Financial Stability Standards for Securities Settlement Facilities – June 2024 Standard 8: Money Settlements

Guidance

A securities settlement facility typically needs to conduct money settlements with or between its participants for a variety of purposes, such as the settlement of individual payment obligations, and funding and defunding activities. To conduct such money settlements, a securities settlement facility can use central bank money, commercial bank money or a combination of the two. Where individual payment obligations are settled in commercial bank money, exposures are typically created between commercial banks, which are ultimately settled in central bank money. A securities settlement facility may not specify how participants fund their obligations. However, the securities settlement facility, its participants, any commercial settlement banks and any commercial bank money settlement agents should take into account the risks associated with alternative money settlement arrangements.

Settlement in central bank money typically involves the central bank of issue assuming the role of money settlement agent, with ultimate money settlement occurring across accounts held by participants or their commercial settlement banks with the central bank. Typically, this sort of arrangement for the settlement of individual transactions minimises the accrual of exposures between commercial settlement banks.

Settlement in commercial bank money typically occurs on the books of a commercial bank money settlement agent. In this model, a securities settlement facility typically establishes an account with one or more commercial bank(s) and requires each of its participants to establish an account with one of them. In some cases, the securities settlement facility itself can serve as the money settlement agent, in which case money settlements are effected through accounts on the books of the securities settlement facility. A securities settlement facility may also use a combination of central bank and commercial bank monies to conduct settlements, for example, by using central bank money for funding accounts at commercial banks, prior to settlement of individual payment obligations in commercial bank money across those accounts.

A securities settlement facility and its participants may face credit and liquidity risks from commercial bank money settlements. Credit risk may arise when participants use commercial settlement banks to effect money settlements, or when the securities settlement facility uses a commercial bank money settlement agent. Liquidity risk may arise in money settlements if, after a payment obligation has been settled, participants or the securities settlement facility itself are unable to transfer readily their assets at the commercial settlement bank, or money settlement agent, into other liquid assets, such as claims on a central bank.

8.1.1 With the use of central bank money, a payment obligation is typically discharged by providing the securities settlement facility, its participants or its participants' commercial settlement banks, with a direct claim on the central bank; that is, the relevant central bank is the money settlement agent, and the settlement asset is central bank money. Central banks have the lowest credit risk and are the source of liquidity with regard to their currency of issue. However, the use of central bank money may not always be practical or available. For example, a securities settlement facility may not have direct access to central bank accounts and payment services in all relevant jurisdictions. A multicurrency securities settlement facility that has access to all relevant central bank accounts and payment services may find that some central bank payment services do not operate, or provide finality, at the times when it needs to make money settlements.

8.2.1 An alternative to the use of central bank money is commercial bank money. When settling in commercial bank money, a payment obligation is typically discharged by providing the securities settlement facility or its participants with a direct claim on a commercial bank money settlement agent. To conduct settlements in commercial bank money, a securities settlement facility and its participants need to establish accounts with at least one commercial bank, and likely hold intraday or overnight balances, or both. The use of commercial bank money to settle payment obligations, however, can create additional credit and liquidity risks for the securities settlement facility and its participants. For example, if a commercial bank money settlement agent became insolvent, the securities settlement facility and its participants might not have immediate access to their settlement funds or ultimately receive the full value of their funds. It also creates operational dependencies on the relevant commercial bank(s).

8.3.1 If a securities settlement facility uses a commercial bank money settlement agent (or a non-bank deposit-taking institution) for its money settlements, it should monitor, manage and limit its credit and liquidity risks arising from this arrangement. For example, a securities settlement facility should limit both the probability of being exposed to the bank's failure and limit the potential losses and liquidity pressures to which it would be exposed in the event of such a failure. A securities settlement facility should establish and monitor adherence to strict criteria for its commercial bank money settlement agents that take into account, among other things, their regulation and supervision, creditworthiness, capitalisation, access to liquidity and operational reliability. Under these criteria, a commercial bank money settlement agent should be subject to effective banking regulation and supervision. It should also be creditworthy, be well capitalised, and have ample liquidity from the marketplace or the central bank of issue. Where money settlements take place in Australian dollars, a securities settlement facility should only utilise an authorised deposit-taking institution (ADI) that holds an Exchange Settlement Account at the Reserve Bank and has been approved to act as an agent for RTGS payments by the Australian Prudential Regulation Authority.

8.3.2 Even where ultimate settlement occurs in central bank money, many participants in a securities settlement facility may not have direct access to accounts with the relevant central bank. They will therefore typically use the services of commercial settlement banks to effect money settlements or carry out funding and defunding activities. These commercial settlement banks play an important role in the smooth functioning of the settlement process and therefore the securities settlement facility should establish appropriate criteria around their financial and operational capacity to fulfil this role, which may include similar criteria to those described in paragraph 8.3.1 (see also SSF Standard 11 on participant default rules and procedures).

8.3.3 In addition, a securities settlement facility should monitor and manage the concentration of its and, to the extent reasonably practicable, its participants' credit and liquidity exposures to commercial bank money settlement agents and commercial settlement banks. The securities settlement facility should consider the diversification of its and its participants' exposures to commercial banks in the settlement process and assess its potential losses and liquidity pressures as well as those of its participants in the event of the failure of a commercial bank money settlement agent or commercial settlement bank (see also SSF Standard 16 on tiered participation arrangements).

8.4.1 Where a securities settlement facility conducts money settlements on its own books, it offers cash accounts to its participants, and a payment or settlement obligation is discharged by providing a securities settlement facility's participants with a direct claim on the securities settlement facility itself. The credit and liquidity risks associated with a claim on a securities settlement facility are therefore directly related to the securities settlement facility's overall credit and liquidity risks. A securities settlement facility should look to minimise these risks by limiting its activities and operations to settlement and closely related processes (see SSF Standard 1.1). Further, to settle payment obligations, the securities settlement facility could be established as a supervised special purpose financial institution and limit the provision of cash accounts to participants. In some cases, a securities settlement facility can further mitigate risk by having participants fund and defund their cash accounts at the securities settlement facility using central bank money. In such an arrangement, a securities settlement facility is able to back the settlements conducted on its own books with balances that it holds in its account at the central bank.

8.5.1 In settlements involving either central bank or commercial bank money, a critical issue is the timing of the finality of funds transfers. These transfers should be final when effected (see also SSF Standard 1 on legal basis and SSF Standard 7 on settlement finality). To this end, a securities settlement facility's legal agreements with any commercial bank money settlement agent should contain clear provisions regarding the finality of funds transfers. The securities settlement facility should communicate the effect of these provisions to participants. Participants' legal agreements with commercial settlement banks should similarly provide clarity in relation to these matters, although in some cases a securities settlement facility may not have access to these agreements. If a securities settlement facility conducts intraday money settlements, the arrangement should provide real-time finality or intraday finality at the times when a securities settlement facility wishes to effect money settlement.