2 International Aspects of Reform

Omotunde Johnson, Jean-Marc Destresse, Nicholas Roberts, Mark Swinburne, Tonny Lybek, and Richard Abrams
Published Date:
March 1998
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The volume and value of cross-border flows have increased considerably over the past two decades, while still relying for their settlement on traditional bilateral correspondent banking arrangements. This situation is now rapidly evolving, with the implementation of reforms driven by two major forces: the demands of the markets for more sophisticated and efficient clearing arrangements, and the cooperative initiatives of the central banks.

International coordination—spearheaded by the industrial countries—has aimed at ensuring that domestic objectives in payment system design and reform are consistent with maintaining the stability, operational efficiency, and competitiveness of international payment arrangements. Central banks—particularly those of countries whose currencies are most utilized in settling international trade and investment transactions—have had to examine and respond to the implications of greatly increased values of cross-border payments and to proposals from the private sector for new arrangements to handle international payments. A major goal of coordination in this context is to have financial firms, as much as possible, face similar institutional and regulatory environments in the various countries in which they operate. But there are more operational reasons motivating coordination as well.

Where time zones are not a major problem, as within the European Union or between North American countries, it is relatively easy to coordinate business hours of interbank funds transfer systems and hence times of central bank settlement services. But for transactions between the major financial “blocs” (the European Union, North America, and Asia), such coordination is not an easy task. Nevertheless, countries have been working at having some overlapping hours of business to link the settlement of different legs of a foreign exchange transaction. The ability to ensure that the settlement is simultaneous, however, also requires that the different domestic systems offer intraday finality and that the timing in each system can be reliably linked to provide “payment versus payment” (PVP).

The recent “Allsopp” report (BIS, 1996b; see below for further details) recommends that the way forward in addressing Herstatt risks should entail reliance mainly on private sector initiatives. One private sector multicurrency netting scheme, ECHO, is already operating, and another, MULTINET (a proposed multicurrency clearinghouse to be run by North American banks), is close to being operational. Some banks from Asia, North America, and Europe have also formed a so-called Group of Twenty to examine solutions to reduce the risk and increase the efficiency of the clearance and settlement of transactions primarily originating from foreign exchange activity. This group, composed of private banks with substantial foreign exchange business, intends to create a global mechanism allowing PVP for the settlement of cross-border currency trades. It will rely on a global private clearing bank that will link gross currency payments. The payments will be matched and settled one at a time through the debiting or crediting of accounts held at the clearing bank by the members. The currencies eligible will be those for which RTGS systems exist in the country of issuance, with overlapping hours of operation. The clearing bank would have access to these domestic RTGS systems, thus allowing it to settle simultaneously both legs of a currency payment.

The rest of this chapter is organized in five sections. The first defines cross-border transactions and describes their main characteristics. The second examines the specific risks involved in cross-border arrangements and describes the strategy that will be implemented by the Group of Ten (G-10) central banks to contain those risks. Next, selected cooperative initiatives in the industrial countries in the area of cross-border payments are outlined, including (1) the harmonization efforts in the European Union countries and the creation of the TARGET system, which will link European Union RTGS systems; (2) the ECHO system, which is a private multilateral netting system for foreign exchange contracts; and (3) a description of two interlinked international securities settlement systems—Euroclear and Cedel. The fourth section discusses a number of cooperative structures among nonindustrial countries, and the final section offers brief conclusions.

Characteristics of Cross-Border Arrangements

Cross-border payment arrangements are characterized by a great heterogeneity in the instruments, the legal and regulatory frameworks governing them, the currencies, and the communications channels involved. Defining a cross-border payment in other than general terms is difficult, given the great diversity in the types of transactions involved. The BIS (1995) describes a cross-border settlement as a “settlement that takes place in a country that is different from the country in which one trade counterpart or both are located.” Examples of cross-border transactions include when two banks located in Tokyo buy or sell dollars between each other through their correspondent banks in New York; when a German bank located in Frankfurt buys a security on the Chinese stock exchange; or when a Portuguese citizen wants to make a credit transfer to his son studying in France. According to the BIS (1996b), systems operators estimate that foreign exchange settlements account for 50 percent of the daily turnover value of CHIPS and CHAPS, 80 percent of the daily turnover value of EAF, and 90 percent of the daily turnover value of SIC—LVTSs operating, respectively, in the United States, the United Kingdom, Germany, and Switzerland.

Many cross-border payments rely on correspondent banking arrangements. Under these arrangements, a domestic bank located in country A, in order to make payments in country B, does not seek direct access to the payment system of country B but uses the services of a domestic bank located in country B that will forward the payment to the beneficiary’s domestic bank. The bank of country A can also participate more directly in the payment system of country B, through a subsidiary or one of its branch offices. These subsidiary or branches may themselves have accounts with the central bank of country B. In all these arrangements, cross-border payments are not made through an ad hoc, individualized, cross-border system linking the two domestic payment systems, but through the multiple decentralized connections linking the two banking systems.

As a natural evolution of these bilateral private arrangements, commercial banks have set up over the past few years specific cross-border payment systems to clear and settle both small-value payments—for instance card transactions—and large-value payments related to foreign exchange operations or securities transactions. These arrangements take the form of bilateral or multilateral netting schemes between several banks.

Initially, cross-border payments were not an area of intervention or concern for public authorities. However, this has changed over the past decade, especially for large-value payments, as central banks have become increasingly sensitive to the systemic risks involved in the settlement of cross-border or multicurrency transactions or both, given: (1) the large volumes and values involved; (2) the lack of simultaneous delivery of currencies; (3) the interrelationships across countries of payment system participants; and (4) the fact that ultimately most cross-border transactions are settled in the country of issue of the respective currencies. In addition, promoters of interbank netting schemes contemplating particular projects or payment and settlement services have often sought the views of central banks.

These factors have led, first, to an in-depth analysis, particularly under the auspices of the BIS, of the policy implications of cross-border arrangements. The first group of studies produced by the G-10 central banks on international payment arrangements include the “Angell” report (BIS, 1989), the “Lamfalussy” report (BIS, 1990), and the “Nöel” report (BIS, 1993a). In these three studies, respectively, the central banks identified issues that may be raised by cross-border and multicurrency netting arrangements; recommended minimum standards and an oversight regime for cross-border netting schemes; and examined possible central bank service options that might improve efficiency and decrease risk in the settlement of foreign exchange transactions.

This analytical work continued with the “Parkinson” report (BIS, 1995) on cross-border securities settlements, and the “Allsopp” report (BIS, 1996b) on settlement risk in foreign exchange transactions. The conclusions of this latter report are analyzed below in the section on the cooperative approach to cross-border payments. They present a strategy under which the private and public sector can together seek to contain the systemic risks inherent in current arrangements for settling foreign exchange transactions.

Public bodies other than central banks also pay increasing attention to cross-border payments. For instance, the European Commission has issued a directive aimed at increasing the speed in processing small-value cross-border payments between European Union member states and limiting the fees charged by banks for providing the services.

Risks, Risk Control, and Reducing Settlement Risk in Foreign Exchange Transactions

In a number of studies, the major industrial countries have been exploring several options for addressing risks involved in cross-border transactions. Important among these are the “Nöel” and “Angell” reports.

Policy and Risk Issues Identified by the G-10 Central Banks in Central Bank Payment and Settlement Services with Respect to Cross-Border and Multicurrency Transactions (Nöel Report)

The “Nöel” report examined possible options for central bank payment and settlement services that might improve efficiency and reduce risks in the settlement of cross-border and multicurrency interbank transactions. Without making specific recommendations, the working group identified a set of options, including modifying or making available certain domestic-currency payment and settlement services; extending the operating hours of home-currency LVTS; establishing cross-border operational links between these payment systems; and developing multicurrency payment and settlement services.

To elaborate, first, the safety of each of the payment legs in a foreign exchange transaction can be enhanced by improving the risk control measures of the domestic large-value settlement systems through which the transactions are ultimately settled. This can be done, for instance, by meeting the Lamfalussy standards in the existing netting systems or by promoting the development of RTGS systems.

Second, as mentioned, the operating hours of domestic payment systems can be extended to allow for greater overlap of systems of different countries. The overlap does not on its own enable simultaneous settlement of transactions if one of the systems is a deferred (net) settlement system; but when both systems are RTGSs, thus allowing intraday finality for both legs of a transaction, this overlap creates the conditions for DVP or PVP mechanisms. Such mechanisms help to eliminate settlement risks because the counterparties can be assured that payments in one currency will be made only on the condition that payment in the other currency (or currencies) will also be made. The information on the settlement of the first leg of the transaction in the first RTGS, which triggers the input of the second leg in the second RTGS, can come from private informal procedures between banks, or, to improve the system, from the creation of institutionalized cross-border linkages between the RTGS systems.

Third, payment arrangements based on multicurrency netting schemes can reduce, although not eliminate, Herstatt risk: since the effect of netting is to reduce the value of the funds needed for settlement to the net positions of the participants, the size of the actual cross-border interbank transfers, which gives rise to Herstatt risk, is also reduced. However, the realization of the full potential benefits of international netting arrangements in terms of reduction of risks presupposes that these systems are themselves well-protected against risks and that the allocation of the supervisory responsibilities is clearly defined. Given the very large sums at stake, compliance with the Lamfalussy standards—notably with standard IV, which requires that the netting scheme be able to settle in the event of failure of the participant with the largest single net debit position—represents an important cost for the participants.

Settlement Risk in Foreign Exchange Transactions (Allsopp Report)

This report (BIS, 1996b) was prepared by a working group set up by the Committee on Payment and Settlement Systems in June 1994. Building on the analysis contained in previous reports, especially the “Nöel” report, the main objective was to define a strategy for the reduction of systemic risk in foreign exchange transactions by examining the adequacy of current market practices for the managing of foreign exchange settlement risks, presenting a menu of choices for the reduction of those risks, and selecting a strategy from this menu.

The need for a survey of market practices in G-10 countries came from the assumption that foreign exchange settlement risk depends not only on the payment infrastructures but also on the way they are used by the private sector. The survey showed that foreign exchange settlement exposure for a given bank was not exclusively an intraday phenomenon, but that such exposure could last several business days for amounts that could far exceed the bank’s capital. It also found that many banks were not always aware of and concerned about the magnitude of foreign exchange settlement risks, and that control of foreign exchange exposures could be significantly improved by the individual banks themselves. The report showed that well-designed multicurrency services could supplement the efforts of individual banks to control their own risks, while noting that absence of sufficient motivation from some of the major foreign exchange market participants might limit the scope of private sector efforts in reducing foreign exchange exposures. These findings led to the development of a strategy based on short-term recommendations for individual banks, industry groups, and central banks; and on further measures to be implemented in two years by the central banks, should insufficient progress be made within this time frame.

In the short term the report advised that individual banks improve their current practices for measuring and managing their settlement exposures; that industry groups develop risk-reducing multicurrency services; and that central banks encourage action by, and cooperate with, individual banks and industry groups to bring about timely, marketwide progress. If central bank action should prove insufficient over a two-year period, further measures could be taken, such as international supervisory action, or new public sector multicurrency settlement services such as those described in the “Nöel” report.

This report is an important contribution to the analysis of the mechanisms and risks involved in the settlement of foreign exchange transactions. The report recognizes the scope for cooperative initiatives to improve the efficiency of, and reduce the risks associated with, cross-border arrangements.

Cooperative Approach in Cross-Border Payments: Industrial Countries

The Trans-European Automated Real-Time Gross Settlement Express Transfer (TARGET) System6

In November 1993, the working group on payment systems issued a report which aimed to harmonize payments systems in the European Union countries by establishing minimum common features for each constituent system (European Monetary Institute, 1993). The objectives of central banks of European Union member states in promoting more unified payment arrangements were to create the technical conditions for the implementation of the future single currency in stage III of Economic and Monetary Union (EMU); and to ensure that differences between domestic payment systems would not create risks for the integrity and stability of domestic and cross-border arrangements and do not distort competition or create opportunities for regulatory arbitrage. Ten principles were adopted, covering six areas: access conditions, risk management policies, legal issues, standards and infrastructures, pricing policies, and business hours. Among the ten principles, the fourth stated that each member state should have, as soon as feasible, an RTGS system through which as many large-value and time-critical payments as possible should be channeled.

In November 1994, the European Monetary Institute (EMI) released a note (EMI, 1994) that described why the European Union central banks planned to link the national RTGS systems, which were operating (or were about to operate), in line with principle four. More recently, a report on the TARGET system (EMI, 1995) gave a detailed description of the future system, explained how that system would be organized, how it would operate, and its possible future links with other payment systems.

The analysis of the existing large-value payment systems in the member countries showed that more than 25 systems were dealing, exclusively or in part, with large-value payments, and that those systems were generally independent and not linked. The exchange of large-value payments between countries was relying, therefore, on correspondent banking arrangements, but these arrangements had been assessed to be inconsistent with the requirements for implementing a single monetary policy. Therefore, in line with principle four, the central banks decided that the future European large-value payment system should allow the exchange in real time, on a gross basis, of payments in central bank money, based on the linkage of the RTGSs that operated (or would soon operate) in European Union countries.

The TARGET system will include the national RTGS systems and their linkages. Within TARGET, the specific infrastructures and procedures that will be used within each RTGS system—or in addition to the RTGS systems—to process cross-border payments will be called the Interlinking System. Only the European Central Bank (ECB) and the National Central Banks (NCBs) will use the interlinking procedures, for their own purposes or on behalf of their customer banks. For instance, a payment from a French bank to a German bank will go first through the future French RTGS; if there are sufficient funds, it will then be sent to the Interlinking System, which will forward it to EIL-ZV, where the account of the receiving bank with the Bundesbank will be irrevocably credited.

The main principles that have been defined for the implementation of the future TARGET system are as follows. First, in keeping with the Maastricht Treaty, the system will be decentralized in the sense that only some limited common functions will be undertaken by the ECB. Except for the very limited number of payments linked to the ECB’s own activities, TARGET payments will be processed by the domestic RTGS systems and exchanged, after settlement, between NCBs. They will therefore not go through any specific ECB system. Second, since TARGET will be composed of RTGS systems, which are not identical, it may be necessary to harmonize some features of the existing systems. Third, consistent with the market-oriented principles of the European Union, the use of TARGET will not be compulsory, except for payments directly related to the implementation of the single monetary policy (for example, in the case of payments related to the interventions on the interbank market). Fourth, it is possible that at the beginning of stage III of EMU, payments denominated in former national currencies could temporarily coexist with payments denominated in the euro, the new common currency. In this case, a money-conversion mechanism will be introduced between the national RTGS systems, which will process payments in two denominations for a transitional period, and the interlinking system, which will work only from the outset in the new common currency. Alongside these main principles, a few important operational features have also been set up: notably, the TARGET system will process credit transfers, and intraday overdrafts when provided by the NCBs will need to be fully collateralized.

TARGET is an example of a cross-border public sector initiative aimed at improving the clearing and settlement of a very specific part of cross-border payment flows. Several private initiatives are also functioning or are under development. For example, the “Group of Twenty” private banks is studying the feasibility of creating multicurrency settlement services. Two examples of such systems, one for settlement of cross-border foreign exchange transactions and the other for settlement of cross-border securities transactions, are described next.

Exchange Clearing House Limited (ECHO)

ECHO is a private sector initiative for the creation of a multilateral netting system for interbank spot and forward foreign exchange contracts. It was set up in 1992 by a group of 15 major banks from 8 countries and started its operations on August 18, 1995.7 Based in London, it operates 24 hours a day in 11 major currencies.8 On each value date, ECHO calculates, on the basis of the bilateral transactions concluded between its users, the multilateral net position that should be paid to or received from each one in each currency. Provided that certain preconditions transparent to both parties in the initial bilateral transactions are met, ECHO stands as the central counterpart to all the transactions. The settlement for a given currency occurs across the accounts opened by ECHO at correspondent banks in the country of issuance, using the domestic payment system of the country. In ECHO, only the net positions are settled.

Risk control measures include membership criteria9 as well as bilateral and multilateral limits on users for different types of exposures. Aside from limits on bilateral exposures, for each participant there are limits on total exposure, exposure related to forward operations, and the exposure in each currency vis-à-vis ECHO. Finally, ECHO holds U.S. dollar securities as collateral. This pool of collateral is provided by ECHO’s users and shareholders, and a loss-sharing agreement allocates the burden for the replenishment of this facility should a failure occur.

Securities Settlement Systems (Cedel, Euroclear)

Euroclear and Cedel (Centrale de Livraison de Valeurs Mobilières) are both International Central Securities Depositories (ICSDs)10 that accept and settle transactions on a full range of international and domestic securities. They are owned by financial institutions, and the participants are major banks and securities companies of several countries. Cedel is based in Luxembourg, and Euroclear, which is operated under contract by a special unit of Morgan Guaranty Brussels, is based in Brussels. Euroclear and Cedel offer clearing and settlement services for international securities, and the transfer of ownership of the securities between the participants occurs by book entry on the securities accounts opened in the books of both institutions. However, the international securities, which are often still in paper form, are not physically deposited with Cedel or Euroclear, but with a worldwide network of various depository banks that perform custody services such as safekeeping and administration. Cedel and Euroclear have cash correspondent banks in the country of each currency used, for the settlement of the payment leg of the transactions. The funds transfers occur, therefore, through correspondent banks and the domestic payment system of each currency involved.

The settlement of cash and securities occurs on a gross basis and under the DVP principle. Since 1980, Euroclear and Cedel have installed an electronic “bridge” that links their securities settlement systems. Each system maintains a securities and a cash account with the other. The “bridge” procedures are complex and have recently been reviewed and improved to allow participants to have later cut-off deadlines and earlier reporting. These improvements have required modifications and harmonization of settlement procedures in both systems. As before, the inter-system credit exposures are covered by letters of credit granted to each organization by two different syndicates of banks; in addition, the duration of these exposures has been reduced.

Other Cooperative Structures

Many groups of countries have established organized structures to clear and settle cross-border payments. The main advantage of such regional payment arrangements is that the liquidity needs for settlement in convertible currencies at the end of each clearing cycle can be reduced by netting. The advantages in terms of savings must, nevertheless, be assessed against the operating costs of such systems and their potential credit risks, since the longer is the duration of the clearing cycle (hence the greater the savings in liquidity), the greater are the intracycle exposures between participants. To address this problem, some systems, while having long clearing cycles, have implemented mechanisms for intracycle limits that allow the participants to monitor and limit their exposures. The cooperative payment arrangements have typically been in the context of promoting regional integration. Major current operative arrangements are discussed in this section.11

In September 1982, the IMF’s Executive Board reviewed the institution’s policy on bilateral payment arrangements and countertrade arrangements, reaching the following broad conclusions: (1) the policy of not approving the maintenance of bilateral payments agreements with restrictive features and of encouraging their termination in the context of Article IV consultations had contributed to a decline in the use of bilateral payment arrangements; (2) the policy on payments arrangements maintained between IMF members in the context of the use of its resources would be continued. Intentions with respect to the elimination of bilateral payment arrangements that are inconsistent with Article VIII of the IMF’s Articles of Agreement would continue to be a performance criterion under upper credit tranche Stand-By and Extended Arrangements; (3) the IMF would continue to encourage members to terminate payment agreements that are inconsistent with Article VIII, including those that are maintained under the transitional provisions of Article XIV; and (4) the use of countertrade arrangements and their impact on the development of a multilateral system of trade and payments needed to be kept under review (see Quirk and others, 1995).

Cross-Border Clearinghouses in Sub-Saharan Africa

In sub-Saharan Africa, cooperative structures have included clearinghouse arrangements (see Johnson, 1995); among these, four are of greatest interest. Three of these have been organized by major integration initiatives in the continent: the Economic Community of West African States (ECOWAS), created in May 1975 by treaty;12 the Economic Community of the Central African States (ECCAS), the treaty of which was approved in 1983;13 and the Preferential Trading Area for Eastern and Southern Africa (PTA), whose treaty came into effect in 1981 and which was established in 1982. The PTA was transformed in 1994 into the Community of Eastern and Southern African States (COMESA).14

The COMESA, ECOWAS, and ECCAS have created clearinghouses in order to save on use of convertible foreign exchange and promote the use of domestic currencies in settling payments among the member states. ECOWAS members have formed the West African Clearing House (WACH), the COMESA members the COMESA Clearing House (COMESACH—formerly PTA Clearing House, PTACH), and ECCAS the ECCAS Clearing House (ECCASCH). WACH was established in June 1975 and started operations in July 1976. COMESACH started operations (as PTACH) in February 1984, and ECCASCH in 1981.

The members of these clearinghouses are central banks; the transactions channeled through the clearinghouses must involve payments for goods and services produced and traded between firms and individuals in the member countries. Generally a transaction is effected in the currency of the country of residence of the beneficiary. Both the importer and the exporter deal with their respective central banks. The exporter’s central bank pays the exporter in domestic currency, and the importer’s central bank receives payment from the importer in domestic currency. Both central banks keep the clearinghouses informed of all transactions. Each clearinghouse does the netting for settlement purposes at the end of the transaction period. In principle, the private institutions involved on the payment side, essentially commercial and investment banks, are not compelled to participate. Final settlement for the three clearinghouses is in convertible currencies at the end of each transaction period. Clearinghouse transactions do not relate to payments between individuals and firms of countries that share a common currency and central bank.

The clearinghouses have sanctions for delays in settlement, in addition to interest charges, although the rigor with which such sanctions are applied is not transparent. Even though maximum net debits and net credit positions are formally established, either in accordance with the protocol or by evolving practice, a central bank can advise a clearinghouse of its decision to increase the amount of its net credit position.

The clearinghouses work in their own units of account, which in practice are also defined in relation to the SDR. Member central banks provide information, typically on a daily basis, on their exchange rates vis-à-vis a set of convertible currencies, as well as the unit of account of the clearinghouse.

Each clearinghouse is supervised by some committee. For ECCASCH, it should be the Exchange and Payments Committee;15 for COMESACH, it is the Clearing and Payments Committee; and for ECOWAS, it is the Exchange and Clearing Committee. The committee, made up usually of the governors of the central banks, determines, inter alia, the transaction period for settlement purposes, the net debits and net credit limits for each central bank, the convertible currencies that can be used in settlement, and the interest rates in case of settlement delays. For instance, currently the net settlement interval is one month for WACH and two months for COMESACH. The operating expenses of the clearinghouses are shared by the central banks of member states.

Because the clearinghouses do not operate for trade between BCEAO16 members (for WACH) and between BEAC members (for ECCASCH), the potential for the clearinghouses, in terms of the share of intraregional trade and financial transactions that go through them, is greatest for COMESACH. COMESACH has also operated smoothly since its inception, with none of the settlement delays (from net debtors to net creditors) that have plagued WACH. On the whole, the potential for these clearinghouses is uncertain because, inter alia, intraregional (private) correspondent banking relationships are expected to grow with intraregional trade and investment.

The fourth arrangement in sub-Saharan Africa to be discussed is the Clearing House of the Economic Community of the Great Lakes Countries (CEPGL), established in 1976 between Burundi, Rwanda, and former Zaïre (Burundi and Rwanda are also member countries of the COMESACH). All current transactions between the countries plus other transactions, if agreed by the parties, are allowed to pass through this system. The unit of account is the SDR, but the settlement currency must be the currency determined by the creditor central bank. A partial multilateral settlement, after bilateral clearing, takes place every three months. Each central bank informs the other members of the balance on their account within 10 days from the end of the transaction period; any balances claimed for transfer have to be transmitted within 30 days. Interest is applied on overdue balances.

The Asian Clearing Union

The Asian Clearing Union (ACU) (see Madan, 1986, and Khan, 1991) was established on December 9, 1974 but did not begin operations until November 1, 1975. The member countries of the ACU are the central banks and monetary authorities of the United Nations Economic and Social Commission for Asia and the Pacific, and membership in the ACU is open to all Asian countries. The member countries are Bangladesh, India, Islamic Republic of Iran, Myanmar, Nepal, Pakistan, and Sri Lanka. Approval of new members into the ACU is granted upon majority of two-thirds of the votes of existing members. No new memberships have been proposed since Myanmar became a member in 1977. The main objectives of the ACU are to provide a facility to settle, on a multilateral basis, payments for current international transactions among the members; to promote the use in current transactions of regional member currencies and economize on use of participants’ exchange reserves; and to promote monetary cooperation among the participants and closer relations among their banking systems and thereby contribute to the expansion of trade and economic activity among the member countries.

The headquarters of the ACU are in the Islamic Republic of Iran, and the Central Bank of the Islamic Republic of Iran administers the system. The Board of Directors is made up of the governors of the central banks of the participating members, with an alternate each, one of whom is chairman for a year by rotation. The Board appointed a Technical Committee of Officers to be in charge of the rules and procedures of the clearing process, and technical officers are nominated at each central bank to be in charge of other ACU matters.

The unit of account is the Asian monetary unit (AMU), equivalent in value to the SDR. All payments and transfers channeled through the system must be expressed in AMUs. The AMU daily exchange rate against each member country’s currency is calculated by the IMF. Daily, the IMF transmits these figures to the member central banks, which in turn transmit to each other their own trading currency and the spot and selling rates.

All payment instruments must be denominated in AMUs or in one of the currencies of the member countries. Eligible payments include those among residents from the member countries; current international transactions (as defined by the IMF); and those permitted by the debtor’s country of residence. The Board of Directors can declare some payments ineligible and can also terminate the ineligibility of payments. For example, initially the payments for petroleum, natural gas, and petroleum gas products, and those which did not relate to current international transactions, were declared ineligible. Payments for invisible transactions including travel payments, although eligible to be routed through the system, can be declared ineligible unilaterally (that is, by a member acting alone). Payments between Nepal and India are regulated by bilateral agreements and are not routed through the ACU. Payments between the Islamic Republic of Iran and Pakistan became eligible in 1990.

Commercial banks of each country are required to keep separate accounts with their branches or with correspondents in other member countries, which are designated as “correspondent accounts” and designed to facilitate intraregional settlements. The commercial banks can dispose of any surpluses in their correspondent accounts, with the correspondent banks or by transacting with their central banks. The central banks are prepared to sell to and buy from commercial banks the currencies of other members.

All eligible payments between the countries must be cleared through the correspondent accounts. Every two months the Administrator General of the ACU calculates each member’s bilateral position, including the accrued interest, on the basis of the reports from the correspondent accounts and notifies each member of the net position. Multilateral settlements have to be made in a convertible currency, usually the U.S. dollar, or a mutually agreed currency such as the creditor’s currency. Payment must be received within four days after notification from the ACU.

Failure to settle within 15 days would lead to automatic exclusion from the system, which would mean that the debtor country could not channel any payments through the ACU to residents in any of the member countries. If seven days after the exclusion no agreement can be reached on how to settle the debt, the debtor country would be suspended from participating in the system. A return to the system would be allowed only after payment was received and certain conditions established by the governing Board of the ACU met. The debtor participant would be given 30 days to agree with the conditions set by the Board, after which it would be assumed that the participant had decided to withdraw from the system. The Board would then set the means for recovering the owed amount from the excluded participant and all other participating banks must adopt the measures.

Interest is charged on daily balances outstanding between settlement dates. The applicable rates are the closing rates offered by the BIS, for a one-month Eurodollar deposit, on the first working day of the last week of the previous calendar month. In case of delay or default, an additional 1 percentage point over the rate applicable for the relevant transaction period, or 1 percentage point over the rate applicable on the day of default, whichever is higher, is charged.

In September 1989 the ACU established a swap facility. This mechanism is available to participants that are in deficit after the multilateral netting. If in deficit, a participant is eligible to use the swap facility, which is an agreement among all member countries. By entering the swap facility the participant has the right to obtain from each participant up to 20 percent of the average gross payments made by it in the last three years. The total amount may not exceed the amount of the deficit at the end of the clearing. The interest rate applied is the LIMEAN17 in U.S. dollars for a two-month period. Borrowing can be done for a period of two months, and it cannot be used in two consecutive periods.

When the ACU was created, the scope of participation was optional to all its members, and the number of transactions channeled through the system was limited. Over the years, transactions pertaining to a number of items, which were initially not permitted to be channeled through the system, have been gradually allowed pursuant to discussions among member countries. By 1983, five of the seven member countries had made it compulsory for all eligible transactions. In 1984 India made it compulsory for all its eligible transactions, and in 1985 Iran started routing all of its trade through the ACU. Currently, all member countries have made the channeling of all payments through the system obligatory. However, countries have also offered incentives to residents for the use of the system, such as the guarantee to convert national currencies into AMUs or into the currencies of other member countries and the guarantee to accept funds at more favorable exchange rates than those offered to transactions not channeled through the system.

One of the biggest achievements of the ACU is the opening of the system in 1985 to channel oil payments. These types of payments were considered very important because they constituted more than 50 percent of the total intratrade transactions of member countries in 1984.

The Reciprocal Payments and Credit Agreement of Latin America

Latin American countries that are members of the Latin American Integration Association (LAIA) have created a system of multilateral settlement, in convertible and freely transferable currencies (LAIA, 1993a-b and 1994). This system was instituted under the Reciprocal Payments and Credits Agreement (RPCA) signed by Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Paraguay, Peru, Uruguay, Venezuela, and the Dominican Republic. Since its creation in 1965 the RPCA has had three main objectives: to stimulate the financial relations among the countries of the region; to facilitate the expansion of reciprocal trade; and to conserve hard currency.

In the RPCA, in principle, each member central bank could pay its own exporters directly, via a commercial bank or other authorized financial institution, for export sales to each of the remaining 11 member countries. An electronic system registers every transaction daily for each central bank and transmits the information to all central banks overnight. Central banks record in their own books the daily positions of the other member central banks and calculate their gross positions with each of the other member central banks. Bilateral and multilateral balances are calculated daily. Central banks have bilateral credit lines with each other that are used to monitor and control their exposures. The clearing process is administered by the Reserve Bank of Peru and is performed on a daily basis.

Settlement—in U.S. dollars—is administered by the Federal Reserve Bank of New York and is performed every four months. At the end of each settlement period, the Reserve Bank of Peru determines the balances between pairs of central banks, which constitute the net bilateral balances, and the net multilateral balance of each central bank vis-à-vis all the other central banks. If a central bank is unable to settle at the end of the period, it may apply for funds from the Automatic Payments Program (APP). The APP allows for a deferment of payment of the multilateral debit balance for an additional period of four months during which the balance must be liquidated in four equal installment payments due on the 25th of each month. A central bank that has complied with the APP in a timely manner will be eligible to enter the program again after two years.

All transactions, except payments for goods originating in nonmember countries, are allowed in the RPCA. The credit arrangements vary according to the bilateral agreements between countries. The ordinary credit lines cover daily outstanding balances between pairs of central banks. Reciprocal extraordinary lines of credit are required for outstanding balances exceeding the ordinary lines of credit. If debit positions exceed both lines of bilateral credit, the central bank may use the Multilateral Use of Credit Margins Mechanism (MUCMM). Under the MUCMM a central bank may, after permission from concerned members, transfer unused credit to eliminate an excess debit position if it is unable to settle the debit in convertible currency.

The bilateral daily net debit balances carry interest. The rate is 90 percent of the arithmetic mean of the daily prime rate of the largest commercial banks in New York City for the first 3½ months of the clearing period. Loans received under the APP after the first utilization will increase by 1 percentage point up to 3 percentage points above the basic interest rate. For a central bank that has participated for six consecutive settlement periods from the last time it made use of the APP and that makes recourse to the APP again, the basic rate of interest is applied. Six payment instruments18 are allowed in this system, as determined by the RPCA regulations, and accepted for transactions in the RPCA if issued by authorized institutions. The instruments can be discounted under the Discount of Instruments Mechanism by commercial banks in third countries. Central banks reserve the right to give authorization to institutions in their own countries to operate under the RPCA.

The Interstate Bank of the Commonwealth of Independent States

Another regional payment arrangement is the Interstate Bank (ISB), located in Russia. The history of the ISB is linked with the gradual dissolution of the ruble zone. In July 1992, Russia started to control flows of funds from the Baltic countries and other states of the former Soviet Union through a system of bilateral correspondent accounts with the other central banks. As many of those countries progressively ran large deficits with Russia, the Central Bank of Russia (CBR) had to quickly block the accounts. The result was a severe payment crisis for interstate transactions, which started in 1992 and continued into 1993.

After several failed attempts to reconstitute a true ruble zone with one common central bank, the process leading to the ISB started formally with the summit of the Commonwealth of Independent States (CIS) held on October 9, 1992 in Bishkek (Kyrgyzstan, now Kyrgyz Republic). During this summit, the CIS heads of state concluded an agreement on a single monetary system to coordinate the monetary, credit, and exchange rate policies of the states that had retained the ruble as legal tender. This decision called also for setting up a working group for preparing specific proposals for the creation of a payment mechanism to be managed by the ISB. On January 22, 1993, the heads of state of the CIS countries signed an agreement establishing the ISB.

The ISB was entrusted with several tasks. First, it was supposed to assist the central banks participating in the arrangement to organize the systematic and standardized clearing of interstate payments by propagating operating rules and technical standards for cross-border transactions. Second, the ISB was supposed to act as a clearing agent of the participating central banks to calculate their multilateral net positions for an agreed settlement cycle and effect settlement through their accounts on its books. Third, the ISB had to provide settlement credit in rubles to participating central banks within binding, predetermined limits. Fourth, the ISB was to provide settlement services to participating central banks to allow them to exchange balances bilaterally and to transfer funds to entities outside the arrangement.

The IMF provided technical assistance at various stages of the design of the ISB. The IMF, inter alia, advised against arrangements and procedures that were inconsistent with the obligations of the member states under its Articles of Agreement.

On the basis of the general principles, there were subsequent agreements on detailed procedures for the functioning of the ISB and for the clearing and settlement of interstate payments. The last and most advanced plan included the following features: (1) the clearing and settlement currency would be the Russian ruble, issued by the CBR; (2) the ISB would hold ruble-denominated accounts for the participating central banks, and calculations would be made every day of their multilateral net positions; (3) the convertibility of these ruble balances into ruble deposits at the CBR would be made possible up to the limit of a credit line opened by the CBR for the ISB; (4) the settlement cycle would be two weeks; (5) if a participating central bank was unable to fund its obligations at the end of the cycle it would be prohibited from originating payments, beginning with the next settlement cycle, until it had brought back its outstanding obligation within the authorized limits (through the flow of its incoming payments or by borrowing ruble funds); and (6) to facilitate the settlement of net positions, an officially agreed settlement facility, called settlement credit, was to be set up by the ISB with access for each country. Ultimately, the CBR had to ensure that the credit line in rubles it had opened to the ISB was sufficient to cover the extreme case in which all the other central banks had reached their country limits.

However, since mid-1994, work on the ISB has slowed to a virtual standstill. The collapse of the ruble zone and the introduction of national currencies by various countries of the CIS have been an explanation for the lack of progress. In addition, certain difficult issues remain to be resolved related to the need to find the right balance of decision-making power between the Russian Federation, on the one hand, and the other CIS countries, on the other, as well as to work out the implications for members’ monetary policies (including Russia’s) of the CBR being effectively the sole provider of credit to the system. In addition, the flows of interstate payments have increasingly taken place through private correspondent banking relationships, as these develop, as well as through efficient bilateral arrangements progressively implemented by the central banks themselves. But the ISB cannot be declared dead as yet. Recent moves in the direction of economic, monetary, and political integration or coordination could easily lead to the activation of this dormant organization or something close to it; if so, the work already done on the ISB could provide a very useful input.

Role of the IMF

The IMF has played a role in the payment system area through its technical assistance to members to support structural reforms (in central banking and related financial sector areas), surveillance of members’ policies, use of Fund resources, and its research activities.

Technical Assistance in Payments

As part of its overall responsibilities for the stability of the international monetary system, in the payment area the IMF has provided technical assistance via missions, expert visits, workshops, and comments on plans and documents from staff at headquarters including consultants on fixed-term assignments.

Nature of Technical Assistance

The advice given has mainly been directed toward central banks. In the transition economies, in particular, the private sector is often weak, and initiatives in payment systems—as in other areas of financial reforms—are likely to be driven mostly by the central bank. But the IMF’s advice has stressed the need for coordination and cooperation—both among commercial banks and between such banks and the central bank.

Technical assistance has given priority to risk management, while drawing attention to the implications of LVTSs for the implementation of monetary policy and assisting countries in developing and sequencing the introduction of LVTSs. Technical assistance has also helped to develop and upgrade the legal and regulatory framework for clearing and settlement arrangements and for new payment instruments.

In the early stages of transition in the Baltic countries, in Russia, and other CIS countries, there was often a need to take appropriate and immediate actions to accelerate payments in the current environment (that is, without major institutional, organizational, and technological changes). For example, to that end, in Russia, recommendations made to the CBR included the use of the telegraph or telephone for large-value payments with appropriate security precautions; speeding up of document transportation between CBR offices; establishing operational performance targets for offices; use of a management reporting system to track operational performance and balance sheet float at every CBR office handling payments; and adoption of availability schedules to help make CBR payment-processing operations float neutral. Many of these recommendations were implemented.

In countries where transportation and telecommunication links are poor, planners must also take account of these limitations. Frequently, in offering technical assistance, the IMF is able to liaise with bodies responsible for supporting infrastructure projects—such as the World Bank, the European Bank for Reconstruction and Development (EBRD), and EC-TACIS—to ensure that the design of projects (for example, to improve telecommunications) is consistent with the requirements for sound financial design of payment systems.

Coordination of Technical Assistance

There are a number of international agencies providing technical assistance in the payment area. The most active are the World Bank, EC-TACIS, the European Investment Bank, and the EBRD. Consistent with its macroeconomic focus, the IMF’s advice on payment matters is directed toward ensuring that payment system initiatives support implementation of market-based monetary and exchange policies (including the development of foreign exchange, money, and government securities markets) and the core policy objectives of the central bank (notably, containing systemic risk in the financial system—in particular, credit risk to the central bank—and facilitating the transmission of interest rate signals and efficiency of resource allocation). In cases where the IMF and other organizations are providing assistance to the same countries, usually formal mechanisms for cooperation are developed.

Surveillance and Use of Fund Resources

As well as providing technical assistance, the IMF is increasingly concerned with payment system issues in the context of surveillance and use of Fund resources. As part of multilateral surveillance, the IMF organizes and participates in international capital market missions and prepares the annual International Capital Markets report as well as half-yearly updates. IMF staff also analyze developments in international capital markets and the implications, inter alia, for the management of systemic risk. Recently the staff has been inquiring into the implications for international liquidity of the widespread adoption of RTGS outside the United States and the possibility of shifts in the composition of currencies used in international capital markets as a result of different payment system architectures.

At a country level, especially where an economic program with the support of IMF resources is planned, the effectiveness of many of the monetary instruments and the attainment of certain intermediate objectives of the program may depend on concomitant reforms to the payment system.

In this light, the programs supported or to be supported by the IMF’s Extended Fund Facility (EFF) in the transition economies tend to include explicit references to payment system reforms.

Research Activities

The increasing globalization of foreign exchange and capital markets has heightened awareness of the risks associated with exposures generated in the payment system. As outlined elsewhere in this book (see especially Chapters 1 and 4), a number of approaches are being followed by different countries, mostly led by their central banks, to limit and control these risks. As discussed earlier in this chapter, there has also been a concerted effort through the BIS to agree on the principles to be followed in individual countries to guard against systemic risks arising from poorly designed cross-border payment systems. The IMF, on a continuing basis, undertakes research on the impact of these initiatives and their implications for the international payment system.

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