Opinion of the European Monetary Institute relating to a proposal for a European Parliament and Council Directive on settlement finality and collateral security
Date: 1996-11-21
Institutions: European Monetary Institute
Subjects: European Monetary Institute, credit guarantee, financial solvency, payment, single market, single monetary policy

21.5.98

EN

Official  Journal  of  the  European  Communities

C  156/17

EUROPEAN  MONETARY  INSTITUTE

OPINION  OF  THE  EUROPEAN  MONETARY  INSTITUTE

(98/C  156/12)

Consultation  from  the  Council  of  the  European  Union
within  the  meaning  of  Article  109f(6)  of  the  Treaty
establishing  the  European  Community  and  Article  5(3)
of  the  Statute  of  the  EMI  relating  to  a  proposal  for  a
European  Parliament 
and  Council  Directive  on
settlement 
finality  and  collateral  security  (the  draft
Directive).

CON/96/09

1.(cid:217)The  above  consultation  was  initiated  on  10  July  1996
by  the  Council  of  the  European  Union  which,  for  this
purpose,  submitted  the  text  of  the  draft  Directive
together  with  an  explanatory  memorandum  (Doc.
COM(96),  193  final)  to  the  EMI.

2.(cid:217)The  EMI  welcomes  the  draft  Directive  as  being  of
crucial  importance  to  the  efficient  and  smooth  func(cid:220)
tioning  of  payment  systems.  Adoption  would  also
foster  the  stability  of  financial  markets  and  institutions
in  general.  Studies  over  the  past  few  years  on  the  legal
aspects  of  payment  systems  identified  the  following
five  areas  of  particular  attention:

-(cid:217)validity  and  enforceability  of  bilateral  and  multi(cid:220)

lateral  netting,

-(cid:217)irrevocability  of  transfer  instructions,

-(cid:217)elimination  of  the  retroactive  effect  of  insolvency
proceedings  (abolition  of  the  zero(cid:220)hour  rule),

-(cid:217)mitigation  of  the  potentially  distortive  impact  of
foreign  law  on  arrangements  governing  partici(cid:220)
pation  in  payment  systems  if  either  a  participant
and/or  collateral  are 
juris(cid:220)
diction,

in  another 

located 

-(cid:217)abolition  of 

impediments  to  the  realisation  of
collateral  provided  in  the  framework  of  payment
systems  or  monetary  policy  operations.

All  the  above  issues  have  now  been  addressed  in  the
draft  Directive.

in 

its  proposal 

3.(cid:217)The  EMI  supports  the  choice  of  a  Directive  for  the
the  Commission’s
same  reasons  as  mentioned 
explanatory  memorandum 
for  a
to 
Directive.  The  development  of  smooth  and  efficient
cross(cid:220)border  payment  systems  to  support  the  internal
market  as  well  as  the  conduct  of  a  single  monetary
policy  in  stage  three  of  EMU  on  the  one  hand,  and
the  differences  in  the  laws  of  the  Member  States  on
key  features  of  payment  systems  on  the  other  hand,
require  a  degree  of  harmonisation  which  can  only  be
achieved  through  a  binding  legal  instrument  estab(cid:220)
lishing  the  general  framework  for  such  harmonisation.

4.(cid:217)The  EMI  would  welcome  application  of  the  regime  of
the  Directive  to  securities  settlement  systems  in  order
to  avoid  systemic  risks  in  the  financial  markets.  These
financial  markets  are  to  such  a  large  degree  interde(cid:220)
pendent  that  issues  such  as,  for  instance,  irrevocability
of  transfer 
instructions  and  the  abolition  of  the
zero(cid:220)hour  rule  cannot  and  should  not  be  dealt  with
for  payment  systems  in  isolation.  For  example,  the
unwinding  of  the  settlement  in  a  securities  settlement
system  may  have  a  negative  impact  on  the  stability  of
financial  markets  and  institutions  in  general  and  in
particular  on  interconnected  or  associated  payment
systems.

settle 

their  obligations  with 

Payment  systems  and  securities  settlement  systems  are
interdependent  through  delivery(cid:220)versus(cid:220)
functionally 
payment  mechanisms,  now  commonly  used  in  most
European  countries  in  order  to  ensure  that  parties  can
(irrevocably) 
the
confidence  that  their  counterparties  have  done  the
same,  thus  safeguarding  the  smooth  functioning  of
financial  markets.  If  the  cash  limb  of  such  operations
were 
for
limb  could  still
payments,  whereas 
for  example,  a
successfully  be  challenged  by, 
liquidator,  this  could  endanger  the  settlement  of  the
operations  concerned  and  give  rise  to  systemic  risk
and,  as  a  result,  the  stability  of  the  financial  markets

the  Directive  aims  at 

the  securities 

final,  and 

this 

C  156/18

EN

Official  Journal  of  the  European  Communities

21.5.98

in 

through 

statutory  and/or 

in  general  could  be  undermined.  Also, 
those
Member  States  where  the  above  mechanisms  are
contractual
supported 
provisions,  adoption  and 
the
Directive  must  not  lead  to  any  unintended  distortions
of 
through
imposition  of  finality  of  payments  but  not  for  delivery
of  securities.  Such  problems  can  be  avoided  if  the
regime  of  the  draft  Directive  also  applies  to  securities
settlement  systems.

implementation  of 

the  mechanisms 

the  equilibrium 

in 

to 

In  addition,  to  the  extent  that  securities  settlement
systems  provide  for  netting,  this  should  be  supported
by 
legislation  for  the  same  reasons  as  for  which
netting  in  payment  systems  is  supported  (see  also
paragraph  6,  first  indent).  Finally,  securities  settlement
the  same  extent  as  payment
systems  should, 
systems,  benefit  from  the  draft  Directive’s  provision
that  a  foreign  participant’s  rights  and  obligations  in
relation  to  participation 
in
another  country, 
in  case  of  such  a  participant’s
insolvency,  are  governed  by  the  insolvency  law  of  the
country  where  that  payment  system  is  located.  The
same  applies 
the
Directive  for  holders  of  collateral  in  the  framework  of
payment  systems,  which  could  also  be  usefully  applied
to  securities  settlement  systems.

the  protective  measures  of 

in  a  payment  system 

to 

securities 

systems  and 

definitions  (e.g.  to  specify  the  scope  of  the  terms
securities, 
fund
settlement 
transfers  through  such  systems);  and,  through  appro(cid:220)
priate  references  and  expansion  of  the  text  in  all
relevant  Articles.  The  EMI  stands  ready  to  provide
drafting  suggestions  and  to  assist  in  analysing  the
implications  of  amendments  to  the  present  draft  for
the  financial  industry  if  this  was  felt  to  be  appropriate.
Finally,  acknowledging  that  the  Directive  will  be
adopted  through  a  co(cid:220)decision  procedure  between  the
European  Parliament  and  Council,  and  again  with  a
view  to  the  avoidance  of  delays,  it  is  suggested  that
the  Council 
the  Parliament  as  soon  as
possible  of  its  efforts  to  include  securities  settlement
systems  in  the  Directive  in  order  to  avoid  delays
during  the  second  reading.

informs 

systemic 

involving 

5.(cid:217)With  regard  to  payment  systems,  the  EMI’s  primary
concern  is  that  those  systems  where  systemic  risks
may  arise  should  all  be  covered.  It  is  acknowledged
that  formulating  a  concise  definition  to  catch  all
arrangements 
is  not  a
straightforward  or  easy  task,  particularly  as  such
in
arrangements  may  vary 
Member  States.  The  EMI  is,  though,  at  the  same  time
of  the  opinion  that  the  draft  Directive  should  contain
a  more  unambiguous  indication  as  to  the  scope  of  its
applicability  and  that  the  definition  of  the  scope
should  be  more  clearly  aimed  to  catch  all  systems
which  may  incur  or  cause  systemic  risks.

in  nature  and 

form 

risks 

The  EMI  is  of  the  opinion  that  securities  settlement
systems  should  preferably  be  covered  in  the  present
Directive  rather  than  in  a  separate  Directive.  Firstly,  it
is  highly  unlikely  that  such  a  separate  Directive  could
successfully  be  negotiated  in  parallel  and  adopted  and
implemented  before  stage  three.  Secondly,  it  is  unde(cid:220)
sirable  that  legislation  on  the  same  types  of  issues  is
dispersed  over  various  pieces  of  Community  legis(cid:220)
lation,  not  least  because  this  could  lead  to  inconsist(cid:220)
encies.  None  the  less,  the  EMI’s  primary  concern  with
regard  to  the  draft  Directive  is  its  timely  adoption  and
in  order  to  safeguard  the  smooth
implementation 
functioning  of  payment  systems 
in  stage  three  of
EMU.  Extension  of  the  draft  Directive  to  securities
settlement  systems  should  therefore  not  be  permitted
to  delay  this  process.  It  seems  possible  to  avoid  the
delay,  which  would  arise  if  a  separate  Directive  were
to  be  prepared  by  making  various  amendments  to  the
draft  Directive  in  order  to  cover  securities  settlement
systems.  This  may  be  accomplished  in  different  (not
mutually  exclusive)  ways,  namely:  through  adjustment
of 
(e.g.  payment  order,
payment  system);  through  the  introduction  of  new

several  core  definitions 

as 

i.e. 

funds 

systems, 

The  definition  of  "direct  participation’  in  Article  2(b),
and  particularly  the  words  "entailing  responsibility  for
settlement’,  seem  to  imply  a  scope  of  applicability
which  is  restricted  to  those  payment  systems  which,  in
the  EMI’s  Compendium  on  Payment  Systems  in  the
European  Union  of  April  1996  (the  "Blue  book’),  are
".(cid:216).(cid:216).
transfer 
defined 
arrangement[s(cid:129) 
.(cid:216).(cid:216).  with  multiple  membership,
common  rules  and  standardised  arrangements,  for  the
transmission  and  settlement  of  monetary  obligations
arising  between  members’.  In  the  opinion  of  the  EMI,
the  Directive  should  indeed,  as  a  minimum,  cover
such  arrangements.  However,  the  EMI  understands
from  Article  2(h)  of  the  draft  Directive  that 
its
intended  scope  is  not  restricted  to  such  systems  and
that  indirect  participation  (or  sub(cid:220)participation),  as
well  as  correspondent  banking  are  also  meant  to  be
covered.  The  EMI  is  of  the  opinion  that,  depending
on  the  system,  there  may  be  good  reasons  to  extend
the  scope  of  the  Directive  in  order  to  cover  payment
arrangements  which  could,  perhaps  indirectly,  lead  to
systemic  risks,  the  very  situation  which  the  Directive
seeks  to  prevent.  This  is  particularly  true  for  payment
systems  with  indirect  participants  or  sub(cid:220)participants.

21.5.98

EN

Official  Journal  of  the  European  Communities

C  156/19

Caution  may,  however,  at  the  same  time  be  appro(cid:220)
priate  with  regard  to  an  unlimited  extension  of  the
protection  of  the  Directive  to  any  bilateral  payment
arrangements,  if  such  arrangements  do  not  have  the
potential  to  create  any  systemic  risks.  Therefore,  as
far  as  correspondent  banking  arrangements  are
concerned,  the  EMI  is  of  the  opinion  that  corre(cid:220)
spondent  banking  should  be  included  to  the  extent
that  the  protection  of  the  Directive  is  needed  to  avoid
systemic  risk  situations  which  might  ensue  from  the
role  of  correspondent  banks 
linking  payment
systems.

in 

individual  provisions  of 

6.(cid:217)The  EMI  makes  the  following,  generally  supportive,
the  draft
remarks  on 
Directive.  These  remarks  are 
large  extent
infuenced  by  the  situation  which  entails  the  biggest
threat  to  the  smooth  and  efficient  functioning  of
payment  systems  and  securities  settlement  systems:  the
insolvency  of  a  participant  in  such  systems.

to  a 

- Article  3

in 

in 

in  certain 

Doubts  on  the  enforceability  of  netting  under  all
circumstances,  and  particularly 
insolvency
situations,  have  in  the  past  been  a  major  obstacle
to  the  development  of  funds  transfer  systems  and
juris(cid:220)
in  particular  payment  systems 
dictions.  A  clear  legal  basis  for  netting  would
therefore  assist  greatly 
facilitating  efficient
payment  systems.  This  would  eliminate  the  risk
that  a  liquidator  of  an  insolvent  participant  may
successfully  require  unwinding  of  net  positions
and 
real
inherent  uncertainties 
exposures  between  participants  thereby  eliminating
a  further  element  of  systemic  risk  from  systems
which  currently  operate  on  a  net  basis  and  which
have  members  from  a  number  of  jurisdictions,
some  of  whose  insolvency  laws  may  currently  not
respect  netting.  This  would  have  a  beneficial  effect
on  the  stability  of  financial  markets  and  insti(cid:220)
tutions.  The  EMI  therefore  fully  supports  the
proposal  that  netting  is  made  enforceable  through
this  Directive,

about 

the 

- Article  4

give  grounds  for  doing  so.  The  draft  Directive
recognises  this  principle,  which  is  welcomed  by  the
EMI,

- Article  5

The  zero(cid:220)hour  rule  (entailing  retroactive  effect  of
a  bankruptcy  to  0:00  hours  on  the  day  of  the
insolvency)  exists  in  various  Member  States  and
threatens  the  efficient  and  smooth  functioning  of
payment  systems,  and  the  EMI  therefore  supports
the  fact  that  this  issue  is  now  being  dealt  with  in  a
conclusive  manner  through  the  draft  Directive,

- Article  6

The  fact  that  rights  and  obligations  arising  from,
or  in  connection  with,  participation  in  a  payment
system  shall  be  determined  by  the  insolvency  law
of  the  country  where  such  a  system  is  located
contributes 
important,
legal  clarity. 
however,  to  ensure  that  the  draft  Directive  and
the  winding(cid:220)up  Directive  are  not  inconsistent  on
this  point.

to 

It 

is 

to 

read 

govern 

satisfaction 

law  chosen  by  the  participants 
system 

Also, 
the  EMI  notes  with 
that
in
Article  6  and  Article  2(1),  when 
conjunction  with  each  other,  provide  for  two
in  terms  of  applicable  (insolvency)
possibilities 
law:  the 
in  a
their  payment
payment 
arrangements  or,  in  the  absence  of  a  choice,  the
law  of  the  Member  State  where  the  settlement
takes  place.  For  cross(cid:220)border  payment  systems,  it
is  important  that  these  two  possibilities  are  main(cid:220)
systems
tained,  as 
settlement  agents  may  be 
in  different
countries  and  a  specific  country  of  location  of  the
payment  system  does,  therefore,  not  exist.  In  this
connection,  the  EMI  understands  that  Article  6  of
the  draft  Directive  will  support  the  adoption  of
the  most  appropriate  legal  construction  and  the
choice  of  the  applicable  law  for  the  Target  system
which  is  presently  being  constructed  by  the  EMI
and  the  national  central  banks  of  the  Member
States,

in  cross(cid:220)border  payment 

located 

is 

transfer  orders 

indeed  a
Irrevocability  of 
prerequisite  for  the  smooth  and  efficient  func(cid:220)
tioning  of  payment  systems.  Irrevocability  serves
the  need  to  safeguard  the  technical  functioning  of
a  payment  system.  It  does  not,  however,  preclude
the  issuer  of  a  payment  order  (or  its  liquidator),
after  execution  of 
from
making  a  claim  equal  to  the  value  of  the  payment
if  the  underlying  circumstances  of  the  transaction

that  payment  order, 

- Article  7

The  requirement  that  collateral  provided  in  the
framework  of  participation  in  a  payment  system  or
in  the  framework  of  monetary  policy  operations
may  be  realised  in  accordance  with  the  terms  of  a
participation  or  credit  agreement  is  again  a  further
prerequisite  for  the  smooth  and  efficient  func(cid:220)

C  156/20

EN

Official  Journal  of  the  European  Communities

21.5.98

tioning  of  payment  systems  and  the  conduct  of
monetary  policy.  Interference  with  such  realisation
would  not  only  endanger  the  smooth  and  efficient
functioning  of  payment  systems,  but  also  the
stability  of  financial  markets  and  institutions  as  a
whole.  Also,  Article  18  of  the  Statute  of  the
ESCB/ECB  obliges  the  ECB  and  the  national
central  banks  of  the  Member  States  to  require
"adequate’  collateral  in  the  framework  of  their
credit  operations.  This  requirement  cannot  be
fulfilled,  if  under  circumstances  where  collateral
had  to  be  realised,  namely  insolvency  situations,
realisation  could  not  take  place  in  accordance  with
the  terms  of  a  participation  or  credit  agreement
due  to  constraints  on  such  realisation  under  the
laws  of  various  jurisdictions.  This  is  particularly
important  where  the  single  market,  the  creation  of
the  Target  system  and  the  conduct  of  a  single
monetary  policy  in  stage  three  logically  will  lead
to  the  extended  use  of  remote  access  to  payment
systems 
policy
operations  as  well  as  to  cross(cid:220)border  use  of

to  monetary 

possibly 

and 

collateral.  A  conditio  sine  qua  non  for  such  possi(cid:220)
bilities  is,  without  prejudice  to  other  conditions,
that  collateral  may  be  realised  in  accordance  with
the  terms  of  the  participation  or  credit  agreement.
The  EMI  therefore  fully  supports  the  objective  of
Article  7  of  the  draft  Directive.

the 

lead 

to  confusion  where 

The  text  of  this  Article  as  it  reads  now  may,
however, 
term
is  used.  Other  types  of  operations  to
"pledge’ 
provide  collateral  such  as  repurchase  transactions
and  other  arrangements  specific 
to  particular
Member  States  should  be  covered  as  well  (see  the
second  full  consideration  in  the  recitals  to  the
Directive  and  the  broad  definition  of  collateral
security  in  Article  2.1).  The  EMI  suggests  that
this,  for  reason  of  legal  clarity,  be  made  clear  in
the  draft  Directive.

7.(cid:217)The  EMI  agrees  that  this  opinion  may  be  made  public
its

the  European  Union  at 

the  Council  of 

by 
discretion.