The Financial Sector's Payments via Kronos

Irene Madsen, Payment Systems

INTRODUCTION

Danmarks Nationalbank's payment system, Kronos, plays a key role in the Danish payments infrastructure. The payments infrastructure is based on electronic payment systems handling retail payments (Dankort, Direct Debit, inpayment forms, etc.) for a daily average of kr. 23 billion, securities transactions (e.g. share and bond trading) for kr. 93 billion, and foreign-exchange transactions (Danish kroner against foreign exchange) for kr. 203 billion. Danmarks Nationalbank acts as settlement bank in the financial infrastructure, i.e. the financial institutions settle their transactions through accounts at Danmarks Nationalbank. This article describes payment flows in Kronos, particularly payments between participants, and payments settled via connected settlement systems.

PAYMENT SETTLEMENT IN KRONOS

Since Danmarks Nationalbank acts as settlement bank, participants in the payments infrastructure hold accounts at Danmarks Nationalbank. The account holders are primarily banks, mortgage-credit institutes and branches of foreign credit institutions.

In addition, other entities may open accounts if they are, in the assessment of Danmarks Nationalbank, of major significance to the settlement of payments. Examples are CLS Bank and Euroclear Bank. Financial institutions that do not hold accounts must use correspondent banks to gain access to the Danish payments infrastructure. At the end of 2007, there were 126 account holders. Some 40 smaller Danish credit institutions did not hold accounts at Danmarks Nationalbank.

Kronos has many direct participants compared with the payment systems of other small countries in Western Europe. This is presumably the reason why the concentration ratio in Danmarks Nationalbank's payment system is relatively low, cf. Table 1.

Payments can be sent to Kronos via SWIFT (Society for Worldwide Interbank Financial Telecommunication) or manually through a Kronos terminal via the PI network. SWIFT is an international financial network used globally by financial institutions, payment and settlement systems, exchanges, etc. to send and receive different types of financial message, including payment instructions. The PI network is a closed network linking together the data centres of Danish banks, VP Securities Services (VP), Payment Business Services (PBS) and Danmarks Nationalbank. To accommodate participants using the Kronos terminal/PI network as well as participants using SWIFT, Kronos includes a module – Poseidon – which can translate SWIFT payment messages into PI-network messages and vice versa. The largest participants typically remit and receive payments via SWIFT, since this allows fully automated processing of payments, i.e. Straight-Through-Processing, STP.

Transactions in Kronos are concentrated on the 10 largest banks, which account for 78 per cent (in value terms) of current-account transactions, cf. Table 2. Total transactions in 2007 amounted to kr. 70,259 billion, corresponding to approximately 40 times Denmark's gross domestic product.

Settlement of payments via the participants' current accounts
Box 1 outlines the key payment and settlement systems in the Danish financial infrastructure. Table 3 shows the current-account transactions of Kronos participants broken down by system.

CORE PAYMENT AND SETTLEMENT SYSTEMS IN THE DANISH FINANCIAL INFRASTRUCTURE	Box 1
Danmarks Nationalbank's payment system, Kronos, is at the hub of Danish payments settlement, cf. Chart 1. Kronos is a real-time gross settlement (RTGS) system and was commissioned in 2001.
PAYMENTS IN KRONER SETTLED AT DANMARKS NATIONALBANK	Chart 1
VP Settlement is VP's system for settlement of securities transactions and periodic payments (interest, repayments and dividend). For securities transactions, the securities leg is settled through VP, while the cash leg is settled via the participants' accounts at Danmarks Nationalbank. The Sumclearing is the Danish Bankers Association's system for settlement of retail payments. Nearly all Danish retail payments are settled via this system, e.g. Dankort transactions, Direct Debit, credit transfers, etc. The system is operated by PBS, while final transfer of funds between participants takes place through accounts at Danmarks Nationalbank. CLS is an international system for settlement, primarily of foreign-exchange transactions, in 15 currencies. CLS Bank International was established in 2002 by some of the world's largest banks. The Danish krone joined CLS in 2003, after which pay-ins and pay-outs for settlement of the krone leg of participants' foreign-exchange transactions take place over CLS Bank's account at Danmarks Nationalbank. In 2007, CLS was extended to include settlement of payments relating to credit derivatives. SCP (Scandinavian Cash Pool) is a system for pledging of cross-border collateral for intraday credit in Danish and Norwegian kroner and Swedish kronor. The system was established in 2003 and is available to credit institutions in Denmark, Norway and Sweden that participate in the payment systems of the respective central banks.

Interbank payments, i.e. payments between participants, account for 44 per cent of transactions in terms of value, cf. Table 3. These payments are settled individually as gross transactions immediately after Danmarks Nationalbank's receipt of the payment instructions.

The concentration on the largest participants is pronounced, cf. Table 4. Interbank payments involving the 10 largest remitters and recipients account for 97 per cent of transactions, of which 76 per cent relate to payments between these 10 participants. Interbank payments between other participants make up only 3 per cent.

Settlement of payments for connected settlement systems (CLS, VP Settlement and the Sumclearing) constitute 32 per cent of the transactions in value terms, cf. Table 3. Gross amounts settled via the settlement systems are considerably larger, cf. Table 5, as opposite payments are set off against one another, i.e. netted, prior to settlement.

Liquidity redistribution via Kronos
Considerable redistribution of liquidity among participants takes place via Kronos, cf. Chart 2. In 2007, such redistribution typically amounted to kr. 5-10 billion, but on peak settlement days it exceeded kr. 45 billion.

Payment settlement traffic in Kronos is significantly influenced by the international financial markets, particularly the US market. A review of settlement of payments in Kronos via the participants' current accounts on US public holidays shows that activity almost halves on these days. Of the 10 days in 2007 when current-account activity was lowest, five were US public holidays.

SETTLEMENT OF PAYMENTS FOR CONNECTED SETTLEMENT SYSTEMS

VP Settlement and the Sumclearing are multilateral net settlement systems in which payments are settled in fixed blocks and netted among participants prior to settlement at Danmarks Nationalbank. CLS is a gross settlement system, but considerable netting takes place, cf. Table 5.

Sumclearing and VP Settlement cycles have been scheduled in consultation with the financial sector. Settlement of retail payments in the Sumclearing primarily takes place in a nightly block, while securities transactions are settled both at night and during the day. Moreover, participants in VP Settlement can opt for real-time settlement of transactions within Kronos' opening hours.

Settlement cycles have been planned so as to take several factors into account. The settlement blocks have been scheduled with a view to minimising participants' liquidity requirements. For example, mortgage payments to the mortgage-credit institutes via the Sumclearing are received before the mortgage-credit institutes disburse interest and payments via VP Settlement. Likewise, government disbursements of interest and payments are placed in the block immediately prior to the first securities trading block. In addition, VP trading blocks are designed to ensure an efficient link to the international markets via Euroclear.

Account holders have separate settlement accounts for the various settlement types. In these accounts, amounts can be reserved for each settlement block, either in their current accounts or under the automatic collateralisation arrangement. This means that within a given period of time, lasting until the settlement block has been run, account holders cannot dispose of the funds in the relevant accounts. In this way Danmarks Nationalbank can guarantee the amounts reserved for settlement without incurring any risk. The settlement concept and the collateral pledged by participants are described in the Appendix.

The Sumclearing
In 2007, 98 per cent of Sumclearing payments were settled in the 1st normal settlement block, which is the primary block. If one or more participants have not reserved sufficient liquidity for settlement, they are excluded from the settlement, and the net positions of the remaining participants are settled. The net positions of the excluded participants cannot be settled until Kronos opens at 7.00 a.m. (2nd extra settlement block). A total of 1.2 per cent of the net payments in 2007 were settled after Kronos had opened.

The liquidity reserved for settlement primarily comes from the participants' current accounts, in that many participants arrange for fixed transfers from their current accounts to their settlement accounts. Participants generally maintain substantial excess liquidity for settlement of payments, cf. Table 6. On average, the liquidity reserved constitutes just over 900 per cent of the funds required for settlement. However, the sums settled via the Sumclearing vary considerably over the month, with large net payments on the first and last few banking days of each month.These are primarily large payments to and disbursements from the central government's account, e.g. taxes, social benefits and interest and repayments on mortgage-credit loans. Average daily net settlement amounted to kr. 5.4 billion, but if the two first and two last banking days of each month are excluded, the average is kr. 3.6 billion per day.

VP Settlement
VP Settlement in Danish kroner settles securities transactions and periodic payments (interest, repayments and dividend). Securities transactions are settled in five blocks at night and during the day, while periodic payments are settled in two blocks. The central government's periodic payments are settled as the first block, after which the first securities block, VP10, is settled. VP10 is the largest trading block by far, comprising 70 per cent of aggregate net payments, cf. Table 7. The larger the number of transactions settled within the same block, the greater the netting effect. Consequently participants aim to settle their transactions in VP10. The next block, VP20, is settled after Euroclear's first nightly settlement block. This block is primarily used to settle Danish participants' purchases of securities issued by VP in the international market. Between blocks VP30 and VP40, periodic payments relating to securities are settled in block VP35. These payments can be reinvested and settled in transactions with the same value date in blocks VP40 and VP60.

Trading settlement does not entail the same need for excess liquidity cover as the Sumclearing. This is primarily attributable to the automatic collateralisation arrangement, whereby participants may pledge their own portfolios of securities as collateral for settlement and may also pledge securities purchased as collateral in the settlement block in which they are received. In trading settlement, use of automatic collateralisation accounts for 76 per cent of net payments, while 24 per cent are drawn on settlement accounts. Automatic collateralisation is used mainly by the large Danish banks.

Participants can also make use of automatic collateralisation when settling periodic payments, but unlike in trading settlement an amount is reserved prior to settlement (the extended automatic collateralisation arrangement). Excess liquidity cover for settlement of periodic payments is considerable, the reason being that these payments are time-critical. While trading for which there is insufficient cover can be deferred until a later settlement block, periodic payments must be settled in full on the date in question.

CLS settlement
Payments through Danmarks Nationalbank to and from CLS settlement take place through settlement accounts or directly by payment into CLS Bank's current account. Any participant opting for automatic collateralisation must have a settlement account. Prior to settlement, CLS sends out a pay-in schedule to participants. The first pay-in to CLS Bank must then take place by 8.00 a.m. As participants know the size and time of their payments prior to settlement, excess liquidity cover is not required on the part of participants in CLS settlement. However, a small excess liquidity cover does exist, cf. Table 8, due to participants' use of automatic collateralisation.

Conclusion
Most Danish payments are settled through Danmarks Nationalbank in Kronos. Despite the high number of direct participants in Kronos, settlement of payments is still mainly concentrated on the largest participants. Several settlement systems are connected to Kronos, and settlement in the Danish systems is coordinated. The Sumclearing and VP Settlement generally involve considerable excess liquidity cover. However, the amounts settled within a day vary considerably, especially around the turn of the month, and thus prudent liquidity management by Kronos participants is required.

LITERATURE

Danmarks Nationalbank (2001), Financial Institutions' Accounts at and Pledging of Collateral to Danmarks Nationalbank, Monetary Review, 4th Quarter.

Danmarks Nationalbank (2005), Payment Systems in Denmark.

Natorp, Lone and Tina Skotte Sørensen (2006), Settlement of Foreign-Exchange Transactions, Danmarks Nationalbank, Monetary Review, 4th Quarter.

APPENDIX

Danmarks Nationalbank's settlement concept is outlined in Chart 3. The current account is the account holder's primary account at Danmarks Nationalbank. It is used for settlement of payments between account holders, i.e. interbank payments. Current accounts are also used for payments between account holders and Danmarks Nationalbank, and for payments to and from the central government. In addition, account holders may have a number of settlement accounts at Danmarks Nationalbank for the connected settlement systems.

Apart from the balance of its current account, a participant may increase the maximum amount available for settlement of payments by obtaining intraday credit from Danmarks Nationalbank. Such credit is collateralised via securities registered in a safe-custody account with VP Securities Services, VP, by way of traditional pledging of securities or under the automatic collateralisation arrangement. Traditional pledging means that the securities used as collateral by the individual participant are registered in an account, known as a safekeeping account, at VP with Danmarks Nationalbank as the account controller. Under the automatic collateralisation arrangement, participants can provide collateral by way of securities in one or more designated accounts at VP, frequently their trading accounts. As opposed to traditional pledging of collateral, this offers the advantage that specific assets are not bound. Automatic collateralisation is most important for the largest participants in VP Settlement, but is also used by small participants.^[1]

For settlement in kroner, an account holder can provide liquidity for the settlement blocks either by transferring funds from its current account to its settlement account prior to settlement or via the automatic collateralisation arrangement. In the Sumclearing, the account holder reserves a specific amount under the automatic collateralisation arrangement prior to settlement. The amount is credited to the account holder's settlement account for the Sumclearing and debited to the account holder's automatic collateralisation account at Danmarks Nationalbank.

For securities settlement in VP, the account holder's entire automatic collateralisation account is included, i.e. no specific amount is reserved. If liquidity is needed for settlement, the automatic collateralisation arrangement is first utilised to its full extent, and if this proves insufficient then the settlement-account deposit is used.

Prior to each settlement cycle, Danmarks Nationalbank notifies the Sumclearing or VP of each individual account holder's settlement-account balance. In the Sumclearing, the settlement-account balance is equivalent to the account holder's line in the settlement block. In VP securities settlement the account holder's line also depends on the amount available under the automatic collateralisation arrangement. The Sumclearing and VP then check that each individual account holder's net payment in the settlement block does not exceed its line. If this criterion is met, the Sumclearing and VP inform Danmarks Nationalbank of the account holders' net positions in that block. Danmarks Nationalbank then books the positions to the account holders' settlement accounts and automatic collateralisation accounts, and settlement has been concluded.

When settlement has taken place, the settlement accounts are emptied and the funds transferred to the current accounts. Any unused amounts reserved under the automatic collateralisation arrangement are, however, first used to reduce the credit under this arrangement. Any excess amount in a Sumclearing settlement account is then deposited to the account holder's current account.

For CLS payments in Danish kroner, participants in Kronos transfer amounts from their own current accounts or CLS settlement accounts to CLS' current account at Danmarks Nationalbank. If the account holder has a CLS settlement account, payments from CLS' current account must always be made to this account.

An account holder must have a CLS settlement account in order to obtain credit for CLS settlement under the automatic collateralisation arrangement. As is the case for the Sumclearing, the account holder reserves a specific amount, which is then credited to its CLS settlement account and debited to the automatic collateralisation account.

Any deposit in the CLS settlement account at 1.30 p.m. is used to reduce the credit under the automatic collateralisation arrangement for CLS settlement. Any residual amount after cover of credit under the automatic collateralisation arrangement is transferred to the account holder's current account.

Danmarks Nationalbank's settlement concept is described in more detail in Danmarks Nationalbank (2005) and in previously published articles, e.g. Danmarks Nationalbank (2001).