Challenges in Overseeing Cross-Border and Multicurrency Payment and Settlement Systems

1. Challenges in Overseeing Cross-Border and Multicurrency Payment and Settlement Systems 11 September 2008 Lawrence M. Sweet Senior Vice President

2. Cross-Border and Multicurrency Systems • Potential oversight relevance to more than one central bank • Currencies, participants, markets, linkages, interdependencies, size • Cooperative oversight can provide a mechanism for mutually fulfilling their respective oversight responsibilities • May be used by central banks and other relevant authorities • Such cooperation can and should be conducted without prejudice to the individual responsibilities of the authorities involved • Discussion topics: • Principles for international cooperative oversight • Current examples of central bank cooperative oversight “in action” • CLS Bank, settling 17 currencies • USD clearing arrangements in Colombia, Hong Kong, and India

3. Cooperative Oversight Principles • Lamfalussy Principles: issued 1990, updated 2005 • Notification • Primary responsibility • Assessment of the system as a whole • Settlement arrangements • Unsound systems

4. 1. Notification “Each central bank that has identified the actual or proposed operation of a cross-border or multicurrency payment or settlement system should inform other central banks that may have an interest in the prudent design and management of the system.” • Central banks with an interest normally include: • The central banks of issue of the currencies in the system • The central banks where the system is located • Mainly concerned with potentially significant large-value systems for interbank settlements, but… • What appears to be a small system in relation to one country’s market could be large in relation to another • Small operations can also grow over time and become more significant • So, initial notification should be made without regard to initial size • Central banks can then discuss and determine whether monitoring or a more active cooperative oversight arrangement is warranted

5. 2. Primary Responsibility “Cross-border and multicurrency payment and settlement systems should be subject to oversight by a central bank which accepts primary responsibility for such oversight, and there should be a presumption that the central bank where the system is located will have this primary responsibility.” • This does not represent any delegation of responsibility from one central bank to another • This does not prejudice the ability of other central banks to fulfill their individual responsibilities • It is designed to avoid a potential gap in the oversight of an international system • It ensures that at least one central bank will oversee the system as a whole

6. 3. Assessment of the System as a Whole “In its oversight of a system, the authority with primary responsibility should periodically assess the design and operation of the system as a whole. In doing so it should consult with other relevant authorities.” • Where applicable, internationally agreed standards should be used • The “primary” overseer should: • Actively solicit the opinions of the other cooperating central banks • Recognize their interests and concerns through a process of consultation • Organize an efficient and effective process for cooperation • All cooperating central banks should keep each other informed of relevant developments • They should agree on their responsibilities and expectations (e.g. MOU)

7. 4. Settlement Arrangements “The determination of the adequacy of a system’s settlement and failure-to-settle procedures in a currency should be the joint responsibility of the central bank of issue and the authority with primary responsibility for oversight of the system.” • These procedures need to be considered in relation to: • The system’s overall risk management arrangements • The variety of factors specific to each currency concerned • These factors include: • The soundness of the relevant legal regimes • The legal, credit, and liquidity implications of a settlement disruption for the respective domestic money markets • The solvency and liquidity of settlement institutions for each currency • The primary overseer thus has a particular duty to consult with the central bank of issue, given the latter’s knowledge of its domestic markets and its concern for their stability

8. 5. Unsound systems “In the absence of confidence in the soundness of the design or management of any cross-border or multicurrency payment or settlement system, a central bank should, if necessary, discourage use of the system or the provision of services to the system, for example by identifying these activities as unsafe and unsound practices.” • Central banks should strive to ensure the prudent operation of international systems on terms acceptable to all relevant central banks • However, this might not be possible in all cases • Therefore, each central bank must maintain its discretion to discourage the use of a system, or the provision of services to a system, if, in its judgment, the system is not prudently designed or managed

9. Cooperative Oversight in Action: CLS Bank • Current oversight committee established in 1994 • Originally formed by the CPSS to reduce foreign exchange settlement risk and to assess emerging FX settlement system proposals • CLS began live operations in 2002, after a long and challenging development • Currently 22 central banks participate in the oversight arrangement • Fed accepts “primary responsibility” for CLS oversight • Federal Reserve also charters and supervises CLS as a bank • Fed has also established a framework for sharing confidential supervisory information with central banks, including an annual assessment • All central banks have agreed to assess CLS against the “Core Principles” • Each central bank may also apply other applicable domestic policies • Each central bank also assesses CLS’ settlement and failure-to-settle procedures in its currency • Fed will not permit CLS to settle any currency if the central bank of issue objects • Cooperating central banks are now in the final stage of establishing a new oversight committee under a new protocol

10. Cooperative Oversight in Action: USD Arrangements • “Off-shore” USD settlement systems have been established in Colombia, Hong Kong, and India • Each of the respective central banks has established an effective cooperative oversight arrangement with the Federal Reserve • Each has notified and consulted with the Fed during the design, launch, and ongoing operations of the system • Each accepts primary responsibility to oversee the system • Each assessed the system as a whole against the “Core Principles”, and did so in consultation with the Fed • This consultation occurred in light of the Fed’s Policy Statement on Payment System Risk regarding USD payment and settlement systems • Furthermore, each central bank provides regular statistics to help the Fed monitor the evolving role of the system in the United States • Each has determined the adequacy of the system’s USD settlement and failure-to-settle procedures jointly with the Fed • These cooperative processes have successfully pre-empted potential concerns by the Fed regarding the prudent operation of these systems