Payment Systems

In 2006, as in previous years, the Danish payment and settlement systems were characterised by substantial turnover. Settlement in these systems is to a large extent based on credits granted by Danmarks Nationalbank against collateral. In 2006 a few minor adjustments and improvements were made to the terms and conditions for the participants' pledging of collateral for credit facilities at Danmarks Nationalbank.

The assessment by the International Monetary Fund, IMF, of the financial system in Denmark also comprised a review of the payment and settlement systems in relation to international standards. The assessment showed that the Danish systems are secure and efficient. However, a few opportunities for improvement were pointed out.

Finally, 2006 saw a number of European initiatives that may have a significant impact on the settlement of payments and securities transactions in the coming years.

DANISH PAYMENT AND SETTLEMENT SYSTEMS IN 2006

In a modern economy, the settlement of payments, securities, etc. is concentrated on a few large systems, cf. Box 8. This concentration entails that the individual systems settle very large sums on an annual basis.

The value of transactions in kroner settled via Danmarks Nationalbank's system, Kronos, increased by 9 per cent in 2006, cf. Table 7. The decline for the VP Settlement is attributable to a decrease in the trading of Danish bonds that exceeded the increase in trading of equities.

The strong increase by 52 per cent in settlement in kroner in CLS reflects a combination of greater activity in the foreign-exchange market and the increasing tendency for large market participants worldwide to use CLS, rather than correspondent banks, for settlement of foreign-exchange contracts.

In the trans-European payment system, Target, the value of payments settled rose by 9 per cent in 2006, cf. Table 8. However, Danish participants' use of the system declined by 16 per cent. This was among other things because a major participant transferred its settlement of foreign-exchange contracts to CLS.^[1] For the remaining Danish participants taken as one, the value of payments settled in Target increased by 14 per cent.

Operational problems in Kronos
In the 2nd half of 2006, the settlement of payments in Kronos was disrupted by several system failures due to problems with the IT supplier's connection to SWIFT^[2]. Most failures were of short duration and did not make special measures necessary, but in order to prevent problems with CLS settlement, Danmarks Nationalbank in three cases had to initiate contingency procedures with respect to manual transmission of funds between participants. In connection with the most serious failure, on 16 November, kr. 12 billion was transmitted between participants in order to ensure timely settlement of foreign-exchange contracts for a total principal of kr. 148 billion. 

The disruption of payment settlement caused by the failure on 16 November 2006 was so severe that it had an impact on the money market. Consequently, Danmarks Nationalbank extended its opening hours and gave access to extraordinary buy-back of certificates of deposit. Thereafter conditions in the money market soon normalised.

Danmarks Nationalbank takes a very serious view of these system failures. A project has therefore been launched to improve the IT provider's SWIFT environment. This work is monitored closely by Danmarks Nationalbank.

PLEDGING OF COLLATERAL FOR CREDIT FACILITIES AT DANMARKS NATIONALBANK

The settlement of payments in the systems is to a large extent based on credits granted by Danmarks Nationalbank as current-account overdrafts. In order to limit Danmarks Nationalbank's risk of credit loss, current-account overdrafts, like monetary-policy loans, are hedged by collateral, primarily eligible securities registered with VP Securities Services. Collateral is provided by the traditional pledging of a securities account, but also via the special automatic collateralisation facility available in connection with settlement credits in payment and settlement systems.^[3]

Adjustment of the terms and conditions for pledging of securities as collateral
The terms and conditions for pledging of securities as collateral to Danmarks Nationalbank were amended with effect from 1 January 2007.^[4] The amendment is limited to a minor adjustment of the " haircuts" deducted from the market value of the securities on calculating their collateral value. The haircuts ensure that even if market prices decrease the credits granted will not exceed the market value of the pledged securities.

The adjustment reflects an equivalent change in the ECB's terms and conditions that likewise took effect on 1 January 2007. Unlike the ECB, Danmarks Nationalbank did not extend the collateral basis to include certain types of bank loans. This is deemed to be unnecessary for several reasons, including Danish banks' very substantial holdings of eligible securities. Consequently, Danmarks Nationalbank's extension of credit to banks, etc. will continue to be based on the collateralisation of bonds, primarily Danish government and mortgage-credit bonds.

Upgraded automatic collateralisation facility
In 2006, the procedures for automatic collateralisation of securities were simplified, so that the principles for traditional pledging of collateral also apply to automatic collateralisation. This simplification has led to an extension of the collateral basis since in future all securities that can be pledged as traditional collateral are also eligible for automatic collateralisation. In addition, haircuts were reduced to the same level as for traditional pledging of collateral.

The introduction of the automated procedures, which have simplified the management of automatic collateralisation and extended the collateral basis, supports the stability of the payment and settlement systems.

OVERSIGHT

Danmarks Nationalbank oversees the financial infrastructure in Denmark in order to contribute to secure and efficient settlement of payments and securities transactions. In practice, oversight is concentrated on the three systemically important systems in Denmark: Kronos, VP Settlement and the Sumclearing.

A key element of the oversight is to assess the systems in relation to international standards for respectively payment and securities settlement systems. These standards lay down the overall requirements of the risk management and efficiency of the systems. Risks in payment and settlement systems fundamentally comprise legal risk, credit and liquidity risk and operational risk. Efficiency is dependent on the costs of using the systems and the usefulness of the services the systems offer to participants.

Oversight is based on the general principles for central-bank oversight of payment and settlement systems established by the Committee on Payment and Settlement Systems.^[5]

Danmarks Nationalbank's oversight of the financial infrastructure is often undertaken in cooperation with the Danish Financial Supervisory Authority. This cooperation was formalised in a Memorandum of Understanding (MoU) in 2001. In 2006, the MoU^[6] was amended in the light of the experience gained during the preceding five years, as well as the incorporation of Danmarks Nationalbank's responsibility for oversight of payment systems in the Danish Securities Trading Act as of 1 March 2006.^[7].

IMF ASSESSMENT OF DANISH PAYMENT AND SETTLEMENT SYSTEMS

In 2005-06, the International Monetary Fund, IMF, performed an assessment (FSAP) of the financial system in Denmark. The IMF's oversight of the financial systems of its member countries is based on these systems' major significance to economic and financial stability, cf. p. 82.

The FSAP also comprised an assessment of the systemically important payment and settlement systems on the basis of the international standards described above.

The assessment of the systems was predominantly positive. The financial infrastructure was thus described as well-developed and based on technologically advanced solutions. The individual systems furthermore broadly complied with international standards.

The IMF did, however, reveal areas where there is scope for improvement of payment systems in Denmark. In these areas, initiatives have been taken to follow up the IMF's comments. This takes place in close cooperation with the system operators.

The IMF's main comments concerned the management of credit and liquidity risk in the Sumclearing. The IMF acknowledged that the system participants (banks) hold extensive portfolios of bonds that can be pledged as collateral to Danmarks Nationalbank. This entails a very high degree of certainty that the other participants will be able to settle their payments even if the participant with the largest payment obligation cannot settle. Nevertheless, the IMF found that further measures could be taken to ensure settlement, e.g. via the establishment of a buffer pool.^[8] The same recommendation was made with regard to VP Settlement, where the issue was, however, considered to be less important.

Following the assessment by the IMF, Danmarks Nationalbank performed an analysis of the problem. Based on the results of the analysis it was concluded that there is still no need to establish a buffer pool or similar in connection with the Sumclearing and VP Settlement.^[9]

Still with a view to reducing credit risk on settlement of retail payments in Denmark, a recommendation was made to restructure the settlement cycle for payments via Betalingsservice (direct debit). The aim is to ensure that such payments are not booked to customer accounts until settlement has taken place in the Sumclearing.

The Danish Bankers Association and PBS have subsequently decided to restructure the settlement cycle.

With regard to the operational risk related to the Danish payment and settlement systems, the IMF concluded that Danmarks Nationalbank's own payment system, Kronos, should include measures to ensure restart of the system within two hours of a system failure. Today, the best real-time gross settlement systems meet this requirement, but it represents a tightening of the requirements applying when Kronos was commissioned in 2001, i.e. a maximum restart time of four hours. The more stringent requirement reflects experience from the terrorist attacks on New York on 11 September 2001.

Danmarks Nationalbank has initiated an investigation of the possibility of reducing the risk of a system failure of more than two hours' duration. Tests of the contingency measures show that in practice restart within two hours is normally possible.

In relation to the efficiency of the financial infrastructure, the IMF pointed out that Danmarks Nationalbank should improve the basis for assessing whether the costs and price structure of Kronos are appropriate. The large number of participants – 127 at end-2006 – indicates that this is the case, and the cost level for Kronos matches that of equivalent systems in other small and medium-sized EU member states. In view of the IMF recommendation Danmarks Nationalbank will reconsider the size and cost-distribution structure of the system.

TARGET2

The development of a new trans-European payment system, Target2, for settlement of payments in euro continued in 2006. The objective of Target2 is to create a single shared platform to replace the current Target system, which is based on links between the payment systems of the participating central banks.

Danmarks Nationalbank coordinates the overall Danish connection to Target2 and acts as the link between the financial sector and the three central banks in Germany, Italy and France that are developing the system.

During 2006 the core pricing scheme and ancillary system pricing scheme were announced and the participant structure was determined.

Participants will migrate from Target to Target2 in three waves. The first member states will migrate in November 2007 and the second group of member states in February 2008, while Denmark is part of the final wave migrating in May 2008.

The development of a major payment system such as Target2 requires exhaustive testing by the participants. Denmark's testing period is planned to begin in mid-2007 and will last until April 2008. Prior to the testing, the participants, i.e. VP Settlement, the Sumclearing and Danmarks Nationalbank, must make the adjustments to their own systems that are necessary to prepare for Target2.

RETAIL PAYMENTS

In the coming years, Danish banks, citizens and enterprises will be affected by two European payments initiatives: the Payment Systems Directive and the Single Euro Payments Area (SEPA).

Payment Systems Directive
In December 2005, the European Commission tabled a draft directive with a view to harmonising the member states' legislation in the area of retail payments. The Directive is aimed at supporting the single market for goods and services in the EU by ensuring a level playing field for the transaction of payments. In addition, it is one of the cornerstones in the development of the Single Euro Payments Area, SEPA, cf. below.

Danmarks Nationalbank has followed the debates on the European Commission's proposal in the European Parliament and the Council closely and has contributed to the process by participating actively in the analysis of the scope and impact of the Directive in relation to Denmark.

The Directive will require a number of amendments and new provisions in Danish legislation, especially with regard to relations between banks and their customers. Overall, the Directive will include rules on (i) access to the provision of payment services in the EU, (ii) information requirements, and (iii) general terms and conditions for execution of payments, e.g. responsibilities and provisions relating to settlement time and value days. It will be a full harmonisation directive, which eliminates divergent legislation in member states.

SEPA – Single Euro Payments Area
Since 2002 the European banks have been building the infrastructure for a Single Euro Payments Area, SEPA. The intention is to create an area where cross-border retail payments are as simple and efficient as domestic payments. With the establishment of SEPA, citizens and enterprises will be able to make domestic and cross-border payments on equal terms.

SEPA will cover the most significant types of payments between bank customers. The European banks have drafted a common set of rules for, respectively, credit transfers and payment services in SEPA, with specific requirements for procedures and standards. In addition, the banks have prepared a set of general principles for payment cards in SEPA in order to ensure that " SEPA cards" are broadly accepted in all terminals and by all acquirers in the euro area.

According to the SEPA timetable, the European banks will offer the new payment products from the beginning of 2008. In a transitional phase these products will exist in parallel with the current national products. By the end of 2010, the national products within the euro area are expected to have been more or less phased out and replaced by the new SEPA payment products. The timetable for SEPA can be changed, however, since the adoption of the payment services directive is delayed.

Danish banks also plan to offer their customers the execution of payments in euro via SEPA payment products. This will enable citizens and enterprises in Denmark, via their (Danish) banks, to remit payments in euro to and receive payments in euro from businesses, suppliers and customers all over Europe, on terms and conditions equivalent to those applying to euro area citizens and enterprises.^[10] Viewed in isolation, SEPA will not entail any changes to Danish krone-denominated payments, so that consumers will not notice any difference when using e.g. the Dankort debit card on an everyday basis.

SECURITIES

In 2006, this area was characterised by the ongoing development of more efficient systems for clearing and settlement of cross-border securities transactions within the EU by removing the Giovannini barriers^[11]. The key initiatives were: (i) the European Commission's previously announced framework directive on clearing and settlement in the EU was replaced by a voluntary Code of Conduct for securities exchanges, central securities depositories (CSD) and central counterparty clearing houses in connection with clearing and settlement of securities transactions, and (ii) the ECB announced the potential establishment of a trans-European securities settlement platform, Target2-Securities.

Code of Conduct for clearing and settlement of securities transactions
In November 2006, the European Commission published a Code of Conduct for clearing and settlement of securities transactions adopted by the European securities exchanges, CSD and central counterparty clearing houses, including VP Securities Services and OMX Nordic Exchange. The objective is to reduce the barriers to development of a single European securities market. The Code of Conduct includes guidelines for:

• Price transparency with respect to services related to clearing and settlement of securities transactions, etc.
• Interoperability and fair access in order to facilitate the participation of financial enterprises in exchanges and CSD within the EU.
• Unbundling of CSD services so that financial enterprises may deselect services that they do not require (including the related accounting separation).

Initially, the Code of Conduct only applies to shares. The organisations who have signed the agreement must gradually implement the guidelines during 2007.

Target2-Securities
On 7 July 2006, the ECB issued a press release stating that the Eurosystem was evaluating opportunities to establish a trans-European settlement platform for securities issued in euro. This platform is to be integrated with the Target2 platform under the name of Target2-Securities. It is envisaged that cash and securities will be settled on the same platform. The ECB expects the establishment of Target2-Securities to make it easier and less expensive to settle cross-border securities transactions, which is a precondition for the development of a single securities market in the EU.

Since mid-2006, the ECB has worked with the future users of the platform on the further design of Target2-Securities. In addition, a cost analysis has been performed, as well as an assessment of whether there is an adequate legal basis for the project. In the consultation phase, the possibility was introduced of enabling settlement of non-euro securities, e.g. securities denominated in Danish kroner, via the platform.

In this connection, in the spring of 2007 the Governing Council of the ECB is expected to decide to commence the next phase of the project: determining user requirements. In this phase public consultation will take place as the basis for the final decision to devote funds to the development of a new joint-European securities settlement platform. This decision is expected to be made at the beginning of 2008.

SETTLEMENT OF FOREIGN-EXCHANGE TRANSACTIONS

In 2006, Danmarks Nationalbank conducted a survey of foreign-exchange settlement in Denmark – in the same way as the central banks in the other countries whose currencies are settled in CLS.^[12] The survey documents that the major Danish participants in the foreign-exchange market generally handle settlement risk prudently.^[13]