Financial Stability Standards for Central Counterparties – December 2012 Standard 8: Settlement Finality

Guidance

A central counterparty should be designed to ensure clear and certain final settlement of payments, transfer instructions or other obligations. Final settlement is defined as the irrevocable and unconditional transfer of an asset or financial instrument, or the discharge of an obligation by the central counterparty or its participants in accordance with the terms of the underlying contract.^[1] A payment, transfer instruction or other obligation that a central counterparty accepts for settlement in accordance with its rules and procedures should be settled with finality on the intended value date.^[2] Completing final settlement by the end of the value date is important because deferring final settlement to the next business day can create both credit and liquidity pressures for a central counterparty's participants and other stakeholders, and potentially be a source of systemic risk. Where necessary or preferable, a central counterparty should ensure intraday or real-time settlement finality to reduce settlement risk. This will be necessary where transactions are settled through an intraday multilateral net batch or on a real-time basis.

Although some central counterparties guarantee settlement, this Standard does not require a central counterparty to provide such a guarantee. Instead, this Standard requires central counterparties to clearly define the point at which the settlement of a payment, transfer instruction or other obligation is final, and to ensure completion of the settlement process no later than the end of the value date, and preferably earlier on the value date. Similarly, this Standard is not intended to eliminate fails to deliver in securities trades.^[3] The occurrence of non-systemic amounts of such failures, although potentially undesirable, should not by itself be interpreted as a failure to satisfy this Standard. However, a central counterparty should take steps to mitigate both the risks and the implications of such failures to deliver securities (see, in particular, CCP Standard 4 on credit risk and CCP Standard 7 on liquidity risk).

8.1.1 A central counterparty's rules and procedures should clearly define the point at which settlement is final. A clear definition of when settlements are final also greatly assists in a resolution scenario such that the positions of the participant in resolution and other affected parties can be quickly ascertained.

8.1.2 A central counterparty's legal framework and rules generally determine finality. For a transaction to be considered final, the legal basis governing the central counterparty, including relevant insolvency law, must acknowledge the discharge of a payment, transfer instruction or other obligation between the central counterparty and system participants, or between or among participants (see CCP Standard 1.5). Where relevant, a central counterparty should take reasonable steps to confirm the effectiveness of cross-border recognition and protection of cross-system settlement finality, especially when it is developing plans for recovery or orderly wind-down or providing the Reserve Bank and other relevant authorities with information relating to its resolvability. Because of the complexity of legal frameworks and system rules, particularly in the context of cross-border settlement where legal frameworks are not harmonised, a well-reasoned legal opinion is generally necessary to establish the point at which finality takes place (see also CCP Standard 1 on legal basis).

Same-day settlement

8.2.1 A central counterparty's arrangements should be designed to ensure final settlement, at a minimum no later than the end of the value date. This means that any payment, transfer instruction or other obligation that has been submitted to and accepted by a central counterparty in accordance with its risk management process and other relevant acceptance criteria should be settled on the intended value date. A central counterparty that is not designed to ensure final settlement on the value date (or same-day settlement) would not satisfy this Standard, even if the transaction's settlement date is adjusted back to the value date after settlement. This is because, in most such arrangements, there is no certainty that final settlement will occur on the value date as expected. Further, deferral of final settlement to the next business day can entail overnight risk exposures. For example, if a central counterparty conducts its money settlements using instruments or arrangements that involve next-day settlement, a participant's default on its settlement obligations between the initiation and finality of settlement could pose significant credit and liquidity risks to the central counterparty and its other participants.

Intraday settlement

8.2.2 Depending on the type of obligations that a central counterparty has, the use of intraday settlement, either in multiple batches or in real time, may be necessary or desirable to reduce settlement risk. Accordingly, a central counterparty should consider the use of real-time gross settlement (RTGS) or multiple batch settlement to complete final settlement intraday. A central counterparty should, for instance, settle margin intraday, preferably via RTGS. If a central counterparty does settle margin via batch settlement, the batch process should not include settlement of non-margin obligations or obligations associated with unrelated products. The timely settlement of margins is a critical component of a central counterparty's risk management process and should not be dependent on the settlement of other transactions. Any time lag between the acceptance and final settlement of instructions should also be minimised where batch settlement is used.

8.3.1 A central counterparty should clearly define the point after which unsettled payments, transfer instructions or other obligations may not be revoked by a participant. In general, a central counterparty should prohibit the unilateral revocation of accepted and unsettled payments, transfer instructions or other obligations after a certain point or time in the settlement day, so as to avoid creating liquidity risks. In all cases, cut-off times and materiality rules for exceptions should be clearly defined. The rules should make clear that changes to operating hours are exceptional and require individual justifications. For example, a central counterparty may want to permit extensions for reasons connected with broader financial market disruption. If extensions are allowed for participants with operating problems to complete processing, the rules governing the approval and duration of such extensions should be clear to participants.