1. Budapest, 28 November 20021

2. 2 Developments in euro payment systems Challenges for accession countries Tom Kokkola, Senior Policy Expert European Central Bank Budapest, 28 November 2002

3. 3 Introduction: The role of the ECB/Eurosystem Article 3.1 (Basic tasks of the ESCB): –definition and implementation of monetary policy –conduct of foreign exchange operations –holding and management of official foreign reserves of the Member States –promotion of smooth operation of payment systems Article 22 (Clearing and payment systems): “The ECB and national central banks may provide facilities, and the ECB may make regulations, to ensure efficient and sound clearing and payment systems within the Community and with other countries.”

4. Budapest, 28 November 20024 The role of the ECB/Eurosystem Maintaining systemic stability Ensuring efficiency of payment systems Maintaining public confidence in payment systems, instruments and currency Protecting the transmission channel for monetary policy The objectives

5. Budapest, 28 November 20025 Introduction Different roles to perform the same task of “promoting the smooth operation of payment systems” Operational role –for example, TARGET and provision of settlement facilities Catalyst role –for example, cross-border retail payment services Regulation Oversight The Eurosystem’s role in payment systems

6. Budapest, 28 November 20026 Introduction Contents: 1. Implications of the move to a common currency 2. Large-value payment systems, including future developments in TARGET 3. Retail payments issues 4. Securities settlement and collateral 5. The utmost importance of co-operation

7. Budapest, 28 November 20027 1. Implications of the move to a common currency -Several currencies One single currency -Autonomous national monetary policies -Segmented money markets -NCBs + European Monetary Institute -National payment systems One monetary policy One money market Eurosystem An integrated payment system Before Monetary Union (-> 1998)In Monetary Union (1999 ->) - - - - - The needs of the single currency

8. Budapest, 28 November 20028 New borders: geographical borders no longer matter, but those of the single currency. Part of what was foreign activities becomes domestic (= euro area). Single European passport. Remote access. Strong foreign participation. 1. Implications of the move to a common currency

9. Budapest, 28 November 20029 1. Implications of the move to a common currency Foreign ownership (expressed as a % of total bank assets, end 2001)

10. Budapest, 28 November 200210 2. Implications of the move to a common currency

11. Budapest, 28 November 2002 11 2. Large-value payment systems, including future developments in TARGET

12. Budapest, 28 November 200212 Trans-European Automated Real-time Gross-settlement Express Transfer 2. Large-value payment systems

13. Budapest, 28 November 200213 2. Large-value payment systems Objectives To contribute to the smooth conduct of monetary policy and the singleness of the money market To improve the soundness of payment systems (risk reduction) To increase the efficiency of cross-border payments in euro

14. Budapest, 28 November 200214 2. Large-value payment systems Guiding principles Market principle Decentralisation principle Minimum approach with regard to harmonisation of national RTGS systems

15. Budapest, 28 November 200215 2. Large-value payment systems Market principle Use of TARGET not mandatory Only payments directly connected with central bank operations (in which the Eurosystem involved either on the receiving or the sending side) and settlement of large-value net settlement systems have to go through TARGET Other payment arrangements (Euro 1, PNS, correspondent banking) can operate in parallel to TARGET

16. Budapest, 28 November 200216 2. Large-value payment systems Decentralisation principle Use of RTGS infrastructures in EU countries Banks settlement accounts at NCBs Direct exchange of payments between NCBs Some centralised functions undertaken by ECB (TARGET co-ordinator, end-of-day functions, helpdesk, test centre, settlement accounts for Euro 1 and CLS)

17. Budapest, 28 November 200217 2. Large-value payment systems The decentralised structure “The central bank correspondent banking model” NCB ECB Bank NCB Bank Interlinking

18. Budapest, 28 November 200218 2. Large-value payment systems Minimum approach Not entirely identical services offered by the different national RTGS systems Rationale: minimising time and cost for the establishment of TARGET Harmonisation only if necessary to ensure - singleness of monetary policy or - level playing field for banks

19. Budapest, 28 November 200219 2. Large-value payment systems National RTGS Interlinking system TARGET Credit institutions 100 NCB (S) 100 R DOMESTIC MESSAGE FORMAT INTERLINKING MESSAGE FORMAT DOMESTIC MESSAGE FORMAT 1 2 3 100 NCB (R) 100 S Queuing + cash management facilities Communication NETWORK

20. Budapest, 28 November 200220 2. Large-value payment systems Operating hours and days Common operating hours, ECB time: Customer payments from 7.00 am to 17.00 Interbank payments from 7.00 am to 18.00 Operating days calendar: in addition to Saturdays and Sundays TARGET closed on New Year’s Day, Good Friday, Easter Monday, 1 May, Christmas Day and 26 December On closing days: no standing facilities, no settlement of euro money market or FX transactions involving the euro, EONIA not published

21. Budapest, 28 November 200221 2. Large-value payment systems Capability of processing a high number of payments End-to end completion of payment execution within minutes in normal operating conditions No liquidity shortages TARGET is de facto standard for large-value payments in euro Three objectives have been met Practical experiences

22. Budapest, 28 November 200222 2. Large-value payment systems Better meet customers’ needs, inter-alia, by providing an extensive harmonised service level Cost-efficiency Is prepared for swift adaptation to future developments including the enlargement of the euro area and the Eurosystem But leave the responsibility for the business relations with the credit institutions with the NCBs Challenges

23. Budapest, 28 November 200223 2. Large-value payment systems 1. Market principle 2. Decentralisation principle: business level, but less platforms than central banks 3. Broadly defined core service 4. Single price structure 5. Cost effectiveness Principles for TARGET2

24. Budapest, 28 November 200224 1. Have an own platform that has to be cost recovery capable at the single price structure and compliant with all agreed TARGET2 features: outside interface, common services,... 2. Join the single shareable platform 2. Large-value payment systems

25. Budapest, 28 November 200225 2. Large-value payment systems

26. Budapest, 28 November 200226 Daily average volume EURO 1 TARGET TARGET cross-border 2. Large-value payment systems

27. Budapest, 28 November 200227 Daily average value TARGET TARGET cross-border EURO 1 2. Large-value payment systems

28. Budapest, 28 November 200228 Average size of transactions TARGET cross-border TARGET EURO 1 2. Large-value payment systems

29. Budapest, 28 November 200229 2. Large-value payment systems Figures as of May 2002

30. Budapest, 28 November 200230 EURO1 - Institutional set-up => EURO 1 is a real cross-border system: The EBA Clearing Company S.A., which is in charge of the daily management and operation of EURO 1, is located in Paris, the legal basis and the clearing rules of EURO 1 are under German law, the netting centre (SWIFT) is incorporated in Belgium and the participants come from 20 different countries. 2. Large-value payment systems

31. Budapest, 28 November 200231 EURO1 - Type of system EURO 1 is a net system, but not a netting system: “Netting” is a legal concept “Net system” is an economic concept 2. Large-value payment systems

32. Budapest, 28 November 200232 EURO1 - Legal structure SOS (Single Obligation Structure) => Economically the SOS is equal to multilateral netting, but legally it is different! => The SOS foresees that a participant has always only one single claim or obligation towards the system (i.e. the community of other participants), payment orders become part of the single claim/obligation upon processing; no bilateral obligations exist at any time. => Due to the SOS an unwinding is not possible. 2. Large-value payment systems

33. Budapest, 28 November 200233 EBA Clearing System: Euro 1 Features: 1. Single obligation structure (SOS) 2. Bilateral credit lines (min EUR 5 million; max EUR 30 million)  multilateral credit and debit limits (max. EUR 1 billion) 3. Cash liquidity pool 4. If failure > liquidity pool, surviving banks provide additional liquidity 5.Settlement at the ECB via TARGET at the end of business day 6.Role of the ECB: Settlement agent, holder of the liquidity pool and overseer 2. Large-value payment systems

34. Budapest, 28 November 200234 EURO1 - Types of transactions EURO 1 processes credit transfers (customer and interbank payments) At present: Division between interbank and customer payments: 35% interbank payments and 65% customer payments Processing of direct debits planned 2. Large-value payment systems

35. Budapest, 28 November 200235 EURO1 - Access criteria Own funds of at least EUR 1.25 billion Short-term credit rating of at least P2 (Moody’s) or A2 (Standard & Poor) Direct access to an EU RTGS system connected to TARGET Adequate technical and operational facilities =>Since 17 September 2001: 73 participants from all 15 EU countries and from Australia, Japan, Norway, Switzerland, USA (EU branches of the latter five countries) 2. Large-value payment systems

36. Budapest, 28 November 200236 Continuous Linked Settlement CLS is a project for establishing a multi-currency system for the settlement of foreign exchange transactions on a PVP basis in the books of a private bank acting as settlement agent where all members will open multi-currency accounts. Start of operations: September 2002 Eligible currencies from the start: euro, pound sterling, US dollar, Swiss franc, Canadian dollar, Japanese yen and Australian dollar. Later on also: Norwegian krone, Hong Kong dollar, Danish krone, Swedish krona and New Zealand dollar. 2. Large-value payment systems

37. Budapest, 28 November 200237 You deliver the currency being soldbut you do not receive the currency you bought  = principal risk the full amount of each trade is at risk = principal risk What is FX settlement risk ? 2. Large-value payment systems

38. Budapest, 28 November 200238 if, Settlement of one leg occurs if, and only if, the other leg settles If you pay, either you will either get paid or or get a refund  No risk of losing principal amount of fx transactions PvP mechanism 2. Large-value payment systems

39. Budapest, 28 November 200239 General Overview of CLS Corporate structure: 2. Large-value payment systems

40. Budapest, 28 November 200240 USD EUR JPY GBP CHF CAD AUS CLS Bank Bank of Japan Bank of England Swiss National Bank Bank of Canada Reserve Bank of Australia NY Fed ECB Fedwire TARGET FEYCS/ BoJ NewChaps SIC LVTS RITS The CLS Bank......has settlement accounts with …to receive and pay funds through 2. Large-value payment systems

41. Budapest, 28 November 2002 41 3. Retail payments issues

42. Budapest, 28 November 200242 Trends within the European Union: Payment instruments 3. Retail payment issues

43. Budapest, 28 November 200243 Banknotes and coins in circulation outside credit institutions, as a percentage of GDP 3. Retail payment issues

44. Budapest, 28 November 200244 3. Retail payment issues

45. Budapest, 28 November 200245 The current situation Relatively poor service level for cross- border retail payments –in terms of pricing –in terms of speed of payment execution Low volumes, but not necessarily low demand 3. Retail payment issues

46. Budapest, 28 November 200246 Too expensive –On average EUR 15.51 to transfer EUR 100 –Double charging in 25% of the transfers –Total average price: EUR 17.10 Too slow execution –Average execution time 3.4 working days –Seven working days or more for 5% of the transfers 3. Retail payment issues

47. Budapest, 28 November 200247 3. Retail payment issues

48. Budapest, 28 November 200248 Future prospects What is needed IPI SWIFT MT102+/103+ Straight-through-processing – consistent routing mechanism --> IBAN/BIC – – Common default interbank exchange fee Reduced balance of payments reporting requirements 3. Retail payments issues

49. Budapest, 28 November 200249 How to achieve the single payment area? –Integrate national and cross-border activity –Clubs –ACH network –Single ACH –Technology jump a possibility? 3. Retail payments issues

50. Budapest, 28 November 200250 EURO1 - STEP 1 STEP 1: EBA developed STEP 1 in order to offer cross- border retail payment services STEP 1 is operating since November 2000 It uses the technical platform of EURO 1 STEP 1 participants settle their balances via a EURO 1 participant 3. Retail payments issues

51. Budapest, 28 November 200251 3. Retail payments issues Participants 5 rounds since 20 th November 2000 81 Institutions from 10 different EU countries 23 different Settlement Banks designated (to be opened to EEA based banks) STEP 1:

52. Budapest, 28 November 200252 Regulation (EC) No 2560/2001: establishes the principle of equal charges for domestic payments and cross-border payments in euros requires banks to inform their customers in advance on the charges they apply for all payment services lays down standards to facilitate automation of payment systems (such as the International Bank Account Number and the Bank Identifier Code). Banks must indicate them on account statements and companies on their invoices national rules, such as statistical reporting obligations, which make practical distinctions between domestic and cross-border payments will be either eliminated or harmonised threshold to be increased from € 12,500 to € 50,000 on 1.1.2006. 3. Retail payments issues

53. Domestic payment areas Cross-border payments + Efficient domestic infrastructure Inefficient cross-border infrastructure Efficient pan-European infrastructure High volume Low margin + & High service level Low prices € 0-3 & High volume Low margin + & High service level Low prices & Low volume High margin + & Low service level High prices € 17-24 & 53 Budapest, 28 November 2002

54. Domestic payments Efficient pan-European infrastructure payments Cross-border Profit margin Processing costs Profit margin Processing costs Cross-border Loss Processing costs Pan-European payments Profit margin Processing costs payments Co-operation bodies Business practises STP standards Clearing&settlement infrastructure Transparency & Competition Price € 17-24 € 0.1- 0.4 “OUR”charging “Eurocred” MIF (cost based) Price € 0-3 54Budapest, 28 November 2002

55. 55 Eurosystem/EPC co-operation European Payments Council Co-ordination group European Payments Council General Assembly European Payments Council Working Groups - customer requirements - cash - cards - STP - infrastructure

56. Budapest, 28 November 200256 STEP2 blueprinting: Objectives and principles offering distribution of payment instructions to any bank operating in the EU a pan-European system with direct bank participation highly automated, simple to use, based on broadly accepted industry standards open to progressive integration of domestic traffic minimising bank internal costs related to processing customer payments 3. Retail payments issues

57. Budapest, 28 November 200257 3. Retail payments issues STEP 2 is currently being built; it should go live in the beginning of 2003 Differences to STEP 1: –will have its own technical platform –no single payment processing (i.e. transaction by transaction), but processing of batches containing several payments –will offer sorting and clearing services (ACH functionalities): banks send one batch, which will be split up; payments are sorted according to recipient bank; a new batch is compiled and forwarded to recipient STEP 2

58. Budapest, 28 November 200258 Decision by EBA Board : Based on the analysis made by EBA of the different proposals received and taking as key criteria the experience of the vendor in developing and operating a robust ACH platform, the commercial terms of the offering, the outlook for volume build-up, achievement of critical mass and successful enlargement STEP2 vendor selection the Board selected the offer made by SIA. 3. Retail payments issues

59. Budapest, 28 November 2002 59 4. Securities settlement and collateral

60. Budapest, 28 November 200260 Liquidity in TARGET Minimum reserves = liquidity available intraday for payment activity Unlimited intraday credit free of interest –Broad range of assets eligible as collateral for both payment systems and monetary policy operations –Easy substitution of collateral –Cross-border use of collateral 100% collateralisation of any credit 4. Securities settlement and collateral

61. Budapest, 28 November 200261 4. Securities settlement and collateral TARGET and Securities Settlement Systems All ESCB lending operations (intraday and overnight) have to be fully collateralised “Standards for the use of EU SSSs in ESCB credit operations” Overall objectives: –avoidance of inappropriate risks –same safety level for all central banks’ operations, regardless of settlement method

62. Budapest, 28 November 200262 4. Securities settlement and collateral  Risk aspects: minimum standards for SSSs Content of the standards Scope of the standards -domestic SSSs -international SSSs -links between SSSs Eligible in Eurosystem operations: -20SSSs(17 + 3) -66 Links - settlement risk - custodian risk - legal aspects - operational aspects

63. Budapest, 28 November 200263 Consolidation Monte Titoli (IT) Horizontal consolidation of SSSs at a domestic level Monte Titoli CAT LDT Iberclear (ES) CADE SCLV 4. Securities settlement and collateral

64. Budapest, 28 November 200264 4. Securities settlement and collateral CIK (BE) Euroclear (ICSD) Sicovam (FR) Necigef (NL) CBISSO (IE) Euroclear Clearstream DBC (DE) CEDEL (ICSD) Crest (UK) Horizontal consolidation of SSSs at a European level Interbolsa (PT) ?

65. Budapest, 28 November 200265 SBF (FR) BXS (BE) AEX (NL) Clearnet BCC (FR) Consolidation of CCPs for securities at a European level 4. Securities settlement and collateral

66. Budapest, 28 November 200266 4. Securities settlement and collateral Trade Execution Central Counter - party Settlement DBAG CLEARSTREAM Eurex Clearing Vertical consolidation at domestic level: Stock Exchanges MEFF-AIAF-SENAF IBERCLEAR MEFF Borsa Italiana MONTE TITOLI Italian CCP

67. Budapest, 28 November 200267 4. Securities settlement and collateral Trade Execution Central Counter - party Settlement EURONEXT EUROCLEAR CLEARNET Vertical consolidation at European level:

68. Budapest, 28 November 200268 4. Securities settlement and collateral

69. Budapest, 28 November 2002 69 5. The utmost importance of co-operation

70. Budapest, 28 November 200270 5. The utmost importance of co-operation Payment and Settlement Systems Committee Eurosystem composition Extended composition Securities Settlement Working Group Payment Systems Policy Working Group TARGET Management Working Group Among central banks

71. Budapest, 28 November 200271 Eurosystem: TARGET issues PSSC TMWG NCBs COGEPS (large value) Ad hoc Meetings TMWG-TWG TARGET user groups Ad hoc groups of banks TWG National banking communities 5. The utmost importance of co-operation

72. Budapest, 28 November 200272 Eurosystem/EPC co-operation PSSC ECB Observer COGEPS (Retail) EPC Co-ordination group EPC General Assembly EPC Working Groups - customer requirements - cash - cards - STP - infrastructure ECBS 5. The utmost importance of co-operation

73. Budapest, 28 November 200273 Securities Clearing and Settlement Systems (SCSS) PSSC COGESI Groups of banks (custodians and users) CSDs & ICSDs 5. The utmost importance of co-operation

74. Budapest, 28 November 200274 5. The utmost importance of co-operation Constructive co-operation between central bank, market participants and systems operators EU and accession countries - Banking associations - Banks and system operators

75. Budapest, 28 November 200275 Summary Move to integrated (and consolidated) euro payment and settlement infrastructures Transition strategy Active co-operation

76. Budapest, 28 November 200276