 

For the European Parliament 

For the Council 

The President 

The President 

AH 

BUSINESS IMPACT  ASSESSMENT 

Proposal for a European  Parliament and Council  Directive on 

settlement  finality  and collateral  security 

l.a.  Taking  account  of the  principle  of subsidiarity, why  is Community  legislation  necessary 

and what  are its main  aims? 

Research  carried  out  on  behalf  of the  Commission  by  banking  lawyers1, together  with  the  analyses 
made  by  the  Commission's  working  group,  confirm  that  there  are  crucial  differences  between  the 
laws  of  the  Member  States  which  prejudice  the  legal  validity  of  certain  key  features  of  payment 
systems2. 

One of the central  features  of a sound payment  system  is that there must be no doubt as to when  and 
how  settlement  becomes  final.  In  the  current  situation,  finality  in  a  payment  system  whose 
participants  are  domiciled  in  different  legal  jurisdictions,(as  under  the  Treaty  and  the  Second 
Banking  Directive  will  increasingly  be  the  case)  depends  ultimately  on  the  laws  of  the  various 
Member  Slates whose  institutions are members. 

Another  essential  prerequisite  is  that  there  must  be  legal  certainty  that  in  the  case  a  participant 
fails  to  meet  its  obligations  vis-à-vis  the  payment  system,  the  latter  can  realise  the  collateral 
security  pledged  by  that  participant.  In  the  current  situation,  the  only  way  to  ensure  that,  is  to 
constitute  the  collateral  security  under  the  same  law  as the  payment  system  itself,  so  as to  avoid 
conflicts  of law. This is contrary to the principle of an Internal  Market. 

Legal  certainty  as  to  collateral  security  and  as  to  finality  of  settlement  can  only  be  achieved  if  the 
national  legislations  are  changed  in a similar  way  in each  Member  State. The  most  efficient  way  of 
achieving this goal  is by way of a directive  laying down the necessary minimum  standards. 

l.b.  Are there likely  to be any wider benefits  and disadvantages  from  the  proposal? 

If  any  effect  is  to  be  expected  for  the  financial  sector,  it  will  be  one  of  protection  of  current 
employment.  The  proposal's  main  goal  is  to  strengthen  the  stability  of  payment  systems  and 
therewith  of  inter  bank  financial  relations  and  to  avoid  the  knock-on  effects  that  currently  could 
arise in the case of bankruptcy  of a large participant  in a payment  system.  Consequently,  the  loss of 
employment  that would occur in such a case would be avoided  as well. 

The  laws  on  credit  transfers  and  their  settlement  in  Member  States  of  the  EU:  Report  for  the  European 
Commission (DG XV), Wilde Sapte - Brussels, 1994. 

The key differences  referred to are: 
- 
- 

settlement finality  in netting schemes: different  possibilities of unwinding the settlement; 
the  effect  of  insolvency  of  a  participant,  on  netting  schemes:  different  powers  of  liquidators  to  prevent 
settlement occurring or to unwind it; 
rules on revocation: different  rules on the time when a payment order becomes irrevocable 

- 

Moreover,  the  establishment  of  a  legal  framework  in  order  to  rule  out  the  legal  uncertainty 
associated  with  cross-border  payment  systems,  is  likely  to encourage  the  further  development  of 
these  systems.  The  consequent  increase  in  the  volume  of  business  might  therefore  generate 
employment. 

I.e.  Were  alternative  proposals  considered,  and with  what  outcome  (e.g.  codes  of  conduct, 

voluntary  arrangements)? 

As  explained  under  II.  3  of  the  explanatory  memorandum,  a  number  of  other  possibilities  were 
considered, but these were abandoned for the reasons exposed. 

2.  Who will be affected  by the proposal? 

Which sector of business? What are the size classes and what is the total employment? 

The proposal will be applicable to any undertaking which participates directly in a payment  system. 
In practice, the large majority  of these undertakings will be credit-institutions. 

Are there any  significant  features  of the business  sector, e.g.  dominance  by a limited  number 
of large firms? 

The main  feature  of this  sector  is the hitherto  lack of integration  of payment  systems  at  European 
level. 

Are there implications for very small businesses, the craft sector or the self-employed? 

Although  small  businesses  are  very  unlikely  to  constitute  a  payment  system  among  themselves, 
such a system would  be covered  by the Directive. However, as end-users of payment  systems, they 
will  benefit  from  the  proposal  and  its effect  of elimination  of legal  risks, increased  efficiency  and 
reduction of costs. These remarks apply equally to the craft  sector and the  self-employed. 

Are  there  particular  geographical  areas  in  the  Community  where  these  businesses  are 
located? 

No. 

3.  What will businesses have to do to comply with the proposal? 

What will be the compliance costs? 

No costs other than the legislative ones are to be expected. 

Are there other administrative procedures or forms to complete? 

No. 

Are licenses or marketing authorisations required? 

No. 

Will fees be charged? 

No. 

M 

4. 

What economic  effects,  costs and  benefits  is the proposal  likely to  have? 

On  employment? 

Within  the  payment  systems  industry, the net effect,  if such  effect  is to be expected  at all, should  be 
positive.  Within  the  segment  of  SMEs,  employment  benefits  are  expected  (more  efficient  payment 
services  => widening  of  intra-EU  trade potential  => contribution  to  growth  and  higher  employment 
=>  greater  and  more  specialised  demand  for  efficient  payment  services, etc.). 

On investment  and  the creation  or start up of new  businesses? 

Marginal  effect,  if any. 

On  the  competitive  position  of  businesses,  both  in  the  Community  and  third  countries' 
markets? 

The  efficiency  gains  and  reductions  in  costs  for  business  within  the  Community  will  be  positive 
(See  paras.  1  and  4  above).  Third  country  businesses  will  benefit  from  the  advantages  of  this 
Directive  inside  the Community  to the same extent as Community  businesses do. 

The unilateral  extension  of  the  benefits  of this  Directive  to  third  country  payment  systems,  e.g.  the 
protection  against  undue  revocation,  the  protection  against  retroactive  effects  of 
insolvency 
proceedings  and  the  insulation  of collateral  security  from  foreign  insolvency  laws,  will  also  benefit 
third  country  payment  systems. Community  businesses will  indirectly  benefit  from  the advantage  of 
the extension  of the  Directive's  scope to the EC participants  of the third  country  payment  systems. 

Therefore,  no distortion  of competitiveness  is to be  expected. 

On  public  authorities  for  implementation? 

Legislative costs of passing the necessary  domestic  legislation. 

Are there other indirect  effects? 

No. 

What  are the costs and  benefits  of the  proposal? 

• 

costs: no costs, other  than  the legislative  ones are to be expected. 

•  benefits: 

-elimination  of  legal  risks  associated  with  participation  in  payment  systems,  leading  to  more 
efficient  and cost-effective  operation of EC payment  systems 

-completion  of  the  Internal  Market:  the  proposal  will  also  facilitate  the  access  by  banks  from  one 
EC  Member  State,  into  the  payment  systems  of  another  EC  Member  State  (remotely  or  via  a 
branch). 

-further  integration  of the EC  financial  sector, both  domestically  and  cross-border,  thus  contributing 
to the free  movement  of capital and to the freedom  of cross-border  services. 

-cross-border  use  of  collateral  securities  is  facilitated.  This  contributes  to  the  free  movement  of 
capital,  to  the  freedom  of  cross-border  services,  to  the  development  of  securities  markets,  to 
developing  the necessary  legal  framework  in which  the  future  European  Central  Bank  may  develop 
its monetary  policy. 

•  balance: overwhelmingly  positive on the benefit  side. 

A 

5. 

Impact  on  SMEs.  Does  the  proposal  contain  measures  to  take  account  of  the  specific 
effect  on SMEs - if not, why not? Are reduced or different  requirements  appropriate? 

No. No direct effect  on SMEs. 

Consultation 

6. 

Indicate  at what  stage  the consultations  were  undertaken  and the date of publication  of 
the prior notification  of an intent to introduce  legislation? 

The  Commission  has, over  many  years,  promoted  the  fullest  consultation  of  all  interested  parties 
and earliest disclosure of its line of policy  in this area. This has materialised  in the following  steps: 

-Green  Paper3  (consultation  paper)  of  September  1990, calling  lor  comments  from  all  interested 
parties; annexed to the Green Paper was a decision to set up two consultative  groups; 

-setting  up  of  two  permanent  consultative  groups  on  payment  systems  in  March  1991,  with 
intensive  frequency  of  meetings  throughout  1991  and  early  1992,  leading  to  reports  to  the 
Commission  (in  February  1992) published  in March  1992; 

-Commission  working document  of March  19924, based  on the detailed  reports of these  consultative 
groups,  announcing  the Commission's  proposed  policy,  including  intent  to  introduce  legislation  in 
this  respect. 

furthermore,  two consultative  hearings  with  representatives  of the  European  Credit  Sector  Industry 
were  held  in the spring  of  1994 and October  1995,  at key stages of the preparatory  work  leading to 
the present proposal  (see Section I above; background). 

List of organisations  which  have  been  consulted  about  the proposal  and set out in detail  their 
main  views,  including  their  concerns  and  objections  to  the  final  proposal.  Why  is  it  not 
possible  or desirable to accede their  concerns? 

European  credit  sector  associations  :  The  European  credit  sector  associations  have  been 
consulted  throughout.  Two "hearings" have taken place with the Commission  and its working  party, 
the  latest  in October  1995.  There  is an overall  support  for this  proposal,  which  is deemed  essential 
by the sector  itself. 

Government  experts,  including  representatives  of  the  EC  central  banks:  Governments 
representatives  which  were  members  of the Commission's  working  group,  take  a positive  stand  on 
this  proposal.  There  are  differences  on  some  technical  issues,  which  it  is  not  possible  to  resolve 
entirely  within  the working  group. The main  point at issue  is that  some delegations  wished  to have 
an  (even  more)  ambitious  approach,  covering  so  called  "securities  settlement"  or  "obligations 
netting". 

EMI: a representative  of the EMI has been present in the working group as an observer. 

Were the SME Business Organisations  formally  consulted? If not, why not? 

No.  However,  SMEs  and  Retailer  organisations  were  kept  regularly  informed  of  progress  being 
made, through their  representatives  in the Commission's  consultative  groups on payment  systems. 

1  Discussion  paper on "Making payments in the Internal Market", COM(90)447. 
4 

"Hasier cross-border payments: breaking down the barriers", SHC(92) 621 of 27 March 1l>92 

A 

Monitoring and Review 

7.  Explain  how  the  effects  and  compliance  costs  of  the  proposal  will  be  monitored  and 
reviewed. How will complaints be dealt with? Can the proposal, once it is legislation, be 
amended easily? 

The  proposal  contains  in  its Article  9 an  undertaking  on the part  of the  Commission  to  report on 
these  matters  to the  European  Parliament  and  Council. The  necessary  preparation  for  this  will  be 
done by the Commission acting with its existing two consultative groups on payment systems. 

There is no comitology procedure, therefore  amendments to the proposal, once this is adopted, will 
require normal legislative procedures. 

Contact point 

Directorate General XV 
Dr. Peter TROBERG 
Av. de Cortenberg, 107 
B-1040 Brussels 

Tel: 

295.41.09 
295.79.78 
295.32.19 
295.94.62 

Fax:  295.07.50 

11 

ISSN  0254-1475 

COM(96) 193  final 

DOCUMENTS 

EN 

09 

Catalogue number  : CB-CO-96-201-EN-C 

ISBN 92-78-03483-5 

Office  for Officiai Publications of the European Communities 

L-2985  Luxembourg 

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