Financial Stability Standards for Securities Settlement Facilities – December 2012 Standard 7: Settlement Finality

Guidance

A securities settlement facility should be designed to provide 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 securities settlement facility or its participants in accordance with the terms of the underlying contract.^[20] A payment, transfer instruction or other obligation that a securities settlement facility accepts for settlement in accordance with its rules and procedures should be settled with finality on the intended value date.^[21] 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 securities settlement facility's participants and other stakeholders, and potentially be a source of systemic risk. Where necessary or preferable, a securities settlement facility should provide 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 securities settlement facilities guarantee settlement, this Standard does not require a securities settlement facility to provide such a guarantee. Instead, this Standard requires securities settlement facilities to clearly define the point at which the settlement of a payment, transfer instruction or other obligation is final, and to complete 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.^[22] 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 securities settlement facility should take steps to mitigate both the risks and the implications of such failures to deliver securities (see, in particular, SSF Standard 4 on credit risk and SSF Standard 6 on liquidity risk).

7.1.1 A securities settlement facility'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.

7.1.2 A securities settlement facility's legal framework and rules generally determine finality. For a transaction to be considered final, the legal basis governing the securities settlement facility, including relevant insolvency law, must acknowledge the discharge of a payment, transfer instruction or other obligation between the securities settlement facility and system participants, or between or among participants (see SSF Standard 1.5). Where relevant, a securities settlement facility 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 SSF Standard 1 on legal basis).

Same-day settlement

7.2.1 A securities settlement facility's processes should be designed to complete 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 securities settlement facility in accordance with its risk management process and other relevant acceptance criteria should be settled on the intended value date. A securities settlement facility that is not designed to provide 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 securities settlement facility 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 securities settlement facility and its other participants.

Intraday settlement

7.2.2 Depending on the type of obligations that a securities settlement facility settles, the use of intraday settlement, either in multiple batches or in real time, may be necessary or desirable to reduce settlement risk.^[23] Accordingly, a securities settlement facility should consider adopting RTGS or multiple batch settlement to complete final settlement intraday. With batch settlement, the time between the acceptance and final settlement of transactions should be kept short. To speed up settlements, a securities settlement facility should encourage its participants to submit transactions promptly. To validate the finality of settlement, a securities settlement facility also should inform its participants of their final account balances and, where practical, settlement date and time as quickly as possible, preferably in real time.

7.2.3 Many securities settlement facilities provide real-time finality by settling individual transactions on an RTGS basis. This would be expected where the trades settled by a securities settlement facility are individually large (in the sense that dealing with a defaulting participant's obligations within a multilateral net batch would cause significant delays, uncertainty or liquidity pressures, see SSF Standard 10.2). However, while an RTGS system can mitigate or eliminate settlement risk, it requires participants to have sufficient liquidity to cover all their outgoing payments and can therefore require relatively large amounts of intraday liquidity. This liquidity can come from various sources, including balances at a central bank or commercial bank, incoming payments and intraday credit. An RTGS system may be able to reduce its liquidity needs by implementing a queuing facility or other liquidity saving mechanisms. Where trade values are small, it may be acceptable for a securities settlement facility to utilise batch settlement (see SSF Standard 10 on exchange-of-value settlement systems). An intermediate model would involve the use of multiple such batches.

7.3.1 A securities settlement facility should clearly define the point after which unsettled payments, transfer instructions or other obligations may not be revoked by a participant. In general, a securities settlement facility 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, cutoff 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 securities settlement facility 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.