*A I COMMISSION OF THE EUROPEAN COMMUNITIES

* ..* 1

Proposal for a

EUROPEAN PARLIAMENT AND COUNCIL DIRECTIVE

ON SETTLEMENT FINALITY AND

COLLATERAL SECURITY

(presented by the commission)

 EXPLANATORY MEMOIUNUUM

I. Background

The present proposal fofa directive is the resukof a process which can be summarised as follows:
The L,amfalussy Report of 1990' highlighted the important systemic risks inherent in payment systems
which operate on the basis of one or more legal tyqes ofpayment netting2. The.Commission's attention
was drawn to these matters by one of its advises committees on payment systems, the Payment
Systems Technical Development Group.
In its March 1992 working document3, the Commission noted that certain features of the law in a
number of Member States, together with the differences between Member States' laws relating to
payment systems in general, were a source of uncertainties and risks. This view was endorsed by the
Con~mittecof Governors of the central banks of the EC4.
Work began on tliesc issues in a group of government legal experts and central bank representatives,
chaired by the Commission, early in 1993. The first phase of the work has consisted of establishing an
inventory of the legal situation in the. areas of payment netting and settlement finality in all Member
States, which has led to a more precise identification of these problems. An extensive study5, ordered
by the Commission and delivered in February 1994, supported these preliminary conclusion%.A first
consultation hearing with the European Credit Sector Industry was held in the spring of 1994.
In a second phase (since 1994) different solutions have been discussed and examined within the group
of government experts. They are listed under point 11.3. A second consultation hearing with the
European Credit Sector Industry was held in October 1995, which confirmed the overall validity of the
approach.
In the light of this process, the Commission has reached operational conclusions, in particular as
regards the questions pertaining to settlement finality and collateral security. It therefore considers that
a directive should be proposed. No operational conclusions have been reached reIating to securities
settlement systems. These issues remain, however, under consideration within the Commission. It may
be necessary to make a further proposal covering these issues in the future.

Overall assessment
The Commission Strategic Programme for the Internal Market clearly identified the establishment of
effective cross-border payment systems as one of the few requirements that still need to be met to
ensure the functioning of the Internal Market. This requires modernisation of systems, which affects
both central banks and commercial banks, and consequent investment on the part of the industry. This

Report to the Governors of the central banks of the Group of Ten countries, Basel, November 1990
For the purposes of the present Proposal, "payment netting" means the conversion into one net claim or one net
obligation of claims and obligations resulting from payment orders which an institution either issues or receives.
with the result that only the net claim can be demanded or the net obligation be owed.
"Easier cross-border payments: Breaking down the barriers", SEC(92)621 final of 27 March 1992.
"Issues of common concern to EC CenEal Banks in the field of payment systems", by the Ad Hoc Working
Group on EC payment systems, September 1992.
The laws on credit transfers and their settlemcnt in Member States of the EIJ: Keporl for the Europcan
C'ommission ( I N XV), Wilde Saptc - Brussels, February 1994.
 3. What are the possibilities of action available to the Community
A number of alternatives were considered:
~ & s tthe
, minimalist approach of developing a solution within the current state of the national laws
was examined. The question in that context was to examine whether it was possible to design a inodel
contract which could be used by members of a payment system and which could remedy the problems
c o n c e ~ e dThis
. approach was rejected for two reasons:
This solution concerns only the parties to the contract, while it is necessary that third parties be
legally bound. This is illustrated by the following case: a Country A bank participates in a
inultilatcral ncttirig system with a central scttlanent agent in Country B. 'I'he Country A bank gocs
bankrupt. I n that case, the creditors -or the liquidator- of the bankrupt Country A bank, attempting
to recover part of their claims against that bank, are likely to challenge the netting agreement under
--
Country A law, since that law may not necessarily recognise multilateral netting. If such action
were successful, it could jeopardise the whole netting system.
Insolvency law contains so-called "ordre public" rules which can overrule contractually stipulated
provisions. Even if a payment system agreement stipulated that in case of insolvency of a member
the payment orders introduced before the lnomcnt of pronouncement of insolvency procced~ngs
'
cannot be unwound, a zero-hour-rule e.g., as it exists in a number of Member States, would
overrule that contractual arrangement. Consequently, unwinding could happen, with potentially
far-reaching and damaging consequences for the payment system concerned.
A second possible solution consisted of the- p approach, under which it is
possible to agree that a payment system established under the Iaws of Country A, a country whose
commercial law recognises netting and whose bankruptcy laws do not interfere with the proper
operation of payment systems, would be governed entirely - including all its members from EIJ
-
countries by the laws of country A. Whether Member State B's law recognises the finality of netting
applicable to bank B, or whethcr that State's insolvency law has provisions "d'ordre public", like t l ~ c
zero-hour rule, would no longer be relevant. Such an approach did not in the final analysis, howcvcr.
prove to be attractive. If chosen, it would mean that the courts in every Member State would in
principle need to be in a position to interpret and apply the different branches of law (comrncrcial 1:iw.
insol-vency law, etc.) of all other Member States. Such a solution, at least when standing alone. seenicd
unnecessarily cumbersome.
A third possibility was to recommend to the Member States, without any binding obligations. the
necessary modifications in their laws. This approach has some procedural attractions in largely
bypassing the EU legislative process but it would not substantially assist the governments of Member
States, who would still have to draft and implement any necessary legislation. From the point of view
of the financial institutions and payment systems, the solution would lack transparency and legal
certainty. Any slight advantage of proceeding in this way was felt to be outweighed by the
disadvantages.
Therefore, as explained in detail in section I above, a binding instrument is now deemed both timely
and necessary.

4. Is uniform legislation necessary or is a directive setting out the general objective and
leaving implementation thereof to the Member States sufficient?
Uniform legislation is not necessary. A directive setting out the general objectives, as they are
outlined hereunder, is sufficient.
Section I of the directive deals with the of the directive and defincs the necessary terms;
Section I1 of the directive lays down the general principle, the objective of which is to ensure that
is made legally enforceable under all jurisdictions and its effects binding on third
parties;
Section I11 provides for the irrevocability of w m e n t orders in accordance with the rules of the
payment system concerned;
Section IV of the directive lays down the general principle, the objective of which is to :
ensure that insolvency proceedings or any other rule or practice do m have a- r on
the rights and obligations of participants.
determine which insolvency law is a p ~ l i c a bto the rights and obligations in connection with
direct participation in a payment system in the event of insolvency proceedings against a
participant in that payment system.
Section V of the directive lays down the general principle, the objective of which is to insulate
collateral securitv from the effects of the insolvency law of the Member State of a failed participant.
These provisions set out the general objective pursued, thus leaving implementation to the Member
States; where appropriate, institutions are free to determine the precise contents of these general
principles.

111. Detailed commentary on the articles

Article I
This Dircctivc's main goal is to rcclucc the syslcmic risk associalcd with participation i n I'aylncnt
Systems. There was a general consensus that this directive should have the widest scopc possible. To
this effect, the directive covers cross-border payment systems as well as domestic systems.
Furthermore, it applies to the following two categories:
EC institutions which are participants in third country payment systems and collateral security
constituted for such a payment system
Third country institutions which participate in an EC Payment System and the collateral security
constituted in favour of that payment system
The inclusion of the first category in the directive's scope implies that the benefits of this Directive are
extended to third country payment systems as far as their EC participants are concerned. Third country
payment systems as such are of course not covered by the directive, but their participants are insofar as
they are EC institutions within the meaning of Article 2 (i).
As far as the second category is concerned, the essential interest of its inclusion in tile directive's scope
lies in the fact that it makes it possible to insulate collateral security, pledged by a third country
institution in an EC Member State, from a possibly universal insolvency law of that third country.
Finally, with a view to the establishment of the future Europem Central Bank, the pledging of
collateral security will increasingly be cross-border. The same probiems arise in that respect as in the
case of the pledging of collateral in the framework of payments systems. Therefore, the scope of this
proposal has been extended to collateral security, pledged in coriection with monetary policy
operations.
Article 2
It. -
tnstltutlon" has been given a wide scope, so as to include not only credit institutions in the sense of
the first Banking Directive, but also investment banks, giro and postal banks and any other
undertaking which participates directly in a payment system. .
"writ order" means an instruction given to carry out a transfer, be it credit or debit, by a book
entry on the accounts of a credit institution or of a centraI bank. On the accounts of a credit institution,
since it is this type of payment system which d i s -from a public policy standpoint- for the kind of
protection which this Proposal for a Directive provides for. On the accounts of a central bank, is added
to anticipate the foreseeable development of real time gross settlement facilities, which necessitate
movements on the accounts of the Central Banks.
Ir
vment system" is defined widely, so as to include systems, regardless of whether they settle on a
gross or net basis and of whether they are based on multilateral or bilateral arrangements. Of course, a
federation of payment systems in itself is also covered by the directive.

Many payment 'systems, handling very large payments ("large value") or smaller values ("retail")
depend on the technique known as netting6 or set-off. "Payment netting" is the conversion into one net
claim or one net obligation of claims and obligations resulting fiom payment orders which an
institution either issues to one or more other institutions or receives from one or more other
institutions, with the result that only the net claim can be demaqded or the net obligation be owed.
This has the effect of reducing greatly the number of settlement transactions required to process a
given number of payments. Instead of settling each payment order individually as it arises during thc
day the basks involved in a netting agreement settle once by paying (or receiving) a single net balance
to (or from)the other members of the system.
The legal enforceability of a netting operation with institutions from different Member States
ultimately depends on the law of the Member State of origin of these institutions. In a number of
Member States netting, especially multilateral netting, is not enforceable under the current state of
legislation. If the liquidator of a failed participant in a payment system were on that basis to chaIIengc
the netting, this would mean that. he could repudiate the net settlement debt, arrived at by netting.
Instead he could insists on payment to him of all the individual underlying amounts originally due to
that iastitution. As for the amounts due from the failed institution, they will be claims on paper in the
insolvency proceedings and unlikely to be met. This phenomenon of repudiating the debt and
accepting the amounts originally due, is called cherry-picking. The consequence of cheny-picking is
serious disruption in the payment system at best, at worst the payment system might break down
(systemic risk) and cause in turn the inability of other members in the payment system to meet their
obligations (knock-on effect).
Therefore, Article 3(1) provides that netting is legally enforceable and binding on third parties, even in
the event of the opening of insoIvency proceedings, insofar as the payment orders have been
introduced into the payment system before the opening of insolvency proceedings.
Article 3(2) specifically focuses on the cases in which a participant who realises that bankruptcy is
becoming inevitable; introduces payment orders into a payment system before the declaration of

From the legal point of view, "netting" in this sense is the same technique as is the subject of the proposal for n
directive on contractual netting, However the latter deals with unmatured obligations, netted on a bilateral ba+s
only, whilst the present initiative concerns payment streams netted bilaterally or multilaterally. Both type. .)f
netting differ markedly from the concept of position netting, as used in the Capital Adequacy Directive.
C
 insolvency in order to remove assets to the detriment of the creditors. Therefore, this article confirms
. that the directive does not shield fraudulent payment orders from invalidation. Such invalidation will,
however, not be permitted to occur through the unwinding of the netting operation, something that thc
directive aims to avoid at all costs, but rather outside the payment system, or indeed in a subsequerli
netting cycle (via a reverse order).
Article 4
It is commonly agreed that the possibility of a significantly large payment being revoked can generatc
systemic risk, if the revocation occurs during the process leading to settlement in a payment systcm. It
would be unacceptable. on the other hand, to disproportionately limit the freedom of operation and thc
freedom of contract of the various parties to a payment system in attempting to reduce or minimise
this risk.
Thus, having recognised that revocation might otherwise lead to an unwinding of settlement, Article 4
(1) precludes the revocation of a payment order after a contractually agreed time, not only by the
parties to the payment system agreement, but also by third parties, e.g. a sub participant. This
prohibition is important not only in the case of netting, but also in the case of real time gross
settlement arrangements.
;
This does not mean, of course, that a payment order which was not due by the originator. but has been
introduced into Lhc paymeni system, is I'orever lost to him. Articlc 4(2) confirms that, if rhc originator,
i.e. a customer, has a right against the bcneiiciary to reclaim an amount that has been introduced into
the payment system, such a right is not cancelled, but will only have to be exercised outside of the
gavment svstem, or by a f l e e

Articles 5 and 6
Irrespective of whether a payment system operates on the basis of netting or gross-settlement, the
different insolvency laws in the different Member States.cause further problems, where rules "d'ordre
public" included in these insolvency laws would lead to the possibiIity of cherry-picking, with its very
damaging consequences, as described above.
This is the case for the so called "zero-hour" rule, which gives retroactive effect to the pronouncement
of insolvency. A consequence of this rule is that payment orders introduced after zero hour of the day
of pronouncement of insolvency of a participant in a payment system but before the pronouncement of
the insolvency, could be challenged by a liquidator of an insolvent institution. The latter would then l
be in a position to insist on payment to him of all the individual underlying amounts originally due to
that institution. As for,the amounts due from the failed institution, they will be claims on paper in the
insolvency proceedings and unlikely to be met. In order to avoid this possibiIity, Article 5 provides
that insolvency proceedings do not have retroactive effect.
There may, however, exist other provisions "d'ordre public", beyond the so called zero-hour rules,
which can potentially lead to cherry-picking. This is why Article 6 has been designed as a catch-all
provision, which is to cover all those cases which have not been identified but are believed to exist.
Therefore, Article 6 states that "in the event of insolvency proceedings against an institution which
participates directly in a payment system, the rights and obligations arising from or in connection with
participation in that payment system, shall be determined by the insolvency law of the country where
the payment system is located." In practice, Article 6 does, of course, not imply that a separate
insolvency proceeding has to be opened in the Member State of location of the payment system. The
insolvency of a member institution would continue to fall under the insolvency law of the Member
State where that institution is established, as is currently the case. If the liquidator, however, would
wish to draw on insolvency provisions "d'ordre public" to challenge a payment made through the
payment system. hc would have to apply thc insolvency law o f t h v M c l l l h c r ~ ~ l o c n t i o l l u l - ~ h c
.- 'I'his approach has thc dvantngc that thc pruii&in a payment systcrn only havc to
examine m insolvency law, namely the insolvency law of the Member State of location of thc
payment system, instead of having to examine and attempt to reconcile the insolvency law of the
Member State of origin of every single participant. This would contribute to reducing costs and
eliminating legal uncertainty.

Article 7
Finally, the directive addresses the problems associated with collateral gecurity which supports
participation in payment systems, on a cross-border basis. Its objective is to avoid a situation where in
the case of insolvency of a participant in a payment system, the insolvency law of that participant's
Member State would'not recognise the validity of collateral security constituted in another Member
State. Article 7(1) therefore provides that, in the case of insolvency of a participant, the rights of the
pledgee shall not be affected .by the insolvency of that participant, This rule is justified for public
policy reasons. Vast sums are transferred through the payment systems on a daily basis: if one
nlembcr were not ablc to meet its obligations and thc collateral could not he rcaliscd, this could -in a
worst casc sccnxio- hwc disastrous conscquc~lccsh r tl~cpnymcnt syslcnl as s u d ~ causing, no lcss
than thc collapse of such a system, with a devastating knock-on effect in financial markets.
It should be pointed out that this Proposal does not alter the rule of law applicable to collateral
security. This remains, as is the current situation, the law of the Member State where the collateral is
located, in accordance with the principle of lex rei sirae.
In its second paragraph, Article 7 provides that in the case of a universal third country insolvency law,
the effects of that law do not extend to the rights of the pledgee in connection with participation in a
payment system or in connection with monetary policy operations, if that collateral security is
constituted in a Member State.
DRAFT PROPOSAL FOR A EUROPEAN PARLIAMENT AND

COLLATEFUL SECURITY
THE EUROPEAN PARLIAMENT AND THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community, and in particular Article I OOA
thereof,

Having regard to the proposal from the Commission,

Having regard to the opinion of the European Monetary Institute,

Having regard to the opinion of the Economic and Social Committee,

In accordance with the procedure laid down in Article 189b pf the Treaty establishing the
.European Community,

Whereas the Lamfalussy report of 1990 to the Governors of the central banks of the Group of Ten
Countries demonstrated the important systemic risk inherent in payment systems which operate
on the basis of one or more legal types of payment netting, be it bilateral or multilateral, on the
one hand'; whereas the reduction of legal risks associated with participation in real time gross
settlement payment systems is of paramount importance, given the increasing development of
these systems, on the other;

Whereas the reduction of systemic risk regards in particular the finality of settlement and the
enforceability of colIateraI security; whereas collateral security is meant to comprise all means
provided by a participant to the other participants in the payment system to secure rights and
obligations in connection with that payment system including, among other means, repurchase
agreements, insurance contracted by a participant in a payment systems for the benefit of the
other participants;

Whereas, by ensuring that payments and movement of capital may be made free of impediments
in the Internal Market, the prcsent directive contributcs to the cficient and the cost-effective
operation of cross-border payment arrangements in the European Union; whereas the directive
thereby follows up the progress made towards completion of the internal market, in particular
towards the freedom to provide services and liberalization of capital movements, with a view to
the realisation of economic and monetary union;

Whereas the present directive is intended to cover payment systems of a domestic as well as of a
cross-border nature; whereas debit as well as credit transfers are covered; whereas the directive is
applicable to EC payment systems and collateral security constituted by their participants, be they
EC or third country participants, in connection with participation in these payment systems;
whereas the directive also covers EC institutions which participate in third country payment
systems; whereas financial flows are increasingly taking place on a world-wide level; whereas EC
institutions and EC payment systems thus are bound to establish and maintain close operational
links with third country payment systems and to participate in them; whereas it is essential,
therefore, that the cross-border relations between EC institutions and EC payment systems on the
one hand and third country payment systems on the other are addressed and facilitated by this
directive with a view to avoiding impediments for EC institutions to participate in third country
payment systems arising from a of lack of legal security; whereas efficient EC payment systems
are vital for the Internal Market and cannot operate properly without links to third country
payment systems because financial markets are inextricably connected with one another;
 Whereas the directive, by covering collateral security provided in connection with monetary
policy operations, assists the EM1 in its task of promoting the efficiency of cross-border payments
with a view to the preparation of the third stage of economic and monetary union and thereby
contributes to developing the necessary legal framework in which the future European Centrzl
Bank may develop its monetary policy;

Whereas the purpose of the present directive is to ensure that netting is legally enforceable under
all Member States' jurisdictions and binding on third parties; whereas the purpose of thc directive
is also to ensure that paynient orders cannot be revohcd after a contractually agreed lime; whcreis
the dircctive aims at sccuring that insolvcncy proceedings do not have a rctroactivc cfl'cct on thc
rights and obligations of participants;. whereas the present directive Whermorc aims at
determining -in the event of insolvency proceedings against a participant in a payment system-
which insolvkncy law is applicable to that part of the insolvency which the rights and obligations
in connection with direct participation in that payment system are; whereas the present directive
finally intends to insulate collateral security fiom the effects of the insolvency law applicable to
the failed participant;

Whereas the present Directive also applies to the relationship between an institution and a
member of a payment system which transfers the payment orders of such institution to the
payment system, given that this relationship can be considered in itself to be a separate payment
. system;

'VCihereas the adoption of the present directive constitutes the most appropriate way of realising
the above objectives; whereas the present proposal is nessary to realise these objectives and does
not go beyond the goal of realising these objectives;

HAVE ADOPTED THIS DIRECTIVE:

L SCOPE and DEFINITIONS

The provisions of this directive shall apply to :

(1) any EC payment system operating in any currency and the ECU and to collateral security
provided in connection with participation in such a system.

(2) any EC instithion which participates directly in a third country payment system and to
collateral security provided in connection with participation in such a system.

(3) collateral security provided in connection with monetary policy operations.

For the purpose of this directive :

'"institution" means any undertaking as defined in Article 1 of Council Directive 771780EEC

including the institutions set out in the list in Article 2(2) thereof, which participates directly
in a payment system, and any other undertaking which participates directly in a payment
system;

"direct" participation means participation in a payment system entailing responsability for

settlement;

"EC institution" means any institution which has its registered office in a Member State;
"third country institution" means any institution which is not an EC institution;

"payment order" means any instruction to place at the disposal of a final recipient an amount
of money by means of a book entry on the accounts of a credit institution or a central bank;

"insolvency proceedings" means any measure which, for reasons of impending or actual
inability to meet financial obligations, is pronounced by a judicial or administrative
authority for the benefit of a collectivity of creditors, and which precludes from making
payments or disposing of property;

"payment netting" means the conversion into one net claim or one net obligation of claims
and obligations resulting fiom payment orders which m institution either issues to one or
more other institutions or receives fiom one or more other institutions, with the result that
only the net claim can be demanded or the net obligation be owed;

"payment system" means any written agreement between two or more institutions for
executing payment orders;

"EC payment system" means a payment system located in a Member State. A payment
system shall be deemed to be located in the Member State the law of which has been chosen
by the institutions which participate directly in that payment system. In the absence of
choice, the payment system shall be deemed to be located in the Member State where the
settlement takes place;
I
"third country payment system" means any payment system which is not an EC payment
system; I
"monetary policy operation" means an outright (spot and forward) buying and selling
operation in the financial markets or such an operation under a repurchase agreement, or
lending or borrowing of claims and marketable instruments, whether in Community or in
non-Community currencies or in precious metals, by a Member State Central Bank or by the
future European Central Bank; it also means the conduct of credit operations, by a Member
State Central Bank or by the future European Central Bank, with credit institutions or other
market participants, with lending being based on adequate collateral;
(1) l ' c ~ ~ I Iscc~~rily'~
~ t ~ ~ ~IIICL~IIS
l a11 USC~S, providcd Ibr thc purposc of sccuring rights and
obligations potentially arising in a payment system or provided to Member State Central Banks or
to the future European Central Bank in connection with monetary policy operations.

Z& FI1VALZTY of PA MWENT NETTING

(1) Payment netting is legally enforceable and shall, even in the event of insolvency proceedings
against any institution which participates directly in a payment system, be binding on third
parties, provided that the payment order was entered into the payment system before the
. opening of insolvency proceedings. The moment of entrance s M l be defined by the d e s of
that payment system.

(2) Any rule on the setting aside of contracts and transactions entered into before the opening of
insolvency proceedings, shall not lead to the unwinding of the netting.

(1) A payment order may not be revoked either by an institution which participates directly in a
payment system or a third party as against the other direct participants .in that payment
system after the moment defined by the rules of that payment system. This rule applies
notwithstanding the opening of insolvency proceedings.

(2) Any right which the originator of a payment order might have to a refund shall be exercised
without prejudice to paragraph 1.

N.NON-RETROACTIVITY and APPLICABLE INSOLVENCY LA W

Insolvency proceedings shall not have retroactive effects on the rights and obligations of an
institution in connection with direct participation in an EC payment system. Any other rule or
practice which has a retroactive effect shall be superseded.
In the event of insolvency proceedings against an institution which participates directly in a
payment system, the rights and obligations arising fiom or in connection with direct participation
in that payment system, shall be determined by the insolvency law of the country where the
payment system is located.

V; INSULA TION of the RIGHTS of the PLEDGEE

from the EFFECTS of the INSOLYENCY of the PLEDGER

-
Article 7 Insulation from the effects of insofvenc?,

The rights of a pledgee in connection with liabilities of one participant to one or more other
participants in a payment system or the rights of monetary authorities to whom collateral
sccurily I~nsbccn pldgcd in conncction with monctary policy operations, shall not bc
d'fected by the opening of insolvency proceedings against the pledger. The collateral
security shall be realised for the satisfaction of rights in connection with participation in a
payment system or with monetary policy operations with priority over all other creditors.

Where a third country institution constitutes collateral security in .a Member State in

connection with participation in an EC payment system or in connection with monetary
policy operations, the rights of the pledgee shall not be affected by the opening of
insolvency prdceedings against that third country institution.

M. FINAL PROVTSIONS

Member States shall bring into force the laws, regulations and administrative provisions
necessary to comply with this Directive before 3 1 December 1998 at the latest. They shall
immediately infmthe Commission.

When Member States adopt these measures, they shall contain a reference to this Directive
or shall be accompanied by such reference at the time of their official publication. The
procedure for such a reference shall be laid down by the Member States.

Member States shall communicate to the Commission the text of the laws, regulations and
administrative provisions which they adopt in the field governed by this Directive. In this
Communication Member States shall provide a table of correspondence showing the
national. provisions which exist or are introduced in respect of each article of this directive.

-
Article 9 Report to the European Parliament and the Corrncil
No later than three years &er the date mentioned in Article 8(1), the Commission shall present a
report to the European Parliament and the Council on the application of this Directive,
accompanied where appropriate by proposals for its revision.

This Directive is addressed to the Member States.

Done at Brussels,

For the European Parliament For the Council

.. The President The President

 Proposal for a European Parliament and Council Directive on
settlement finality and collateral security

La. Taking account of the principle of subsidiarity, why is Community legislation necessary
and what are its main aims?
Research carried out on behalf of the Commission by banking lawyers', together with the analyses
made by the Commission's working group, confirm that there are crucial differences between the
laws of the Member States which prejudice the legal validity of certain key features of payment
systems2.
One of the central features of a sound payment system is'that th&e must be no doubt as to when and
how settlement becomes final. In the current situation, finality in a payment system whose
participants arc domiciled in different legal jurisdictions (as under the Treaty and the Second
Banking Directive will increasingly bc the case) depends ultimately on the laws of thc various
Membcr Statcs whosc institutions arc mcmbcrs.
Anothcr essential prcrccpisilc is tlial ,lhcre must bc lcgal certainty that in thc casc a participinl
fails to meet its obligations vis-A-vis the payment system, the latter can realise the collateral
security pledged by that participant. In the current situation, the only way to ensure that, is to
constitute the collateral security under the same law as the payment system itself, so as to avoid
conflicts of law. This is contrary to the principle of an Internal Market.
Legal certainty as to collateral security and as to finality of settlement can only be achieved if the
national legislations are changed in a similar way in each Member State. The most efficient way of
achieving this goal is by way of a directive laying down the necessary minimum standards.

1.b. Are there likely to be any wider benefits and disadvantages from the proposal?

If any effect is to be expected for the financial sector, it will be one of protection of current
employment. The proposal's main goal is to strengthen the stability of payment systems and
therewith of inter bank financial relations and to avoid the knock-on effects that currently could
arise in the case of bankruptcy of a large participant in a payment system. Consequently, the loss of
employment that would occur in such a case would be avoided as well.

he laws on credit transfers and their settlement in Member States of the EU: Report for the European
-
Commission (DG XV), Wilde Sapte Brussels, 1994.
The key differences referred t o are:
- settIement finality in netting schemes: different possibilities of unwinding the settlement;
- the effect of insolvency of a participant, on netting schemes: different powers of liquidators to prevent
settlement occurring or to unwind it;
- rules on revocation: different rules on the time when a payment order becomes irrevocable
Moreover, the estzblishment of a legal framework in order to rule o u t the legal uncertainty
associated with cross-border payment systems, is likely to encourage the further development O S
thcsc .systems. Thc consequcni incrcasc in the volume of business might therefbrc generatc
employment.

1.c. Were alternative proposals considered, and with what outcome (e.g. codes of conduct,
voluntary arrangements)?

As explained under 11. 3 of the explanatory memorandum, a number of other possibilities were
considered, but these were abandoned for the reasons exposed.

2. Who will be affected by the proposal?

Which sector of business? What are the size classes and what is the total employment?
The proposal will be applicable to any undertaking which participatcs directly in a payment systcm.'
In practice, thc large majority of' these undertakings will bc crcdit-instilutions.
-1

Are there any significant features of the business sector, e.g. dominance by a limited number
of large firms?
The main feature of this sector is the hitherto lack of integration of payment systems at European
level. . -
Are there implications for very small businesses, the craft sector o; the self-employed?
Although small businesses are very unlikely to constitute a payment system among themselves,
such a system would be covered by the Directive. However, as end-users of payment systems, they
will benefit from the proposal and its effect of elimination of legal risks, increased efficiency and
reduction of costs. These remarks apply equally to the craft sector and the self-employed.
Are there particular geographical areas in the Community where these businesses are
located?
No.

3. .What will businesses have to do to comply with the proposal?

What will be the compliance costs?
No costs other than the legislative ones are to be expected.
Are there other administrative procedures or forms to complete?
No.
Are licenses or marketing authorisations required?
No.
Will fees be charged?
No.
4. What economic effects, costs and benefits is the proposal likely to have?
On employment?
Within the payment systenls industry, the net effect, if such effect is to be expected at all, should be
positive. Within the segment of SMEs, employment benefits ate gxpected (more efficient payment
services a widening of intra-EU trade potential a contribution to growth and higher employment
greater and more specialised demand for efficient payment services, etc.).
On investment and the creation or start up of new businesses?
Marginal effect, if any.
On the competitive' position of businesses,- both in the Community and third countries'
markets?
The efficiency gains and reductions in costs for business within the Community will be positive
(See paras. 1 and 4 above). Third country businesses will benefit from the advantages of this
Directive inside the Community to the same extent as Community businesses do.
-.

The unilateral extension of the benefits of this Directive to third country payment systems, e.g. the
protection against undue revocation, the protection agaiiwt rctl-oactive eIl'ccts o f insolvency
proceedings and thc insulation of collateral security from foreign insolvency laws, will also benefit
third country payment systems. Community businesses will indirectly benefit from the advantage of
the extension of the Directive's scope to the EC participants of the third country payment systems.
~herei'ore,no distortion of competitiveness is to be expected.
o n public authorities for implementation?
Legislative costs of passing the necessary domestic legislation.
..
Are there other indirect effects?
No.
What are the costs and benefits of the proposal?
costs: no costs, othcr than the legislative ones are to bc expected.
benefits:
-elimination of legal risks associated with participation in payment systems, leading to more
efficient and cost-effective operation of EC payment systems
kompletion of the Internal Market: the proposal will also facilitate the access by banks from one
EC Member State, into the payment systems of another EC Member State (remotely or via a
branch).
-further integration of the EC financial sector, both domestically and cross-border, thus contributing
to the free movement of capital and to the freedom of cross-border services.
-cross-border use of coliateral securities is facilitated. This contributes to the free movement of
capital, to the fieedom of cross-border services, to the development of securities markets, to
developing the necessary legal framework in which the future European Central Bank may develop
its monetary policy.
balance: overwhelmingly positive on the benefit side.
5. Impact on SMEs. Does the proposal contain measures to take account of the specific
-
effect on SMEs if not, why not? Are reduced o r different requirements appropriate?
No. No direct effect on SMEs.

6. Indicate a t what stage the consultations were undertaken and the date of publication of
the prior notification of a n intent to introduce legislation?
The Commission has, over many years, promoted the fullest consultation of all interested parties
and earliest disclosure of its line of p o k y in this area. This has materialised in the following steps:
Green Paper3 (consuItdion paper) of September 1990, c a h g for comments from all interested
parties; annexed to the Green Paper was a decision to set up two consultative groups;
-setting up of two permanent consultative groups on payment systems in March 1991, with
intensive frequency. of meetings throughout 1991 and eariy 1992, leading to reports to the
Commission (in Febr~rary1992) published in March 1092;
-Commission working clocumcnt oi'Marc11 19924, based an tbc dctailcd rcports O S tllcsc consullativc
groups, announcing tllc Con~mission'spl-oposcd policy, including intcnt to introduce legislation in
this rcspcct.
Furthc5rrnore; two col~sultativchearings with representatives of the European Credit Sector Industry
were held in the spring of 1994 and October 1995, at key stages of the preparatory work leading to
the present proposal (see Section I above; background).

List of organisations which have been consulted about the proposal and set out in detail their
main views, including their concerns and ~b~jections to the final proposal. Why is it not
possible o r desirable to accede their concerns?
European credit sector associations : The European credit sector associations have been
consulted throughout. Two "hearingsn have taken place with the Commission and its working party,
the latest in October 1995. There is an overall support for this proposal, which is deemed essential
by the sector itself.
Government experts, including representatives of the EC central banks: Governments
representatives which were members of the Commission's working group, take a positive sland on
this proposal. There are differences on some technical issues, which it is not possible to resolve
entirely within the working group. The main point at issue is that some delegations wished to have
an (even more) ambitious approach, covering so called "securities settlement" or "obligations
netting".
EMI: a representative of the EM1 has been present in the working group as an observer.
Were the SME Business Organisations formally consulted? If not, why not?
No. However, SMEs and Retailer organisations were kept regularly informed of progress being
made, through their representatives in the Commission's consultative groups on payment systcms.

Discussion paper on "Making payments in the Internal Market", COM(90)447.

"Easier cross-border pavments: breaking down the barriers", SEC(92) 62 1 of 27 March 1992
 r
.' m

Monitoring and Review

7. Explain how the effects and compliance costs of the proposal will be m~nitoredand
. . -.. %

reviewed.:How wiil compliimts be dealt d t h ? Can the once)it is legjislation, be ,

. amended easily?
The proposal contains in its ~ h i c l e9 an undertaking on the part of the Commission to report on
these matters to the European Parliament and Council. The necessary preparation for this will be
done by the Commission acting with its existing two consultative groups on payment systems.
There is no comitology procedure, therefore amendments to the proposal, once this iq adopted, will .
require normal legislative procedures.

Directorate General XV
Dr. Peter TROBERG
AV.de Cortenberg. 107
B-1 040 Brussels

Tel: 295.4 1.O9

295.79.78 '

295.32.19
295 .94.62

Fax: 295.07.50