Bank of England — Payment Systems Oversight Report 2005

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Payment Systems Oversight
Report 2005
Bank of England
February 2006
Issue No. 2

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Useful information
The Payment Systems Oversight Report 2005 is available as a complete document in pdf
format on the Bank of England’s website:
www.bankofengland.co.uk/publications/psor/psor2005.pdf.
Text from the Payment Systems Oversight Report may be reproduced provided that the source
and copyright status are acknowledged.
© Bank of England 2006
ISSN 1745-7149 (print)
ISSN 1745-7157 (online)

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1
Payment Systems Oversight Report 2005
Payment systems are fundamental to the functioning of the economy.  In the United Kingdom payment systems
are not subject to statutory oversight;  but the Bank of England, under the terms of the 1 997 Memorandum of
Understanding with HM Treasury and the Financial Services Authority, and on the basis of its experience as a
designer, operator and user of payment systems, applies a non-statutory oversight regime, focusing especially on
those systems whose reliable functioning is critical to financial stability.  The Oversight Report explains how the
Bank is discharging its public policy responsibilities in this field.
Overall, the main UK payment systems continue to exhibit a high level of robustness by international standards.
Specifically, the high-value payment systems in the United Kingdom come close to observing fully the
internationally-recognised Core Principles for Systemically Important Payment Systems, and stand favourable
comparison with high-value systems in other countries.  The Bank’s oversight activity in the past year has aimed
at further addressing systemic risk in UK payment systems.  Significant progress has been made in a number of
the areas identified in last year’s inaugural Oversight Report, including:
G the Bank of England becoming concentration bank for sterling and euro payments in LCH.Clearnet Ltd’s
Protected Payments System (in September);
G CLS Bank and Abbey becoming members of CHAPS Sterling (in November), and UBS AG announcing its
intention to become a member in 2007 ;
G the implementation of a Liquidity Funding and Collateralisation Agreement for BACS and the Cheque and Credit
Clearings (in May);  and
G the designation of BACS under the UK settlement finality regulations (in December).
These developments are among a number that are described in more detail in the main text of this
Oversight Report, along with the Bank’s current assessment of UK payment systems against the Core Principles.
For UK and relevant international systems, the Bank continues to encourage progress where its assessment
suggests improvement to be desirable.
The structure of this Oversight Report is as follows.  After setting out the general rationale for, and the Bank’s
role and approach to, payment systems oversight (Chapter 1), it picks up on the themes set out in the previous
Oversight Report, and updates on progress (Chapter 2).  Developments in individual UK payment systems are
assessed against the Core Principles (Chapter 3 and annexes).  Finally, as part of the Bank’s forward-looking
agenda, a number of possible issues related to updating and extending the Core Principles are discussed
(Chapter 4).
Executive summary

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Payment Systems Oversight Report 2005
Executive summary 1
Chapter 1:  An introduction to payment systems oversight 5
1.1 The role of central banks in the oversight of payment systems 5
1.2 The oversight process in the United Kingdom 7
1.3 A new risk -based framework for oversight 8
Chapter 2:  Progress since the previous Oversight Report 10
2.1 Tiering in UK infrastructures 10
2.2 Operational risk and business continuity planning 1 2
2.3 Corporate governance and financial infrastructures 1 4
2.4 Co-operative oversight arrangements 1 4
Box 1: CPSS Report on Central bank oversight of payment and settlement systems 18
Chapter 3:  Updated Core Principles assessments of the main UK payment systems 20
3.1 CHAPS 21
3.2 TARGET 24
3.3 CREST 25
3.4 LCH.Clearnet Ltd 2 7
3.5 CLS 30
3.6 BACS 32
Box 2: OFT Payment Systems Task Force 36
Box 3: Shorter clearing cycles 37
3.7 The Cheque and Credit Clearings 3 9
3.8 LINK 41
3.9 Debit and credit card systems 42
3.10 SWIFT 43
Chapter 4:  Issues and priorities for future work 46
4.1 Corporate governance and financial infrastructures 46
4.2 Transparency 47
4.3 Business risk 48
4.4 Interlinkages 50
4.5 Infrastructure/institutional distinction 5 1
Annexes:  Detailed assessments of payment systems 52
A CHAPS 53
B CREST 59
C LCH.Clearnet Ltd 64
DB A C S 69
E The Cheque and Credit Clearings 7 4
F LINK 80
G UK Maestro 85
Glossary of terms and abbreviations 90
Payment Systems Oversight Report 2005

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5
Payment Systems Oversight Report 2005
The role of central banks in, and the Bank of
England’s specific responsibilities for, oversight of
payment systems were set out in the first issue of
the Payment Systems Oversight Reportlast year
(hereafter ‘the previous Oversight Report’).
(1) A more
recent article in the Bank of England’s Quarterly
Bulletin summarises the role of central banks in
payment systems oversight.(2) The opening chapter
of this second issue of the Oversight Report draws
out the salient points from these earlier
publications.  It also reports on work by the Bank
to put together a quantitative, risk -based framework
for guiding its oversight activities, as presaged in
the previous Oversight Report.
1.1 The role of central banks in the oversight of
payment systems
A payment system is an organised arrangement —
often described as a network — for transferring
monetary value between its participants.  In broad
terms, payment systems support wholesale
financial market activity, and allow transactions to
take place between individuals and/or companies.
Both types of payment activity are vital for a
market economy to function.  In 2004, the total
value passing through UK payment systems was
around £1 60 trillion, and this is estimated to
have increased to around £1 7 5 trillion in 2005
(Table A).
(3) These are enormous sums:  more than
1 40 times UK annual GDP .  As a general rule,
these payments are effected smoothly.  This is
because the systems are designed and operated
robustly.
Payment systems are nevertheless exposed to a
variety of risks;  and because payment systems are
networks, some of these risks can be transmitted
through the financial system.  For example, the
financial or operational failure of one payment
system participant can adversely affect other
participants, if exposures have arisen during the
course of making payments.  Alternatively, the
financial or operational failure of a component
of a payment system can cause payments between
participants not to be effected at the intended
time (or indeed at all), again with potentially
adverse impacts on others.  If these risks
crystallise, there can be losses to the real
economy — both directly, because payments
have been delayed, have had to be redirected
through other (more expensive or less efficient)
payment systems, or have not been effected at all;
and indirectly, because the failure of one
participant has caused losses among one or
more other participants.
Privately operated payment systems and their
participants have incentives to mitigate these risks
insofar as they might have an impact on their own
objectives.  However, since such incentives may
not always be perfectly aligned with the public
good, the risks may not be mitigated to the degree
that would be optimal for the wider economy.
Systemic risk in payment systems has, in effect, the
characteristics of a ‘public bad’ .  Furthermore,
competitive pressures on providers of payment
services are often limited, because, for different
types of payment service, payment systems are
subject to various economies of scale and other
factors that limit competition.  Among other
things, this can mean that technological and
organisational innovation, which can also help to
mitigate risks in payment systems, is slower than
might otherwise be the case.
(4) All this provides
the rationale for a third party, acting in the public
interest, to carry out oversight with the purpose of
securing systemic stability in payment systems.
That third party has typically been some public
Chapter 1: An introduction to payment systems
oversight
(1) Bank of England (2004), Payment Systems Oversight Report, Chapters 1 and 2 in particular, available at: 
www.bankofengland.co.uk/publications/psor/psor2004.pdf.
(2) Haldane, A and Latter, E (2005), ‘The role of central banks in payment systems oversight’ , Bank of England Quarterly Bulletin, Spring, pages 66–71, available at: 
www.bankofengland.co.uk/publications/quarterlybulletin/qb050 106.pdf.
(3) These figures are based on the value of flows through CHAPS (Sterling and Euro), BACS, the Cheque and Credit Clearings (C&CC ), Visa, MasterCard, LINK 
and the payment arrangements supporting CREST and LCH.Clearnet Ltd.
(4) Some of these points are set out in more detail in a paper to the Bank of England’s Future of Payments conference (2005), Leinonen, H, ‘e-Settlement:  
Soon a reality?’ , May, a draft of which is available at:  www.bankofengland.co.uk/financialstability/futureofpayments/leinonen.pdf.

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Payment Systems Oversight Report 2005
Volume Value Important payment types Most likely short-term substitutes
(£ millions)(b)
Payment systems
CHAPS G Settlement of financial market G CHAPS Sterling bypass mode
Sterling 1 1 7 ,657 206,5 1 4 transactions G Manual procedures for making a
Euro(c) 2 7 ,468 1 72,680 G House purchases small number of payments
G CLS pay-ins and pay-outs G Possible use of correspondent
G Other time-critical payments banking arrangements for some
other payments
BACS 20,53 7 ,00 1 1 2,60 1 G Salary and benefit payments G Perhaps some limited scope for
G Bill payments by Direct Debit switching to other instruments in
G Telephone and internet banking the short term — eg cheques or
cash
C&CC(d) 7 ,634,307 4,869 G Payments for goods and services G BACS
by consumers and businesses G Card networks
G Bill payments and small financial G Cash
transactions (eg payments into
savings accounts)
G Person-to-person payments
Visa (credit and 1 6,063,000 886 G Payments for goods and services G Cheques
debit cards)(e) by consumers and businesses G Other card networks
G Cash
MasterCard(f) 1 4,906,000 77 6 G Payments for goods and services G Cheques
(credit and by consumers and businesses G Other card networks
debit cards)(e) G Cash
LINK 6,7 49,3 1 5 260 G Withdrawal of cash using an ATM G Own bank’s ATMs
not operated by the customer’s own G Other cash withdrawal channels
bank
CREST (payment arrangements supporting CREST)(g)
Sterling 300,03 8 G Settlement of gilts, equities and G Increased free-of-payment
US dollar 1,236 money market instruments transfers of securities could be
Euro 1,0 1 8 (including in respect of OMOs accommodated within CREST
Total CREST 2 72,1 7 8 302,292 and repo market transactions but with increased principal risk
more generally)
LCH.Clearnet (Protected Payments System)(h)
Sterling 1 82 453 G Settlement in respect of cash G If disruption does not prevent
US dollar 1 5 5 72 7 margin payments calculation of settlement
Euro 126 585
G Payments for commodity deliveries obligations, contingency payment
Other 244 90 G Cash settlements procedures may be invoked
Total LCH 707 1,85 5 G Default fund contributions G Contingency algorithms can be
used to calculate obligations
if usual mechanisms are
unavailable
Foreign exchange settlement system
CLS G Settlement of foreign exchange G Correspondent banking
All currencies 92,000 57 4,000 trades arrangements in the relevant
Of which sterling
(i) 1 4,000 82,000 countries but with increased
principal risk
Sources:  APACS, Bank of England, CLS Bank International, CRESTCo, LCH.Clearnet Ltd and LINK Interchange Network Ltd.
Table A
Volumes, values and main payment types (daily averages, 2005)(a)
(a) Except where indicated.
(b) US dollar, euro and ‘other’ figures are shown as sterling equivalent.
(c) Comprises domestic and cross-border euro payments (including both inward to and outward from the United Kingdom).
(d) Volumes include items drawn on other branches of the same bank.  Values only include those drawn on other banks.
(e) Data for 2004 are shown.
(f) Includes UK Maestro and Solo transactions.
(g) Value figures refer to cash movements within CREST (and will therefore include the value of transactions settled between CRE ST members who use 
the same settlement bank).  The volumes figure refers to all transactions processed within CREST, of which not all involve cash movements.
(h) Figures for the LCH.Clearnet Ltd Protected Payments System refer to the sum of all (net) payments between LCH.Clearnet Ltd a nd its members 
through the PPS.  Volume figures are for August 2004.
(i) Trades in which one leg is denominated in sterling.

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sector agency, and generally the central bank,(1)
given that its liabilities (‘central bank money’) have
long provided the ultimate, risk-free, means of
discharging financial obligations between
participants.
1.2 The oversight process in the United Kingdom
In the United Kingdom, the Bank of England’s
oversight responsibilities in respect of payment
systems were formalised in the Memorandum of
Understanding (MoU) with HM Treasury and the
Financial Services Authority (FSA) agreed in
1997.
(2) The MoU places responsibility with the
Bank for oversight of UK payment systems in
general;  in practice, the Bank focuses oversight
resources on those payment systems and
infrastructure providers where the crystallisation of
risks would have the greatest impact on the wider
economy — ie those systems which pose the
greatest systemic risk.
Unlike many other central banks, the Bank of
England does not have statutory powers to carry
out its oversight.
(3) It therefore seeks to convince
the management and owners of payment systems
of the rationale for risk-reducing changes, where it
assesses that the risks to the wider economy are
not sufficiently recognised or, where appropriate,
addressed by the operators of payment systems and
their participants.  In making any
recommendations, the Bank bears in mind the
Better Regulation Commission (BRC) principles of
proportionality, transparency, accountability and
consistency.
(4)
Generally, the Bank’s dialogue with system
operators (on the case for, and progress with
agreed risk-reducing changes) takes place in a
pragmatic and co-operative environment.  The
significant progress in implementing risk-reducing
measures reported in Chapters 2 and 3 of this
Oversight Report is testimony to the fact that these
arrangements are capable of working effectively.  If,
however, they do not, then the Bank has a number
of means for pursuing an issue, including through
publications such as the Oversight Report, and
speeches by senior Bank officials.
(5) Ultimately, if
the Bank were unable to secure the risk-mitigating
actions that it thought necessary, then the MoU
requires ‘the Bank to advise the Chancellor [of the
Exchequer]... on any major problem inherent in
the payments system’ .
As part of its ongoing oversight, the Bank also
assesses a number of those payment systems, with
which it maintains an ongoing oversight
relationship, against the internationally-recognised
standards provided by the Core Principles for
Systemically Important Payment Systems.
(6) It
publishes the results in the annexes to this
Oversight Report, which have been expanded on this
occasion to provide detailed assessments of two
further payment systems against the Core
Principles — LINK and UK Maestro.
The Bank expects payment systems’ degree of
observance of the Core Principles to be
proportionate to the systemic importance of the
system in question.  The expected degree of
observance for a system may differ as between
different Core Principles.  For the most
systemically important systems, the Bank may
expect standards that go beyond those that would
qualify for full observance of the Core Principles;
for some other systems, full observance of all the
Core Principles may not be deemed necessary.
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Payment Systems Oversight Report 2005
(1) As set out in Table 1 of the previous Oversight Report, this is the approach that an increasing number of countries have adopted.
(2) Memorandum of Understanding between HM Treasury , the Bank of England and the Financial Services Authority(1 997), available at: 
www.bankofengland.co.uk/financialstability/mou.pdf.
(3) The Bank does have some limited statutory responsibility for designating UK payment systems under the UK settlement finality  regulations, which 
implemented the EU Settlement Finality Directive (SFD) (1 998) in the United Kingdom.  Once designated, the payment system’s relevant rules are protected 
from legal challenge if a participant should become subject to insolvency proceedings.  Payment systems do not require designat ion in order to operate, and 
the Bank cannot oblige payment system operators to seek it.  The EU SFD has been the subject of a recent evaluation report by t he European Commission, 
which noted that increasing numbers of systems want to be designated in order to gain the SFD’s quality label.  This evaluation report is available at: 
http://europa.eu.int/comm/internal_market/financial-markets/docs/settlement/evaluation_report_en.pdf.
(4) More information on the role of the BRC is available at:  www.brc.gov.uk.
(5) For example, the Governor of the Bank of England’s comments at the Mansion House on 1 6 June 2004, available at: 
www.bankofengland.co.uk/publications/speeches/2004/speech222.pdf.  Publications (and speeches) are also vehicles for acknowledging action taken to 
mitigate risks — for instance, comments by the Bank’s Governor in the subsequent Mansion House speech on 22 June 2005, availabl e at: 
www.bankofengland.co.uk/publications/speeches/2005/speech250.pdf.
(6) The full text of the Core Principles and guidance on their implementation are available on (among others) the Bank for Inter national Settlements website — 
CPSS (200 1) Core Principles for Systemically Important Payment Systems, available at:  www.bis.org/publ/cpss43.pdf.

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In some instances, the Bank works together
with other public bodies, where more than
one such authority has an interest in the payment
system in question.  Within the United Kingdom,
the Bank works closely with the FSA on the
oversight of CREST and LCH.Clearnet Ltd,
dovetailing its responsibilities for oversight of the
payment arrangements in these systems with the
FSA’s responsibilities as supervisor of CRESTCo
and LCH.Clearnet Ltd.  The Bank is also a member
of a number of international co-operative
oversight arrangements, since some systems serve
markets in several countries including the United
Kingdom.  These international arrangements are
described in greater detail in Chapter 2 of this
Oversight Report.
1.3 A new risk-based framework for oversight
During 2005, the Bank has aimed to strengthen
the way in which oversight is conducted, by
designing a new risk-based framework for
oversight.  The new framework seeks to deliver a
more consistent and structured approach, and
help the Bank focus its attention and resources
where the level of risk is greatest.  The framework
is set to be implemented during 2006.
The foundation of the Bank’s new risk-based
framework is a payment systems ‘risk register’ — a
comprehensive list of the most likely causes of
disruption to individual payment systems.  This is
designed to deliver consistency across risk
assessments of different payment systems — by
providing a common starting point for those
assessments.
The risk register incorporates the main types of
risk that can arise in payment systems.  A
counterparty may fail to meet an obligation for
full value, either when due, or at any time
thereafter — ‘credit risk’ — or may fail to settle
an obligation for full value when due, but then do
so at a later time or date — ‘liquidity risk’ .  Losses
may result from inadequate or failed internal
processes or systems, people (such as human
error or fraud) or external events (such as
terrorist attacks or extreme weather) —
‘operational risk’ .  It is also possible that the
unexpected interpretation of the law, or legal
uncertainty, leaves payment system participants
and users with unforeseen financial exposures —
‘legal risk’ .
In practice, these types of risk are interrelated and
overlapping.  If, for example, an operational
disruption delays receipt of funds, this can create
liquidity problems for those who were relying on
funds received to make their own outgoing
payments.  The crystallisation of these risks can be
both cause and effect of problems in a payment
system — one party’s failure to pay can, for
example, cause others’ failure to pay.  To ensure
that, to the extent possible, the list of risks is not
overlapping, the risk register groups the events
that could lead to disruptions to payment systems
under three headings:
G ‘settlement risk’ is the risk that a participant in a
system cannot or does not meet its financial
obligations when, under the rules of the system,
they fall due, or that another institution that
facilitates the settlement of those obligations —
such as the settlement agent — becomes
insolvent;
G ‘operational risk’ is the risk that a system operator
or core infrastructure provider to the system is
operationally unable to process or settle payments
as intended;  and
G ‘business risk’ is the risk that the payment system
or any of its components — eg an infrastructure
provider serving it — cannot be maintained as a
going concern in the face of adverse financial
shocks, which may disrupt or terminate its
capacity to deliver processing services.
The risk-based approach to oversight begins
with assessments of the risks in the risk register
for each of the UK payment systems within the
scope of ongoing oversight.  This first involves
analysis of whether and how the risk can
crystallise.  Among other things, this entails an
assessment of the main risk ‘controls’ that the
system operator has implemented, and of the
quality of those controls.  The assessment of
payment systems against the Core Principles is
an important input.  Bearing in mind
these controls, the next step is to seek to quantify
how likely the risk is to occur — the ‘probability’
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Payment Systems Oversight Report 2005

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of the risk — and the range of plausible adverse
effects on the economy should it do so — the
‘impact’ .  This quantification is made in relation to
the direct and indirect channels through which
risks in payment systems can affect the real
economy (Section 1.1).
Overall risk in a payment system is calculated by
aggregating estimated probability and impact
‘scores’ for all the risks affecting that system.
These assessments can then provide management
information to guide where oversight resources
should be concentrated.
The risk assessment process acknowledges the fact
that systems do not exist in isolation and that risks
in different systems are not necessarily
independent (Section 4.4).  The Bank takes these
correlations into account when risks are
aggregated across payment systems.
The risk-based framework for oversight is
supplemented by ongoing monitoring of the
systems that the Bank oversees.  The Bank seeks
access to a variety of regular information from
system operators and other sources, with the aim
of detecting new developments that could affect
assessments of risk — for example, an
upgrade/downgrade to the credit rating of a major
participant or an increase/ decrease in the
number of operational problems experienced by
the system.  If new risks are identified through this
regular monitoring, these are incorporated into
the risk register as it is updated.
As noted above, Core Principles assessments of the
quality of risk controls continue, in the context of
this new risk-based framework, to play an
important role in the oversight of UK payment
systems.  The new methodology for assessing risks
should ensure that the Bank has a consistent,
risk-based approach for deciding whether the level
of observance that a system currently achieves
against the Core Principles is sufficient.  It is one
contributor to the Bank’s work to support a
possible update and extension to the Core
Principles.  This goal is discussed in greater detail
in Chapter 4.  The Bank intends to publish more
details of its new risk -based framework for
oversight during 2006.
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10
Payment Systems Oversight Report 2005
The previous Oversight Report set out a number of
priorities for the oversight work of the Bank in
2005.  This chapter reports on progress.  The
issues (with cross-references to the discussion in
this Oversight Report) were:
G settlement risk in payment and settlement
systems (system-by-system, throughout Chapter 3
below);
G tiering in UK infrastructures (Section 2.1 below);
G operational risk and business continuity planning
(Section 2.2 below);
G corporate governance and financial infrastructures
(Sections 2.3 and 4.1 below);
G co-operative oversight models (Section 2.4 below);
G the operational implications of the
CREST-Euroclear merger (Section 3.3 below);  
and
G a new risk-based framework for oversight
(Section 1.3 above).
2.1 Tiering in UK infrastructures
The previous Oversight Report set out the potential
credit, legal and operational risks associated with
‘tiering’ in payment systems and especially with
the tiered structure of the high-value payment
systems in the United Kingdom.  These risks may
arise when direct members, or ‘first-tier’
participants, of a payment system make payments
on behalf of their banking customers.  It is worth
noting, however, that some degree of tiering may
be economically efficient as a way of structuring
payment arrangements.  The important issue from
a public policy point of view is to identify any
associated systemic risk and take measures to
address it, whether through reducing the degree of
tiering or otherwise.
The Bank has carried out work to quantify the
credit risk arising from intraday settlement-related
unsecured exposures between first and second-tier
banks in CHAPS Sterling.  It has found that, in
normal circumstances, these exposures, though
sizable in absolute terms, are relatively small in
relation to the capital of first-tier banks.
(1) The
Bank has also analysed risks from tiering in the
payment arrangements supporting CREST sterling,
Continuous Linked Settlement (CLS) and the
payment arrangements supporting LCH.Clearnet
Ltd.
A comparison with securities settlement systems in
other G10 countries appears to suggest that the
degree of tiering in CHAPS Sterling and CREST
sterling’s payment arrangements is relatively high,
reflecting the relatively small number of settlement
banks.  However, the total number of direct
members in a payment or settlement system is not
always a good indication of its degree of tiering.
In the market for securities settlement of
government bonds in the United States, for
example, two commercial banks account for over
7 5% of transfer volume despite the fact that
around 8,000 institutions are direct members of
the securities settlement system.
(2)
In CREST sterling, tiering arises because just
1 5 settlement banks settle the payment leg of
securities transactions on behalf of over
2,400 corporate and financial institutions and
over 40,000 personal members.  Transactions
between CREST members who share the same
settlement bank can be internalised, that is, settled
across the books of the settlement bank rather
than through the central payments infrastructure.
It is estimated that the value of these internalised
transactions is around £55 billion a day.
Data collated from a survey of CREST
settlement banks carried out by the Bank indicate
that the intraday credit limits extended for
Chapter 2: Progress since the previous
Oversight Report
(1) Bank of England Financial Stability Review (December 2004), pages 77–8 1, available at:  www.bankofengland.co.uk/publications/fsr/2004/fsr1 7art4.pdf.
(2) Figures for 2004.

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settlement to non-clearing members were larger
than for CHAPS.  However, in contrast to CHAPS
where the majority of intraday credit extended for
payment purposes is unsecured, in CREST a
substantial proportion of these lines is secured
with securities held in CREST by the customers of
these banks.
Most banks allocate limits on a bilateral
counterparty rather than on a system-by-system
basis.  As membership of CREST sterling and
CHAPS Sterling is almost identical,
(1) the Bank
analysed the credit risks to settlement banks
arising from these exposures using data for the
sum of their unsecured CREST and CHAPS
exposures.  The results indicated that, overall,
tiering does not pose substantial systemic credit
risk in normal circumstances.  This is because
settlement-related exposures represent only a small
proportion of first-tier bank exposure to
customers.
In very stressed market conditions, however, it is
possible that the combination of a substantial
increase in second-tier banks’ own credit
exposures and an increase in their utilisation of
intraday credit lines extended by first-tier banks
could lead to a significant increase in the credit
risk faced by the latter.  This combination of
circumstances has not materialised so far.
(2)
This analysis does not, however, take account of
the likely behavioural response of first-tier banks
to an increase in credit risk of second-tier banks.
One possible reaction might be to cut credit lines
to the affected second-tier banks, but this might
sharply exacerbate the impact of the initial shock
and potentially lead to wider market dislocation.
One alternative approach would be for more firms
to become direct members of the large-value
payment systems.
(3) In the case of CHAPS and the
payment arrangements supporting CREST, this
facilitates access to intraday credit from the Bank,
subject to them having adequate collateral
available.
(4) This may be particularly important to
large complex financial institutions with large
payment values, on which liquidity pressures might
build up quickly in stressed conditions.  Since the
previous Oversight Report, Abbey and CLS Bank
have now become members of CHAPS Sterling and
Abbey has also joined CREST sterling.  UBS AG has
announced its intention to join CHAPS Sterling in
2007.
Tiering exists in LCH.Clearnet Ltd because
1 3 Protected Payments System (PPS) banks make
payments to LCH.Clearnet Ltd on behalf of
LCH.Clearnet Ltd members (1 1 6 in total at the end
of November 2005), via a ‘concentration bank’ .
The profile of LCH intraday credit is reasonably
predictable, with payments of initial margin and
contract cash settlement funds being made in the
morning, followed by smaller variation margin
payments later in the day.
(5) Total payments made
through PPS banks are around £1.7 billion a day.
The credit risks, though, taken by PPS banks in the
payment system supporting LCH.Clearnet Ltd are a
small proportion of each of the PPS bank’s total
assets, and considered in isolation do not
constitute a significant systemic risk.
Many of the large UK clearing banks are also
settlement members of the CLS foreign exchange
settlement system.  Tiering exists in CLS insofar as
56 settlement members settle trades on behalf of a
much larger number of ‘third-party users’ (657 at
the end of 2005, from just over 200 at the end of
2004).  This development has reduced systemic
risk because third-party participation in CLS
significantly reduces foreign exchange principal
exposure compared with settling outside CLS
(Section 3.5).  Settlement members in CLS can,
however, have unsecured intraday exposures to
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Payment Systems Oversight Report 2005
(1) The exceptions are KAS Bank which is a CREST sterling member but not a CHAPS Sterling member and CLS Bank which is a member of CHAPS Sterling but
not CREST sterling.
(2) For more detail, see Harrison, S, Lasaosa, A and Tudela, M (2005), ‘Tiering in UK payment systems:  credit risk implications ’,  Bank of England Financial Stability
Review, December, pages 63–72, available at:  www.bankofengland.co.uk/publications/fsr/2005/fsr1 9art6.pdf.
(3) The efficiency gains from settling on the books of a central bank are analysed in Kahn, C M and Roberds, W, ‘Payments settle ment:  tiering in private and
public systems’ , presented at the Bank of England’s Future of Payments conference, May 2005.  The paper is available at:
www.bankofengland.co.uk/financialstability/futureofpayments/kahnroberdsBOE.pdf.
(4) One consequence of the reforms to the sterling money markets currently being implemented by the Bank may be to make direct s ettlement membership of
CHAPS more attractive.
(5) ‘Initial margin’ is a returnable deposit required from a member for each open position, designed to offset the costs to LCH. Clearnet Ltd of settling open
positions in the event of member default.  ‘Variation margin’ is funds paid by (received by) members to (from) LCH.Clearnet Ltd to settle any losses (gains)
resulting from marking open positions to market.

PDF PAGE 14

their third-party users or vice versa.  The value of
trades settled involving third-party users is
approaching 30% of total settled value.  While
many of the exposures between settlement
members and third-party users appear to be
appropriately controlled, their overall magnitude is
less well known — suggesting that further work on
this front could be warranted.
2.2 Operational risk and business continuity planning
Operational vulnerabilities in payment systems are
important both because they can significantly
exacerbate existing credit and liquidity risks and
because they can lead directly to disruption of the
financial system.  The previous Oversight Report
highlighted the growing focus on operational risk
and business continuity planning.  The following
section looks at how this work has developed over
the past year.
Oversight of operational risk
The Bank has continued to pursue a number of
approaches to ensure that operational risks in
payment systems are adequately addressed.  One
approach has been to investigate and target types
of operational risk that affect more than one
system.  Information security risk, which could
affect the integrity, confidentiality and availability
of systems’ networks, is one such area.  Payment
system business continuity is another major
example of cross-system work.
In parallel, the Bank has looked to identify
system-specific operational risks and support their
mitigation.  The encouragement given to CLS to
become a direct member of CHAPS Sterling
(Section 3.5) in order to remove a layer of
operational dependency in its sterling payment
arrangements is one example.
Risks can be identified as a result of operational
incidents.  Following major incidents, the Bank
seeks assurance from system operators that
adequate controls are in place to ensure that the
specific problems can be dealt with effectively.  It
is also important that systems give full
consideration to understanding the wider aspects
of incidents and their full implications.  For
example, an outage to the UK Real-Time Gross
Settlement (RTGS) processor occurred in January
2005 when operational difficulties experienced by
a non-UK large-value payment system (connected
to RTGS via TARGET) led to an unanticipated
slowdown to the processing of payments in RTGS
and disruption to CREST payments.  As well as
addressing the underlying technical issues which
caused this problem to arise, the unexpected
knock-on effects of the event suggested that a
number of systems might usefully strengthen 
their stress testing to include operational
incidents arising from dependencies between
systems.
The Bank continues to assess observance of
recognised standards for operational robustness,
security and contingency planning, and seeks to
establish new standards where gaps exist.  As
shown in the annexes to this Oversight Report,
existing assessments for CHAPS, CREST,
LCH.Clearnet Ltd, BACS and the Cheque and
Credit Clearings (C&CC) against Core Principle
VII (which concerns operational risk) have been
reviewed in the light of recent developments and
new assessments have been undertaken for LINK
and UK Maestro.  International work is under way
to establish a more structured framework for the
assessment of SWIFT’s operational risk
management (Section 3.10).  The Bank has also
reviewed systems’ approaches to operational risk
management.
Quantitative information on operational risk is a
crucial input to the Bank’s analysis of a payment
system’s observance of best practice standards.  To
that effect, the Bank has collected new data on
operational performance from systems such as
LCH.Clearnet Ltd and LINK over the past year.
Additional qualitative information on operational
risk has resulted from holding more meetings with
systems’ external auditors.
Over the next year, this work will be synthesised
within the new risk-based framework for oversight.
As part of implementation, the Bank plans to use
new qualitative techniques to benchmark different
systems’ underlying vulnerability to operational
risks;  to assess the controls used by systems to
mitigate and reduce these risks;  and to produce
‘residual’ risk exposure assessments.  Using
scenario analysis techniques, quantitative
12
Payment Systems Oversight Report 2005

PDF PAGE 15

estimates of the probability and impact of severe
operational risk events are also being built up.
A major constraint in making robust quantitative
estimates of operational risk in payment systems is
the limited availability of usable data, particularly
on the extreme — perhaps once in every 50 year
— events that can have greatest impact on the
financial system.  The Bank is in the process of
building its own database of operational incidents
affecting UK payment systems.  Separately,
arrangements already exist to collect and share
information on incidents affecting euro large-value
payment systems among the European System of
Central Banks (ESCB) (Section 3.2).
Oversight of business continuity
Business continuity analysis and policy has been a
particular focus over the past year, its importance
underlined by the terrorist attacks in London on
7 July 2005.  These attacks led to widespread
disruption, particularly through the impact on the
transport network.  The direct impact on the
financial sector, however, was small.
Following the attacks, the Tripartite Authorities
(HM Treasury, the Bank of England and the FSA)
conducted a post-incident review of the impact on
the financial sector.  Over 40 institutions,
including the major infrastructure providers, were
consulted.  The review found that most payment
and settlement systems experienced relatively low
levels of physical disruption.  Of the systems with
which the Bank maintains an ongoing oversight
relationship, only LCH.Clearnet Ltd was directly
affected, due to its proximity to one of the attacks
(Section 3.4).
The Bank has also discussed the events with many
of the payment systems.  Although not directly
affected, a number of systems reviewed their
internal procedures in the light of the attacks.
Areas where systems have looked to strengthen
procedures include improving processes to identify
the location of staff following a major event.
During 2005, the UK payment systems took part in
the Resilience Benchmarking Project organised by
the Tripartite Authorities.  The objective of the
project was to determine the robustness of the UK
financial services sector in the event of major
operational disruption.  To this end, the resilience
and recovery capacity of over 60 major market
participants and financial market infrastructure
providers was assessed — both individually and
collectively.  The project also looked at the
dependencies between participants.  The project
established that the major UK payment systems are
highly resilient, with rapid recovery times to be
expected for such crucial parts of the UK financial
system.
(1)
The Tripartite Authorities also organise UK
financial sector market-wide exercises.  These
exercises are designed to practise co-ordination of
responses to sector -wide disruption among key
participants in the financial sector;  to enhance
the understanding of, and confidence in, the role
of the financial authorities in the event of major
operational disruption;  to provide an opportunity
for participants to run internal exercises based on
the scenario;  and to identify areas for
improvement in existing procedures.  The latest
exercise took place in November 2005 and
involved some 80 financial sector organisations,
including most of the UK payment systems.
(2)
Other UK developments in the past year include
the establishment of the Cross Market Business
Continuity Group (CMBCG) and work by the
Money Markets Liaison Group (MMLG).  The
CMBCG is convened in a crisis as a forum for the
Tripartite Authorities, infrastructure providers and
key firms to pool information.  The CMBCG was
first convened in its crisis mode on 7 July.
(3) The
MMLG provides a high-level forum for discussion
of structural developments affecting sterling
money markets and related infrastructure.  Its
recent contingency planning work has included
clarifying responsibilities for decision-making in
the event of major operational disruption to the
13
Payment Systems Oversight Report 2005
(1) The discussion paper is available at:  www.fsc.gov.uk/section.asp?catid=320&docid=942.  Further information on the exercise is available on the UK
Financial Sector Continuity website:  www.fsc.gov.uk.
(2) A report on the exercise will be published later in 2006 and will be available on the UK Financial Sector Continuity website .
(3) The Financial Sector Business Continuity Annual Report (October 2005) has more detail on the authorities’ business continuity work:
www.fsc.gov.uk/section.asp?catid=350&docid=948.

PDF PAGE 16

sterling money markets or major UK payment
systems.
Business continuity is one area where best practice
has evolved since the publication of the Core
Principles.  To reflect this, the Bank has worked
with international authorities to develop and
strengthen standards in this area.  In May 2005,
the ESCB published draft implementation
guidelines for payment systems business continuity
based on Core Principle VII.
(1) The guidelines set
out more comprehensively the key elements of
business continuity planning, such as the
formulation of business continuity objectives and
the development, testing and updating of business
continuity plans.  The Bank intends to reflect the
guidelines in its oversight assessments.
2.3 Corporate governance and financial infrastructures
In 2005, the Bank participated in a number of
working groups under the Office of Fair Trading
(OFT) Payment Systems Task Force (Box 2),
exploring the benefits of various governance
arrangements.  Across these working groups, the
Bank made the case for strengthening the
influence of non-bank stakeholders in the payment
schemes’
(2) decision-making.
Observance of a number of the Core Principles
increased during 2005 (Chapter 3;  annexes),
which, in itself, can be seen as evidence for
effective governance.  Nonetheless, there is room
for improvement of governance arrangements
(Section 4.1).  As the schemes have been awaiting
the working groups’ recommendations, which are
due between 2006 and early 2008, progress has
been limited in the past year, although governance
arrangements improved in BPSL (Section 3.6).
2.4 Co-operative oversight arrangements
Many of the systems assessed in this Oversight
Report operate cross-border, or are part of a
cross-border group, and are systemically important
in a number of countries.  The United Kingdom’s
ability to minimise systemic risk depends
therefore, in part, on the robust design and
smooth functioning of systems located abroad.
However, oversight responsibilities for
infrastructures continue to be organised on a
national basis.  It follows that co-operative
arrangements between central bank overseers and
other interested authorities are needed to
facilitate adequate mitigation of the systemic risks
posed by cross-border and multicurrency payment
systems in all jurisdictions.
Since 1 990, co-operative oversight arrangements
between G10 central banks have been guided by
the Lamfalussy Principles for co-operative
oversight.
(3) Box 1 discusses a recent report from
the Committee on Payment and Settlement
Systems (CPSS) on Central bank oversight of payment
and settlement systems, which, among other things,
reviewed and updated the Lamfalussy Principles.  A
number of the specific co-operative arrangements
in which the Bank is involved are described below.
Co-operative arrangements for CLS 
The CLS system settles foreign exchange
transactions in 1 5 currencies using the large-value
payment systems (RTGS or equivalent) of the
countries of issue for these currencies.  The US
Federal Reserve authorises the establishment, and
is the primary supervisor, of CLS Bank
International (CLS Bank) — the institution that
provides the CLS service — and accepts primary
responsibility for the oversight of the CLS system.
As required by Lamfalussy Principle 3, central
banks, led by the Federal Reserve, work with CLS to
update their Core Principles assessment of CLS
where necessary — for example, prior to new
currencies being introduced or material changes
being made to risk management arrangements.
The CPSS Foreign Exchange Settlement Risk
sub-group (hereafter ‘the sub-group’), which is
chaired by the Federal Reserve, serves as the
primary forum for co-operation between overseers
of CLS.  All central banks and monetary
authorities that issue currencies settled in CLS
are represented on the sub-group, along with
14
Payment Systems Oversight Report 2005
(1) Available at:  www.ecb.int/ecb/pdf/cons/paysysbusinesscontinuity/paysysbusinesscontinuity.pdf.
(2) Several payment systems in the United Kingdom have separated the company providing the infrastructure service from the schem e that is responsible for
setting out the rules that determine the way the system operates.
(3) Available at:  www.bis.org/publ/cpss04.pdf.

PDF PAGE 17

five euro-area national central banks.  The
Federal Reserve has agreed to provide the
members of the sub-group with information
relevant to the oversight of CLS on a confidential
basis.
In accordance with Lamfalussy Principle 4, prior to
the inclusion of a currency into the CLS system,
the Federal Reserve asks each of the relevant
central banks to confirm that it is satisfied that
CLS’s settlement arrangements are sufficiently
robust.  New information and analysis regarding
CLS’s settlement and failure-to-settle procedures
is provided to the relevant central banks on a
timely basis, when major changes to the system
are made.
Co-operative arrangements for SWIFT
Co-operative oversight arrangements for SWIFT
have developed out of discussions at CPSS, and,
like the arrangements for CLS, draw heavily upon
the Lamfalussy Principles.  Unlike the other
co-operative arrangements discussed here, the
National Bank of Belgium (NBB) as lead overseer
has no statutory enforcement powers over SWIFT;
therefore central banks rely on moral suasion to
influence SWIFT.
The NBB acts as lead overseer because SWIFT is
incorporated in Belgium.  A protocol has been
signed between SWIFT and the NBB, in order to
formalise a common understanding of SWIFT
oversight objectives, and the activities that will be
undertaken to achieve these objectives.
The NBB conducts its oversight in co-operation
with the other G10 central banks.  The
arrangements between these central banks and the
NBB are laid down in bilateral Memoranda of
Understanding (MoU).  In particular, these specify
the details of three SWIFT oversight groups, all
chaired by the NBB, which have responsibility for
different aspects of SWIFT oversight.  The Bank is a
member of all these groups.
(1)
The bilateral MoU contain provisions for the
treatment of confidential information being
shared under the co-operative agreement.  In
accordance with Lamfalussy Principle 5, they
expressly allow an overseer, in extreme
circumstances, to make public any concerns it has
over a potential systemic threat posed by SWIFT,
even where this view is based on the analysis of
confidential information.
Oversight arrangements do not currently include
provisions for periodic comprehensive assessments
of the design of SWIFT against agreed standards.
A notable obstacle to such an assessment is that
no appropriate internationally agreed standards
exist for messaging systems.  Collective work by
overseers is now under way to establish a more
structured framework for the assessment of
SWIFT’s operational risk management
(Section 3.10).
Co-operative arrangements for the Euroclear group
CRESTCo is incorporated in the United Kingdom
and subject to supervision by the FSA, with the
Bank having responsibility for the oversight of the
payment arrangements supporting securities
settlement.  CRESTCo is a wholly-owned
subsidiary of Euroclear SA/NV (ESA), which is
incorporated in Belgium.  Under Euroclear’s
long-term business plan, settlement in the group’s
centralised securities depositories (CSDs) which
include CREST, will shift to common data centres
in Europe and, ultimately, occur on a single
platform owned and operated by ESA
(Section 3.3).
This concentration of the main settlement
activities creates a need for enhanced co-operative
oversight arrangements between authorities with
responsibility for entities within the Euroclear
group.  To this end, a multilateral MoU has
recently been signed between the relevant
authorities in Belgium, France, the Netherlands
and the United Kingdom.  The MoU specifies
arrangements for both the exchange of
information between authorities, and the
organisation of the co-ordinated assessment of the
common services provided by ESA.  As ESA is a
regulated entity under Belgian law, the NBB and
15
Payment Systems Oversight Report 2005
(1) A detailed description of co-operative oversight arrangements for SWIFT — and Euroclear — can be found in the National Bank of Belgium’s Financial
Stability Review (2005), pages 95–103, available at:  www.bnb.be/doc/ts/Publications/FSR/FSR_2005_EN.pdf.

PDF PAGE 18

the Belgian Banking, Finance and Insurance
Commission (CBFA) are the co-ordinating
authorities with respect to co-operative oversight
and supervision.
In practice, two committees, co-chaired by the
co-ordinating authorities, have been set up to
implement the co-operative framework.  Both
committees are given administrative support by a
permanent secretariat managed by the Belgian
authorities.  The intention is that the supervisory
assessment and resulting supervisory actions
should be agreed by all relevant authorities.
Where relevant, the CPSS-IOSCO (International
Organization of Securities Commissions)
Recommendations for Securities Settlement
Systems (RSSS) will be used as a benchmark for the
co-ordinated assessment.
Co-operative arrangements for the LCH.Clearnet
group
Co-operative arrangements for the LCH.Clearnet
group have much in common with those for the
Euroclear group:  individual entities within the
group are subject to local supervision, central
banks are required to co-operate with banking
and securities regulators, and recent consolidation
has led to a need for enhanced co-operation
between authorities.
LCH.Clearnet Group Ltd has two wholly-owned
subsidiaries, LCH.Clearnet Ltd, and LCH.Clearnet
SA.  LCH.Clearnet Ltd, the London-based central
counterparty (CCP), is subject to supervision, as a
Recognised Clearing House (RCH), by the FSA,
with the Bank having responsibility for the
oversight of its payment system.  LCH.Clearnet SA,
which clears trades on, among others, the
Euronext exchanges, is incorporated in France and
subject to supervision and oversight by the French
authorities as a bank, a CCP clearing house, and
an operator of a securities settlement system.  As
LCH.Clearnet SA is also a CCP for regulated
markets in the Netherlands, Belgium and Portugal,
this supervision is conducted in close
co-ordination with the relevant Dutch, Belgian and
Portuguese authorities.  LCH.Clearnet Group Ltd,
the parent entity, is incorporated in the
United Kingdom.  However as LCH.Clearnet SA is
regulated as a credit institution in France, its
parent company is defined as a financial holding
company under the EU Banking directive and thus
is subject to consolidated supervision by the
Commission Bancaire.
A MoU has been agreed between the relevant
French, Belgian, Dutch, Portuguese and UK
authorities to facilitate effective supervision and
oversight of LCH.Clearnet Ltd, LCH.Clearnet SA
and LCH.Clearnet Group Ltd.  The authorities
undertake to harmonise their supervisory methods
where possible, to co-operate in identifying key
risks attached to the group and to develop policies
to address these risks.
Additionally, an exchange of information letter has
been signed by the Dutch and UK authorities to
complement the wider MoU relating to
LCH.Clearnet group activities (Section 3.4).
Co-operative arrangements for international card
schemes
The Bank and the European Central Bank
(ECB) have recently initiated discussions which
seek to increase co-operation in collecting
information relevant to the oversight of Visa
Europe, whose European operations are based in
the United Kingdom.
Effectiveness of co-operative arrangements
In the previous Oversight Report, the Bank
undertook to review the degree to which
international co-operative arrangements have
enabled the Bank to fulfil effectively its
responsibility for oversight of UK payment systems.
As outlined above, considerable progress has been
made in developing suitable arrangements,
designed in accordance with the Lamfalussy
Principles, which enable the Bank to discharge its
oversight responsibilities.  The arrangements for
CLS and SWIFT are well-developed and have been
working without major problems for several years.
Euroclear group and LCH.Clearnet group are still
in the process of developing their key systems and
therefore it is too early to comment on the
effectiveness of the co-operative arrangements for
these groups.
16
Payment Systems Oversight Report 2005

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17
Payment Systems Oversight Report 2005
Going forward, the design and operation of
co-operative oversight arrangements will continue
to provide challenges to overseers.  Further
consolidation of infrastructures seems likely,
requiring existing arrangements to adapt and new
arrangements to be made.  The main areas where
the Bank considers further improvement in the
design of co-operative arrangements to be
necessary are:  (i) specifying which authorities are
represented, and to what extent, in co-operative
arrangements;  and (ii) agreeing the appropriate
degree of disclosure by authorities in a co-operative
arrangement (discussed further in Section 4.2).
A common issue when designing co-operative
arrangements is arriving at an appropriate level of
representation.  It is clearly desirable to include in
the arrangement all authorities to whom an
infrastructure is of potential systemic importance.
However, this must be weighed against the need to
make co-operative arrangements as efficient as
possible.  For example, SWIFT supplies messaging
services in over 200 countries, but it would be
unworkable to attempt to include authorities from
all these countries in a co-operative oversight
arrangement for SWIFT.
The Bank, along with the FSA and HM Treasury,
has argued that the composition of authorities
involved in co-operative arrangements should be
guided by criteria that capture the potential
impact of a disruption to an institution, on the
financial systems of the countries in which it is
active.
(1) That is, oversight responsibilities should
be aligned with measures of systemic risk.
Such an alignment is allowed for within the
framework of the Lamfalussy Principles.  However,
to date, central banks have not attempted to agree
specific guidance on potential impact criteria that
could be used to measure the relevance of an
infrastructure.  In the Bank’s view this would be a
worthwhile exercise.
The impact of a disruption to an infrastructure
might be analysed using the following four broad
criteria:
(i) Scale — of the infrastructure’s activity in the
domestic currency or markets;  both relative and
absolute measures might be appropriate;
(ii) External interlinkages — potential for
spillovers from the infrastructure to other
institutions or markets;
(iii) Internal interlinkages — potential for
spillovers between entities within an infrastructure
group;  and
(iv) Substitutability — potential for the activities
being performed by the infrastructure to be
performed elsewhere within a reasonable time
period.
(1) These arguments are set out at:  www.bankofengland.co.uk/publications/other/europe/fsapjan05.pdf.

PDF PAGE 20

In May 2005 the Committee on Payment and
Settlement Systems (CPSS) published its report on
Central bank oversight of payment and settlement
systems.
(1) On the basis of the analysis contained
in that report, two sets of principles are laid out to
guide central banks in organising and conducting
effective oversight.  One set is generally applicable
to all oversight arrangements;  the other set is
specifically applicable to co-operative oversight
arrangements.
This box discusses the set of general principles
which are applicable to the oversight of any
scheme, arrangement or institution involved in
clearing, netting or settlement.  Each principle is
listed below accompanied by an explanation of
how it is met by the Bank.
Principle A:  Transparency
‘Central banks should set out publicly their oversight
policies, including the policy requirements or
standards for systems and the criteria for
determining which systems these apply to.’
The Bank publicly set out its oversight policies in
Oversight of Payment Systems(2000).
(2) Chapter 2 of
the previous Oversight Reportexplained the framework
in which payment systems oversight was conducted
in the United Kingdom.  Section 1.3 of this Oversight
Reportoutlines a new risk -based framework for
oversight to be implemented during 2006.
The Bank believes that it can further enhance the
transparency and accountability of its oversight by
publishing an assessment of the systems it oversees
in an annual Oversight Report.  A discussion of
transparency provisions in the Core Principles can
be found in Section 4.2 of this Oversight Report.
Principle B:  International standards
‘Central banks should adopt, where relevant,
internationally recognised standards for payment
and settlement systems.’
The Bank has adopted the Core Principles as
applicable standards against which to oversee
payment systems.  Chapter 4 of this Oversight Report
discusses areas where, in the Bank’s view, the Core
Principles could usefully be updated and extended.
Principle C:  Effective powers and capacity 
‘Central banks should have the powers and
capacity to carry out their oversight
responsibilities effectively.’
Under normal circumstances the Bank’s requests
for information or attempts to induce change from
the systems it oversees are fulfilled through moral
suasion.  By regularly publishing oversight
assessments of individual systems, the Bank can
strengthen a system’s incentive to co-operate, for
example by creating pressure for change from
system participants.
A number of UK payment systems settle interbank
obligations by means of credits and debits to
accounts at the Bank of England.  Settlement
membership of many payment systems therefore
depends on having a settlement account at the
Bank.  The Bank can attach contractual conditions
to its agreement to act as settlement agent.  If
these conditions were considered too onerous,
however, this could encourage use of alternative
settlement agents, thereby undermining the Bank’s
risk-reduction objectives.
Of the 1 5 central banks who are represented in the
report, the Bank is one of a small minority who
lack any direct statutory powers to obtain
information and induce change from the system
operators they oversee.
(3)
Principle D:  Consistency
‘Oversight standards should be applied
consistently to comparable payment and
settlement systems, including systems operated by
the central bank.’
Box 1:  CPSS Report on Central bank oversight of payment and settlement systems
(1) Available at:  www.bis.org/publ/cpss68.pdf.
(2) Available at:  www.bankofengland.co.uk/publications/psor/ops.pdf.
(3) The Bank does have some limited statutory responsibility for designating payment systems under the ‘UK settlement finality r egulations’ , which implemented
the EU Settlement Finality Directive (1 998) in the United Kingdom.  This role is described in Bank of England (2000), Oversight of Payment Systems.
Payment Systems Oversight Report 2005
18

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Payment Systems Oversight Report 2005
By assessing all overseen payment systems against
the Core Principles, the Bank seeks to ensure a
consistent application of oversight standards.  In
the Bank, the functions of oversight and operation
of key payments infrastructure are organisationally
separated.  The Systemic Risk Reduction Division
has responsibility for oversight of payment systems,
and is located within the Bank’s Financial Stability
directorate.  Policy towards and the operation of
the RTGS platform that, among other things,
settles CHAPS transactions is the responsibility of
the Market Services Division, which is located
within the Banking Services directorate.
Principle E:  Co-operation with other authorities
‘Central banks, in promoting the safety and
efficiency of payment and settlement systems,
should co-operate with other relevant central
banks and authorities.’
In the United Kingdom a framework for
co-operation between the Bank, FSA and
HM Treasury in the field of financial stability was
specified in the MoU signed in 1 997 (Section 1.2).
This sets out the Bank’s responsibility for the
overall stability of the financial system as a whole
including, among other things, an involvement
with payment systems at home and abroad.  The
FSA is given responsibility for, among other things,
the supervision of clearing and settlement systems.
Principles for international co-operative oversight
The CPSS report reviews and updates the
Lamfalussy Principles, which have guided
co-operative oversight between central banks since
their publication in 1 990.
(4) These principles were
originally developed with netting schemes as their
primary focus, but have subsequently been applied
to a variety of co-operative arrangements.  The
CPSS report concludes that these principles
continue to provide a useful framework for
international co-operative oversight and makes
clear that their scope is not limited to netting
schemes.  The revised principles are listed below.
Section 2.4 of this Oversight Report discusses the
role of these principles in the co-operative
oversight arrangements of which the Bank is a
member.
Principle 1 is relevant to any cross-border or
multicurrency scheme, while the remaining four
principles apply only to systems deemed to be of
sufficient relevance to more than one central bank
to warrant a co-operative oversight arrangement.
1:  Notification — ‘Each central bank that has
identified the actual or proposed operation of a
cross-border or multicurrency payment or
settlement system should inform other central
banks that may have an interest in the prudent
design and management of the system.’
2:  Primary responsibility — ‘Cross-border and
multicurrency payment and settlement systems
should be subject to oversight by a central bank
which accepts primary responsibility for such
oversight, and there should be a presumption that
the central bank where the system is located will
have this primary responsibility.’
3:  Assessment of the system as a whole — ‘In its
oversight of a system, the authority with primary
responsibility should periodically assess the design
and operation of the system as a whole.  In doing
so it should consult with other relevant
authorities.’
4:  Settlement arrangements — ‘The
determination of the adequacy of a system’s
settlement and failure-to-settle procedures in a
currency should be the joint responsibility of the
central bank of issue and the authority with
primary responsibility for oversight of the system.’
5:  Unsound systems — ‘In the absence of
confidence in the soundness of the design or
management of any cross-border or multicurrency
payment or settlement system, a central bank
should, if necessary, discourage use of the system
or the provision of services to the system, for
example by identifying these activities as unsafe
and unsound practices.’
(4) The principles were set out in the 1 990 Lamfalussy report, formally titled the Report of the Committee on Interbank Netting Schemes of the central banks of the
Group of Ten countries, and are available at:  www.bis.org/publ/cpss04.pdf.
19

PDF PAGE 22

20
Payment Systems Oversight Report 2005
I:
Legal basis
II:
Understanding
financial risks
III:
Management of
financial risks
IV:
Prompt final
settlement
V:
Settlement in
multilateral
netting systems
VI:
Settlement asset
VII:
Security and
operational
reliability
VIII:
Efficiency
IX:
Access criteria
X:
Governance
CHAPS
£ & €
CREST
£ & €
CREST
US$
LCH.
Clearnet
Ltd PPS(a)
BACS C&CC LINK UK
Maestro
Key Not
observed
Partly
observed
Broadly
observed
Observed N/A Under
review
Not
rated
2004
rating
Table B
Summary assessment of the main UK payment systems against the Core Principles
(a) The LCH.Clearnet Ltd Protected Payments System (PPS) enables settlement of obligations between LCH.Clearnet Ltd and its memb ers in twelve currencies.  
The assessment shown in Table B relates to the main three currencies settled, namely sterling, euro and US dollar.  One exception to the assessment shown in 
Table B is that the Bank continues to assess the UK PPS’s arrangements for US dollar settlement partly to observe Core Principle VI, and for the US PPS’s 
arrangements for US dollar settlement broadly to observe Core Principle VI (Annex C).

PDF PAGE 23

21
Payment Systems Oversight Report 2005
This chapter discusses developments in individual
UK payment systems during 2005.  It draws on
the Bank’s detailed Core Principles
assessments that have been updated from the
previous Oversight Report.
(1) These are available
in the annexes to this Oversight Report.  Table B
summarises these assessments.  In addition to
updated Core Principles assessments for CHAPS,
the payment systems supporting CREST and
LCH.Clearnet Ltd, BACS and the Cheque and
Credit Clearings, this Oversight Report introduces
Core Principles assessments for the LINK (ATM)
network and the UK Maestro card system.  It also
reviews, as last year, the main developments and
their implications for systemic risks in CLS and
SWIFT, two of the international infrastructures
for which the Bank is part of a co-operative
oversight process.  In addition, risks at other
main UK debit and credit card systems are again
reviewed.
As in the previous Oversight Report, the overall
message is encouraging:  the high standards
noted last year are being maintained.  The
broad direction is towards a further reduction
in systemic risk.  Overall, more UK payment
systems are now closer to observing the
minimum standards defined by the Core
Principles.  Among the risk-reducing initiatives
driven forward by some payment systems owners
and operators in the past year, the most significant
advances have been at LCH.Clearnet Ltd, BACS
and the Cheque and Credit Clearings.  Such work
— described in detail later in this chapter — has
resulted in more robust and resilient payment
systems.  This is reflected in their improved
assessments against the Core Principles.  The
expansion of CHAPS membership to include CLS
Bank and Abbey is also welcome.  At the same
time, there are still various areas where further
risk-reducing measures could usefully be
undertaken by each of the operators of UK
payment systems.  The main areas where further
improvements may be warranted are also set out in
this chapter.
3.1 CHAPS
The Bank assesses CHAPS (both CHAPS Sterling
and CHAPS Euro) to observe fully six of the nine
relevant Core Principles, with the other three
broadly observed.  This is unchanged from the
previous Oversight Report.  Although CHAPS is
clearly an effective and highly resilient system,
there are a number of outstanding areas where
observance of the Core Principles could be
reinforced.  The limited progress made by CHAPS
Clearing Company Ltd (CHAPSCo) in addressing
these areas over the past year suggests that a more
ambitious timetable for change may need to be
set.
The Bank attaches particular importance to the
mitigation of risk in CHAPS because of the very
high value of transactions processed by the system:
average daily values exceed £200 billion, which is
roughly equivalent to a sixth of annual UK GDP
(Chart 1).  CHAPS Euro typically processes daily
domestic euro transactions with a value of over
€30 billion and incoming and outgoing TARGET
transactions, both with a value of over
€1 10 billion.  Domestic CHAPS Euro and TARGET
values have risen strongly during 2005 (Chart 2).
Chapter 3: Updated Core Principles assessments
of the main UK payment systems
(1) The Bank’s approach to Core Principles assessments of UK payment systems is set out in Section 1.2 of this Oversight Report.
0
50
100
150
200
250
2001 02 03 04 05
0
30
60
90
120
150 Thousands £ billions
Value (right-hand scale)
Volume (left-hand scale)
Chart 1
Average daily volume and value of payments processed
in CHAPS Sterling
Source:  Bank of England.

PDF PAGE 24

On 3 1 December 2005, there were 1 4 members of
CHAPS Sterling (excluding the Bank of England),
an increase of two on last year.  Abbey and CLS
Bank, both of which joined CHAPS Sterling in
November 2005, are the first new CHAPS Sterling
members since ABN AMRO in 1 997 .  There are 1 8
members of CHAPS Euro (excluding the Bank),
unchanged from last year.
Settlement risk (Core Principles V , VI and IX)
CHAPS operates on a Real-Time Gross Settlement
(RTGS) basis, settling in central bank money.  This
means that credit risk exposures between CHAPS
members do not arise within the system.  However,
some settlement risk issues remain, associated with
tiering and in the unlikely event that CHAPS had
to invoke its tertiary contingency method:  the
operation of CHAPS Sterling when in ‘bypass
mode’ .
Tiering
Section 2.1 discusses how the highly tiered
membership structure of payment
arrangements for systems such as CHAPS Sterling
has potentially negative implications for
settlement risk.  The Bank therefore sees risk
benefits in a reduction in the degree of tiering
and has encouraged institutions to consider
joining CHAPS Sterling directly, especially if
payment values are large.  In this context, the
decisions by Abbey to join in 2005, and UBS AG to
join in 2007 , are welcome.
(1)
One step in addressing tiering in CHAPS Sterling
is to ensure that there are no unnecessary barriers
to membership of the system.  The previous
Oversight Report highlighted how the fixed costs of
joining CHAPS (including a £100,000 joining fee)
and fixed annual fees were high relative to other
systems (if not high in absolute value) and fall
disproportionately on lower -volume members.
Since then, CHAPSCo has reduced the joining fee
to £70,000.  The Bank believes there is scope for
reducing this fee further.
One consequence of the reforms to the sterling
money markets currently being implemented by
the Bank may be to make direct settlement
membership of CHAPS more attractive.
(2)
Following the reforms, CHAPS Sterling banks will
be able to use reserve accounts at the Bank,
remunerated at the Monetary Policy Committee
official rate, to support intraday payments.
Bypass mode
An area where settlement risk in CHAPS Sterling
may potentially emerge is in contingency
situations.  In the very unlikely event of an
operational problem at the Bank of England
preventing the settlement of payments on an RTGS
basis, CHAPS Sterling operates in ‘RTGS bypass
mode’;  that is, a multilateral deferred net
settlement (DNS) system.
(3)
As with other multilateral DNS systems, careful
consideration needs to be given to how the failure
to pay by a member in a net debit position would
be handled if CHAPS Sterling operated in bypass
mode, to ensure that settlement could complete in
a timely fashion and that credit risk exposures
between members were limited.  Over the past few
years, CHAPSCo has introduced procedures to
reduce potential exposures between members in
bypass mode.  For example, since 2003,
commercial bank settlement members have had
‘net sender caps’ to ensure that multilateral net
22
Payment Systems Oversight Report 2005
0
20
40
60
80
100
120
2001 02 03 04 05
 Inward TARGET 
Domestic CHAPS Euro
€ billions
Chart 2
Average daily value of CHAPS Euro payments and
payments sent to the United Kingdom via TARGET
(a)
Source:  Bank of England.
(a) The value of payments sent to the United Kingdom via TARGET is 
approximately equal to the value of payments sent out of the United Kingdom 
via TARGET.
(1) The decision by CLS Bank to join CHAPS Sterling is likely to have minimal implications for tiering, but is also welcome beca use of the potential benefits it 
could bring in reducing CLS operational risk (Section 3.5).
(2) More details can be found at:  www.bankofengland.co.uk/markets/moneymarketreform/index.htm.
(3) So far, it has never been necessary to use bypass mode.  There is no bypass mode for CHAPS Euro.

PDF PAGE 25

obligations to each other are limited.(1) However,
some weaknesses in the arrangements remain.  The
Bank has encouraged CHAPSCo to investigate and
put in place during 2006 more robust
arrangements for settlement in bypass mode.
Legal risk (Core Principle I)
A robust legal framework is critical to the overall
soundness of a payment system.  Taking into
account general legal principles and the
regulations that implemented the Settlement
Finality Directive in the United Kingdom, the Bank
believes that the UK legal framework provides a
sufficient and enforceable legal basis for the
operation of payment systems such as CHAPS.
Where systems like CHAPS have a cross-border
dimension (such as participants incorporated
outside the United Kingdom), laws in other
countries may also be relevant to the soundness
of the system.
During 2005, CHAPSCo largely completed
outstanding work to confirm that where settlement
membership is held by a branch of a bank
incorporated overseas, such a member has the
authority to commit itself to abide by the CHAPS
scheme rules, and that the home-country legal
system of the parent bank would not interfere with
the member’s ability to fulfil its obligations under
the rules.  The conclusion of this work will be an
important step towards CHAPS achieving full
observance of Core Principle I.
The Bank would like two other pieces of legal work
to be completed by CHAPS.  First, CHAPSCo is
looking to introduce requirements and processes
to ensure that it is made aware of changes to the
legal capacity of UK or foreign CHAPS members,
or to the legal framework of their relevant local
jurisdictions.  This should help mitigate the risk
that the legal soundness of the CHAPS systems
diminishes as a result of changes to legal capacity
occurring without CHAPSCo’s knowledge.
Second, the Bank has encouraged CHAPSCo to
review whether the lack of formal contracts
committing members to abide by the CHAPS
scheme rules and decisions of the CHAPS Board
represents an unnecessary risk.  Although it is
likely that a court would conclude that members
had implicitly agreed to abide by the rules, any
ambiguity would be eliminated through the use of
written contracts.  This is an approach recently
adopted in both BACS and the C&CC.
Governance (Core Principle X)
The previous Oversight Report highlighted the
desirability for CHAPSCo to consider proactively
how its governance arrangements might better
ensure that management pursued the interests of
all stakeholders.  Introducing Board representation
for stakeholders outside of the community of
CHAPSCo’s shareholders could help achieve that.
Given the systemic importance of CHAPS, there
may also be a case for CHAPSCo adopting systemic
risk considerations, alongside those of other
stakeholders, into the Company’s objectives.  The
Bank has therefore encouraged CHAPSCo to
review its governance arrangements in the context
of wider sector developments (Sections 2.3 and
4.1).
Operational risk (Core Principle VII)
The operational effectiveness of CHAPS is
dependent on the robust availability and security
of the different components of the system,
including the RTGS infrastructure provided by
the Bank of England, the information messaging
system provided by SWIFT, and members’ feeder
systems and interfaces with RTGS.  Over time,
CHAPSCo has developed a set of service level
agreements (SLAs), MoU, contracts, and internal
policies and procedures, to help ensure a robust
level of operational performance from all parties.
So far, these have proven effective, with another
year of robust operational performance in 2005.
RTGS
The recent operational performance of the
RTGS system has been strong, with only two
outages during 2005.  Both outages resulted in
the Bank missing a requirement under the
MoU with CHAPSCo to ensure that settlement
facilities are available for an average of at least
99.9 5% of the operating day over the course of
each month.
23
Payment Systems Oversight Report 2005
(1) The net sender caps ensure that multilateral net obligations do not exceed unused intraday liquidity that would have been av ailable from the Bank (if details 
of unused amounts are available) or £1 billion (if information on unused amounts is unavailable).

PDF PAGE 26

G On 28 February 2005, RTGS technical problems
meant that the opening of CHAPS was delayed by
20 minutes.
G On 1 8 July 2005, overnight technical problems
resulted in RTGS systems falling back from the
primary to the secondary processor.  Procedural
errors during the fallback meant that it took
longer than necessary, resulting in a delay to the
opening of CHAPS of 1 hour 1 5 minutes.
CHAPSCo and the Bank’s operational area have
processes in place to monitor, review and follow up
on operational incidents that affect RTGS.  These
processes have proved effective in ensuring that
technical errors and problems are dealt with and
rectified expediently.  However, it is also important
that the wider aspects of incidents are considered
and their potential implications fully understood.
Since the 1 8 July incident, the Bank has reviewed
the impact of developments such as split-site
working and 24-hour manning on staff resources,
and introduced arrangements to test system
fallback more regularly.
SWIFT
CHAPS experienced no downtime due to SWIFT
being unavailable during 2005.
CHAPS members
Member operational performance has been steady
in 2005.  The CHAPS Procedures set out various
guidelines for the service levels expected of
members, such as managing their payments so as
to minimise requests for cut-off extensions to the
daily CHAPS timetable.  During 2005, members
made recourse to fewer extensions, compared with
either of the previous two years, though a few
extensions were unusually long.
The previous Oversight Report highlighted the fact
that CHAPS relies on peer pressure (a so-called
‘Star Chamber’) to enforce service levels.  It was
suggested that, if member operational standards
were to slip, then CHAPSCo should investigate use
of more stringent disciplinary processes, such as
financial penalties.  The record on member
extensions over the past year suggests that such
change is not pressing.  Nevertheless, some further
consideration of what level of extensions is
acceptable may be worthwhile.
Business Continuity Planning (Core Principle VII)
CHAPS’ business continuity and recovery
procedures are extensive and of a high standard.
Important developments during the year to
strengthen resilience include the successful
introduction of split-site working for RTGS
operations.
Internationally, the benchmark for the resilience of
the most important parts of the financial
infrastructure has been rising.  It is therefore
appropriate to continue to review the adequacy of
CHAPS’ contingency arrangements and, if
necessary, look for ways to strengthen them further.
Given that bypass mode can provide CHAPS
Sterling with a further layer of contingency, it is
important that CHAPSCo addresses the associated
outstanding issues concerning settlement risk.  The
Bank has also encouraged CHAPSCo to put in place
arrangements that will help minimise the time
CHAPS Sterling would need to operate in bypass
mode following a major event.
3.2 TARGET
CHAPS Euro is the second largest component of
TARGET (the Trans-European Automated Real-time
Gross settlement Express Transfer system) by volume
and value of cross-border payments made (Chart 3),
and fourth largest for all payments (cross-border
and domestic euro payments).
24
Payment Systems Oversight Report 2005
0
5
10
15
20
25
30
Germany
United
Kingdom
France
Netherlands
Belgium
Italy
Other
 2003  2004 Per cent
Chart 3
Share of cross-border TARGET payments by TARGET
component
(a)
Source:  European Central Bank.
(a) Value of outward cross-border TARGET payments.

PDF PAGE 27

As a component of the TARGET system, CHAPS
Euro is subject to the collective oversight
arrangements of the Eurosystem.  Although these
arrangements are well established, work has been
ongoing to develop a consistent framework for
oversight across the 1 7 TARGET components.  The
recent development and implementation of a
TARGET Oversight Guide has been an important
milestone in this process.
Operational risk (Core Principle VII)
One of the outputs from the TARGET Oversight
Guide has been the development of a common
framework for reviewing and sharing information
on significant operational incidents affecting
TARGET components.  Such a framework is
particularly useful for understanding incidents
that affect multiple systems or have common
causes.  One such incident occurred in June 2005,
when technical problems experienced by a telecom
company that provides access to SWIFT network
services affected at least six different TARGET
components.  Although CHAPS Euro was not
directly affected, the incident highlighted
important issues concerning the robustness of
telecom services and the maintenance of resilient
telecom access.  The operational problems in
January 2005 (Section 2.2) were another example
of a single incident that affected multiple
infrastructures.
Looking forward, a key development is the
introduction of TARGET2, which is expected to go
live in 2007 .  In TARGET2 there will be a single
technical platform for processing and settling
payments, replacing the existing TARGET network
and its component RTGS systems, including
CHAPS Euro.  The Bank will not participate as a
direct member of TARGET2.
3.3 CREST
The Bank’s summary assessment of the payment
arrangements supporting CREST settlement is
unchanged from that in the previous Oversight
Report.  CREST’s sterling and euro payment
arrangements observe fully seven of the nine
relevant Core Principles.  By contrast, the US
dollar payment arrangements — and, most
notably, the interbank settlement of those
payments — fall short of full observance in a
number of areas (just three of the nine relevant
Core Principles are fully observed).  Some progress
has been made, however, in planning alternative
interbank settlement arrangements that, if
implemented, will help to address these
weaknesses.
Together with the FSA, the Bank is carrying out
an updated assessment of CREST against the
CPSS-IOSCO RSSS.  These cover a wider range of a
securities settlement system’s activities than the
Core Principles.  The full assessment will be
published in due course.
Chart 4 shows the daily value of sterling Delivery
versus Payment (DvP) transactions in CREST.
Averaging approximately £300 billion a day in
2005, these values are larger than those processed
in any other payment system overseen by the
Bank.
(1) CREST also provides for transactions to
be settled in euro and US dollars.  In 2005,
sterling equivalent daily averages for euro and US
dollar settlement were approximately £1 billion
and £1.2 billion respectively.
Settlement risk (Core Principles III, IV , V and VI)
CREST’s DvP settlement service provides
settlement of UK securities in sterling and euro
without any principal risk to participants.  The
25
Payment Systems Oversight Report 2005
(1) This figure does not include liquidity flows generated by the Self-Collateralised Repo mechanism.  This mechanism enables se ttlement banks to use certain 
categories of security as collateral for raising additional central bank liquidity on the platform.
0
50
100
150
200
250
300
350
400
July Nov. Mar. July Nov. Mar. July Nov.
£ billions
2003 0504
Chart 4
Sterling DvP transactions in CREST
Source:  CRESTCo.

PDF PAGE 28

interbank settlement arrangements for
transactions in US dollars are not, however, as
robust.  Obligations are settled through settlement
banks’ correspondents in the United States, on an
end-of-US-day bilateral net basis.  As a result,
settlement banks are briefly exposed intraday to
the risk that the bank from which they are due to
receive US dollars will fail to deliver.
Although US dollar settlement values remain small
relative to those for sterling settlement, they have
risen significantly since the beginning of 2004
(Chart 5) and are expected to rise further in the
future.
The possibility of developing a formalised and
suitably robust multilateral net settlement
arrangement is currently being investigated by
CRESTCo and the settlement banks.  Working with
CRESTCo, the Bank is conducting a cost benefit
analysis of these proposals.  The results will be
presented to settlement banks.  They will then
decide whether to proceed with the current
proposals and, if so, how the costs of
implementation should be spread.
The payment arrangements supporting CREST
sterling settlement are tiered:  cash settlement is
provided by 1 5 settlement banks to over 2,400
corporate and financial institutions and over
40,000 personal members.  The risks associated
with such tiering and possible mitigation measures
are discussed in Section 2.1.
Euroclear’s business plan (Core Principles I, VI, VII,
VIII and X)
On 1 January 2005, a corporate restructuring of
Euroclear created a new holding company,
Euroclear SA/NV, for the group’s operating
subsidiaries.  As a result, CRESTCo, Euroclear
France, Euroclear Nederland and CIK have become
sister companies to Euroclear Bank rather than its
subsidiaries.
(1) This new structure is intended to
create an appropriate framework to support
Euroclear’s business model and to help segregate
the national securities settlement systems from
Euroclear Bank’s small unsecured credit exposures.
The Bank of England is working with other
regulators and overseers to ensure that the new
structure achieves these aims.
While the merger and restructuring has had no
impact on the settlement process in CREST,
implementation of Euroclear’s long-term business
plan will have a significant effect.  This will have
implications, among other things, for settlement,
legal and operational risk in CREST.  Of particular
relevance to CREST is the migration of its
transaction processing onto Euroclear’s Single
Settlement Engine (the SSE), scheduled for August
2006, and the proposed migration of CREST’s
sterling central bank money settlement onto the
new Single Platform, scheduled for late 2009.
Migration to the SSE will coincide with the shift of
IT systems to new data centres in Continental
Europe.  In order to comply with the United
Kingdom’s Uncertificated Securities Regulations,
which require that records of legal title reside in
the United Kingdom, a separate system located in
the United Kingdom — the ‘Local Legal Record’
— will be built and incorporated into the
settlement process.  Together with the FSA, the
Bank is reviewing these arrangements to ensure
that the legal basis of settlement remains robust
and that operational risks are adequately managed.  
CREST central bank money settlement currently
takes place throughout the day, at the end of each
of over 600 processing cycles.  When CREST
migrates to the SSE in 2006, this cycles-based
processing will be replicated in so-called ‘pseudo
26
Payment Systems Oversight Report 2005
0
1
2
3
4
5
6
July Oct. Jan. Apr. July Oct. Jan. Apr. July Oct.
US$ billions
2003 04 05
Chart 5
US dollar transactions in CREST
Source:  CRESTCo.
(1) CIK joined the group on 1 January 2006, adopting the commercial name ‘Euroclear Belgium’ .

PDF PAGE 29

cycles’ .  As far as is consistent with settlement
efficiency, the Bank will seek to ensure that, upon
migration to the SSE, cycle duration is reduced
during periods when high settlement values are
generated.  This is desirable because a reduction
in cycle duration would increase the frequency of
information flow from CREST to the Bank (during
a cycle the Bank has no information on the
liquidity positions of individual settlement banks)
and would reduce the time taken to detect a
mid-cycle processing malfunction.
The Bank is working closely with CRESTCo,
Euroclear and other affected central banks to
ensure that the operational risk controls following
migration to the SSE and to the new data centres
are at least as resilient as current arrangements.
Indeed, in the light of the concentration of several
markets’ settlement activity on a single processing
platform, operational risk management and
business continuity arrangements may need to be
even more robust than in current national systems.
As part of the co-operative oversight arrangements,
a technical working group has been assessing
Euroclear’s project management.  This will be kept
under review as the projects move into the trialling
and implementation phases.
Integration of CREST sterling settlement onto the
Single Platform in 2009 will change the payment
arrangements fundamentally.  Euroclear’s proposal
is to introduce a harmonised ‘integrated’ central
bank money settlement model for the group’s
CSDs.  This will involve the outsourcing of the
operation of central bank money accounts to
Euroclear’s settlement platform.  This will contrast
with the current UK model, in which CREST
central bank money accounts are held by the Bank.
Cycles-based settlement will be replaced by
continuous settlement on a transaction by
transaction basis.
The Bank has accepted this integrated settlement
model, subject to the provision of monitoring and
control tools that effectively replicate the current
arrangements.  These will ensure that:
G overdrafts cannot occur on central bank money
accounts on the platform;
G the Bank has up-to-date data on each settlement
bank’s position on the platform for risk control
and crisis management purposes;  and
G the Bank has adequate control in the event of an
error in the system and, more generally, over the
automatic collateralisation process on the
platform.
If the Bank’s validation process were to indicate an
error in Euroclear’s settlement algorithm (for
example, an overdraft on a bank’s settlement
account), then the Bank would need to be able to
suspend UK settlement with immediate effect and
until the situation is rectified.  Such control is
vital from a central bank perspective, since it is
ultimately its balance sheet at stake.  The Bank
has set out these requirements in detail to
Euroclear.
The implementation of this business plan will
necessitate a reassessment of the system against
the Core Principles and the CPSS-IOSCO
Recommendations.  Arrangements for co-operative
oversight will also assume much greater
importance.  The effectiveness of current
co-operative arrangements is discussed in
Section 2.4.
The Bank is working with CRESTCo to devise
suitable payment arrangements for euro settlement
in CREST for the period between the launch of the
TARGET2 platform (in which the Bank will not be
participating directly) and CREST’s migration to
the Single Platform.
Operational risk (Core Principle VII)
Together with the FSA, the Bank monitors CREST’s
operational performance and business continuity
arrangements.  Overall, CREST provides a robust
and resilient service, achieving average settlement
availability of 99.8% in 2005.
3.4 LCH.Clearnet Ltd
Over the past year, LCH.Clearnet Ltd, the
London-based central counterparty (CCP), has
completed a number of workstreams to improve
observance of its Protected Payments System (PPS)
with the Core Principles.  The Bank now assesses
the UK PPS, for transfers made in sterling and
27
Payment Systems Oversight Report 2005

PDF PAGE 30

euro, to observe eight of the nine applicable Core
Principles.  This section highlights the work done
by LCH.Clearnet Ltd over the past year to improve
observance of the PPS with the Core Principles,
including the work to transfer the role of
concentration bank for sterling and euro payments
to the Bank of England.
Chart 6 shows the average value of payments made
between LCH.Clearnet Ltd and its members
through the 1 3 UK PPS banks.  The amounts are
small in comparison with those made through
most other systems overseen by the Bank.
However, a problem with the PPS could potentially
cause wide disruption to financial markets and
institutions, since LCH.Clearnet Ltd operates as
CCP in a number of markets, and the PPS forms a
critical element in the practical implementation of
LCH.Clearnet Ltd’s management of its
counterparty risk.
Financial and liquidity risk (Core Principles II
and III)
In the previous Oversight Report, the Bank noted
two particular weaknesses in the management of
financial and liquidity risks within the PPS.  The
first was that the PPS Agreement, under which PPS
banks conduct their business with LCH.Clearnet
Ltd, did not explain sufficiently the financial risks
that PPS banks incur.  The second weakness was
that there was no deadline by which PPS banks
had to submit payments to LCH.Clearnet Ltd’s
concentration bank accounts, other than a
requirement to submit before the CHAPS cut-off
time.  The concentration bank account is the
account used by LCH.Clearnet Ltd to gather all
positive balances from PPS banks, make payments
to PPS banks in a net credit position, and invest
surplus funds.  Many PPS banks were making
payments to the concentration bank late in the
day, exposing LCH.Clearnet Ltd to unnecessary
liquidity risk and resulting in LCH.Clearnet Ltd
needing to use intraday credit lines at the
concentration bank in order to meet its
obligations.
In April 2005, LCH.Clearnet Ltd introduced a new
PPS Agreement for UK PPS banks.  This includes a
more explicit description of the financial risks
incurred through participation in the PPS and
through performing particular tasks (such as
sending payment confirmation messages).  As a
result, the Bank now deems the PPS to observe
Core Principle II.
The new PPS Agreement also includes a requirement
for PPS banks to transfer funds to the relevant
concentration bank account no later than two
hours after LCH.Clearnet Ltd sends the payment
instruction (or before the CHAPS cut-off time,
whichever is sooner).  Non-financial penalties have
been introduced for PPS banks that consistently
fail to meet these deadlines, which require them to
explain why they have not complied and provide a
plan of action outlining how and by when they will
be able to comply.  If the PPS bank continues to
miss deadlines, LCH.Clearnet Ltd is entitled to
terminate that bank’s participation in the PPS.
The introduction of an appropriate deadline
together with procedures for non-compliance
brings the UK PPS into broad observance of Core
Principle III.
Chart 7 shows that since the introduction of the
new PPS Agreement, UK PPS banks are now
generally making transfers to the concentration
bank earlier in the day, and in particular within
two hours.  However, a few are still regularly
making payments beyond the two-hour deadline.
In order to reach full observance of Core Principle
III, the disciplinary procedures will need to prove
effective in ensuring that PPS banks consistently
pay within the required two hours over the coming
year.
28
Payment Systems Oversight Report 2005
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Feb. June Oct. Feb. June Oct. Feb. June Oct.
Euro Sterling US dollar
Other Total
2003 04
£ billion (equivalent)
05
Chart 6
Average daily flows over the UK PPS,(a) by currency
Sources:  LCH.Clearnet Ltd and Bank calculations.
(a) LCH.Clearnet Ltd Protected Payments System.

PDF PAGE 31

Settlement asset (Core Principle VI)
LCH.Clearnet Ltd’s concentration banks play a
critical role in the operation of the PPS.  The
failure of a concentration bank, or deficiencies in
its operating systems and procedures, would have a
significant impact on the functioning of
LCH.Clearnet Ltd as a CCP .  Over the past two
years, preparations have been made to transfer the
role of concentration bank for sterling and euro
payments to the Bank of England.  The transfer
successfully took place on 29 September 2005.  It
effectively eliminates any possibility of commercial
credit risk arising from the concentration bank in
these PPS currencies.  The Bank now deems the
PPS to observe Core Principle VI for transfers in
sterling and euro.
As shown in Chart 6, US dollar payment flows in
the PPS are the largest of all currencies.  Following
the completion of the sterling and euro
concentration bank project, LCH.Clearnet Ltd is
investigating ways of eliminating, or at least
reducing, credit risk in the US dollar payment
arrangements.  This would improve observance of
the PPS with Core Principle VI for transfers in US
dollars.  For other currencies, the impact of
concentration bank failure is not deemed
sufficiently large by the Bank for there to be a
need at this stage to eliminate the very small
probability of commercial bank default.
Operational risk (Core Principle VII)
The operation of the PPS is dependent on a
number of factors, including the ability of
LCH.Clearnet Ltd to conduct office-based treasury
operations.  Following the London bombings on
7 July 2005, LCH.Clearnet Ltd was required to
evacuate its head office and operate from its
secondary office site.  LCH.Clearnet Ltd regularly
tests operations from its secondary site, and key
staff were able to continue office-based operations
within two hours of evacuating head office.  PPS
operations were unaffected and took place
according to the normal timetable.  This was
within LCH.Clearnet Ltd’s planned two-hour
maximum recovery of business-critical functions,
already deemed fully to observe Core Principle VII.
The primary data centre, which is located away
from the head office, was unaffected.
Access criteria (Core Principle IX)
LCH.Clearnet Ltd has now introduced a publicly
available set of criteria for participation in the
PPS.
(1) These minimum criteria are based on the
financial and operational requirements needed to
maintain the smooth functioning of the PPS.
The Bank now deems the PPS to observe Core
Principle IX.
Co-operative oversight (Core Principle X)
In February 2005, the Bank and FSA, together with
Belgian, Dutch, French and Portuguese central
banks and regulators signed a MoU to promote
co-operation and co-ordination between the
LCH.Clearnet group regulatory authorities.
(2)
Since the signing of the MoU, the regulatory
authorities have jointly met with LCH.Clearnet
group on a regular basis to discuss matters relating
to the harmonisation of activities between the two
central counterparties, LCH.Clearnet Ltd and
LCH.Clearnet SA.  The Bank hopes that over the
next few years the MoU will prove to be an
effective tool for addressing regulatory concerns,
and will improve efficiency in communications
between LCH.Clearnet group and the regulatory
authorities.
29
Payment Systems Oversight Report 2005
0
1
2
3
4
5
6
7
Aug. 2004,
EUR, average
Nov. 05,
EUR, average
Aug. 04,
GBP , average
Nov. 05,
GBP , average
Transfer time (hours)
Chart 7
Sterling and euro transfer times August 2004 vs
November 2005
(a)
Sources:  LCH.Clearnet Ltd and Bank calculations.
(a) Each blue point represents a different UK PPS bank.
(1) The criteria for participation in the PPS can be found at:  www.lch.com/risk_and_margining/pps_bank_requirements.asp.
(2) The English version of the MoU can be found at:  
www.afm.nl/marktpartijen/upl_documents/Memorandum_of_Understanding_LCH_Clearnet_Groep_120505.pdf.

PDF PAGE 32

Additionally, in September 2005, the Bank and
FSA, together with the Dutch central bank De
Nederlandsche Bank, and Dutch regulator
Autoriteit Financiële Markten, signed a separate
exchange of information letter relating to the
LCH.Clearnet Ltd’s EnClear service, which is used
to clear trades conducted on the Dutch regulated
energy futures exchange operated by Endex.  This
exchange of information letter, which specifically
focuses on and is restricted to sharing information
on particular aspects of LCH.Clearnet Ltd’s
EnClear service, complements the wider MoU on
co-operation relating to the supervision and
oversight of LCH.Clearnet group activities.
3.5 CLS
Continuous Linked Settlement (CLS) is a system
designed to eliminate principal risk in the
settlement of foreign exchange transactions.  The
US Federal Reserve authorises the establishment,
and is the primary supervisor, of CLS Bank
International (CLS Bank), the institution that
provides the CLS service.  Together with the other
central banks (including the Bank of England)
participating in the co-operative oversight of CLS,
the Federal Reserve formally assesses the system
against the Core Principles.
Settlement and liquidity risk (Core Principle III)
Central bank overseers have continued to work
with CLS and its members in 2005 to ensure that
CLS’s risk management and operational
procedures are consistent with the Core Principles.
Central banks have also continued to monitor the
extent to which the CLS Inside/Outside (I/O) swap
mechanism, used by many settlement members to
reduce the liquidity pressures generated by their
pay-in requirements, reintroduces principal risk
outside the system.  An article in the December
2004 Financial Stability Review explained that UK
members of CLS consider the reintroduction of a
small proportion of foreign exchange principal risk
to be an acceptable cost for reducing the liquidity
risk that could otherwise result from having to
make large pay-ins to CLS Bank according to tight
deadlines.
(1) Chart 8 shows that the share of I/O
swaps as a proportion of the total principal risk
eliminated by the system remained relatively small
throughout 2005, averaging around 5%.  The
liquidity/principal risk trade-off in CLS therefore
remains acceptable.
CLS has been working with members to examine
ways of expanding the scope of the risk-reduction
and cost-saving benefits that it offers.  In
September 2005, CLS announced its intention to
offer, subject to regulatory approval, services for
the settlement of cash-flow positions for
non-deliverable forwards and foreign exchange
option premiums.  These services will be
introduced in a phased approach with
non-deliverable forwards targeted to go live
in 2006 Q4 and foreign exchange option
premiums in 2007 Q1.  Other possible new
services currently being considered for
introduction at a later date include additional
(later) settlement sessions for foreign exchange
trades, services for currencies not eligible for the
full CLS settlement service and settlement of cash
flows from some derivative products.
(2) Again,
overseers will be working with CLS to satisfy
themselves that the proposed new services are
30
Payment Systems Oversight Report 2005
(1) Sawyer, D (2004), ‘Continuous Linked Settlement (CLS) and foreign exchange settlement risk’ , Bank of England Financial Stability Review, December, 
pages 86–98.  This article also gives more information on the Inside/Outside swap mechanism, as well as setting out more broadly  issues relating to the 
contribution by CLS to reducing foreign exchange settlement risk.  It is available at:  www.bankofengland.co.uk/publications/fsr/2004/fsr1 7art5.pdf.
(2) Later settlement sessions could be used for settling same-day foreign exchange trades, which are agreed too late for settlem ent in the current main 
settlement window, and some of the current out legs of Inside/Outside swap transactions.  Services for non-eligible currencies could include the provision of 
bilateral netting information.
CLS total settled values (right-hand scale)
Inside/Outside swaps values (right-hand scale)
Inside/Outside swaps percentage (left-hand scale)
0
500
1,000
1,500
2,000
2,500
3,000
Jan. Apr. July Oct. Jan. Apr. July Oct.0
2
4
6
8
10
2004
US$ billionsPer cent
05Chart 8
Inside/Outside swaps(a)
Source:  CLS Bank International.
(a) The chart compares the average daily value of Inside/Outside swaps with the 
average daily total values settled in CLS.  It also shows the percentage of 
principal risk reintroduced outside the system by the Inside/Outside swap 
mechanism.

PDF PAGE 33

introduced without adding undue risks to the
system or its members.
Foreign exchange settlement risk
The central banks that oversee CLS are also
monitoring the long-term progress of the G10
strategy to reduce foreign exchange settlement
risk.  Chart 9 shows that values and volumes of
trades settled in CLS, and hence for which
principal risk is eliminated, continued to increase
in 2005.  Factors responsible for the growth
included a sharp increase in the number of
third-party users (from just over 200 at the end of
2004 to 657 at the end of 2005) and existing
members settling a larger share of their trades in
CLS.  Four more banks also became settlement
members at the end of 2004 (there are now 56 in
total) and four new currencies were added to the
system in December 2004.
The four new currencies — the Hong Kong dollar,
Korean won, New Zealand dollar and South African
rand — were, by 2005 Q3, accounting for an
average $56 billion of sides settled daily in CLS, or
around 3% of the total settled across all
currencies.
(1) Other new currencies may be
introduced into the system in the future if they
satisfy CLS’s eligibility criteria and the system with
the new currencies observes the Core Principles.
CLS appears to have captured a significant share
of the foreign exchange transactions of the largest
banks active in the foreign exchange market.  For
instance, in the United Kingdom, the four major
banks operating in the foreign exchange market
(Barclays, HSBC, RBS and Standard Chartered)
have been settlement members since CLS went
live.  They reported to the Bank that by 2005 Q3
they were settling on average between 40% and
65% of the total value of their foreign exchange
trades through CLS.  As anticipated in the previous
Oversight Report, other UK banks active in the
foreign exchange market have also started
participating in CLS as third-party users, as have
two UK building societies.  However, only a small
number of non-bank UK institutions are currently
third-party users.
Overall, estimates suggest that a substantial share
of global foreign exchange settlement may still be
taking place outside CLS.  This raises questions
about how the resulting settlement risk is being
managed and controlled.  Participation in CLS may
not be appropriate for all users of the foreign
exchange market, particularly those with small
volumes or total values of business.  Discussions
with settlement members, together with the latest
list of CLS members and third-party users,
indicate, however, that there are still financial
institutions and corporates with significant
volumes and values of foreign exchange business
that continue to settle outside CLS and therefore
may generate avoidable settlement risk.  Mindful of
these gaps in CLS’s market penetration, central
banks continue to assess what further action is
necessary to ensure the success of the G10
strategy to reduce foreign exchange settlement
risk.  As part of this process, they have decided to
undertake a survey to find out how banks and
other financial institutions currently settle their
foreign exchange transactions and how well the
ensuing risks are managed and controlled.  This
survey will be carried out in April 2006.
Operational risk (Core Principle VII)
Management of operational risk is given a high
priority by CLS and the overseeing central banks,
in particular to minimise the potential
cross-border impact of an operational failure
31
Payment Systems Oversight Report 2005
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
2,200
2,400
2,600
Sep. Mar. Sep. Mar. Sep. Mar. Sep.
0
20
40
60
80
100
120
140
160
180
200
220
240 Number of sides (thousands) US$ billions
2002 03 04
Volume (left-hand scale)
Value (right-hand scale)
05
Chart 9
Daily volumes and values settled in CLS (30-day moving
average)
(a)
Source:  CLS Bank International.
(a) The unit of measurement for trade volumes is ‘sides’ — there are two sides to 
each transaction.  Both sides are counted in the value figures.
(1) The other currencies settled in CLS are the Australian dollar, Canadian dollar, Danish krone, euro, Japanese yen, Norwegian krone, Singapore dollar, sterling, 
Swedish krona, Swiss franc and US dollar.

PDF PAGE 34

affecting any of its settled currencies.  Service
reports provided by CLS to its members and to the
overseeing central banks during 2005 show that
CLS experienced a few incidents of mainly low
severity that had little or no adverse impact on
settlement and pay-out target deadlines.  There
were no instances of the system failing to settle all
the transactions submitted to it at the start of its
settlement day.
CLS Bank uses the large-value payment systems
(RTGS or equivalent) of the currencies that it
settles to make and receive payments to and from
members.  Generally, it accesses these payment
systems either as a direct participant or, as in the
United Kingdom until recently, indirectly by using
the central bank as its correspondent.  While both
types of arrangement have worked well in practice,
the Bank of England believes that, given CLS
Bank’s critical role in the international payments
infrastructure, it should make and receive its
sterling payments with the minimum number of
possible points of operational failure.  To this end,
CLS Bank has removed a layer of operational
dependency in its sterling payments by joining
CHAPS Sterling as a direct member at the end of
November 2005.
3.6 BACS
BACS is the United Kingdom’s largest retail
payment system by volume, processing on average
around 20 million electronic payments (Direct
Debits, Direct Credits and standing orders) with a
value of around £12.5 billion each day during
2005.
(1) In the period 2003–05 volume growth
has accelerated, reflecting increased use of Direct
Credits to make state benefit payments.  In 2005
the total volume of BACS payments processed grew
by around 1 2% year -on-year (Chart 10), while the
aggregate value of those payments grew by 10%
year -on-year.
Last year, the Bank assessed BACS to observe six
Core Principles either fully or broadly, but to fall
short on three others — most notably Core
Principles III and V relating to settlement risk, but
also Core Principle IX relating to access criteria.
Over the past year, BPSL and its members have
made considerable efforts to improve observance
of these Core Principles, a proactive approach
that has paid dividends.  The Bank now assesses
BACS fully to observe four Core Principles and
broadly to observe a further five.  Only in
relation to Core Principle VIII, concerning
efficiency, does the Bank assess BACS to be
partly observant.
(2)
Legal risk (Core Principle I)
The previous Oversight Report assessed BACS
broadly to observe this Core Principle but noted
that a successful application for designation under
the UK settlement finality regulations would
strengthen observance.
BACS was designated under these regulations in
December and the Bank now assesses BACS fully to
observe Core Principle I.
(3) This assessment
reflects how the regulations are helpful for
mitigating systemic risk arising from uncertainties
surrounding the legal enforceability of a payment
system’s rules and its arrangements for dealing
with participant insolvency.  Specifically,
designation under the regulations provides that a
system’s rules shall take precedence over the
general provisions of insolvency law, such that
payments, once entered into the designated
payment system, continue to be subject to the
rules of the payment system (eg rules relating to
32
Payment Systems Oversight Report 2005
(1) BACS Payment Schemes Ltd (BPSL) is responsible for the Direct Credit, Direct Debit and standing order payment products.  The  core processing of these 
transactions is outsourced to a single third party — Voca Ltd.
(2) The previous Oversight Report did not assess BACS against Core Principle VIII (efficiency) on account of insufficient evidence.
(3) As described in Section 1.2, the Bank of England is the UK authority responsible for designating payment systems under the Financial Markets and Insolvency 
(Settlement Finality) Regulations (1 999), which implemented the EU Settlement Finality Directive (1 998) in the United Kingdom.
0
5
10
15
20
25
30
2001 02 03 04 05
Total
Standing orders
Direct Credits
Direct Debits Growth year-on-year (per cent)
Chart 10
Growth in BACS volumes by payment instrument
Sources:  APACS and Bank calculations.

PDF PAGE 35

irrevocability, calculation of multilateral net
amounts) notwithstanding the insolvency of a
participant.  The benefit of greater legal certainty
extends to the members and users of a designated
payment system.
Settlement risk (Core Principles III and V)
In the previous Oversight Report the Bank assessed
BACS not to observe the requirements of Core
Principle V, which states that a DNS system should,
at a minimum, be able to ensure timely completion
of daily settlement if the participant with the
largest obligation to the system is unable to meet
that obligation.  Following the implementation of
the Liquidity Funding and Collateralisation Agreement
(LFCA) in May 2005, the Bank now assesses BACS
broadly to observe this Core Principle.  The LFCA
(which also covers the C&CC) additionally
provides members of BACS with greater clarity
concerning liquidity and credit risks faced through
their participation in the system, such that the
Bank now assesses BACS broadly to observe also
Core Principle III.
Under the LFCA, settlement is completed by
recourse to committed liquidity, backed by
collateral.  In the event of a member failing to
meet its settlement obligations, liquidity to meet
the affected member’s obligations would be
provided by other members.  Those members
providing liquidity would then be reimbursed
(though not necessarily in full) through realisation
of collateral pledged by the affected member.
Committed liquidity would be drawn on first,
helping to avoid sale of collateral at distressed
values.
The total amount of liquidity committed is
determined by reference to historical multilateral
net debit positions of members in BACS and the
C&CC.  Currently, this is a little over £2 billion.
Within this, the amount of liquidity committed by
each member is determined by the amount of risk
it brings to the system.
(1) Members also pledge
collateral sufficient to ensure that the total pool of
collateral is equal to liquidity committed.  In the
event of a member’s failure to meet its settlement
obligations, the loss to each unaffected member is
measured by the liquidity it provides, less
recoveries from the affected member including
collateral pledged.  Such residual losses are a
direct claim on the defaulter or its liquidator.
(2)
The LFCA has significantly reduced settlement risk
in BACS (and the C&CC) but has not eliminated it,
because the obligations to the system of an
affected member could still exceed the amount of
liquidity committed by other members.
Functionality to cap debit positions within BACS
will be available through the NewBACS processing
platform, which is scheduled to be delivered in
2006.  Additionally, NewBACS will provide the
functionality to remove the payments of an
affected member (so-called ‘regression’).
Removing intraday exposures on the day of default
would reduce further the probability of the
affected member’s settlement obligations being
larger than the liquidity committed under the
LFCA.  Implementation of debit caps and
regression would thus further reduce settlement
risk in BACS, potentially delivering greater
observance of Core Principles III and V.
Even then, settlement risk would persist because
the LFCA covers both BACS and the C&CC and
debit cap functionality is not considered
practicable for the latter.  This means that BACS
members could face uncapped exposures to a
defaulted member who is also a member of the
C&CC, with those exposures in excess of liquidity
committed under the LFCA.  There is currently no
arrangement ensuring any such liquidity shortfall
would be met.  Given the very low probability of
such a shortfall occurring, any such arrangement
would need to be pragmatic in design but could
help BACS achieve full observance of Core
Principle V.
Operational risk (Core Principle VII)
The Bank continues to assess BACS broadly to
observe Core Principle VII.  Target levels of
performance that Voca must meet are specified in
33
Payment Systems Oversight Report 2005
(1) This is defined as the average of the sum of net debit settlement amounts for each member across BACS and the C&CC over the preceding twelve months, 
plus one standard deviation.
(2) The LFCA is considered in more detail in:  Bank of England (2005), Bank of England Financial Stability Review, June, pages 83–86, available at:  
www.bankofengland.co.uk/publications/fsr/2005/fsr1 8art4.pdf.

PDF PAGE 36

SLAs with members, and performance against
these targets is monitored by BPSL on a monthly
basis.  During 2005, performance was sound at all
stages of the payment process.  The availability of
channels through which BACS users can submit
payments to Voca for processing was typically in
excess of target levels and Voca delivered
processing output to members promptly.
Separately, cumulative delays to settlement at the
settlement agent were slightly longer during 2005
than during the previous year but remained
generally short in duration (Chart 1 1).
Even with such sound operational performance, it
is important for member banks to understand the
potential implications of a significant delay to
output from Voca, because costs could be imposed
on the users of BACS through disruption to
transactions.  If a delay of more than one day
occurred, members could be required to process
two or more days’ output in a single processing
day.  Agreed procedures for handling such a
backlog of payments do not currently exist but
would help to improve the operational robustness
of BACS.  Equally, agreed procedures would enable
member banks to have greater certainty regarding
the impact of a significant processing outage on
their customers.
One way that a delay to processing might occur
would be as a result of the unexpected financial
failure of Voca.  Although such a default could be
triggered by a number of events, its impact would
be operational.  Controls exist to mitigate this risk
— so-called business risk — if it were to
materialise, and these are explored further in
Section 4.3.  The Bank’s guidance has been for
Voca to hold capital in excess of six months’
operating expenditure, the rationale being that
this would be a sufficient period for Voca to
address any adverse financial shock before the
company’s operations (ie processing of BACS
payments) were endangered.  Recent agreement by
Voca’s shareholders to provide additional funds
will improve its financial robustness and help to
ensure that the company adheres to the Bank’s
guidance by 2007 .
NewBACS
The NewBACS project involves the upgrade of
Voca’s systems and networks which provide the
central infrastructure to BACS.  It is a large and
complex undertaking for BPSL, its members and
Voca.  The project is necessary to ensure BACS has
sufficient processing capacity for forecast payment
volumes.  Progress during 2005 has remained on
the critical path and the project’s completion
during 2006 should further improve the
operational robustness of the system.
The key deliverable of NewBACS is a new
processing platform.  This will not only deliver the
required processing capacity but also offer the
risk-reducing debit caps and regression
functionality already described.  From a user
perspective, NewBACS also provides a new
payment submission channel — BACSTEL-IP —
offering users greater security and faster payment
confirmation.  Migration of existing users to the
new channel continued during 2005, with BPSL
working to avoid any late surge in migration and
associated resource constraints ahead of the
end-2005 target completion date.
Management of risks to the NewBACS project has
been undertaken by several parties.  Voca has
sought — and obtained — independent
assurances regarding the suitability of the
proposed system design for its intended use.
Similar assurances regarding the quality of project
management processes have also been obtained.
BPSL and Voca have agreed on allocation of costs
associated with any delay to delivery of NewBACS,
including those relating to contingency
arrangements for the existing processing platform.
While the decision to establish contingency
34
Payment Systems Oversight Report 2005
0
20
40
60
80
100
120
140
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Minutes
2004 05
Chart 11
Settlement delays in BACS
Source:  Bank of England.

PDF PAGE 37

arrangements means that processing of payments
could continue even if delivery of NewBACS were
delayed, these potential costs provide a clear
incentive for Voca, BPSL and members to achieve
delivery of NewBACS to schedule.  It remains
essential that BPSL and Voca work together to
ensure an appropriate degree of member
engagement with the project and ensure that
problems involving the internal systems of BPSL
members do not cause material delays to the
overall project.  To that end, recent efforts by Voca
and BPSL to involve senior project sponsors at the
member level should help to ensure that all parties
remain committed to the project.
Practicality and efficiency of BACS
(Core Principle VIII)
The previous Oversight Report noted that growth in
the use of Direct Debits and Direct Credits was
indicative of BACS payment instruments being a
practical and efficient method for users to make
payments.  Continued growth in volumes during
2005 remains consistent with this view.
Faster payments
The Bank did not assess BACS against Core
Principle VIII in the previous Oversight Report, in
large part because work in this area was already
underway by the OFT Payment Systems Task Force
(Box 2).  That work was completed in May 2005,
and identified demand for shorter clearing cycles
for telephone and internet banking payments
across a range of user groups (Box 3).  This
suggests that some BACS payment instruments are
not as practical or efficient for some users as they
could be.  The industry’s response to the Task
Force’s findings has been to start work on building
a faster payments service to be operational by
November 2007 .  This service may attract some
volumes away from BACS and other payment
systems used for time-critical retail payments.
In the absence of a faster payments service, the
Bank has assessed BACS partly to observe Core
Principle VIII.  Although beyond BPSL’s direct
control, successful delivery of such a service
should help BACS to achieve greater observance,
because payments remaining within BACS will be
made through a payment system with a clearing
cycle of appropriate duration for users.
Nevertheless, reduction of the existing three-day
BACS cycle is not beyond BPSL’s control and work
by the Bank has shown that shorter interbank
clearing cycles would deliver benefits to users and
to the wider financial system.  BPSL could consider
these benefits further, weighing them against the
cost to members in terms of required changes to
their internal systems.
Access and governance (Core Principles IX and X)
The Bank assesses BACS broadly to observe Core
Principles IX and X.  Since the previous Oversight
Report, BPSL has worked to improve access and
governance arrangements.
In December 2005, BPSL introduced an Affiliate
membership class, enabling BACS users (eg
corporate users, consumer representative bodies)
to obtain information on and contribute to BPSL
Board discussions.  Because Affiliate membership
is open to any interested party, its introduction has
made access to the payment scheme more open,
without introducing additional risk to the
processing and settlement of payments in the
BACS system.  This has been reflected in the Bank’s
improved assessment of BACS against Core
Principle IX.
In terms of governance, during 2005 BPSL
implemented a broader scheme objective, one
which seeks to ensure that the scheme is
responsive to the needs of its users and actively
considers the need for innovation.  Given the
importance of BACS to the wider economy, this is a
positive step.  Nevertheless, the Bank still believes
that there is a case for the BPSL Board to be wider
in composition than the scheme’s ownership, to
help ensure that BPSL is transparent in its
decision-making and accountable to the wide
community of BACS stakeholders.
35
Payment Systems Oversight Report 2005

PDF PAGE 38

The Cruickshank Report (2000) first raised
concerns about competition in UK payment
systems.
(1) These concerns arose from the ‘network
effects’ in payment systems.  Network effects create
benefits for existing users of payment systems if
further users are added to the system, but can also
adversely impact on competition, efficiency and
innovation in payment systems.  Following the
Cruickshank Report, the payments industry carried
out a number of reforms to both infrastructure —
eg the initiation of the NewBACS programme —
and governance arrangements — eg BPSL, the
Cheque and Credit Clearing Company (C&CCC)
and CHAPSCo became more independent of the
Association for Payment Clearing Services (APACS).
The industry was reviewed again in 2003 by the
Office of Fair Trading (OFT), which found that
some competition concerns remained.
(2) Following
the Chancellor’s Pre-Budget Report in November
2003, a Payment Systems Task Force, to be chaired
by the OFT, was established to address these
concerns.  The Task Force seeks to bring together a
range of stakeholders to identify, consider and seek
to resolve competition, efficiency and incentive
issues related to payment systems.
(3) Government
legislation remains an option if the Task Force does
not resolve these issues.  The Task Force includes
representatives from consumer and business
associations, as well as the operators of UK
payment systems.  The Bank and HM Treasury
participate in the Task Force as observers.  The
Bank has a particular interest in issues related to
financial stability.
The first issue considered by the Task Force was
the scope for, and costs and benefits of, innovation
in BACS.  In May 2005 the Task Force published a
report which, while showing that BACS met many
of its users’ needs, identified demand for, and the
benefits of, shorter clearing cycles for telephone
and internet banking payments in the United
Kingdom.  One component of these benefits is the
reduction in settlement risk, discussed further in
Box 3.
The Task Force is currently considering the
demand for, and costs and benefits of, innovation
in the cheque clearings.
The Task Force is also examining the access and
governance issues of UK payment systems.  The
Bank places significant weight on good
governance, which it recognises as a key principle
of well-functioning financial infrastructures
(Sections 2.3 and 4.1).  The Task Force has
considered access and governance in the BACS
system and is currently considering these issues in
LINK.  The work of the Task Force in relation to
BPSL has led to a broader debate about
governance arrangements in the UK payments
industry.  The Task Force plans to examine access
and governance in CHAPS, and the debit and
credit card systems in 2006.
The Task Force is scheduled to examine the
broader issues of price inefficiency, transparency
and innovation in UK payment systems before its
completion in 2008 Q1.
Box 2:  OFT Payment Systems Task Force
(1) Cruickshank, D (2000), ‘Competition in UK banking’ , available at:
www.hm-treasury.gov.uk/documents/financial_services/banking/bankreview/fin_bank_reviewfinal.cfm.
(2) OFT (2003), UK Payment Systems, available at:  www.oft.gov.uk/NR/rdonlyres/10DB2458-FBD9-4B5C-9EE7-CEB7ACA472BB/0/oft658.pdf.
(3) More details are available at:  www.oft.gov.uk/Business/Payment+systems+task+force/default.htm.
36
Payment Systems Oversight Report 2005

PDF PAGE 39

Background
Both BACS and the C&CC currently operate to
a three-day interbank clearing cycle.  Payments
are submitted to the system on day 1, with the
net obligations relating to those payments
settled among the members of BACS and the
C&CC on day 3.  There are, therefore, up to
three open settlement cycles at any one time.
This increases the aggregate level of credit
exposures between members of the system.
Credit exposures can also arise between end
users of both BACS and the C&CC if an end
user receives a good or service before payment
for that good or service is received.  The duration
of this credit exposure may or may not coincide
with the length of the interbank clearing cycle.
The point at which the end user obtains cleared
funds is a competitive decision determined by
individual banks.
So as well as benefits associated with greater
efficiency and practicality, shorter interbank
clearing cycles could reduce settlement risk within
BACS and the C&CC.
Current position — Task Force and subsequent work
In 2005, under the aegis of the OFT-led Payment
Systems Task Force, the payments industry and
user -representative groups considered the case for
shortening clearing cycles for BACS payments.  It is
currently looking at the same issue for cheques.
The work of the Task Force has led to plans to
introduce an alternative payment service with a
shorter cycle.
The Task Force conducted research into demand
for a faster electronic payments service among
consumers and business users, as well as
undertaking a cost-benefit analysis of such a
service.  The Task Force’s work identified clear
demand for a faster payments service offering
same or next-day clearing for telephone and
internet banking payments.
(1) The Task Force
estimated annual net benefits to the UK economy
of such a service of between £7 5 million and
£1 34 million.
In response to the Task Force’s findings, the
payments industry has established a Faster
Payments Implementation Group (FPIG), with
responsibility for delivering a new faster payments
service by November 2007 .  It is being developed
on the basis of a ‘near real time’ service for users,
with multiple settlement cycles occurring during
the course of a processing day.
(2) Such a
specification will directly reduce settlement risk
because some payments operating on the
three-day interbank clearing cycle in BACS will
migrate to the new service.  Initial estimates
suggest that up to 10% of existing BACS volumes
could migrate from the outset, along with payment
volumes from other systems used to make same-day
retail payments, such as CHAPS.
(3)
The FPIG is currently working with Voca/LINK as
its chosen infrastructure provider to develop the
central payment processing system required for the
new service, which will be established as a new
payment scheme.
Shortening the BACS and C&CC clearing cycles
Through its membership (as an observer) of the
Task Force, the Bank supported introduction of a
new faster payments service on the basis of
reduced settlement risk.  However, because BACS
and the C&CC will remain on a three-day
interbank clearing cycle, a reduction in the
interbank clearing cycles for these systems would
yield benefits beyond those arising from the new
faster payments service.  Such benefits would
comprise reduced settlement risk and the reduced
cost of mitigating settlement risk.
Box 3:  Shorter clearing cycles
37
(1) Further detail can be found in the Payment Systems Task Force (2005) BPSL Innovation Working Group Report, May, available at:
www.oft.gov.uk/NR/rdonlyres/6A1BE3AB-F702-4292-84C9-D59BE8 1 6E966/0/oft789b.pdf.
(2) In a ‘near real time’ system, the account of a customer receiving a payment can be credited as soon as the receiving custome r’s bank receives confirmation of 
the transaction from the paying customer's bank.  In order to send confirmation to the receiving customer’s bank, the paying customer’s bank — following 
input of a transaction by the paying customer — must carry out a number of checks to authenticate the transaction and ensure th at the paying customer 
has sufficient funds in its account.  This confirmation process should take only a matter of seconds, hence the term ‘near real time’ .
(3) The implications of these and other initiatives on CHAPS volumes are explored in Bank of England (2005), Bank of England Financial Stability Review, 
December, pages 47–50, available at:  www.bankofengland.co.uk/publications/fsr/2005/fsr1 9art4.pdf.
Payment Systems Oversight Report 2005

PDF PAGE 40

Payment Systems Oversight Report 2005
38
The main control for settlement risk in BACS and
the C&CC is the Liquidity Funding and
Collateralisation Agreement (LFCA), under which
members commit to fund a shortfall up to the peak
exposure to any member in the previous twelve
months (Section 3.6).  In the previous Oversight
Report the Bank estimated that reducing both the
BACS and C&CC interbank clearing cycles by one
day would reduce the peak aggregate exposure to
any member (and hence the settlement risk posed
by members of the system) by £1 1 5 million.  There
would also be a welfare gain associated with this
reduction in settlement risk, through a reduction
in collateral committed under the LFCA.
Further work by the Bank has shown that
additional benefits of shorter clearing cycles in
BACS and the C&CC would arise through
reduction in the settlement risk faced by end
users of retail payment instruments.
(4) Such a risk
arises if end users choose to release goods or
services before payment is received, which they
might choose to do rather than incur inventory
and depreciation costs over the period the
payment takes to clear.
(5) End users can mitigate
this settlement risk with payment guarantee
services or insurance;  the insurance premia
represent in part a real resource cost.  Reducing
both the BACS and C&CC interbank clearing
cycles by one day would reduce the cost of
mitigating settlement risk associated with
payments received in arrears of goods and
services.
Of course, some payments will migrate from BACS
and the C&CC to the new faster payments service.
As mentioned previously, up to 10% of existing
BACS payments are expected to migrate from the
outset, reducing the benefits available from shorter
clearing cycles in BACS and the C&CC.  Some
benefits would remain but set against these would
be costs attached to investing in central
infrastructures and banks’ own systems.  The
payment schemes themselves would be well placed
to undertake further work assessing the magnitude
of such costs, allowing their members better to
assess whether or not there exists a clear business
case for shorter clearing cycles in BACS and the
C&CC.  For the latter in particular, the declining
use of cheques may weaken any such business case.
Nevertheless, for both systems the investment costs
would largely be one-off, whereas the benefits, to
both member banks and end users, would be
enduring.
(4) This assumes that any reduction in interbank clearing cycles is passed on to the end user, ie the end user obtains cleared f unds earlier. 
(5) To the end user, ‘settlement risk’ is the risk that an individual might default on their payment obligation following receip t of goods or services in advance of
payment.

PDF PAGE 41

3.7 The Cheque and Credit Clearings
The Cheque and Credit Clearings (C&CC)
enable instructions given in paper form
(cheques and paper credits) to be processed,
exchanged and settled between banks.  The
C&CC are managed by the Cheque and
Credit Clearing Company (C&CCC).  The
paper clearings process an average of around
7 .6 million payments each day, with a total value
of around £4.9 billion.  The number of C&CC
payments processed has fallen by around 46%
since 1 99 1, although the nominal value of
payments processed has remained relatively
constant over this period (Chart 12).
In the previous Oversight Report, the Bank
assessed the C&CC to observe six of the Core
Principles either fully or broadly.  This year,
the Bank assesses the C&CC to observe eight
of the Core Principles either fully or broadly.
This reflects improvements made by the
system during 2005.  The Bank has chosen not
to assess the C&CC against Core Principle VIII,
pending completion of work by the OFT Payment
Systems Task Force Cheque Working Group
(Box 2).  The Bank took the same approach in
relation to Core Principle VIII in the previous
Oversight Report.
Legal risk (Core Principle I) and settlement risk
(Core Principles III and V)
The C&CC are a deferred multilateral net
settlement system.  The Bank highlighted in the
previous Oversight Report that a drawback of
multilateral netting was the potential uncertainty
about who would bear any loss in the event of a
default by a member in a net debit position.  The
Liquidity Funding and Collateralisation Agreement
(LFCA), covering BACS and the C&CC, addresses
this uncertainty by defining procedures to manage
credit and liquidity exposures that would
crystallise in such a situation (Core Principle III).
Section 3.6 explains the LFCA in greater detail.
Following the introduction of the LFCA in
May 2005, the Bank assesses the C&CC to observe
broadly Core Principle V.  As with BACS, a residual
risk remains in the C&CC that the largest single
net debit position could exceed the value of
liquidity committed.  The Bank has encouraged the
C&CCC and BPSL to consider approaches to
reduce this residual risk, which would further
strengthen observance of Core Principles III and V.
In 2005, the C&CCC progressed work further to
establish clear procedures and incentives for the
management of credit and liquidity risks.  Once
completed, this work will enhance observance of
Core Principle III.  The C&CCC has developed a
process — due to be implemented in 2006 — that
will deal with significant errors in settlement figures.
Such errors increase settlement risk within the
system:  a member’s net debit settlement position
could be greater than the amount of liquidity
available to it.  The Bank considers this ‘high value
adjustment’ process to be a necessary control
against settlement risk, and encourages the C&CCC
to complete this project as soon as possible.
Members are also working to agree a Cheque and
Debit Recall Agreement, which aims to prevent a
liquidator seeking to return by way of the unpaids
process all cheques drawn on a failed member and
its customers.
(1) This would reduce legal, credit and
operational risk within the system, strengthening
the system’s observance of Core Principles I, II and
VII in addition to Core Principle III.
39
Payment Systems Oversight Report 2005
0
2
4
6
8
10
12
14
1991 93 95 97 99 2001 03 05
0
2
4
6
8
10
12
14
16
18
20
Value (right-hand scale)
Volume (left-hand scale)
£ billionsMillions
Chart 12
Average daily volume and value of payments processed
in the C&CC
(a)(b)
Sources:  APACS and Bank calculations.
(a) Volumes include items drawn on other branches of the same bank
(inter -branch).  Values only include those drawn on other banks.
(b) Changes in agency arrangements and individual member processing policies are
likely to have resulted in a proportion of inter -branch transactions being 
excluded from the volume data in 2005.
(1) There are instances in which a cheque could not be paid by the paying member bank.  For example, if the payer had insufficie nt funds in its account to 
cover the full value of the cheque.  The unpaids process is used to return to the collecting member bank those cheques that can not be paid by the paying 
member bank.

PDF PAGE 42

In the event of a member default, a surviving
member has two possible courses of action for
dealing with cheques drawn on itself and already
exchanged with the failed member but not yet
settled:  honour those cheques exchanged with the
failed member and settle its obligation in respect
of those cheques by way of the interbank
settlement;  or return the cheques as unpaid to the
failed member without settling them.  If a
surviving member returned cheques as unpaid,
then customers of the failed member might
recover the full value of these cheques deposited
by another route.  If a surviving member settled its
obligations to the failed member, customers of the
failed member might receive only a proportion of
the value, after liquidation of the failed member
had taken place.  A member, acting in its capacity
as paying bank, might face claims from customers
of a failed member, if it settled its obligations to
the failed member, rather than returning the
cheque as unpaid, and the customers did not
receive full value.  This is known as ‘conversion
risk’ .  The C&CCC has not undertaken a legal
investigation of conversion risk, hence the
existence and extent of the risk is unknown at
present.  The Bank has encouraged the C&CCC to
carry out such a legal investigation.
Additional legal assurance of the system’s default
arrangements could be forthcoming if the C&CC
were designated under the UK settlement finality
regulations.  This could further strengthen
observance of Core Principle I.  Members plan to
consider in 2006 whether to apply for designation.
Operational risk (Core Principle VII)
The Bank analyses a wide set of data on the
operational performance of infrastructure
providers to the C&CC and members of the
scheme.  A core piece of infrastructure for the
sterling cheque clearing — by far the largest
clearing within the C&CC by both value and
volume — is the Interbank Data Exchange (IBDE)
network, across which details of each cheque are
sent to members and which is used by the C&CCC
to compile multilateral net settlement figures.  The
IBDE network is currently supplied by Voca.
Notwithstanding occasional delays and errors, the
overall record of reliability of the IBDE network is
high.
Apart from IBDE, there is relatively little central
infrastructure.  Members are responsible for
processing their own cheques, and most have
chosen to outsource this function.  The C&CCC
monitors members’ operational performance
against a number of Service Level Codes (SLCs),
which provide targets for operational performance.
Targets are tightened periodically and used by the
C&CCC as a tool for continued improvement in
operational performance.  Members’ performance
against SLCs declined over the eight-month period
to end-January 2005 (Chart 1 3).  This temporary
decline can be attributed at least in part to a key
piece of work for the C&CC, its members and their
third-party suppliers to consolidate the
infrastructure used to process cheques and credits.
This programme of consolidation was subject to
delay and rescheduling.  The decline in
performance over this period is indicative of the
industry’s work to consolidate processing
infrastructure.  However, the deterioration in
performance against SLCs posed no risk to the
completion of interbank settlement.
The C&CCC worked in accordance with its
escalation procedures to deal with members’
decline in operational performance.  The C&CCC
has no formal relationship with third-party
suppliers of processing services, but sought to
open dialogue with suppliers in 2005 to help
resolve some of the problems surrounding the
programme of infrastructure consolidation.  The
Bank also discussed operational performance with
both the C&CCC and some of the third-party
suppliers involved.  Operational performance has
40
Payment Systems Oversight Report 2005
Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep.
1 2 3 4 5
052004
C&CC members 
0
1
2
3
4
5
6
7
8
9
10
11
Chart 13
Operational performance against Service Level Codes(a)
Sources:  C&CCC and Bank calculations.
(a) Performance is categorised from 1 to 5, with 1 being the best performance.

PDF PAGE 43

41
Payment Systems Oversight Report 2005
improved gradually since March 2005.  This issue
might, however, have been resolved earlier if the
C&CCC had exercised its existing indirect rights to
audit members’ third-party suppliers.  At present,
the C&CCC relies on members to self-certify their
compliance with the C&CCC’s control objectives.
Access and governance (Core Principles IX and X)
The C&CCC has undertaken a number of access
and governance changes through its Scheme
Governance Steering Committee, which was
established to review the system’s current access
and governance arrangements.  In December 2005,
members agreed to sign the Membership Agreement
committing them to abide by the rules and
decisions of the Company Board.  This strengthens
the system’s observance of Core Principle I.
The committee is currently reviewing the system
rules to address, among other things, any gaps in
the membership criteria.  The Bank highlighted in
the previous Oversight Report that one such gap was
an absence of any procedure to deal with a
settlement member whose credit quality
deteriorated to an extent that brought a high level
of financial risk to the multilateral settlement.  The
Bank expects the C&CCC to address this issue as
part of its governance review.  This would
strengthen observance of Core Principle IX.  The
C&CCC plans to complete the review of the system
rules in 2006.
The C&CCC Board has the incentives and tools to
pursue the interests of the system and its
settlement members.  Incentives for the Board to
pursue the interests of the public and the wider
economy are generally less clear.  The Bank
believes that there may be a case for the C&CCC
to consider the case for independent or further
public interest representation on the Board.  This
would strengthen observance of Core Principle X.
3.8 LINK
The LINK card scheme (the Scheme) is the United
Kingdom’s largest ATM network, which enables its
members’ customers to withdraw cash from all but
a few of the United Kingdom’s ATMs.  The LINK
Interchange Network Ltd encompasses both the
Scheme and its infrastructure provider (the
Company).  The Company provides transaction
switching for members of the Scheme, by routing
transaction information from the ATM used by the
customer to the card issuer’s own computer
network.  The LINK Interchange Network is a
for -profit, limited company owned by a subset of
the members of the Scheme.
In the year to December 2005, the LINK
Interchange Network Ltd processed a daily
average of 6.7 million transactions (mainly cash
withdrawals) with an aggregate value of around
£260 million.  Chart 1 4 shows that the number
of transactions processed by LINK rose by over
1 50% between 2000 and 2005.  However, growth
in transaction volumes has been slowing since
2002.
In 2005, the Bank carried out its first full
assessment of the Scheme against the Core
Principles (Annex F).  The Bank assesses the
Scheme to observe eight of the Core Principles
either fully or broadly, but to fall short of this for
the two others;  Core Principles I and III.  These
relate to settlement risk.
Settlement risk (Core Principles I, II, III, IV and V)
LINK is a deferred multilateral net settlement
system.  This means that payments submitted
are netted to produce a single obligation to, or
claim on, the other participants of the system.
Net settlement is carried out across accounts at
the Bank of England.  Net settlement obligations
are around 10% of the value of those in BACS and
30% of the value of those in the C&CC.
0
50
100
200
250
300
350
2000 01 02 03 04 05
0
1
2
3
4
5
6
7
8
Volume (left-hand scale)
Value (right-hand scale)
£ millions  Millions
150
Chart 14
Average daily volume and value of payments processed
in LINK
(a)(b)
Sources:  LINK Interchange Network Ltd and Bank calculations.
(a) Data for earlier than 2000 are not available.
(b) Volumes include non-cash withdrawal transactions (such as balance enquiries).

PDF PAGE 44

Multilateral netting can reduce credit exposures
within the system.  Under current procedures, in
the event of the default of a participant in a
multilateral net debit position, the Scheme would
unwind the multilateral netting.  Credit exposures
would be lower if the multilateral netting were
retained.  Legally robust multilateral netting would
need to be coupled with a procedure to share any
losses that arose following a participant default.
The Bank has encouraged the Scheme to examine
current default arrangements and consider ways to
reduce credit exposures within the system.
Additional assurance of the enforceability of the
system’s default arrangements might later be
obtained if the Scheme were designated under the
UK settlement finality regulations.
The Bank has also suggested that the Scheme
consider ways to improve settlement risk
management.  In the past, there have been
insufficient controls on credit and liquidity risk
and little incentive for participants to manage
settlement risk effectively.  Reforms agreed in
2005 will, however, improve the management of
credit and liquidity risk, and strengthen
participants’ understanding of the financial risk
they incur through participation in the system.
For example, the Scheme has agreed new rules,
which will take effect after a trial period in early
2006 to encourage timely funding of settlement
accounts by participants in a net debit position.
This should help to address the frequent number
of delays to settlement in LINK (Chart 1 5).  The
company is developing technology that will enable
the Scheme to monitor settlement positions
intraday and impose debit caps on participants’
settlement positions.  This could be used to
impose controls on participants that bring
additional settlement risk to the system.  The
technology is due to be launched in stages over
the next two years.  Completion of this work
should lower settlement risk in the LINK system
and thereby boost observance of the associated
Core Principles.
Governance (Core Principle X)
Over the past two years the LINK Interchange
Network Ltd has sought to increase the degree of
separation between the Scheme and the Company,
but has chosen not to pursue legal separation of
the two entities.  Governance arrangements would
be more transparent and accountable if reporting
lines within the Scheme and the Company were
clearer.
To increase the effectiveness of its governance,
LINK has appointed independent chairmen to the
governing bodies of both the Scheme and the
Company.  As part of governance reforms, the
LINK Interchange Network Ltd is considering the
appointment of an additional independent
director to the Company Board.  There would also
be merit in the Scheme considering the
appointment of further independent
representatives to its governing body, the Network
Members Council.
A review of access and governance arrangements in
the LINK Interchange Network Ltd is taking place
under the aegis of the OFT-led Payment Systems
Task Force (Box 2).
3.9 Debit and credit card systems
Visa Europe, MasterCard Europe and S2 Card
Services manage the main credit and debit card
systems in the United Kingdom.  S2 Card Services
is the management company for the UK domestic
Maestro (formerly Switch) and Solo schemes.
Together, the systems process an average of
3 1 million electronic payments worth around
£1.7 billion a working day (Charts 1 6 and 1 7).
The Bank has assessed the UK domestic Maestro
scheme against the Core Principles.  The Bank
assesses the UK domestic Maestro scheme to
42
Payment Systems Oversight Report 2005
Range of daily net settlement time
Average daily net settlement time
10.30
11 . 3 0
12.30
13 . 30
14 . 30
15 . 30
16 . 30
Apr May June July Aug. Sep. Oct. Nov. Dec.
Time settled
2005
.
Chart 15
Time of daily LINK multilateral net settlement(a)
Sources:  Bank of England and Bank calculations.
(a) LINK daily settlement should take place by 1 1.30.

PDF PAGE 45

observe fully or broadly eight of the Core
Principles already.  There are, however, several
areas where the overall level of observance of the
Core Principles could be improved.  Further
information on this can be found in the full
assessment in Annex G.
While the Bank has not conducted a full
assessment of either the Visa credit and debit or
MasterCard credit schemes, it continues to liaise
with both to establish that their settlement
arrangements for sterling transactions and
business continuity arrangements are consistent
with the standards set by the Core Principles.
Whereas management of the UK domestic Maestro
scheme lies with UK-based S2 Card Services,
management of the MasterCard credit and Visa
credit and debit schemes is conducted to a greater
extent on an international basis.  Given this, the
Bank is continuing to discuss with other central
banks how they can best co-operate to oversee
these schemes.
At a European level, in the past year the Bank and
ECB have increased co-operation in collecting
information relevant to the oversight of Visa
Europe, whose European operations are based in
the United Kingdom.  This co-operation has
enabled both parties to gain a better
understanding of the recently introduced clearing
and settlement arrangements for euro
transactions.  Visa Europe satisfied the Bank that
they have failure-to-settle arrangements for this
service, which allow the timely completion of
settlement if the participant with the largest net
debit is unable to settle, as recommended by Core
Principle V.
In September 2005, the migration of
authorisation, clearing and settlement processing
of UK Maestro and Solo transactions onto
MasterCard Europe platforms was completed.  As
part of this, interbank settlement arrangements for
UK domestic Maestro and Solo transactions
changed from a series of bilateral net payments
through CHAPS, to multilateral net settlement
under MasterCard Europe arrangements.  In line
with Core Principle V, the new arrangements
include procedures to complete settlement in the
event that a member defaulted.  The Bank
obtained assurance from MasterCard that
MasterCard International’s pool of liquid resources
and credit lines were sufficient to meet the largest
single settlement obligation, consistent with Core
Principle V.
3.10 SWIFT
SWIFT provides secure messaging services to
financial institutions and market infrastructures
covering 7 ,800 users in over 200 countries.  Five
market infrastructures of importance to the
financial stability of the United Kingdom (CHAPS,
CLS, CREST, LCH.Clearnet Ltd and TARGET) all
use SWIFT.  For this reason, even though SWIFT is
43
Payment Systems Oversight Report 2005
0
2
4
6
8
10
12
14
16
18
1993 94 95 96 97 98 99 2000 01 02 03 04
MasterCard(b)
Visa
S2 Card Services(b)
Other systems
Millions
Chart 16
Average daily volume of payments through the debit
and credit card systems
(a)
Sources:  APACS and Bank calculations.
(a) Data include ‘on-us’ transactions (where the merchant and cardholder use the 
same member/Licensee).  ‘On-us’ transactions are processed internally by the 
member/Licensee.
(b) Since 2004 S2 Card Services’ transactions have been processed by MasterCard.  
Average daily volume of transactions processed by MasterCard in 2004:
1 4.9 milliion.
0
100
200
300
400
500
600
700
800
900
1,000
1993 94 95 96 97 98 99 2000 01 02 03 04
MasterCard(b)
Visa
S2 Card Services(b)
Other systems
£ millions
Chart 17
Average daily value of payments through the debit and
credit card systems
(a)
Sources:  APACS and Bank calculations.
(a) Data include ‘on-us’ transactions (where the merchant and cardholder use the 
same member/Licensee).  ‘On-us’ transactions are processed internally by the 
member/Licensee.
(b) Since 2004 S2 Card Services’ transactions have been processed by MasterCard.  
Average daily value of transactions processed by MasterCard in 2004:
£77 6 million.

PDF PAGE 46

not a payment or settlement system itself, its
services are of systemic importance to the
United Kingdom.
The Bank participates with other G10 central
banks in the co-operative oversight of SWIFT, with
the National Bank of Belgium as lead overseer
(SWIFT’s headquarters are in Belgium).  The
objective of overseers is to seek satisfaction that
SWIFT appropriately manages risks to its
operations that could otherwise threaten the
smooth functioning of the international financial
system.  Over the past year, further improvements
have been made to the arrangements for
co-operative oversight.  For example, SWIFT’s
external security auditors had concerns about
sharing information with overseers;  these
concerns have now been addressed and overseers
have subsequently met with them to discuss
SWIFT’s Statement on Auditing Standards Number 7 0
(SAS 70) report.  As suggested in the previous
Oversight Report, collective work by overseers is also
now under way to establish a more structured
framework for the assessment of SWIFT’s
operational risk management.  While the Core
Principles are not designed to be directly
applicable to SWIFT, operational risk (Core
Principle VII) and governance (Core Principle X)
have continued to be a major focus of the Bank’s
oversight activities.
Operational risk (Core Principle VII)
Since the previous Oversight Report, SWIFT has
maintained strong availability of its critically
important FIN messaging service (Chart 1 8)
despite a period of technological change.  The
target availability of 99.964%
(1) has been achieved
for each of the past twelve months.  SWIFT has also
further enhanced its resilience capabilities.
(2)
The Bank welcomes SWIFT’s focus on resilience
and believes that further communication on this
topic would benefit the SWIFT user community, so
that they can plan their own contingency
arrangements accordingly.  During regular testing
of its disaster recovery capability this year, SWIFT
uncovered some organisational and operational
issues which it is now addressing.  This reinforces
the value of such testing and the importance of
ensuring the user community is well represented
in such testing.  More generally it underlines the
importance of continuous improvement in the area
of resilience and testing, to which SWIFT is
committed.
The ‘SWIFTNet FIN Phase 1’ project was
completed at the beginning of 2005.  This project
migrated FIN customers from X.25, a network
technology that is considered out of date (with
associated operational risks) to more widely used
internet-based network technologies.  Active
planning for the complete lifecycle of the usage of
technology can significantly contribute to the
management of operational risks.  In this context,
the completion of this project is welcomed by the
Bank.
In September 2005, SWIFT launched ‘SWIFTNet
FIN Phase 2’ , a project to improve the management
of security in the FIN service.  This is scheduled to
complete rollout by the end of 2008.  Prior to
launch, SWIFT responded positively to
consultation on its proposals, introducing
additional security measures to address
deficiencies that had been identified in those
proposals.  The Bank believes that the project has
benefited considerably from the widespread
consultation that SWIFT initiated among its user
community.  SWIFT should continue to consider
44
Payment Systems Oversight Report 2005
(1) This is a ‘weighted availability’ target calculated by SWIFT on the basis of the volume of traffic affected.  Individual SWIFT users may experience lower 
availability.
(2) Schrank, L (2005), ‘The road to 20 10’ , presentation to the SIBOS conference, available at:  www.swift.com/index.cfm?item_id=57798.
99.80
99.85
99.90
99.95
100.00
June Sep. Dec. Mar. June Sep. Dec.X.25 FIN Service
SWIFTNet FIN Service
FIN Service Target
05
Per cent
2004
00.00
Chart 18
Weighted availability of SWIFT FIN(a)
Source:  SWIFT.
(a) Weighted availability is calculated by SWIFT.  It takes into account the 
percentage of SWIFT users without access to SWIFT services and the length of 
time they are without this access.

PDF PAGE 47

45
Payment Systems Oversight Report 2005
the end-to-end security of SWIFT services as well
as the security of SWIFT-managed components.
Governance (Core Principle X)
During the past year, SWIFT has continued to
enhance its internal audit function, with the
appointment of a new head of internal audit, the
internal audit charter being revised and the
internal audit methodology enhanced.
More broadly, Core Principle X states that
effective governance provides incentives for
management to pursue objectives in the interest
of the system, its participants and the public
more generally.  In the Bank’s view, SWIFT’s
forward-looking strategy for corporate governance
will need to ensure accountability both to its
member -shareholders and to those users that are
not direct member -shareholders.
SWIFT recognises this challenge and believes that
debates on governance should be stimulated
within SWIFT.
(1) SWIFT believes that the entrance
of corporate users could act as a catalyst to review
its membership and participant structure.  The
Bank believes that there may also be scope for
greater input from market infrastructures, which
account for a growing — and systemically
important — share of SWIFT traffic.  SWIFT’s
ongoing dialogue with G10 central banks is
another example of how broader market and
public interests can be incorporated into SWIFT’s
decision-making and governance processes.
SWIFT is keen to enhance further the experience,
standing and expertise on the SWIFT Board.  One
practical development is that SWIFT has reviewed
and strengthened Board profiles outlining the
expected attributes of Board members.  The Bank
welcomes this initiative and looks forward to
future governance initiatives by SWIFT.  For
example, the Bank continues to believe that Board
members drawn from outside SWIFT’s user
community — independent directors — could be
one effective vehicle for enhancing the experience,
standing and expertise of the SWIFT Board.
(1) Kamp, J (2005), ‘Transformation and SWIFT’ , presentation to the SIBOS conference, available at:  www.swift.com/index.cfm?item_id=57797 .

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46
Payment Systems Oversight Report 2005
The previous Oversight Report noted that the Core
Principles ‘offered only a minimum standard’ , and
that ‘in some cases, national and international
standards of best practice have evolved since the
Core Principles were published’ , back in 200 1.
(1)
This chapter sets out some of the Bank’s oversight
priorities for 2006 and beyond, in some cases
arising from the implementation of its new
risk-based framework for oversight (Section 1.3
above).  In the Bank’s view, the work described in
this chapter could usefully inform any future
international discussions on updating and
extending the Core Principles.
There are areas where the Core Principles have
identified an issue, and best practice has since
moved on.  These include operational risk
(specifically, business continuity planning —
Section 2.2 above), governance (Section 4.1
below) and transparency (Section 4.2 below).
Elsewhere, an extension to the Core Principles
might be warranted where they currently do not
provide for a means of assessing a risk:  for
instance, business risk (Section 4.3 below).  Nor
do the Core Principles capture fully either the
systemic risks arising from interlinkages between
payment systems (Section 4.4 below), or the
increasing overlap in the services provided by
systems and banks (Section 4.5 below).  While the
Core Principles themselves may not be suitable for
taking account of these latter two issues, they
highlight the importance of supervisors and
overseers working collaboratively when using the
Core Principles and other international standards
to assess risks.
4.1 Corporate governance and financial infrastructures
As set out in Section 1.1, privately operated
payment systems may not sufficiently invest to
control operational, credit, liquidity and business
risk.  This can be partly addressed through means
that ensure the inclusion of the public interest in
the decisions of payment system operators.
Ensuring good governance is, perhaps, the most
flexible method of doing so since it keeps public
intervention in payment systems’ decision-making
to a minimum.
(2)
Core Principle X broadly outlines how good
governance can be achieved:  ‘Those who make up
the governing body of a systemically important
payment system should be accountable both to the
system’s owners and the wider community of
users....  Representation on the governing body is
one such means.’
The Core Principle does not lay out the
specific means by which such accountability
can be achieved.  Several options are available.
Close contact between operators and central
banks is one such option.  Other arrangements
could integrate public-interest representation
directly into a payment system operator’s
decision-making.
In the Bank’s view, the most promising
arrangement involves the direct representation of
external stakeholders on the decision-making
bodies.  For example, recent recommendations by
the Irish Competition Authority on a reform of the
Irish payment system are instructive:  these
propose an arrangement in which management
and operation of Irish payment systems are
combined into one entity with a single, unified
board of directors.  This board should primarily
deal with strategic issues and include other
stakeholders.  Committees under the board should
deal with specific technical matters requiring
specialised skills.
(3)
There may be benefits in ensuring board
representation is broader than the ownership of a
Chapter 4: Issues and priorities for future work
(1) Bank of England (2004), Payment Systems Oversight Report, page 1 1, available at:  www.bankofengland.co.uk/publications/psor/psor2004.pdf.
(2) The importance of good governance for mitigating principal-agent problems and systemic risk in a framework of self-regulatio n was briefly discussed in the 
previous Oversight Report, page 5 1.
(3) The Competition Authority (2005), ‘Competition in the (non-investment) banking sector in Ireland’ , available at:  
www.tca.ie/banking/banking_report_final.pdf.

PDF PAGE 49

payment system, particularly where the community
of external stakeholders (ie those without an
ownership stake) is wide.  Additionally, system
operators could adopt into their objectives the
interests of all stakeholders, including systemic risk
considerations.  Board representation for external
stakeholders could help to ensure that such
interests are taken into account by the board.
Correctly appointed, such representatives could
also bring other benefits to board discussion, such
as their specific expertise and broader strategic
vision.
Over the coming year, the Bank will continue to
explore the implications that different governance
arrangements for financial infrastructures have for
systemic risk.
4.2 Transparency
Transparency is recognised in the Core Principles
as an important tool for promoting financial
stability.  Two distinct, though related, aspects of
transparency are identified:  (i) public disclosure
by central banks of their roles and responsibilities
with respect to payment systems;  and (ii) public
disclosure by payment system operators of their
rules and procedures to allow participants to
develop a clear understanding of the potential
risks they face.  With regard to both aspects, a case
can be made that best practice has evolved since
the publication of the Core Principles.  An
extension of the Core Principles to capture recent
innovations would therefore be desirable.
Public disclosure by central banks
The CPSS report on the Core Principles
(1) sets out
four responsibilities that a central bank should
meet when applying the Core Principles.
Responsibility A states that a central bank should
‘define clearly its payment system objectives and
should disclose publicly its role and major policies
with respect to systemically important payment
systems’ .  The accompanying text explains that
transparency of this kind improves central bank
accountability by providing a benchmark by which
the public can judge its success in achieving its
objectives.  It goes on to specify that appropriate
disclosure of major policies should include
identifying systems that are systemically important,
and might also outline the steps that the central
bank would take if it judged that a system did not
comply with the Core Principles.
However, the Core Principles stop short of
recommending that a central bank should
consider disclosing its Core Principles assessment
of systemically important payment systems.  By
publishing in this Oversight Report its assessment of
payment systems with which it maintains an
ongoing oversight relationship, the Bank aims
further to enhance its accountability, and to
provide greater clarity to payment system operators
on areas where opportunities exist to strengthen
further their systems and risk controls.  In
addition, such disclosure promotes awareness and
understanding among users, of risks that may arise
in payment systems.  This could improve discipline
imposed on system operators by users, and
ultimately has the potential to strengthen public
confidence in payment systems.  A
recommendation that central banks consider
publication of their Core Principles assessments
could usefully be incorporated into any extension
or revision of the Core Principles.
Public disclosure by payment system operators
Core Principle II requires that ‘the system’s rules
and procedures should enable participants to have
a clear understanding of the system’s impact on
each of the financial risks they incur through
participation in it’ .  This imposes clear
requirements on operators of payment systems
to disclose key rules relating to financial risks to
their users.
The explanatory text, however, does not
recommend that a system operator should disclose
information on the degree of the system’s
observance of the Core Principles.  In contrast,
such a disclosure requirement is included in the
CPSS-IOSCO Recommendations for Central
Counterparties, published in 2004.
(2)
Recommendation 1 4 on Transparency states that
CCPs should disclose their answers to the key
47
Payment Systems Oversight Report 2005
(1) Available at:  www.bis.org/publ/cpss43.htm.
(2) Available at:  www.bis.org/publ/cpss64.htm.

PDF PAGE 50

questions in the report.  A similar requirement for
CSDs is stated in Recommendation 1 7 of the
CPSS-IOSCO RSSS.
(1)
Disclosure of a system’s self-assessment against the
Core Principles is likely to enhance users’
understanding of the costs and risks that they are
exposed to as a result of participation in the
system.  This enables users to impose effective
discipline on system operators, encouraging them
to pursue risk-mitigating objectives that are
consistent with those of participants.  A
recommendation to that effect could give
guidance on the level of detail to be included in
such an assessment and stipulate a time frame for
updating assessments.  System operators should
avoid disclosing information regarding the
positions of individual users when publishing such
assessments.
4.3 Business risk
Business risk refers to the risk that the payment
system or any of its components — eg an
infrastructure provider serving it — cannot be
maintained as a going concern in the face of
adverse financial shocks.  These shocks may arise
internally, from business decisions resulting in
financial losses, or externally, from changes in the
demand for payment services caused, for example,
by the introduction of a cheaper system offering a
similar service.
The Core Principles do not cover business risk
explicitly, perhaps because its importance has
become apparent only recently.  The Bank’s new
risk-based framework for oversight (Section 1.3)
will include an explicit assessment of business risk.
Controlling business risk in payment and
settlement systems has also proved a relevant issue
outside the United Kingdom.  In the United States,
for example, there is ongoing work, following the
events of 1 1 September 200 1, on determining what
mechanisms should be in place to address the
failure of a major infrastructure provider in
securities settlement.
(2)
Conditions under which business risk is relevant
In principle, business risk can arise whenever any
of the components of the payment system are
privately owned, either wholly or partially.
Currently in the United Kingdom, this is the case
for all schemes and infrastructure providers with
the exception of the RTGS infrastructure, which is
used by CHAPS (and other systems) and owned by
the Bank of England (Table C).  Therefore, the
possibility of business risk materialising is a
current issue for all schemes and the majority of
infrastructure providers in the United Kingdom.
In addition, the trend in the evolution of
ownership of payment systems implies changes in
the nature of business risk.  In particular, in line
with recommendations aimed at increasing
competition and innovation in the payments
industry, several payment systems in the United
Kingdom have separated the company providing
the infrastructure service from the member -owned
scheme that is responsible for setting out the rules
that determine the way the system operates.
(3)
Alongside the benefits that separation may bring
to competition and innovation, it changes the
nature of business risk.
(4) Separated companies
are more likely to become involved in business not
directly related to the payment system, which
increases the range of factors that may trigger
business risk events.  In addition, since their
ownership can be broad and include investors that
are not major users of the system, they may be less
likely to extend funds to support financial losses
incurred as a result of adverse business risk events.
(The reason for this is that these investors will
consider only the direct benefit they obtain from
this financial support as owners, and not the
benefit to users of the continued availability of the
system.)
48
Payment Systems Oversight Report 2005
(1) Available at:  www.bis.org/publ/cpss46.htm.
(2) In particular, the Federal Reserve Board formed the Working Group on Government Securities Clearance and Settlement with rep resentatives from the 
private sector.  The report delivered by the Working Group in December 2003 can be found at:  
www.federalreserve.gov/boarddocs/press/other/2004/20040 107/attachment.pdf.
(3) Cruickshank, D (2000), Competition in UK banking, available at:  
www.hm-treasury.gov.uk/documents/financial_services/banking/bankreview/fin_bank_reviewfinal.cfm.  Office of Fair Trading (2003), UK payment systems, 
available at:  www.oft.gov.uk/NR/rdonlyres/10DB2458-FBD9-4B5C-9EE7-CEB7ACA472BB/0/oft658.pdf.
(4) These benefits are generally expected to be more pronounced when the ownership of infrastructure providers is different to t he ownership of the scheme.  In 
practice, this is currently not the case for some of the systems (Table C).

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49
Payment Systems Oversight Report 2005
In an extreme case, business risk may lead to the
insolvency of an infrastructure provider.  Although
it is in the interest of the private companies to put
controls in place to reduce the possibility of
insolvency, these controls may not be sufficiently
robust to satisfy the public interest in maintaining
continuation of payment services.  This implies a
role for the overseer to propose controls to secure
the continuity of payments.
At the same time, separation of schemes from
infrastructures can bring about risk-reducing
benefits.  Rendering the provision of infrastructure
services open to competition could lead to an
expansion of potential suppliers, which in turn
would make it easier for schemes to find
alternative providers in the event that their
existing supplier can no longer provide the service.
In addition, involvement of infrastructures in
business other than payments diversifies their
sources of revenue, which can make them more
resilient to adverse shocks.
Table C
Ownership of scheme and infrastructures in the main UK payment systems
System Ownership
Scheme Infrastructure
System Ownership
Scheme Infrastructure
BACS BPSL:
Member -owned
Voca:
Member -owned
LCH (PPS) LCH.Clearnet Ltd:
Member/exchange-owned
C&CC C&CCC:
Member -owned
Voca:
Member -owned
EDS: Publicly
traded
iPSL:
5 1% Unisys,
49% banks
LINK LINK:
Member -owned
LINK
Interchange
Network Ltd:
Member -owned
(subset of
scheme owners)
CHAPS
CHAPSCo:
Member -owned
RTGS: Bank of
England
SWIFT:
Member -owned
MasterCard MasterCard
Members’ Forum
(MMF) UK/
MasterCard
Europe (MCE):
Member -owned
(via MasterCard
Incorporated)
MasterCard
Europe:
Member -owned
(via MasterCard
Incorporated)
CLS CLS Group
Holdings
(including CLS
Bank as part of
group):
Member -owned
IBM: Publicly
traded
SWIFT:
Member -owned
CLS Services:
Member -owned
UK Maestro S2 Card Services
(convergence of
rules with MCE
going forward,
but separate
legal entity):
Member -owned
MasterCard
Europe:
Member -owned
(via MasterCard
Incorporated)
CREST Euroclear plc (incl. Euroclear Bank
part of group):  Member -owned
Also uses Bank of England’s RTGS
and SWIFT
Visa Visa UK Ltd/
Visa Europe Ltd:
Member -owned
Visa Europe:
Member -owned

PDF PAGE 52

Controls for business risk
In determining appropriate controls for business
risk, two questions need to be answered:  (i) should
controls be applied to the scheme or the
infrastructure provider;  and (ii) what are the
means to control and minimise the likelihood of
business risk events and their impact? 
The first question is relevant in the context of
separation between schemes and infrastructure
providers.  The answer will depend on what is the
most effective way to fulfil the public policy
objectives.  On the one hand, there is the public
policy objective of securing the continuity of
payment services, which would call for controls
over both types of agent.  On the other hand, there
is the public policy objective of ensuring that the
provision of infrastructure services is an attractive
business for third parties.  Moreover, it should be
taken into account that there are limitations in the
influence that overseers can exert in ensuring that
non-financial companies meet appropriate
controls.  The latter arguments call for controls to
be applied to the scheme.
As for the second question, it should be noted that
the main public policy objective is to ensure
continuity of payment services, rather than in itself
avoiding insolvency of the infrastructure provider.
This implies that controls should not be directed
only towards controlling the risk of insolvency, but
also towards securing a smooth transition to a new
provider if a business risk event were to
materialise.
A standard approach in controlling the likelihood
of insolvency of a company is for it to hold capital.
Arguably, it is reasonable to use this control in this
case too.  Capital could also be required to secure
continuity of payments in the interim period
following the insolvency of an infrastructure
provider until a new provider is found and
becomes operational.
(1) In addition to capital,
other controls can be considered, such as ensuring
that key assets are held temporarily away from
liquidators in the case of the bankruptcy of an
infrastructure provider, and having in place in
advance arrangements among scheme participants
to cover the financial needs that would arise in
that situation.
Over the next year, the Bank plans to analyse these
issues further.  Current regulations in the United
Kingdom contain certain controls for specific
systems, in particular RCHs.
(2) The Bank’s work on
this topic will review the appropriateness of
extending these and other controls to the payment
systems with which it maintains an ongoing
oversight relationship.
4.4 Interlinkages
Risks from interlinkages between systems are not
currently given significant attention in the Core
Principles.  Interlinkages may arise in a number of
ways, including:
G the membership of two systems may overlap, in
which case the insolvency of a member may
crystallise credit risk in both systems;
G the same infrastructure provider may be used by
more than one system, or different infrastructure
providers may use a common telecom company.  If
the common provider or the common telecom
company suffers an operational problem, then
risks may crystallise in a number of systems
simultaneously;  and
G the liquidity in one system may depend in part
upon another system.
Such interlinkages may have become more
important over the past decade.
(3) Moreover,
interlinkages may increase the aggregate level of
risk.  If a bank is a member of two DNS systems
(‘overlapping membership’) and has a net debit
position in both systems, then members of both
systems are exposed to it.  In these circumstances,
credit risk will crystallise in both systems if the
bank becomes insolvent with a net debit position
50
Payment Systems Oversight Report 2005
(1) For this control to be effective, funds should be clearly ear -marked to be used for this purpose.
(2) In particular, the FSA has issued guidance requiring that LCH.Clearnet Ltd and CREST should maintain net capital equal to at  least six months’ worth of 
operating costs.  A similar benchmark has been agreed between the Bank and Voca, the infrastructure provider to BACS, in relation to the company’s capital 
base (Section 3.6).
(3) For example, Richard Pattinson has argued that CLS has led to the development of a large ‘risk balloon’ , by connecting the RTGS (or equivalent) systems of 
major currencies — referred to in Millard, S and Saporta, V (2005), ‘The future of payments’ , Bank of England Financial Stability Review, December, page 59, 
available at:  www.bankofengland.co.uk/publications/fsr/2005/fsr1 9art5.pdf.

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in both (if the exposures are not fully
collateralised).  This gives rise to a positive
correlation between credit risk in the two systems;
and if two risks are positively correlated, then the
aggregate risk may be greater.
While overlapping membership gives rise to
correlations between credit risks, common
infrastructure or telecom providers may cause
correlations between operational risks.  For
example, SWIFT provides messaging services for a
variety of financial institutions and market
infrastructures, including CHAPS, CLS, CREST,
LCH.Clearnet Ltd and TARGET.  In addition, a
number of systems, including those just
mentioned, depend to some degree upon the
RTGS infrastructure provided by the Bank of
England.  Another example is the dependency of at
least six different TARGET components on a single
telecom company:  the incident in June 2005
(Section 3.2) highlighted the importance of
interlinkages between systems through common
telecom dependencies.
The move away from DNS to RTGS systems has
heightened the importance of liquidity.  This raises
the prominence of another type of interlinkage —
when a system depends for its liquidity on a
second system.  For example, payouts from CLS
make a significant contribution to liquidity in
CHAPS Sterling.  Another example is the
interlinkage that exists, because of their common
liquidity pool, between CHAPS Sterling and CREST
sterling.
Over the next year, the Bank intends to assess
additional risks arising from interlinkages between
systems.
4.5 Infrastructure/institutional distinction
Developments in market structure also pose
challenges for the current oversight framework,
highlighting the need for the committees
responsible for the different parts of the
international financial architecture to increase
their collaboration to tackle such changes.
The distinction between the services provided by
systems such as large-value payment systems,
securities settlement systems and central
counterparties and those provided by certain
banks is less clear than might be supposed.  Some
banks settle or clear transactions across their own
books and several banks account for such a
significant proportion of a system that they
constitute key points of failure.  In parallel, certain
systems supply banking services to their customers.
The extent of this blurring is more marked in
certain sectors and countries than in others.
Section 2.1 includes a description of tiering — ie
the extent to which banks provide infrastructure
services for other banks — in the main UK
large-value payment and settlement systems.
These structural issues illustrate the need for
standard setters for banks and systems to work
together closely on the development of standards
in this area.  For example, work on standards for
securities clearing and settlement by the ESCB
and the Committee of European Securities
Regulators (CESR) highlighted the need for
additional analysis of the relationship between the
banking supervisory framework and the proposed
ESCB/CESR standards relating to credit risks.
(1) If
material inconsistencies exist between such
frameworks, additions to the existing rules or
standards may need to be considered.  Any such
changes would, of course, require close
co-operation between the relevant committees.
The different committees also have to come
together to ensure risks highlighted by any one
group are tackled in a joined-up manner.
Addressing foreign exchange settlement risk has
been an important campaign for the CPSS, and
while the 2002 launch of CLS was a significant
milestone, estimates suggest that a substantial
share of global foreign exchange settlement —
well over a half — may still be taking place outside
CLS.  Ensuring that banking supervisors continue
to monitor how banks manage settlement risk in
such transactions and whether enough has been
done to reduce this risk is therefore important.
(2)
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Payment Systems Oversight Report 2005
(1) Details on this are available at:  www.cesr -eu.org.
(2) Sawyer, D (2004), ‘Continuous Linked Settlement (CLS) and foreign exchange settlement risk’ , Bank of England Financial Stability Review, December,
pages 86–92, available at:  www.bankofengland.co.uk/publications/fsr/2004/fsr1 7art5.pdf.

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Payment Systems Oversight Report 2005
The CPSS Core Principles for Systemically Important
Payment Systems set out the types and level of risk
mitigation that should be exhibited by a safe and
efficient payment system.  They provide a
benchmark for central banks in their oversight
function, aiding the identification of relative areas
of strength and weakness in the design or
operation of particular payment systems.  These
annexes contain the Bank’s (updated) Core
Principles assessments of the main UK payment
systems.
As explained in Section 1.2, the Bank expects
payment systems’ degree of observance of the Core
Principles to be proportionate to the systemic
importance of the system in question.  The
expected degree of observance for a system may
differ as between different Core Principles.  For the
most systemically important systems, the Bank may
expect standards that go beyond those that would
qualify for full observance of the Core Principles;
for some other systems, full observance of all the
Core Principles may not be deemed necessary.
The following seven annexes cover:
G CHAPS (Annex A);
G the payment arrangements supporting CREST
(Annex B);
G the Protected Payments System operated by
LCH.Clearnet Ltd (Annex C);
G BACS (Annex D);
G the Cheque and Credit Clearings (Annex E);
G LINK (Annex F);  and
G UK Maestro (Annex G).
Annexes: Detailed assessments of payment
systems

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A. CHAPS
CHAPS is the United Kingdom’s high-value
payment system, providing members with
Real-Time Gross Settlement (RTGS) of credit
transfers.  CHAPS consists of two systems:  CHAPS
Sterling and CHAPS Euro, which — as their names
suggest — provide settlement facilities for sterling
and euro payments respectively.  The following
assessment covers both systems.  Where the Bank
assesses observance of the Core Principles to vary
between the two, this is identified.
I. The system should have a well-founded legal basis
under all relevant jurisdictions.
The CHAPS Rules are clear and comprehensive and
appear to provide an adequate contractual basis
for the system’s operation.  CHAPS is designated
under the Financial Markets and Insolvency
(Settlement Finality) Regulations (1 999), which
implemented the EU Settlement Finality Directive in
the United Kingdom (the ‘UK settlement finality
regulations’).  Taking into account these
regulations and the general principles of English
law, the Bank judges that the legal basis for the
enforcement of rules governing irrevocability of
instructions, finality of settlement, default
arrangements and collateral security is robust.
Protections afforded under the UK settlement
finality regulations extend equally to CHAPS
Sterling and CHAPS Euro payments.
CHAPS members’ relationship with the Bank of
England, as provider of settlement accounts, is
governed by contracts (the RTGS Mandate and the
Master Repurchase Agreement).
As a condition of continued CHAPS membership,
members are obliged to comply with the technical
and operational requirements of the CHAPS
systems.  However, CHAPS members do not sign
formal contracts or acknowledgements committing
themselves to abide by the CHAPS Rules and
decisions of the CHAPS Board.  To date, the lack of
a formal contract or acknowledgement by members
has not given rise to any risk concerns — relying
on the basic principle of English law that if a
member enters payments into the system, that
member can be regarded as having accepted the
rules of the system by conduct.  However, the
decisions to introduce such contracts for BACS
and the C&CC suggest that the situation for
CHAPS should also be reviewed.
During 2005, CHAPSCo largely completed legal
work to confirm that where settlement membership
is held by a branch of a bank incorporated
overseas, these members have the authority to
commit themselves to abide by the CHAPS scheme
rules, and that the home-country legal system of
the parent bank would not interfere with the
member’s ability to fulfil its obligations.  This legal
work complements the Bank of England’s own
requirement for legal opinions regarding the
enforceability of contracts governing the operation
of RTGS settlement accounts and the supply of
intraday liquidity by the Bank to all
overseas/non-UK incorporated holders of RTGS
settlement accounts.
(1) The Bank has also asked
CHAPSCo to introduce requirements and processes
to ensure that the Company is made aware of
changes to the legal status of UK or foreign CHAPS
members, or to the legal framework of relevant local
jurisdictions.  This should help eliminate the risk
that the legal soundness of the system diminishes
in the future as a result of changes in legal status
occurring without CHAPSCo’s knowledge.
Pending the outcome of work on legal capacity
and contracts, the Bank assesses CHAPS broadly
to observe Core Principle I.  With satisfactory
legal advice, it would upgrade that assessment to
full observance.  This assessment is unchanged
from last year.
II. The system’s rules and procedures should enable
participants to have a clear understanding of the
system’s impact on each of the financial risks they
incur through participation in it.
The CHAPS system is in principle a simple one,
and the risks associated with it should be readily
identifiable by members.  The CHAPS Rules set out
high-level rights and duties of members.  The
respective responsibilities of the Bank as operator
and settlement agent, CHAPSCo as the scheme
governance organisation, and the members, are set
out in a Memorandum of Understanding (MoU).
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Payment Systems Oversight Report 2005
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All of the risk management features in CHAPS
(with the exception of bypass mode procedures in
the event of an operational disruption at the Bank
— see Core Principle V) are clearly and
comprehensively explained in the CHAPS Rules and
supporting procedural documentation.  A
hierarchy is in place comprising rules, high-level
procedures and detailed operational manuals.
Together, these documents cover all aspects of
CHAPS operation and design, both in normal
running and in contingency situations.
The settlement process does not give rise to credit
risk between settlement members other than in
bypass mode.  Procedures for processing and
settlement are covered by the CHAPS Procedures and
the RTGS Reference Manual.  The rules relating to
the irrevocability and finality of payments are clear.
The Procedures and the Reference Manual also explain
the controls and measures designed to minimise
liquidity risk.  These include throughput guidelines,
operation of ‘circles’ processing to minimise the
risk of gridlock, and the transfer of sterling liquidity
in contingency situations (Core Principle III).
Formal responsibility for determining the Rules
rests with the CHAPS Board.  The Board has
delegated responsibility to the CHAPS Legal
Committee for ensuring that the Rules remain
robust and up to date, and for considering
proposed changes.
The Bank assesses CHAPS to observe Core
Principle II.  This assessment is unchanged from
last year.
III. The system should have clearly defined procedures
for the management of credit risks and liquidity
risks, which specify the respective responsibilities
of the system operator and the participants and
which provide appropriate incentives to manage
and contain those risks.
In an RTGS system such as CHAPS, the settlement
process does not give rise to the credit risk that
can be involved in deferred settlement.  Domestic
payments are both irrevocable and final at the
point at which the relevant member’s settlement
account is debited.
The main form of financial risk associated with
RTGS is liquidity risk.  CHAPS payments cannot be
made unless the paying bank has sufficient funds
(or liquidity) available on its settlement account
with the Bank of England.  If there were
insufficient liquidity in the system as a whole (or it
were not distributed sufficiently well) to permit a
regular flow of payments, then the result could be
gridlock.  Liquidity pressures could also arise as a
result of time-critical payments, such as those
associated with CLS pay-ins, being delayed.
However, there is no evidence of CHAPS members
experiencing liquidity management difficulties in
meeting CLS pay-in deadlines.
To reduce liquidity risk, the Bank provides intraday
liquidity to all CHAPS Sterling members, limited
only by the availability of eligible collateral.  For
CHAPS Euro, this credit is further limited to
approximately € 3 billion in aggregate each day.
However, members are able to raise additional
liquidity within the euro area and transfer this
through TARGET to CHAPS Euro.  To aid liquidity
management, all banks have real-time information
on balances and the status of payment messages,
with additional real-time monitoring by Bank of
England operators.  Both central and local
schedulers enable members to manage the order
in which payments settle, though the majority of
members use local scheduling controls.  In
addition, throughput guidelines (the requirements
for banks to settle certain proportions of their
total payments by certain times), are in place,
partly to stop settlement banks ‘hoarding’ liquidity.
In extreme scenarios, the Sterling Liquidity
Contingency Regime can be invoked if there is a
risk that liquidity might get drained from the
system because a member is unable to send
payments (though it can still receive).
In 2005, the Bank introduced an additional
liquidity-saving feature.  Members are now allowed
to submit CHAPS Sterling payment messages to the
RTGS processor without necessarily posting
sufficient liquidity for the payments to settle.
Instead, a member can queue outgoing payment
messages within the RTGS processor until liquidity
becomes available from, for example, incoming
payments.  ‘Circles’ processing — whereby
offsetting payments are settled on a ‘simultaneous
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gross’ basis — can be used to clear any build-up
of queues.
Evidence suggests that the procedures currently in
place are effective for controlling liquidity risk.
Bank analysis shows that system participants have
ample liquidity to cope with temporary operational
difficulties affecting even the largest members.
Since the change to allow the queuing of CHAPS
Sterling payments, there has been no evidence of
members significantly changing their payments
behaviour.
There is some evidence that member throughput
has deteriorated in 2005, with a few CHAPS
members consistently breaching throughput
requirements.  This could be interpreted as a sign
of growing liquidity pressures.  However,
investigations suggest that the deterioration in
throughput performance mainly reflects changes
in the distribution of payments’ submission times,
rather than member liquidity constraints.
Nevertheless, this is a development that CHAPSCo
should look to monitor carefully.
The Bank has encouraged CHAPSCo to explore
practical and efficient ways of reducing potential
settlement risk that can arise in RTGS bypass
mode (Core Principle V).
The Bank assesses CHAPS to observe Core
Principle III.  This assessment is unchanged from
last year.
IV. The system should provide prompt final settlement
on the day of value, preferably during the day and
at a minimum at the end of the day.
A settlement bank receiving a payment instruction
receives value from the paying bank
simultaneously and with finality.  The designation
of CHAPS under the UK settlement finality
regulations should prevent successful legal
challenge to the finality of settlement in the event
of member insolvency.  The Bank assesses CHAPS
to observe Core Principle IV.  This assessment is
unchanged from last year.
V. A system in which multilateral netting takes place
should, at a minimum, be capable of ensuring the
timely completion of daily settlements in the event
of an inability to settle by the participant with the
largest single settlement obligation.
This Core Principle is not relevant to CHAPS in
normal operational mode, as settlement of
payments is conducted on a gross rather than net
basis.  Netting would apply only if CHAPS
Sterling’s first and second levels of contingency
and redundancy proved inadequate and bypass
mode were invoked.  This has never been
necessary.
In bypass mode there are no arrangements to
ensure that settlement of net obligations could be
completed in the event of a settlement member
being unable to provide the necessary funds.
Since 2003, all commercial bank settlement
members have had in place ‘net sender caps’ ,
limiting multilateral net obligations to the amount
of unused intraday liquidity that the member had
posted with the Bank (if this information is
available) or £1 billion (if this information is not
available).
The Bank believes that greater protection in
bypass mode could be achieved through the
introduction of arrangements to allocate any
multilateral net shortfall between members with
net credit positions vis-à-vis the defaulting
member, so that new settlement positions can be
calculated and settlement completed.  There may
also be scope to reduce settlement risk through
modifying the operational arrangements in bypass
mode.  The Bank has asked CHAPSCo to undertake
work in this area and would like any new
arrangements to be introduced by end-2006.
VI. Assets used for settlement should preferably be a
claim on the central bank;  where other assets are
used, they should carry little or no credit risk and
little or no liquidity risk.
Settlement between CHAPS Sterling and CHAPS
Euro members takes place by transfers of claims on
the Bank of England.  The Bank assesses CHAPS
to observe Core Principle VI.  This assessment is
unchanged from last year.
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In the previous Oversight Report, the Bank noted
that only settlement members of CHAPS enjoy the
risk-reduction benefits of settlement in central
bank money.  The decisions by Abbey to join
CHAPS Sterling in 2005 and UBS AG to join
CHAPS Sterling in 2007 are therefore welcome.
Other indirect member banks are also encouraged
to consider joining CHAPS Sterling, especially if
their payment values are large.
VII. The system should ensure a high degree of
security and operational reliability and should
have contingency arrangements for timely
completion of daily processing.
CHAPS’ security controls and measures appear to
be effective.  The system’s record of operational
availability is good.  Contingency procedures are
tested regularly and external audits of both
CHAPSCo’s control framework and of the Bank’s
operations take place every year.
CHAPS’ controls are set out in documents such as
the Security Policy and the Security Code of Conduct.
The former is a high-level policy description
covering end-to-end clearing, which is reviewed
annually (or additionally when major changes
occur) and approved by the CHAPS Board.  CHAPS
Internal Audit periodically reviews how the policy
is being maintained.  The Security Code of Conduct
implements the CHAPS Security Policy at a lower
level and specifies a range of security controls that
CHAPS members and suppliers are expected to
have in place.  Members are required to self-certify
compliance with the Code annually.
Operation of the core RTGS processing
infrastructure is outsourced by CHAPSCo to the
Bank.  The MoU (Core Principle II) lists a wide
range of performance measures for the Bank,
including ensuring that settlement facilities are
available on average for 99.9 5% of the operating
day over the course of each month.  RTGS met this
requirement for ten of the twelve months in 2005.
CHAPSCo and the Bank’s operational area have
processes in place to monitor, review and follow up
on operational incidents that affect RTGS.  These
processes have proved effective in ensuring that
technical errors and problems are dealt with and
rectified expediently.  However, it is also important
that the wider aspects of incidents are considered
and their potential implications fully understood.
Members also play a key role in the smooth
operation of the system and CHAPS places high
importance on the resilience and robustness of
members’ feeder systems and interfaces with
CHAPS.  The Procedures set out various guidelines
for the service levels expected of members, and
there are arrangements to enable CHAPSCo to
monitor and assess members’ performance.  Under
the guidelines, among other requirements,
members are expected to minimise requests for
‘cut-off extensions’ of the daily CHAPS timetable.
Too many requests for extensions (or other
breaches in Service Level Code criteria) can result
in a member being asked to appear before a
so-called ‘Star Chamber’ .  At the hearing, a
member will be asked to set out the steps it is
taking to restore its service to the expected level.
The International Monetary Fund (IMF) Financial
Sector Stability Assessment highlighted the need
to monitor the level of extensions with a view to
implementing more stringent disciplinary
processes than peer pressure if problems persisted.
Since the assessment was carried out, the evidence
has been mixed.  The number of extensions
increased sharply in 2003, but in 2005 fell back to
2002 levels.  Some further consideration of
whether this level of extensions is acceptable
would be worthwhile.
CHAPS’ business continuity resilience and
recovery procedures are extensive, and have been
shown to be of a high standard.  However,
internationally, the benchmark for the resilience of
the most important parts of financial
infrastructure has been rising.  It is therefore
appropriate to continue to review the adequacy of
CHAPS’ contingency arrangements and, if
necessary, look for ways to strengthen them
further.  Given that bypass mode can provide
CHAPS Sterling with a further layer of
contingency, it is important that the associated
outstanding issues concerning settlement risk are
addressed.  The Bank has also encouraged
CHAPSCo to put in place arrangements that will
help to minimise the amount of time that CHAPS
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Sterling would need to operate in bypass mode
following a major event.
The Bank assesses CHAPS to observe Core
Principle VII, and welcomes the efforts that
CHAPS is making to reinforce further its
contingency arrangements.
VIII. The system should provide a means of making
payments which is practical for its users and
efficient for the economy.
Although charges for customers wanting to use
CHAPS for retail payments are typically high
relative to the underlying tariffs (which, together
with fees, cover the operating costs of CHAPS,
including the services provided by the Bank),
banks are free to compete in this market.
Settlement member banks can also compete freely
to attract third-party participants.
RTGS systems impose high liquidity demands on
their direct participants, but the Bank provides
collateralised intraday liquidity free of charge, and
there is no evidence that members lack adequate
collateral (in part because many current members
must hold such assets to meet end-of-day
regulatory liquidity requirements and are free to
use them intraday in the payment system).  Recent
changes to allow the queuing of CHAPS Sterling
payments in RTGS (Core Principle III) may
introduce further liquidity efficiencies.
Going forward, developments such as the
introduction of a new faster payments service may
lead to falls in CHAPS Sterling volumes, potentially
increasing per -unit costs of making RTGS
payments.
(1) However, the value of payments using
the system should be largely unaffected by these
changes, and CHAPS should remain a practical way
for making systemically important time-critical
payments.
The Bank assesses CHAPS to observe Core
Principle VIII.  This assessment is unchanged
from last year.
IX. The system should have objective and publicly
disclosed criteria for participation, which permit
fair and open access.
The Bank considers CHAPS access criteria to be
objective and fair.  These are defined in the Rules
and are available on the CHAPS website.
Membership is restricted to financial institutions
that hold sterling and/or euro settlement accounts
at the Bank and have the ability to comply on a
continuous basis with the technical and
operational requirements of the CHAPS systems, as
set out in the reference documents.  Membership
of CHAPS Euro is subject to additional
requirements, as set out in Article 3 of the TARGET
Guideline.
The Bank will normally be prepared to provide a
settlement account to any member of a payment
system for which it is prepared to settle.
Differences in facilities offered by the Bank (in
particular the availability of intraday credit) are
determined using objective, risk-based standards.
The Bank’s settlement account criteria are
available on its website.
(2) Following the reforms of
the Bank’s operations in the sterling money
markets, settlement account banks will
automatically become part of the Bank’s reserve
scheme, and have access to standing facilities.
In June 2005, the CHAPS entry fee for new
members was reduced from £100,000 to £70,000
(prior to 200 1, the fee was £1 million) following
an annual review by CHAPS.  New members are
now no longer required to make a contribution to
the development costs of ‘NewCHAPS’ in 200 1,
which had been paid for by existing members.
Given depreciation, there was no case for
continuing to recover these development costs
from new members — the change was therefore
appropriate.
The remaining £70,000 fee is justified by CHAPS
as a contribution to the technical costs for
CHAPSCo and existing members of adding new
members to the system.  The Bank has questioned
the appropriateness of this approach because it:
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(1) Bank of England (2005), Bank of England Financial Stability Review, December, pages 47–50, available at:
www.bankofengland.co.uk/publications/fsr/2005/fsr1 9art4.pdf.
(2) Bank of England (2002), Bank of England Settlement Accounts, available at:
www.bankofengland.co.uk/financialstability/paymentsettlementsystems/pdf/boesettleaccs02 1 1 28.pdf.

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assumes that new members are only a cost burden
on existing members and bring no benefits;  does
not reflect the wider settlement risk benefits of
increasing the proportion of large-value sterling
payments made across the books of the Bank;
could be perceived as being anti-competitive;  puts
a relatively large burden on lower volume
institutions;  and does not take into account the
economies of scale of taking on multiple members
at one time.  The Bank has therefore encouraged
CHAPSCo to review again the basis on which it
sets its fees.
The Bank assesses CHAPS broadly to observe
Core Principle IX.  This assessment is unchanged
from last year.
X. The system’s governance arrangements should be
effective, accountable and transparent.
CHAPSCo has a clear governance structure, with
the Board having ultimate responsibility for the
management of the system.  The Bank considers
the Board to exercise effective control over the
Company’s executive.
The CHAPS Board is composed entirely of
settlement member banks, which have both the
incentives and tools to pursue the interests of the
system and settlement members.  Incentives for
management to pursue the interests of
stakeholders more generally are less clear, though
the Bank of England provides one of the Board
directors.  However, there may be alternative,
preferable ways of getting external stakeholder or
public interest representation on the CHAPS
Board, which might be usefully explored.  Given
the systemic importance of CHAPS, there may also
be a case for CHAPSCo adopting systemic risk
considerations, alongside those of other
stakeholders, into its objectives.  The Bank has
therefore encouraged CHAPSCo to review its
governance arrangements in the context of wider
sector developments.  The Bank assesses CHAPS
broadly to observe Core Principle X.  This
assessment is unchanged from last year.
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B. CREST
CREST is the United Kingdom’s securities
settlement system, providing a Delivery versus
Payment (DvP) settlement service for UK
securities. 
CREST has three payment systems:
G Real-Time Gross Settlement (RTGS) in central bank
money in sterling;
G RTGS in central bank money in euro;  and
G a bilateral net settlement arrangement for
transactions settled in US dollars.
This assessment covers all three, differentiating
between them as necessary.
(1) As noted earlier,
payment systems are by their nature collaborative
ventures.  In conducting this assessment, a
distinction is drawn between the systems and
procedures operated by CREST, for which
CRESTCo is responsible;  and the overall payment
arrangements supporting securities settlement,
which are a collaboration between CRESTCo, the
Bank of England (for sterling and euro settlement)
and the CREST settlement bank community.
I. The system should have a well-founded legal basis
under all relevant jurisdictions.
There are no material changes to report in respect
of this Core Principle compared to last year’s
assessment.  CREST is designated under the
Financial Markets and Insolvency (Settlement Finality)
Regulations (1 999) (the ‘UK settlement finality
regulations’), which implemented the EU Settlement
Finality Directive in the United Kingdom, so that
the finality of both securities and payment
transfers (including those effected through all
three payment systems) is protected from legal
challenge in the event of an insolvency.  The
protection provided by the UK settlement finality
regulations also extends to the CREST settlement
banks’ arrangements for taking collateral to secure
their customers’ debit caps.  There are bilateral
and multilateral contractual arrangements between
CRESTCo, the Bank and the CREST settlement
banks governing the operation and provision of
the DvP payment arrangements in sterling and
euro (including the operation of settlement
accounts at the Bank of England and the
self-collateralising repo mechanism that may be
used by CREST settlement banks to generate
intraday liquidity from the Bank).  These contracts
are governed by English law.  Even in the case of
CREST settlement banks that are the branches of
banks incorporated outside the European
Economic Area, CRESTCo has obtained legal
opinions confirming that these banks have the
authority to commit themselves to abide by the
relevant rules, and that the relevant home-country
legal systems of the parent banks would not
interfere with those banks’ ability to fulfil their
obligations.  The Bank assesses the CREST
sterling and CREST euro payment arrangements
to observe Core Principle I.
The US dollar payment arrangements are currently
supported by end-of-day settlement of bilateral net
obligations between pairs of settlement banks.
The arrangements for such settlement are part of
the overall relationship that each settlement bank
has with its US dollar correspondent in the
United States, and fall outside the scope of
CRESTCo’s responsibility.  Although the US dollar
arrangements have been given the protection of
the UK settlement finality regulations, and involve
settlement of bilateral rather than multilateral net
obligations, it remains unclear whether the
provisions of US insolvency law might prevent
completion of an orderly settlement in the
United States if a US-incorporated CREST
settlement bank failed.  The Bank assesses the
CREST US dollar payment arrangements
broadly to observe Core Principle I.
II. The system’s rules and procedures should enable
participants to have a clear understanding of the
system’s impact on each of the financial risks they
incur through participation in it.
There are no material changes to report in respect
of this Core Principle compared to last year’s
assessment.  The payment arrangements do not
have their own separate rules and procedures;
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Payment Systems Oversight Report 2005
(1) While the assessment focuses on the payment arrangements between the 1 5 CREST settlement banks, these settlement bank arrange ments are underlain by
payments between over 42,000 CREST members across Cash Memorandum Accounts (CMAs) held with settlement bank members.  Payment obligations arise
between settlement bank members when a trade takes place between members that hold CMAs at different settlement banks.

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instead, there are rules and procedures governing
the DvP arrangements for the three settlement
currencies included in CREST documentation (the
CREST Rules and Manual) and, for the sterling and
euro payment arrangements, in the RTGS
documentation (specifically the RTGS Reference
Manual).  CREST documentation also describes in
detail the operation of members’ Cash
Memorandum Accounts (CMAs) and the
management of CMA debit caps.  This
documentation is regularly updated.  The US
dollar CREST settlement banks are investigating
with CRESTCo the possibility of improving that
payment mechanism to reduce the size and
duration of the interbank exposures that the
mechanism generates and to remove the potential
for uncertainty about when finality is achieved (as
set out in the commentary to Core Principles III
and IV).  The Bank assesses CREST’s payment
arrangements to observe Core Principle II.
III. The system should have clearly defined procedures
for the management of credit risks and liquidity
risks, which specify the respective responsibilities
of the system operator and the participants and
which provide appropriate incentives to manage
and contain those risks.
There are no material changes to report in respect
of this Core Principle compared to last year’s
assessment.  Because sterling and euro CREST
settlement banks settle their obligations across
central bank accounts in real time, these two
payment arrangements generate no credit risk
between settlement members.  There are likely,
however, to be credit exposures between settlement
members and the members to whom they offer
CMAs.  CRESTCo provides the technical and legal
infrastructure to reduce the exposure of settlement
members to second-tier members by means of
collateralisation (and such collateralisation has the
protection of the UK settlement finality
regulations — see Core Principle I).  The extent to
which uncollateralised credit is granted depends
on the terms of the agreement between each
settlement bank member and its customer, with
responsibility falling clearly to the parties who
would bear any losses in the event of default.
Liquidity risk could arise in the sterling or euro
payment arrangements if settlement members were
unable to raise the liquidity to settle transactions,
or unable to repay intraday liquidity provided by
the Bank of England.  Liquidity can be raised in
CREST either by transfer from CHAPS, or, in the
case of CREST sterling, by self-collateralising repo
to the Bank of England.  The mechanism for
transferring liquidity between the CREST
settlement accounts and the banks’ CHAPS
settlement accounts has proved reliable and
flexible.  Settlement banks can consider the two
accounts as a ‘virtual single pot’ of liquidity, with
the option of repositioning balances between the
accounts after each of the 600-plus CREST
settlement cycles each day.  The rules on
generating and transferring liquidity are set out in
the RTGS Reference Manual.
It is normally the case that 99% by value of CREST
transactions settle on their intended settlement
date and there is no indication that liquidity
shortages are the cause of the failure to settle the
remainder.  Both the RTGS and CREST
documentation describe the responsibilities of the
different parties involved in the daily operation of
the DvP mechanism in contingency as well as
normal conditions.  The Bank assesses CREST
sterling and CREST euro payment arrangements
to observe Core Principle III.
The current interbank settlement arrangements
supporting CREST US dollar settlement are
deficient in a number of respects as regards this
Core Principle.  The settlement banks take on their
CREST customers’ gross bilateral payment
obligations during the CREST settlement day, and
these gross interbank exposures are converted into
bilateral net obligations only at the end of the day.
These net exposures are not extinguished until the
settlement banks’ US dollar correspondents have
made the necessary payments on their behalf in
the United States.  To the extent that settlement
banks pre-fund their accounts at their US dollar
correspondent, they are also subject to the small
risk of settlement agent failure until the settlement
is completed.  Participants, however, have the right
incentives to manage these risks.
Although US dollar settlement values remain
modest relative to those for sterling settlement,
they have risen significantly over the past three
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years, increasing from a daily average value of
around US$500 million in 2003 to approximately
US$1.5 billion during 2004 and into 2005.  There
was a further step change with effect from
June 2005 to around US$2.25 billion.  With
CRESTCo and the Bank, the US dollar settlement
banks are now investigating a formal multilateral
net settlement procedure, supplemented by
measures to ensure settlement can complete.  The
Bank assesses the current US dollar payment
arrangements partly to observe Core
Principle III.  The level of observance should
improve as work on the US dollar interbank
settlement arrangement progresses, although full
observance for a multilateral net settlement
arrangement would require measures to ensure the
completion of settlement if a net payer failed to
settle.
IV. The system should provide prompt final settlement
on the day of value, preferably during the day and
at a minimum at the end of the day.
There are no material changes to report in respect
of this Core Principle compared to last year’s
assessment.  For sterling and euro settlement, the
payment arrangements offer real-time finality of
the settlement banks’ gross obligations at the end
of each CREST settlement cycle.  Average cycle
duration is between 50 seconds and one minute.
At certain times in the day there are a small
number of longer cycles.
For the US dollar payment system, cash finality is
achieved when the bilateral interbank payments
are settled in the United States.  Given the time
difference, it may be that a settlement bank does
not become aware that finality has been achieved
until the following morning.  The level of
observance should improve once the planned
changes to US dollar settlement are implemented.
The Bank assesses CREST sterling and CREST
euro payment arrangements to observe Core
Principle IV , and the US dollar payment
arrangements partly to observe Core
Principle IV.
V. A system in which multilateral netting takes place
should, at a minimum, be capable of ensuring the
timely completion of daily settlements in the event
of an inability to settle by the participant with the
largest single settlement obligation.
None of the CREST payment arrangements
currently employs multilateral netting, so this Core
Principle is not relevant to CREST arrangements.
As mentioned under Core Principle III, CRESTCo
and the settlement banks are currently exploring
the possibility of moving from bilateral to
multilateral netting for the US dollar payment
arrangements.  The Bank considers it important
that the multilateral arrangement chosen should
observe this Core Principle.
VI. Assets used for settlement should preferably be a
claim on the central bank;  where other assets are
used, they should carry little or no credit risk and
little or no liquidity risk.
There are no material changes to report in respect
of this Core Principle compared to last year’s
assessment.  Interbank settlement in both the
sterling and euro payment arrangements takes
place in central bank money.  Although the tiered
nature of the CREST settlement arrangements
means that non-settlement bank CREST members
receive a claim on a commercial bank (a CMA
balance) in final settlement of their transactions,
such CMA postings generate an irrevocable
instruction to the Bank to debit the settlement
account of the buyer’s settlement bank and credit
the settlement account of the seller’s settlement
bank.  For the US dollar payment arrangements,
the interbank settlement involves transfers of funds
between major US correspondent banks.  The
Bank assesses CREST sterling and CREST euro
payment arrangements to observe Core
Principle VI, and the US dollar payment
arrangements partly to observe Core
Principle VI.
VII. The system should ensure a high degree of
security and operational reliability and should
have contingency arrangements for timely
completion of daily processing.
There are no material changes to report in respect
of this Core Principle compared to last year’s
assessment.  CREST achieved an average 99.9%
settlement availability in 2005.  This performance
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was supported by the high resilience of the
payment arrangements, including the Bank-CREST
DvP link on which the day-to-day operation of the
sterling and euro payment arrangements rely.  If
the link between CREST and the Bank of England’s
accounts were interrupted, or in the event of an
operational failure of the Bank’s RTGS system,
CREST is able to continue settling in ‘recycle
mode’ .  This involves CREST continuing settlement
using the last verified set of settlement bank
liquidity postings, with a contingency facility for
banks to top up and draw down such liquidity.
Both CREST and RTGS have back-up processing
capability that can be made fully operational
within an hour of a major failure at the prime site.
These arrangements are tested regularly.
The US dollar payment arrangements operate on a
highly decentralised basis.  There have been very
few instances (and they have involved small
bilateral net payments) of the end-of-day
settlement not completing on the day because of
operational difficulties.
The Bank assesses CREST’s payment
arrangements to observe Core Principle VII.
VIII. The system should provide a means of making
payments which is practical for its users and
efficient for the economy.
There are no material changes to report in respect
of this Core Principle compared to last year’s
assessment.  CREST serves over 42,000 members
who range from private clients (the vast majority)
to banks and broker dealers, generating a mixture
of low, medium and high-value payments.  As
mentioned under Core Principle III, 99% of trades
by value (around 9 1% by volume) settle on their
intended settlement date.  The liquidity transfer
mechanisms supporting the sterling and euro
payment arrangements appear practical, and the
self-collateralising repo mechanism enables
settlement banks to economise on the liquidity
devoted to the sterling payment arrangements.
The Bank assesses CREST’s payment
arrangements to observe Core Principle VIII.
IX. The system should have objective and publicly
disclosed criteria for participation, which permit
fair and open access.
A prospective CREST settlement bank has to meet
CRESTCo’s participation criteria (which are also
applied to other CREST participants or users).
These criteria are both objective and publicly
disclosed (in the CREST Rules and Terms and
Conditions).  The CREST Manual also describes the
functions which a CREST settlement bank is
required to perform.  However, the Bank and the
existing CREST settlement banks have a right to
determine whether a prospective participant
should be admitted as a CREST settlement bank.
This right is represented in an Agreement of
Adherence that CRESTCo, the Bank, the existing
settlement banks and any prospective participant
have to agree and sign.  The Bank published its
policy on the provision of CREST settlement
accounts in November 2002.  In 2003 it became
possible to become a member of the sterling
and/or euro payment arrangements without also
being a member of CHAPS.  There are, however, no
participation criteria publicly disclosed by the
CREST settlement bank community.  While
CRESTCo’s criteria for participation are objective
and publicly disclosed, the Bank does not see any
justification for existing settlement members
having a theoretical veto over other banks’ seeking
to become CREST sterling or CREST euro
settlement banks.  (Given that the US dollar
payment arrangements still generate intraday
exposures, there are objective reasons to have
credit quality requirements for banks wishing to be
admitted as US dollar settlement banks.  However,
these should be publicly disclosed.)  The Bank
assesses CREST’s payment arrangements partly
to observe Core Principle IX.
CRESTCo has prepared a draft rule which is
designed to ensure that all the participation
criteria which apply to CREST settlement banks
are publicly disclosed.  This will be discussed with
the Bank, the Financial Services Authority (FSA)
and existing CREST settlement banks.  It is hoped
that the rule, and accompanying criteria agreed by
existing CREST settlement banks, will be published
early in 2006.
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X. The system’s governance arrangements should be
effective, accountable and transparent.
There are no material changes to report in respect
of this Core Principle compared to last year’s
assessment.  As mentioned under Core Principle I,
the provision of sterling and euro payment services
is governed by a variety of contracts between
CRESTCo, the Bank and the individual members of
the payment systems.  These detail which elements
of the sterling and euro payment arrangements
each party is responsible for, and are supported by
external audit, with both RTGS and CREST subject
to SAS 70 reporting.  There are a variety of fora at
which the interests of the various parties to these
contracts, and of the wider CREST community, can
be represented.  These include the UK Market
Advisory Committee:  a consultative body set up as
part of the Euroclear group’s policy to ensure a
high degree of user -governance in the various
national markets where Euroclear provides
settlement services.  The settlement banks,
CRESTCo and the Bank also have meetings
co-ordinated by the Association for Payment
Clearing Services (APACS) to discuss operational
and business issues related to the payment
systems.  While these various arrangements appear
effective individually, the collaborative nature of
the payment arrangements supporting CREST
settlement means that there is no over -arching
governance framework in place.  Consequently, the
Bank assesses CREST’s payment arrangements
partly to observe Core Principle X.  To increase
the effectiveness of the governance structure for
the interbank payment arrangements, the Bank
and CRESTCo are discussing how a suitable
governance framework could be established.  It is
hoped that this will be put in place during 2006.
Notwithstanding the current assessment, the
governance arrangements of CREST as a system
have a number of desirable features, in particular
the involvement of independent Board directors
within the Euroclear corporate structure.  These
help to maintain the accountability of the
CRESTCo executive and ensure that wider public
interest objectives are considered.
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C. LCH.CLEARNET LTD
LCH.Clearnet Ltd operates a payment mechanism
to effect transfers of funds to and from its
members in the currencies in which it incurs
exposures.  This is known as the Protected
Payments System (PPS).  The PPS is the mechanism
by which LCH.Clearnet Ltd discharges obligations
relating to cash-settled transactions, collects initial
margin and transfers variation margin.
(1) The PPS
consists of a network of commercial banks, which
provide a settlement bank service to, and process
payment transfers between, LCH.Clearnet Ltd and
its members.  LCH.Clearnet Ltd holds an account
at each PPS bank and each member must have an
account at a PPS bank in each currency in which it
does business.  For each currency, there is also a
‘concentration bank’ for LCH.Clearnet Ltd.
Positive balances on LCH.Clearnet Ltd’s accounts
at the PPS banks as a result of the transfers
between LCH.Clearnet Ltd and members are
collected in LCH.Clearnet Ltd’s account at the
concentration bank.  LCH.Clearnet Ltd meets any
net credit positions with PPS banks, as well as
investing surplus funds in the money market,
through its concentration bank account.
The PPS in fact consists of two separate systems.
The UK PPS is used for making calls (member
debits) and pays (member credits) during the day.
A second PPS operates in the United States (the
US PPS), which is used to meet intraday margin
calls made late in the day after the UK payment
systems have closed.  Given that the flows in the
US PPS are small (average daily flows are less than
1% of the average daily flows in the UK PPS), the
risks present within the arrangements are much
smaller than in the UK PPS.  The US PPS is
therefore not covered in this assessment, except
where explicitly mentioned.
I. The system should have a well-founded legal basis
under all relevant jurisdictions.
The arrangements for transfer of payments
between LCH.Clearnet Ltd and its members
through the UK PPS are governed by English law.
The PPS is covered by LCH.Clearnet Ltd’s
designation under the Financial Markets and
Insolvency (Settlement Finality) Regulations (1 999),
which implemented the EU Settlement Finality
Directive in the United Kingdom (the ‘UK
settlement finality regulations’).  Under these
regulations, payment transfer orders through the
PPS are protected from the potentially disruptive
effects of insolvency proceedings against
participants in the system.  Separate Settlement
Finality Regulations form part of LCH.Clearnet Ltd’s
General Regulations, Default Rules and Procedures.
PPS banks that are not members of LCH.Clearnet
Ltd are also signatories to the same Settlement
Finality Regulations.  In addition, LCH.Clearnet Ltd
has obtained legal opinions to confirm that
members who are not resident in the
United Kingdom are able to commit to governance
of their relationship with LCH.Clearnet Ltd under
English law.  The Bank assesses the PPS in the
United Kingdom to observe Core Principle I.
II. The system’s rules and procedures should enable
participants to have a clear understanding of the
system’s impact on each of the financial risks they
incur through participation in it.
The participants in the PPS comprise LCH.Clearnet
Ltd, its members, the PPS banks and the
concentration banks.  LCH.Clearnet Ltd’s General
Regulations, Default Rules and Procedures contain a
section (Settlement Finality Regulations) setting out
how the PPS operates and the obligations of the
various parties.  The Settlement Finality Regulations
also define when payment transfers are considered
to have entered into the system, and the point at
which they become irrevocable.
Members of LCH.Clearnet Ltd are required to sign
a PPS mandate, which grants permission for the
PPS bank to debit the member’s account according
to instructions received from LCH.Clearnet Ltd.
This mandate states the actions that the PPS banks
are able to take without seeking further authority
from the member.
PPS banks sign a PPS Agreement with LCH.Clearnet
Ltd, which explains the obligations of each PPS
bank in the system.  In the past year, LCH.Clearnet
Ltd has introduced a new PPS Agreement for
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(1) ‘Initial margin’ is a returnable deposit required from a member for each open position, designed to offset the costs to LCH. Clearnet Ltd of settling open
positions in the event of member default.  ‘Variation margin’ is funds paid by (or received by) members to (or from) LCH.Clearnet Ltd to settle any losses
(or gains) resulting from marking open positions to market.

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UK PPS banks.  This more fully explains the
financial risks that PPS banks incur during the
transfer process, particularly with regard to
sending payment confirmations, and improves
transparency of financial risks for the PPS banks.
The US PPS Agreement also explains financial risks
to a similar level.  As a result of these changes,
the Bank assesses the PPS to observe Core
Principle II.
III. The system should have clearly defined procedures
for the management of credit risks and liquidity
risks, which specify the respective responsibilities
of the system operator and the participants and
which provide appropriate incentives to manage
and contain those risks.
Credit exposures arise between members and
LCH.Clearnet Ltd as the central counterparty
(CCP), rather than bilaterally between members.
Since payments to and from LCH.Clearnet Ltd are
made through the PPS banks, credit and liquidity
exposures can also arise between a PPS bank and
members, and between LCH.Clearnet Ltd and the
PPS banks.  However, because all the exposures are
bilateral, the failure to pay by one of the PPS banks
or by an individual LCH.Clearnet Ltd member
would not disrupt the PPS arrangements more
broadly, unless the amounts were enough to affect
LCH.Clearnet Ltd’s ability to meet its own
obligations in a timely manner.  The failure of the
‘concentration bank’ in any currency would be
likely to cause more severe disruption to
LCH.Clearnet Ltd, since the net funds held by
LCH.Clearnet Ltd are collected in an account at
this bank before they are invested in the money
market.
The new PPS Agreement between LCH.Clearnet Ltd
and the UK PPS banks, introduced in the past year,
includes a formal deadline for transfer of funds to
the concentration bank.  This is two hours from
the time that LCH.Clearnet Ltd notifies PPS banks
to transfer funds to the concentration bank, or the
CHAPS cut-off time, whichever is earlier.  Although
these funds are already held in the name of
LCH.Clearnet Ltd on accounts at the PPS banks,
the transfer of funds to the concentration bank
allows LCH.Clearnet Ltd to offset the outgoing
payments resulting from other obligations and to
invest excess funds in the money market.  Hence, if
PPS banks make these transfers earlier in the day,
the credit and liquidity pressures on LCH.Clearnet
Ltd are reduced, and the CCP does not have to use
intraday credit lines at the concentration bank in
order to meet its obligations.
The new PPS Agreement also includes procedures
for PPS banks which fail to meet the two-hour
deadline on a consistent basis.  The procedures do
not include financial penalties, but do ultimately
provide for LCH.Clearnet Ltd to terminate a bank’s
participation in the PPS if the bank is unable to
resolve its inadequate performance.  Initial data
show that transfers are now being made earlier in
the day, but that a few PPS banks continue to make
payments beyond the deadline.  However, there is
not yet a sufficient run of data to determine
whether the procedures provide the appropriate
degree of incentive for PPS banks to make timely
payments over a sustained period of time.  If the
arrangements and procedures for non-compliance
do prove effective over the coming year, the Bank
would deem the PPS to observe Core Principle III.
However, until it is clear that these arrangements
are effective, the Bank assesses the PPS broadly
to observe Core Principle III.
IV. The system should provide prompt final settlement
on the day of value, preferably during the day and
at a minimum at the end of the day.
PPS banks are required by 09.00 UK time on the
day of receipt of the payment instruction to
confirm to LCH.Clearnet Ltd that they will meet
the required payments on behalf of the clearing
members.  At this point, the PPS banks have made
an irrevocable commitment to pay the amount
owed to LCH.Clearnet Ltd.  However, final
settlement of these transfers between the members
and LCH.Clearnet Ltd takes place when the
relevant individual debit and credit entries are
made across the accounts of the PPS banks.  In
some currencies this will not take place until the
following day, which will be the next value date for
that currency.
In sterling and euro, the net amount due between
LCH.Clearnet Ltd and the relevant PPS bank is
then transferred between accounts in the name of
LCH.Clearnet Ltd at the PPS bank and at the
Bank of England, which acts as concentration bank
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for LCH.Clearnet Ltd in those currencies.  These
latter transfers are made via CHAPS and thus are
settled with intraday finality.  As noted above,
prompt payment of these amounts by the PPS
banks reduces the intraday risk to
LCH.Clearnet Ltd.
US dollar transfers take place in both the UK and
the US PPS systems.  The arrangements for
US dollar transfers in the UK PPS system are the
same as those for sterling and euro, except that the
transfers to and from the concentration bank
(Citibank in this case) take place across nostro
accounts, rather than via CHAPS.  The US PPS
system is used for intraday calls after 1 6.00 UK
time.  Again, PPS banks are required to confirm
their commitment to pay LCH.Clearnet Ltd.
Concentration bank transfers are made via
Fedwire, which is the US RTGS system, so these are
also final on the same day.
While sterling, euro, US dollar and Canadian dollar
transactions are processed with same-day value in
the PPS, for Australian dollar, Swiss franc, Danish
krone, Hong Kong dollar, Japanese yen, Norwegian
krone, New Zealand dollar and Swedish krona
transactions, the nostro arrangements in place
allow for final settlement only on the day after the
payment instructions are sent.  However, as
LCH.Clearnet Ltd makes calls in these currencies
for next-day value, final settlement still occurs on
the day of value.  In addition, LCH.Clearnet Ltd
receives an irrevocable commitment on the same
day as instructions are sent out, and the amounts
transferred in these currencies are currently small
relative to those processed with same-day value,
representing less than 5% (£89 million on average
a day) of the total amount transferred on average
through the PPS.  For some of the above
currencies, time-zone constraints will prevent
same-day finality.  The Bank assesses the PPS to
observe Core Principle IV.
V. A system in which multilateral netting takes place
should, at a minimum, be capable of ensuring the
timely completion of daily settlements in the event
of an inability to settle by the participant with the
largest single settlement obligation.
There is no multilateral netting of payments in the
PPS.  This Core Principle is not applicable to the
PPS.
VI. Assets used for settlement should preferably be a
claim on the central bank;  where other assets are
used, they should carry little or no credit risk and
little or no liquidity risk.
The first stage of the two-leg transfer of funds from
members to LCH.Clearnet Ltd occurs via a
book -entry transfer in commercial bank money on
the books of the PPS banks.  This transfer occurs if
the member has sufficient funds on its account, or
has in place credit lines with its PPS bank
sufficient to allow the payment to take place.  The
credit risk at this stage for LCH.Clearnet Ltd is on
the PPS banks, while for the PPS banks there may
be a credit exposure to the members for which
they provide PPS services.  Credit risks also occur
in the opposite direction when LCH.Clearnet Ltd
is due to make payments to members.  PPS banks
must have a minimum long-term rating of A- from
Fitch Ratings or the equivalent from Moody’s or
Standard & Poor’s.
The net amount transferred between LCH.Clearnet
Ltd and its members is collected in an account in
the name of LCH.Clearnet Ltd at the
concentration bank.  All transfers of funds to and
from LCH.Clearnet Ltd and its members, as well as
the transfers resulting from LCH.Clearnet Ltd’s
investment of cash in the money markets, pass
across the concentration bank accounts.  So the
concentration bank plays a key role in the PPS
arrangements.
Since late September 2005, the Bank of England
has performed the role of sterling and euro
concentration bank, ensuring that LCH.Clearnet
Ltd has access to a settlement asset free of credit
risk.  The concentration process in sterling and
euro occurs by transfers from the other PPS banks
to the Bank of England via CHAPS.  Not all of the
PPS banks are direct members of CHAPS, which
results in the possibility of credit or liquidity risks
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arising between indirect members and the CHAPS
banks that process their payments.  However, there
is no evidence that those PPS banks that do not
have direct access to CHAPS experience delays in
making transfers to the concentration bank.
In the remaining currencies, the concentration
bank transfers are made across nostro accounts at
commercial banks.  Citibank is the concentration
bank for US dollars in both the UK and US PPS,
and HSBC acts as concentration bank for the
other currencies.  The amounts transferred in
these currencies are small, with the exception of
transfers in US dollars in the UK PPS system.
Given the size of US dollar flows, it would
materially reduce the overall risk in the PPS if
LCH.Clearnet Ltd were able to establish an
arrangement in US dollars which resulted in funds
being transferred through a Real-Time Gross
Settlement (RTGS) system, and then being held in
the form of central bank account balances free of
credit risk.
Following the successful transfer of the role of
sterling and euro concentration bank to the
Bank of England, LCH.Clearnet Ltd is investigating
potential ways to reduce US dollar settlement asset
risk.  If it proves impossible or impractical for
LCH.Clearnet Ltd to hold US dollar funds in the
form of central bank balances, LCH.Clearnet Ltd
should then investigate whether steps could be
taken to reduce further the risk of using a
commercial bank settlement asset.
In light of the Bank of England taking over the role
of sterling and euro concentration bank, the Bank
assesses the PPS to observe Core Principle VI
for transfers in sterling and euro.  For US dollar
transfers, the Bank assesses the UK PPS partly
to observe Core Principle VI, and the US PPS
broadly to observe Core Principle VI.  For
transfers in other currencies, the Bank assesses
the PPS broadly to observe Core Principle VI.
However, for these other currencies the impact of
a concentration bank failure is not deemed
sufficiently large for there to be a need at this
stage to eliminate the very small probability of
commercial bank default.
VII. The system should ensure a high degree of
security and operational reliability and should
have contingency arrangements for timely
completion of daily processing.
The PPS arrangements rely on SWIFT and the
CHAPS system, as well as on the operational
reliability of the individual PPS banks, the
concentration banks and LCH.Clearnet Ltd’s
Treasury Operations department.  LCH.Clearnet
Ltd has both alternative data centres and
operations sites, so that primary facilities do not
represent a potential single point of failure in the
event of a major disruption.  The exact recovery
times for processing to switch to the secondary
sites would depend on the nature of the
disruption, but plans allow for recovery of
‘business critical’ functions (including treasury
operations) within two hours.  During the events of
7 July, when LCH.Clearnet Ltd was required to
evacuate its head office, key staff were able to
transfer to the secondary operations site well
within the established recovery time.  The primary
data centre, located away from the head office, was
unaffected.
In the event of a SWIFT outage, LCH.Clearnet Ltd
would communicate with the PPS banks by fax.
SWIFT and CHAPS have taken measures to ensure
continuity of core services, as noted elsewhere in
this Oversight Report.  In addition, LCH.Clearnet
Ltd can make calls in the PPS system in the
United States, which uses the Fedwire system.  The
operational reliability and resilience of the systems
used across the LCH.Clearnet group are important
for the functioning of the PPS.  The PPS itself is an
arrangement to transfer amounts owing between
LCH.Clearnet Ltd and its members, but the
calculation of these amounts is undertaken in
other systems within LCH.Clearnet Ltd.  These
systems are also part of the ‘business critical’
functions under the business continuity plans
mentioned above.  The Bank assesses the PPS to
observe Core Principle VII.
VIII. The system should provide a means of making
payments which is practical for its users and
efficient for the economy.
Each LCH.Clearnet Ltd member is required to hold
an account in each currency in which it incurs
settlement obligations.  There are currently
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1 3 banks in the UK PPS arrangements, and eleven
in the US PPS.  Although not all the UK PPS banks
provide accounts in all currencies, there is ample
competition between PPS banks to ensure that
members receive an adequate level of service and
costs.  The Bank assesses the PPS to observe
Core Principle VIII.
IX. The system should have objective and publicly
disclosed criteria for participation, which permit
fair and open access.
All members of LCH.Clearnet Ltd are required to
hold an account with at least one PPS bank.  This
requirement to participate forms part of the
General Regulations of LCH.Clearnet Ltd, which are
publicly disclosed.  Members sign an LCH.Clearnet
Ltd standard account mandate at the opening of
an account, but all other aspects of the
arrangement between the PPS banks and the
members for whom they provide PPS services are
part of a general banking relationship.  Members
are free to choose which PPS bank to use and may
use a different bank for each currency.
In the past year, LCH.Clearnet Ltd has produced a
publicly available set of criteria for participation
in the PPS.  This details the minimum financial
and operational requirements important to the
continued smooth operation of the PPS, which the
PPS banks must maintain.  It also details orderly
exit procedures for PPS banks if they either fall
below the minimum financial and operational
requirements, or choose to resign their
membership.  This set of criteria is published on
the LCH.Clearnet Ltd website.
(1) The website also
advises interested parties how to obtain further
information on participation in the PPS.  Given
that LCH.Clearnet Ltd now publishes these
criteria, and these criteria are based on aspects
important to the continued smooth functioning of
the PPS, the Bank assesses the PPS to observe
Core Principle IX.
X. The system’s governance arrangements should be
effective, accountable and transparent.
Since the PPS is the payment mechanism that
serves the LCH.Clearnet Ltd system as a whole, it
does not have clearly distinct governance
arrangements.  However, LCH.Clearnet Ltd is
subject to regulation by the FSA and its
governance arrangements include the presence of
independent non-executive directors (both on the
Board of LCH.Clearnet Ltd and its parent), as well
as User Consultative Committees to take account
of members’ interests.  In addition, LCH.Clearnet
Ltd holds a meeting with the group of PPS banks
in the United Kingdom four times a year and
annually in the United States.  The Bank has not
identified any weaknesses in the effectiveness,
accountability or transparency of the governance
arrangements for the PPS.  The Bank assesses the
PPS to observe Core Principle X.
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D. BACS
The BACS payment system provides processing of
bulk electronic automated payments.  Its principal
products are the Direct Debit, Direct Credit, and
standing order payment instruments.  The
payment system is owned by BACS Payment
Schemes Limited (BPSL), the members of which
outsource provision of core processing services to
Voca Limited, a third-party company that provides
the central infrastructure for BACS.
I. The system should have a well-founded legal basis
under all relevant jurisdictions.
Settlement of interbank obligations in BACS is
governed by the Settlement Agreement, a formal
contract between members providing assurances
regarding the multilateral net settlement process.
In December 2005 BACS was designated under the
Financial Markets and Insolvency (Settlement Finality)
Regulations (1 999), which implemented the EU
Settlement Finality Directive (1 998) in the
United Kingdom.  Chapter 3 described how
designation removes uncertainties that the finality
of BACS payments would survive legal challenge in
the event of insolvency of a member, reducing the
likelihood that a legal challenge would be
mounted.  Following designation, the Bank judges
the legal basis for enforcement of the rules
governing irrevocability of instructions, the
multilateral settlement process, the finality of
settlement and default arrangements in BACS is
robust.
The Bank assesses BACS to observe Core
Principle I.
II. The system’s rules and procedures should enable
participants to have a clear understanding of the
system’s impact on each of the financial risks they
incur through participation in it.
The Settlement Agreement governs settlement of
obligations between members, whereas the
Liquidity Funding and Collateralisation Agreement
(LFCA, implemented in May 2005) provides a
greater degree of clarity as to surviving members’
obligations in the event of another member’s
failure to pay.
Both agreements, as well as the clear,
comprehensive rules governing BACS, ensure
members understand the financial risks related to
settlement of multilateral net positions.
The Bank assesses BACS to observe Core
Principle II.
III. The system should have clearly defined procedures
for the management of credit risks and liquidity
risks, which specify the respective responsibilities
of the system operator and the participants and
which provide appropriate incentives to manage
and contain those risks.
The basic obligation of BACS members to settle
multilateral net amounts is clear and the Settlement
Agreement between members makes that obligation
enforceable.
Introduction of the LFCA (as detailed in Core
Principle V) has clarified the procedure for
managing liquidity and credit risks and is
structured on the basis that those who bring risk
to the system bear the cost of meeting those risks.
Despite the LFCA, the obligations of a defaulting
member to the system could still exceed liquidity
committed and collateral pledged, leaving
surviving members with residual exposures.  There
are currently no clear controls to avert such
situations or clear procedures to manage residual
liquidity and credit risks if such a situation were
to arise.
Completion of work on debit caps and regression
(the removal of payment instructions involving a
failed member input on the day of its default)
could contribute to managing such risks.  Debit
caps determined in relation to the amount of risk
each participant typically brings to the system
would place hard limits on exposures among
participants, although these caps would need to be
carefully calibrated to avoid impeding the
efficiency of the system.  Introduction of
regression would further reduce exposures
between participants in the event of a member
default and also reduce the likelihood of any such
default resulting in a shortfall of liquidity greater
than that provided for by the LFCA.  The
functionality necessary to implement both debit
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caps and regression will be delivered by the
NewBACS infrastructure renewal project.
The Bank assesses BACS broadly to observe
Core Principle III.  Implementation of further
innovations described above would strengthen
observance.
IV. The system should provide prompt final settlement
on the day of value, preferably during the day and
at a minimum at the end of the day.
Under normal circumstances, final settlement in
BACS occurs on the day of value.  Although the
point of finality is not defined in the BACS rules, it
seems likely that settlement would be considered
final when the net positions have been posted to
members’ settlement accounts at the Bank of
England.  It is at this point, on day 3 of the
clearing cycle, when members receive value.
Outside normal circumstances, the LFCA provides
a mechanism for ensuring timely settlement of
obligations between BACS members in the event of
the failure of a member in a net debit position to
meet its obligations.  This only occurs if the net
debit position of the affected member can be met
in full by the liquidity committed under the LFCA.
Otherwise settlement might not take place until
after day 3 of the interbank clearing cycle.  But for
the LFCA not to ensure prompt final settlement
would require an historically large net debit
position on the part of the affected member,
something which the Bank considers to be well
outside normal circumstances.
The Bank assesses BACS to observe Core
Principle IV.
V. A system in which multilateral netting takes place
should, at a minimum, be capable of ensuring the
timely completion of daily settlements in the event
of an inability to settle by the participant with the
largest single settlement obligation.
The LFCA covers both BACS and the C&CC and
provides a mechanism to ensure timely settlement
in the event of a settlement member default.
The agreement was described in the previous
Oversight Report as well as the June 2005 Financial
Stability Review.
(1) It is designed so that, in the
event of a member being unable to meet its
obligations, other members are obliged collectively
to provide liquidity to fund the affected member’s
position, up to a limit determined by reference to
net debit positions of members across both
clearings during the previous twelve months.  That
limit is currently a little over £2 billion.  Collateral
pledged by the defaulter under the terms of the
LFCA is used to reimburse survivors either in full
or in part.  Members commit liquidity and pledge
collateral in proportion to the degree of risk they
bring to the system, as measured by their historical
net debit settlement positions and the volatility of
those positions.  The practicalities and timings of
dealing with a failure to pay means that funds are
made available by calling liquidity rather than by
liquidating collateral.  Liquidation of collateral can
occur some time after liquidity is committed, to
avoid sale at distressed prices.  The eventual loss
to each survivor is measured by the value of
liquidity it contributed to fund the affected
member’s multilateral net debit settlement
position, less any recoveries from that member,
including the latter’s collateral.  Any residual loss
constitutes a direct claim on the affected member
or its liquidator, not the payment system.
As noted under Core Principle III, net debit
positions could still exceed the committed
liquidity of surviving members.  Debit caps in
BACS would not, however, eliminate the potential
for losses to survivors because the LFCA covers
both BACS and the C&CC and debit caps cannot
be practicably enforced in the latter.  A member of
both systems could therefore default in a net debit
position in excess of the liquidity committed under
the LFCA.  The probability of such exposures
arising is very low so any arrangement to meet
those losses and ensure settlement can complete
would need to be pragmatic, practicable and
low-cost.
In the absence of such arrangements, the Bank
assesses BACS broadly to observe Core
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Principle V.  Establishing a procedure for
allocating residual liquidity shortfalls between
survivors would help strengthen observance.
VI. Assets used for settlement should preferably be a
claim on the central bank;  where other assets are
used, they should carry little or no credit risk and
little or no liquidity risk.
Settlement of multilateral obligations between
members of BACS takes place across accounts held
at the Bank of England.
The Bank assesses BACS to observe Core
Principle VI.
VII. The system should ensure a high degree of
security and operational reliability and should
have contingency arrangements for timely
completion of daily processing.
BPSL has documented a wide range of operational
risk controls applicable to member banks and users
of BACS.  Similarly, Voca has established operational
risk controls relating to processing of BACS
payments.  Operational performance against agreed
standards is monitored by the BPSL Operations and
Development Committee.  An external SAS 70
review process covering both the payment scheme
and infrastructure provides further independent
assessment of the performance of controls against
control objectives.  Although members and users
generally adhere to scheme rules, BPSL has
established disciplinary procedures and
mechanisms for monitoring member behaviour
against operational rules, including
self-certification.  However, it remains unclear what
powers of sanction BPSL can draw on in the event
of rule breaches other than the exclusion of the
offending member(s) from the system.
BPSL members are responsible for their own
processing arrangements in BACS and have all
established contracts with Voca Ltd for the
provision of core processing services.  Voca’s
processing performance is measured against target
levels defined in the service level agreement (SLA)
with BPSL members.  Monthly reporting of Voca’s
performance against these targets provides
transparency for BPSL and its members.  Much like
2004, Voca’s overall operational performance was
strong during 2005.  Delivery of processed output
to members was completed to schedule in every
month and availability of payment file submission
channels was typically in excess of SLA-defined
minimum levels.  In support of its operations, Voca
has developed extensive business continuity
arrangements which are tested regularly, including
switching of payment processing from primary to
secondary sites.
For members, it remains unclear what processes —
if any — have been established for handling a
backlog of payments, in the event that delivery of
output from Voca is delayed for more than 24 hours.
In such instances, members would be required to
process two or more days’ output in a single day.
BPSL has only recently begun to investigate the
robustness of members’ existing processes.
Establishment of agreed procedures would provide
greater certainty of operational robustness.
Successful delivery of the NewBACS infrastructure
renewal programme is essential to ensure that
forecast BACS volumes can be processed reliably
and securely.  Independent assessment of Voca’s
project management arrangements and design of
the underlying technology has helped provide
BPSL and the Bank with some assurance regarding
project delivery.  However, such reviews are no
guarantee of operational robustness.  Ongoing
monitoring of project progress has been achieved
through the BPSL Member Programme Steering
Committee (MPSC) and, increasingly, the BPSL
Board.  It is important that the MPSC continues to
scrutinise Voca’s management of the project and
seek assurances from independent parties where
appropriate (eg through independent audit of
progress in NewBACS).
Equally, it is important that the MPSC acts to
ensure that an appropriate degree of engagement
between members and Voca is achieved as the
project nears completion, not least because of the
testing of and changes to members’ own systems.
Recent efforts by BPSL to ensure more detailed
reporting of progress by members and Voca to the
MPSC should help achieve such engagement.  The
recent agreement by members, Voca and BPSL to a
revised NewBACS Project Agreement has also helped
to ensure that parties remain committed to the
project timescale through to completion.
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Failure to ensure that members move forward in a
co-ordinated fashion could result in unnecessary
delay to NewBACS.  To mitigate the impact of such
a delay, BPSL and Voca have worked to secure
contingency arrangements for the existing core
processing platform, providing assurances that
payment processing could continue on a secure,
reliable basis in the event of NewBACS being
delivered later than currently expected.
The Bank assesses BACS broadly to observe
Core Principle VII.  Clear confirmation that
NewBACS is at least as robust as existing
technology, alongside confirmation that member
banks have in place processes to handle a backlog
of payments, would strengthen observance.
VIII. The system should provide a means of making
payments which is practical for its users and
efficient for the economy.
The use of Direct Debits and Direct Credits has
increased significantly over the past decade, partly
as users have substituted out of other payment
instruments.  More recently, growth has been
driven by the use of Direct Credits for an
increasing number of state benefit payments.  This
suggests that BACS payment instruments offer
members a practical and efficient means of making
customer payments.  BACS’ operational
performance also suggests a high degree of
operational efficiency.
It is more difficult to assess the pricing efficiency
of BACS payment instruments.  While payments by
BACS instruments are provided free of charge to
in-credit individual retail users, corporate access
through a sponsoring BACS member attracts a
charge.  However, corporate users benefit from a
competitive market for the provision of BACS
payment services and there is no evidence that
charges for this access adversely affect incentives
to use BACS payment instruments.
BACS was not assessed against Core Principle VIII
in the previous Oversight Report, pending
conclusion of research by the OFT Payment
Systems Task Force into clearing times of electronic
retail payments (Box 3).  This work identified
demand for faster telephone and internet banking
payments, with associated net benefits to the UK
economy.  These benefits include those accruing to
users as well as those accruing to member banks
through reduced settlement risk.
In response to the Payment Systems Task Force’s
recommendation that a faster electronic retail
payments service be introduced, the banking
industry has formed an Implementation Group to
take forward the delivery of a new faster payments
service.  Industry forecasts indicate that such a
service could initially attract up to 10% of existing
BACS volumes.  Although this could grow, it
suggests that current clearing cycles will be of
appropriate duration for those payments which do
not migrate from BACS to the new service.  That
said, reduction of the current BACS clearing cycle
could still deliver risk-reducing benefits to member
banks and practical benefits to users.  These
benefits, weighed against the cost of necessary
changes to members’ systems, could be usefully
considered by BPSL in greater detail.
The Bank assesses BACS partly to observe Core
Principle VIII.  Although beyond BPSL’s control,
the successful implementation of a faster payments
service for electronic retail payments would
strengthen observance.  Work to reduce existing
BACS clearing cycles would also strengthen
observance, if such a reduction can be shown to
deliver clear net benefits.
IX. The system should have objective and publicly
disclosed criteria for participation, which permit
fair and open access.
In order to limit the risk that multilateral net
settlement could fail to complete on account of a
settlement member’s failure to meet its obligations
in a timely fashion, BPSL restricts settlement
membership to credit institutions which are
subject to prudential capital and liquidity
regulation.  Given the importance of BACS to the
wider economy, this is an important control.
Following introduction of the LFCA, costs of
settlement membership for existing members have
become, in terms of collateral pledged, directly
related to the risk that such members bring to the
system in terms of the historical profile of their net
settlement positions.  To manage settlement risk
brought by prospective settlement members, for
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whom such positions may be unobservable, BPSL
could consider arrangements to relate collateral
pledged to the credit ratings of applicants.
Equally, arrangements could be established to
determine the amount of additional collateral
pledged by a member experiencing a rapid
deterioration in its credit rating.
The Payment Systems Task Force considered BPSL’s
access arrangements and noted the competitive
nature of the market for access via agency banks.
Payment Systems Task Force research also found
appetite for so-called Affiliate membership of
BACS, under which a wide range of interested
BACS user groups (eg corporate users, consumer
groups) could contribute views to the BPSL Board
on certain issues.  To meet this demand, in
December BPSL introduced the new membership
class and also established an Affiliate Interest
Group.  This has helped improve access to the
BACS scheme without introducing additional risk
to processing or settlement in the BACS system.
The Bank assesses BACS broadly to observe
Core Principle IX.  Establishing a mechanism to
deal with risks brought to the system by an
existing member with deteriorating financial
credit-worthiness would strengthen observance.
X. The system’s governance arrangements should be
effective, accountable and transparent.
The governance arrangements of BPSL are clear
and effective in relation to the needs of members.
Control over and responsibility for management of
the system ultimately rests with the BPSL Board,
which exercises effective control of the company’s
executive team.  The Board is supported by a
number of technical committees, which operate
under clear terms of reference and benefit from
industry-wide membership, helping to ensure an
appropriate level of expertise.
The relationship between BPSL, its members and
Voca is specified through a number of contractual
arrangements.  BPSL has recently reviewed those
arrangements and found Voca to be acting in
accordance with key contractual requirements.
Equally, the quality of relationship between BPSL
and Voca appears sound, the former monitoring
the latter’s operational performance and broader
financial position as a control against risks to
payment processing.  Progress in NewBACS has
been monitored effectively by BPSL through the
MPSC and, increasingly, by the BPSL Board.
During 2005 BPSL has been proactive in
progressing work to strengthen BACS’ observance
of the Core Principles in a number of areas, as
evidenced by the assessment in this Oversight
Report.  This approach, which the Bank views
positively, is a reflection of the quality of BPSL’s
governance arrangements.
While providing appropriate incentives to act in
the interest of system members, it is less clear
whether BPSL’s governance arrangements provide
appropriate incentives for management of the
system to be accountable to the wider community
of users and the public more generally.  Largely,
this is because BPSL is a member -operated
company whose Board has no independent
representation, in contrast to best practice in
corporate governance for listed companies.
(1) In
view of BACS’ importance to the smooth running
of the UK economy, the Bank considers the
company to have a clear public role and that best
practice in corporate governance is relevant to
BPSL.  To that end, board representation of
external stakeholders could help to ensure the
interests of such groups are included in BPSL’s
decision-making process.  Careful appointment of
individuals to such a role could also complement
BPSL’s recently adopted company objective to
promote efficiency and innovation in payments
while responding to the needs of BACS users on a
cost-effective basis.
The Bank assesses BACS broadly to observe
Core Principle X.  Extending board
representation to external stakeholders, or more
wide-ranging changes to governance structures
which can provide accountability and transparency
to BACS stakeholders, would strengthen
observance.
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(1) The Combined Code on Corporate Governance (2003), recommends that the board of a listed company include independent, non-executive directors.  It is
available at:  www.fsa.gov.uk/pubs/ukla/lr_comcode2003.pdf.

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E. THE CHEQUE AND CREDIT CLEARINGS
The Cheque and Credit Clearings (C&CC) consist
of three separate clearings, which provide clearing
and settlement for sterling debits (cheques);  euro
debits;  and sterling credits respectively.  While
these instruments are processed separately and in
slightly different ways (in particular, the degree of
automation of processing is higher for the majority
of sterling cheques than for the other payment
instruments) they are part of a single payment
scheme.  Most members of the C&CC have chosen
to outsource their processing operations.  The
following assessment covers all three clearings.
I. The system should have a well-founded legal basis
under all relevant jurisdictions.
Unlike other payment instruments, there is a
substantial body of English law pertaining to
cheques.  Statutes relate to the treatment of paper
cheques, and the C&CC must operate in
accordance with these statutes.  The rules and
procedures of the C&CC cover the main aspects of
the system’s operations and appear to provide an
adequate legal basis for its operation.  In
December 2005 members also agreed to sign
formal contracts, the Membership Agreement,
committing them to abide by the rules and
decisions of the Company Board.  This defines
more clearly the obligations of members.
The C&CC are a three-day deferred multilateral
net settlement system.
(1) Payments submitted are
netted to produce a single obligation to, or claim
on, other members.  The settlement of
inter -member obligations within the C&CC, which
takes place on day 3 of the clearing cycle, is
governed by the Settlement Agreement, a formal
contract between members which seeks to remove
legal uncertainties about whether these
inter -member obligations would be upheld
following the insolvency of a member.  The Bank
noted in the previous Oversight Report that
additional assurance of the enforceability of the
system’s default arrangements could be obtained if
the C&CC were designated under the UK
settlement finality regulations.  Members plan to
consider in 2006 whether to apply for designation.
Notwithstanding the Settlement Agreement, there is
currently a possibility that a liquidator could seek
to return via the unpaids process all cheques
drawn on a failed member and its customers.  This
could cause operational difficulties for members in
handling a large volume of unpaid cheques, and
crystallise credit exposures on surviving members
in respect of dishonoured cheques already
credited to their customers’ accounts.  Members
are currently working to agree a Cheque and Debit
Recall Agreement (the Recall Agreement) that would
aim to prevent this.
In the event of a member default, a surviving
member has two possible courses of action for
dealing with cheques drawn on itself and already
exchanged with the failed member but not yet
settled:  honour those cheques exchanged with the
failed member and settle its obligation in respect
of those cheques by way of the interbank
settlement;  or return the cheques as unpaid to the
failed member without settling them.  If a
surviving member returned cheques as unpaid,
customers of the failed member might recover the
full value of these cheques deposited by another
route.  If a surviving member settled its obligations
to the failed member, customers of the failed
member might receive only a proportion of the
value, after liquidation of the failed member had
taken place.  A member, acting in its capacity as
paying bank, might face claims from customers of a
failed member, if it settled its obligations to the
failed member, rather than returning the cheque
as unpaid, and the customers did not receive full
value.  This is known as ‘conversion risk’ .  The
Cheque and Credit Clearing Company (C&CCC)
has not undertaken a legal investigation of
conversion risk, hence the existence and extent of
the risk is unknown at present.  The Bank has
encouraged the C&CCC to carry out a legal
investigation of conversion risk.
The Bank assesses the C&CC partly to observe
Core Principle I.  Completion of work already
under way on the Recall Agreement, work to
investigate conversion risk, and a successful
application for designation under the UK
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settlement finality regulations would strengthen
observance of the Core Principle.
II. The system’s rules and procedures should enable
participants to have a clear understanding of the
system’s impact on each of the financial risks they
incur through participation in it.
Work on the Settlement Agreement and the Liquidity
Funding and Collateralisation Agreement has enabled
members to examine, clarify and reduce the credit
and liquidity risks associated with the settlement
of multilateral net positions.  The C&CCC has also
identified the potential increase in settlement risk
that could arise as a result of significant errors in
settlement figures, and sought to mitigate this risk
with the forthcoming high-value adjustment
process.  Work on the Recall Agreement has also
identified and sought to mitigate further the
financial risk that members incur through
participation in the system.  Work on conversion
risk would further improve this understanding.
The Bank assesses the C&CC to observe Core
Principle II.
III. The system should have clearly defined procedures
for the management of credit risks and liquidity
risks, which specify the respective responsibilities
of the system operator and the participants and
which provide appropriate incentives to manage
and contain those risks.
The basic obligation of members to settle net
amounts is clear and the Settlement Agreement
should make those obligations enforceable.
The Liquidity Funding and Collateralisation Agreement
(LFCA) covering BACS and the C&CC defines
procedures for managing credit and liquidity
exposures that would crystallise in the event of a
member insolvency and subsequent failure to
settle.  Annex D contains further explanation of
the LFCA.  The LFCA substantially reduces, but
does not remove, credit and liquidity risk from the
system.  As with BACS, a residual risk remains that
a member could default on a larger amount than
the liquidity that surviving members would be
committed to provide.  The C&CCC has not
defined procedures to manage this residual risk.
The C&CCC has yet to implement a process to
deal with the possibility of significant errors in
settlement figures.  Such errors increase settlement
risk within the system:  a member’s net debit
settlement position could be greater than the
amount of liquidity available to it.  Members have
agreed upon a high-value adjustment process to
address this risk.  The Bank considers this process,
which is due to be implemented in 2006, to be a
necessary control against settlement risk.
Implementation would strengthen observance of
Core Principle III.  Completion of the Recall
Agreement and an investigation of the existence and
extent of conversion risk would further strengthen
observance. 
The Bank assesses the C&CC broadly to observe
Core Principle III.  Implementation of further
innovations described above would strengthen
observance.
IV. The system should provide prompt final settlement
on the day of value, preferably during the day and
at a minimum at the end of the day.
Although the point of finality is not defined in the
C&CC rules, it is likely that settlement would be
considered final when the net positions of
members had been posted to members’ settlement
accounts (on day 3 of the interbank clearing
cycle).
Outside of normal circumstances, the LFCA
provides a procedure to ensure timely settlement
in the event of the failure of a settlement member
in a net debit position to make its pay-in.  A
residual risk remains that liquidity committed by
members under the LFCA could be insufficient to
cover the net debit settlement position of the
affected member.  If this occurs, settlement might
not take place until after day 3 of the interbank
clearing cycle.  Under normal circumstances,
however, final settlement occurs on the day of
value, so this risk is not sufficient to prevent the
system from observing the Core Principle.
The Bank assesses the C&CC to observe Core
Principle IV.
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V. A system in which multilateral netting takes place
should, at a minimum, be capable of ensuring the
timely completion of daily settlements in the event
of an inability to settle by the participant with the
largest single settlement obligation.
The LFCA establishes a procedure to ensure timely
completion of settlement if a settlement member
fails in a net debit settlement position.  A small
risk remains that the largest single net debit
settlement obligation could exceed the amount of
liquidity committed by surviving members under
the LFCA.  This residual risk could be avoided if
BACS and the C&CC had the ability to cap
exposures at the level of liquidity committed.
While this will be possible in BACS, the Bank
recognises that there may be significant practical
obstacles to placing debit caps on members’
multilateral net settlement positions in a
paper -based system such as the C&CC.
Given the inability to cap exposures in the C&CC,
the system could instead define procedures to
allocate residual risk.  For example, any shortfalls
in liquidity could be met by surviving members in
proportion to their underlying bilateral net
settlement positions in the C&CC vis-à-vis the
defaulter.  This would ensure that, in the event
that multilateral net debit positions exceeded the
liquidity committed by surviving members, only
those exposed to the defaulter would suffer any
loss.  The Bank has encouraged the C&CCC to
consider whether allocation of residual risk on the
basis of underlying bilateral settlement positions is
a legally robust and practical solution.
The Bank assesses the C&CC broadly to observe
Core Principle V.  Work to define procedures to
allocate residual settlement risk would strengthen
observance of the Core Principle.
VI. Assets used for settlement should preferably be a
claim on the central bank;  where other assets are
used, they should carry little or no credit risk and
little or no liquidity risk.
Settlement between members takes place across
accounts held at the Bank of England.
The Bank assesses the C&CC to observe Core
Principle VI.
VII. The system should ensure a high degree of
security and operational reliability and should
have contingency arrangements for timely
completion of daily processing.
The systems and controls set out by the C&CCC
for controlling operational risk are wide ranging
and are generally well documented.  Policies and
procedures are in place to identify and address
potential weaknesses.  These are reviewed regularly,
including an external SAS 70 review of
performance against control objectives.
Contingency arrangements appear extensive, with
the exception of one potential shortcoming, which
the C&CCC has identified and is seeking to
address.
A core piece of infrastructure for the sterling
cheque clearings — by far the largest clearing
within the C&CC by both value and volume — is
the Interbank Data Exchange (IBDE) network,
across which details of each cheque are sent to
members and which is used by the C&CCC to
compile multilateral net settlement figures.  The
IBDE network is currently supplied by Voca.
Notwithstanding occasional delays and errors,
the overall record of reliability of the IBDE network
is high.
IBDE apart, there is relatively little central
infrastructure.  Members are responsible for
processing their paper cheques and credits, and
most have chosen to outsource this function to
one of three suppliers.  The C&CCC has no direct,
formal relationship with the outsourced service
providers.  Members self-certify their compliance
with the system’s control objectives.  The C&CCC
has, however, sought to open dialogue with
third-party infrastructure suppliers where their
operations affect the performance of the C&CC as
a whole against its control objectives.  It is still
unclear whether the C&CCC can receive adequate
assurance of compliance with the various controls
that govern cheque processing via such informal
channels.
One possible source of operational risk, identified
in the previous Oversight Report, is the high volume
of changes to members’ outsourced processing
arrangements.  Members have been working to
consolidate the infrastructure used to process
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cheques and credits.  This consolidation impacted
on members’ performance against Service Level
Codes — which provide targets for operational
performance — over the eight-month period to
end-January 2005.  The issue, however, posed no
risk to the completion of interbank settlement.
The temporary deterioration in operational
performance might have been resolved earlier if
the C&CCC had exercised its existing indirect
rights to audit members’ third-party infrastructure
suppliers (Core Principle X).
Increased outsourcing has resulted in a decline in
operational expertise among members.
Experienced staff have transferred to third-party
infrastructure suppliers, and members are no
longer involved in day-to-day processing
operations.  There is a risk that members might in
the future lack the requisite expertise to assess
adequately members’ compliance with the
requirements and objectives of the scheme.
Third-party suppliers are now represented on some
scheme committees, which the Bank views to be a
positive step forward given the decline in
operational expertise among members.  The
C&CCC has also taken steps to include the views
of third-party suppliers in major projects such as
‘certainty of fate’ (Core Principle VIII).  The
C&CCC also attempted to increase strategic
discussion between the scheme and third-party
suppliers in 2004 with the establishment of an
Infrastructure Advisory Forum, which was designed
to provide a forum for discussion between the
C&CCC, members and third-party suppliers.
However, suppliers were unwilling to enter into
open discussion with their competitors, and the
Forum was disbanded in 2005.
The Bank assesses the C&CC broadly to observe
Core Principle VII.
VIII. The system should provide a means of making
payments which is practical for its users and
efficient for the economy.
Cheque volumes in the United Kingdom have
declined steadily since 1 990.  The cheque remains
a popular payment instrument in the
United Kingdom at present, but volumes are
predicted to decline by almost 50% by 20 1 4.  Unit
processing costs are relatively high in comparison
to other retail payment instruments, and will rise
further as cheque volumes decline.  Members have
chosen not to price explicitly personal cheques.
Unlike in other developed countries where
cheques have traditionally been a common
payment instrument, the C&CCC and its members
have not chosen to seek the potential product
enhancements and potential cost savings that
could be derived from replacing the current
exchange of physical cheques with electronic data
(for example, electronic images of cheques).  They
have, however, sought to achieve cost efficiencies
through increased consolidation of the
infrastructure used to process cheques.
A system that takes undue time to clear and settle
payments might cause end-users to incur
significant, real resource costs.  The three-day
interbank clearing cycle and the process for
returning unpaid cheques is slow in comparison
with other developed countries.  The decline in
volumes, however, weakens the business case for
investing in improvements to clearing cycles.  The
argument that costs are likely to exceed benefits
may be particularly powerful for the less
automated parts of the clearings, where volumes
and values are considerably lower than for sterling
cheques.
It may be easier to accelerate the sterling cheque
clearing, which is already relatively highly
automated.  Data on cheque settlement positions
are available almost a day in advance of settlement.
Interbank settlement for sterling cheques could be
moved from day 3 to day 2 of the cheque clearing
cycle.  This would yield a small but significant
settlement risk benefit.  The Bank understands
that this would involve little infrastructure change,
and has encouraged the C&CCC to weigh the
costs and benefits of bringing forward interbank
settlement.  Bringing forward interbank settlement
would not, however, impact upon end-users if
members chose not to give earlier value to cheque
recipients.  Giving earlier value to customers might
involve investment in members’ accounting
systems.
At present customers do not receive value without
recourse (‘certainty of fate’) on cheques, as no
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point is defined after which a cheque cannot be
returned as fraudulent.  Members have been
working on a project which aims to guarantee
certainty of fate on cheques.  If implemented, the
project, which would involve investment in the
existing infrastructure to improve the process for
returning unpaid cheques, should bring benefits
for end-users.  Members have yet to commit to the
certainty of fate project, and are likely to await the
outcome of the OFT Cheque Working Group
(Box 2) before making such a commitment.
The OFT is examining the costs and benefits of,
and demand for, change to the current system as
part of its Payment Systems Task Force (Box 2).
The Bank will consider the outcome of work in the
Task Force and by C&CC members.  Pending
completion of that work, there is insufficient
evidence for the Bank to assess whether the
C&CC observes Core Principle VIII.
IX. The system should have objective and publicly
disclosed criteria for participation, which permit
fair and open access.
The criteria for settlement membership seem
suitable for controlling the risks that arise in the
system.  In particular, the restriction of settlement
membership to credit institutions subject to
prudential capital and liquidity regulation provides
some assurance that members can meet their
settlement obligations in a timely manner, and so
prevent the possible disruption to the wider
system and public that a failure to settle could
cause.  One current gap in the membership
criteria identified in the previous Oversight Report
is a procedure to deal with a settlement member
whose credit quality deteriorates to an extent that
brings a high level of risk to the multilateral
settlement.  The C&CC Scheme Governance
Steering Committee plans to complete a review of
the system rules in 2006.  This will include
consideration of a means of dealing with a
member whose credit quality deteriorated to a
level that brought additional financial risk to the
system.
The Bank is not aware of any significant demand
for membership of the C&CC from institutions
that are not already members.  Financial
institutions that are not members can access the
system via bilateral agency relationships with
settlement members.  The OFT found in 2003 that
there was a competitive market for agency services
and that agency banks could compete on a
reasonably level playing field with direct
members.
(1)
The Bank assesses the C&CC broadly to observe
Core Principle IX.  Amendment of the system
rules to include exit criteria to deal with a
settlement member whose credit quality has
deteriorated to an extent that brought
unreasonable financial risk to the clearings would
strengthen observance.
X. The system’s governance arrangements should be
effective, accountable and transparent.
The C&CCC has a clear governance structure, with
ultimate responsibility for management of the
clearings resting with the Board.  The Bank
considers the C&CCC’s executive to be broadly
accountable to the Board.  The Core Principles
state that effective governance entails proper
incentives for management to pursue objectives in
the interests of the system, its participants, and the
public and wider economy more generally.  The
C&CCC Board is composed entirely of settlement
member banks (the Company Manager and the
CEO of APACS also attend but do not have a vote).
The Board has both the incentives and tools to
pursue the interests of the system and its
settlement members.  Incentives to pursue the
interests of the public and wider economy more
generally are less clear.  There may be a case for
the C&CCC to consider the case for independent
or further public interest representation on the
Board.
Another potential weakness in the system’s
governance arrangements is that there is no formal
relationship between the C&CCC and the
third-party infrastructure suppliers that process
the majority of cheques, although suppliers are
now invited to attend some operationally
orientated committees.  Members of the C&CC do,
however, enter into bilateral contracts with their
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suppliers, and must certify annually that
processing is conducted in accordance with the
C&CCC’s various risk controls.  The C&CCC audits
the initial outsourcing arrangements of members,
and conducts an audit review of any high-risk
change to processing proposed by members.  The
C&CCC has indirect rights to audit members’
outsourced suppliers, but has so far chosen not to
exercise these existing audit rights.
The Bank places a high weight on good
governance, which it recognises as a key principle
of well-functioning financial infrastructures that
provides a sound basis for observance of the other
nine Core Principles.  In the case of the C&CC,
several strands of work were completed in 2005,
which improved the scheme’s observance of the
Core Principles.  Work is also in hand to improve
observance of the other Core Principles.  But work
has typically taken a significant amount of time to
reach a satisfactory conclusion.
The Bank assesses the C&CC broadly to observe
Core Principle X.
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F. LINK
The LINK card scheme (the Scheme) is the
United Kingdom’s largest ATM network, which
enables its members’ customers to withdraw cash
from all but a few of the United Kingdom’s ATMs,
irrespective of the bank at which they hold their
account.  The LINK Interchange Network Ltd
encompasses both the Scheme and its
infrastructure provider (the Company).  The
Company provides transaction switching for
members of the Scheme, by routing transaction
information from the ATM used by the customer to
the card issuer’s own computer network.  The LINK
Interchange Network is a for -profit, limited
company owned by a subset of the members of
the Scheme.
I. The system should have a well-founded legal basis
under all relevant jurisdictions.
All members enter into formal contracts with each
other as part of their membership of the Scheme.
These contracts specify members’ rights and
obligations, and commit them to abide by the
system’s rules and procedures.  The rules and
procedures of the system cover the main aspects of
the system’s operation, but default procedures are
not adequately defined in the main body of the
rules.  These procedures might therefore be
subject to legal challenge in the event of a member
insolvency.  It is also unclear from the rules
whether, in the event of a member insolvency,
surviving members would face a potential credit
exposure equal to their bilateral gross or bilateral
net settlement position vis-à-vis the insolvent
member.  The Scheme plans to amend its rules to
clarify members’ net settlement obligations.
The system’s legal basis would be more robust if
the system’s rules clearly defined the obligations of
members in all circumstances.  Once this had been
achieved, additional assurance of the
enforceability of the system’s default arrangements
might be obtained if the Scheme were designated
under the UK settlement finality regulations.
The Bank assesses the Scheme partly to observe
Core Principle I.  In the first instance, clearer
definition of the rules and procedures of the
system, and the obligations of members, would
strengthen observance.
II. The system’s rules and procedures should enable
participants to have a clear understanding of the
system’s impact on each of the financial risks they
incur through participation in it.
System participants incur both credit and liquidity
risk through participation in the Scheme.  Rules
and procedures exist to manage credit and
liquidity risk within the system under ‘normal’
circumstances.  The rules of the system clearly
outline normal settlement procedures.  Parties to
the multilateral net settlement are also required to
have the tools to manage adequately liquidity and
credit risk within the system.  For example, card
issuer members, who can accrue multilateral net
debit positions, are required to monitor their
settlement positions.
Procedures apply to ‘abnormal’ circumstances —
circumstances that might prevent the completion
of the multilateral net settlement — such as a
participant insolvency.  However, these procedures
are not adequately defined in the main body of the
system’s rules.  Furthermore, the system rules do
not define clearly the bilateral net nature of
surviving participants’ credit exposures to the
insolvent participant.
Given the current rules and procedures of the
system, participants are likely to have an
incomplete understanding of the risks incurred
through participation in the system.  The Scheme
has, however, identified settlement risk
management as an area for review, and has
prompted discussion of this issue within the
governing body of the Scheme, the Network
Members Council (NMC).  The Bank continues to
encourage the Scheme executive to address
settlement risk-related issues in collaboration with
Scheme participants.
The Bank assesses the Scheme broadly to
observe Core Principle II.  Clearer definition of
the rules of the system and the obligations of
system participants, and further work to examine,
clarify and reduce settlement risk within the
system, would strengthen observance of the Core
Principle.
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III. The system should have clearly defined procedures
for the management of credit risk and liquidity
risk, which specify the respective responsibilities
of the system operator and the participants and
which provide appropriate incentives to manage
and contain those risks.
Participants’ basic obligations within the system
under ‘normal’ circumstances are clearly defined.
The system also has procedures in place in the
event of a participant insolvency, and an allocation
of responsibility to cover credit losses that could
arise as a result of insolvency is laid out in these
procedures.  However, participants’ obligations
within the system might not be clear, because the
system’s default procedures are not adequately
defined in the main body of the system’s rules.
Under the system’s default procedures, multilateral
netting would be unwound and recast excluding
the insolvent participant.  Survivors’ credit
exposures should equal bilateral net amounts owed
to them by the insolvent participant, although this
obligation is not clearly defined within the rules.
Potential credit losses within the system would be
reduced if bilateral netting were made more
robust.  Losses would be further reduced if the
system retained its multilateral netting, coupled
with an agreed allocation of responsibility to cover
any losses that could result within the system
following a participant default.
The system places few restrictions on access (Core
Principle IX).  For example, card issuer
participants — who can accrue net debit
settlement positions — are not required to be
financial institutions.  In consequence,
participants might face credit exposures vis-à-vis
non-financial institutions.  The Core Principles
suggest that criteria that impose few membership
restrictions should be coupled with appropriate
risk management controls, to ensure that no
participant brings an unacceptable level of credit
and liquidity risk to the system.
The Scheme has imposed some controls to manage
credit and liquidity risk within the system.  Credit
risk could be reduced further if settlement
positions that accumulated over weekends and
bank holidays were netted and settled as part of a
single aggregate settlement file.  The Scheme is
examining the feasibility of netting over weekends,
which will be possible once the Scheme has
introduced new settlement software that will allow
settlement figures to be broken down easily by
product and by participant.
(1) The Company is
also developing a new settlement system capable of
monitoring intraday participants’ settlement
positions.  This would enable the system to impose
debit caps.  Going forward, these initiatives should
equip the Scheme with the tools to manage more
effectively credit and liquidity risk within the
system.  The Scheme has yet, however, to consider
fully what additional controls should be placed
upon participants who are non-financial
institutions accruing multilateral net debit
settlement positions, in order to mitigate the
increased financial risk that these participants
might bring to the system.
The Bank assesses the Scheme partly to observe
Core Principle III, but successful completion of
work already under way to control credit and
liquidity risk within the system would strengthen
observance of the Core Principle.
IV. The system should provide prompt final settlement
on the day of value, preferably during the day and
at a minimum at the end of the day.
The Scheme is a deferred multilateral net
settlement system operating on a T+1 cycle:
Scheme members dispense cash from an ATM to
customers of other members on day T;  settlement
of multilateral net positions occurs across
accounts held at the Bank of England on day T+1.
Although the point of finality of interbank
settlement is not defined in the rules of the
system, it is likely that settlement would be
considered final once postings of net positions
had been made to participants’ settlement
accounts on day T+1.
The system has not in the past provided
participants with sufficient incentives for timely
funding of settlement accounts.  As a result,
participants owing net balances have not always
funded their positions promptly, which has led to
delays to settlement.  Settlement has never been
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(1) Settlement of the LINK card scheme is combined with settlement of a number of other schemes or ‘products’ for which the LINK  Interchange Network Ltd
provides infrastructure services, such as a mobile phone top-up scheme enabling individuals to top-up pay-as-you-go phones at ATMs.

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delayed beyond the day of value.  The NMC is
informed of delays to settlement.  The NMC has
recently agreed new rules that discourage late
pay-ins, and these will be introduced after a trial
period in early 2006.  If effective, this initiative
would strengthen the system’s observance of the
Core Principle.
For historical reasons a small group of Scheme
participants are also members of an organisation
known as FTS.  FTS members connect to LINK via a
third party.  FTS members ‘sub-settle’ among
themselves and submit a single multilateral net
settlement amount to the main LINK settlement.
Hence the main LINK settlement cannot complete
until FTS members have settled among themselves.
This arrangement complicates the system’s
settlement procedures and can lead to settlement
delays.  Delays to settlement might be less frequent
if FTS members took part directly in the main
settlement, or made bilateral arrangements
through another participant that was part of the
main settlement.  The Bank has encouraged the
Scheme to review the current settlement
arrangements for FTS.
Settlement would also be delayed in the event of a
participant insolvency.  Under the procedures in
place in the event of the failure of a participant in
a net debit position to make its pay-in, settlement
would be delayed until the next banking day.  In
normal circumstances, however, final settlement
occurs on the day of value, and these risks are not
sufficient to prevent the system from observing
broadly this Core Principle.
The Bank assesses the Scheme broadly to
observe Core Principle IV.  Successful
implementation of measures to ensure prompt
pay-ins by members in a net debit position would
strengthen observance.
V. A system in which multilateral netting takes place
should, at a minimum, be capable of ensuring the
timely completion of daily settlements in the event
of an inability to settle by the participant with the
largest single settlement obligation.
The Scheme has procedures to ensure that
settlement completes if a system participant fails
in a net debit position.  Settlement of multilateral
net amounts (excluding the insolvent participant)
would take place on the next working day following
the participant insolvency.  This is not considered
to be ‘timely’ relative to other systems that settle
on a multilateral net basis.  However, full
observance of this Core Principle would not
necessarily be expected given the relatively small
settlement values involved.
The system’s default procedures could be subject
to challenge from surviving participants, who do
not commit to them as part of the system’s rules.
Challenge would be most likely if the recalculation
of settlement figures minus the insolvent
participant resulted in an increase in the
multilateral net debit settlement position of a
surviving participant.  While unlikely to be
successful, the possibility of challenge adds legal
uncertainty, and could delay settlement further.
There would be merit in the Scheme considering
ways to strengthen legal certainty of the
enforceability of existing default arrangements.
The Bank assesses the Scheme broadly to
observe Core Principle V.
VI. Assets used for settlement should preferably be a
claim on the central bank;  where other assets are
used, they should carry little or no credit risk and
little or no liquidity risk.
Settlement between members takes place across
accounts held at the Bank of England.
The Bank assesses the Scheme to observe Core
Principle VI.
VII. The system should ensure a high degree of
security and operational reliability and should
have contingency arrangements for timely
completion of daily processing.
The LINK Interchange Network Ltd encompasses
both the Scheme and the Company, which
provides processing services to the Scheme.  The
system’s record of operational availability is good;
over the past three years (to end-2005) the
Company has maintained 100% availability of the
switch for routing transactions.  The Company
maintains bilateral service obligations to members
of the Scheme through the Scheme’s membership
agreement and operating rules.  In 2006, the
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Company plans to contractualise its service
obligations to the Scheme in separate SLAs
between the Company and members of the
Scheme.
The LINK risk control framework provides a
structured process through which risks are
identified by function.  It was designed by the
LINK Interchange Network Ltd, and the Scheme is
considered as one ‘function’ within this framework.
The risk control process is reviewed independently
of day-to-day operations by the LINK Interchange
Network Ltd senior management, and the overall
framework is subject to independent external
audit.  The Company Board has responsibility for
determining the overall risk appetite.  While it is
logical for the Company to identify and manage
those operational risks related to Company
processes, there would be merit in the Scheme
developing more formally its own risk framework to
manage Scheme-specific operational risks.  The
NMC has identified risk as an area for review.
The controls underlying the system’s risk
management framework for managing operational
risk are determined by the LINK Interchange
Network Ltd and appear wide ranging and
generally well documented.  The system maintains
standards — determined by the Scheme — which
cover, among other things, encryption,
authentication and availability.  Participants
self-certify their compliance with the required
standards.  Business continuity arrangements are
tested regularly and appear to be extensive.
The Bank assesses the Scheme to observe Core
Principle VII.
VIII. The system should provide a means of making
payments, which is practical for its users and
efficient for the economy.
The number of transactions processed by the LINK
Interchange Network Ltd rose by over 1 50%
between 2000 and 2005.  However, transaction
growth, particularly growth in transaction volumes,
has been decelerating since 2002.
The lack of separation between the Scheme and
the Company does not appear to have prevented
Company innovation;  the Company has
introduced a number of new products.  The large
size of the NMC might hinder the effectiveness of
the Scheme’s decision-making and thus the level of
Scheme-wide innovation, although the Scheme has
attempted to improve the decision-making process
with the introduction of a NMC sub-committee,
the Review Group (Core Principle X).  The
Scheme’s rules also allow participants a degree of
autonomy to innovate, subject to certain required
system standards.
Card issuers pay a switching and settlement fee to
the LINK Interchange Network Ltd for the cost of
routing transaction information from the ATM
used by the customer to the card issuer’s own
computer network.  This cost-based fee is a small
fraction of participants’ total fees.  System
participants also pay membership fees to the
Scheme.  These fees are comparatively small.  Both
the switching and settlement fee and the
membership fee are unlikely to constitute a
significant barrier to entry.
Card issuers also pay a multilateral interchange fee
to acquirers on shared ATM transactions that pass
through the LINK network.  The multilateral
interchange fee is a flat-rate fee set centrally by
the Scheme, based upon an independent cost
survey.  There is a separate multilateral
interchange fee for branch and non-branch ATM
transactions, and only a fixed fraction of the
multilateral interchange fee is applicable to
non-cash withdrawal transactions, such as account
balance enquiries.  It is not clear that the centrally
set interchange fee reflects the cost of service
provision in all cases, particularly for ATMs
handling lower transaction volumes, which
typically incur higher unit operating costs.
However, the rules of the system allow participants
to forgo the interchange fee and instead impose a
surcharge on users of their ATMs.  The system
currently has a Competition Act exemption for its
centrally set interchange fee.  This exemption
expires in 2006.  In making its exemption decision,
the OFT found that, while a centrally set fee was
anti-competitive because it restricted the freedom
of members to set their own pricing policy, the
countervailing benefits of a centrally set fee were
great enough to allow this to persist.
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Participants may also impose charges on their
customers.  Customer charging is outside of the
Scheme rules — determined by individual system
participants who are free to compete in this
market — and is therefore not considered in this
assessment.
While it is not straightforward to assess the
efficiency of a payment system, the Bank assesses
the Scheme to observe Core Principle VIII.
IX. The system should have objective and publicly
disclosed criteria for participation, which permit
fair and open access.
The system’s membership criteria appear
objectively justified and are available to all
prospective members.  The criteria in theory allow
open access to the Scheme.
As the criteria impose few restrictions on
membership, the Bank has encouraged the Scheme
to consider what changes could be made to its
settlement risk controls to ensure that participants
do not bring an unacceptable level of credit or
liquidity risk to the system.  This was reflected in
the Bank’s assessment of the Scheme against Core
Principle III.
The Bank assesses the Scheme to observe Core
Principle IX.
X. The system’s governance arrangements should be
effective, accountable and transparent.
Although there is no legal separation of the
Scheme and the Company, there are, however,
separate governing bodies with clearly defined
functions.  Ultimate responsibility for management
of the Scheme rests with the Scheme’s governing
body, the NMC.  The large size of the NMC might
reduce the effectiveness of its decision-making.
The Scheme has attempted to improve the quality
of debate within the NMC with the creation of a
NMC sub-committee, the Review Group, which
advises the NMC on various strategic and process
matters facing the Scheme.  While the objectives of
both the NMC and the Company Board are clearly
defined, reporting lines are somewhat blurred
under the current governance model.  This might
impact upon the transparency and accountability
of governance arrangements.  The LINK
Interchange Network Ltd could achieve some of
the benefits of legal separation, such as
transparency and accountability, within its existing
governance structure.  For example, the
accountability of the executive to the NMC could
be strengthened if the Scheme management
reported to the NMC rather than the Company
CEO for Scheme-related issues.
The NMC is chaired by an independent
non-executive and is composed of one
representative appointed from each of the Scheme
members.  The LINK Scheme Director and the
CEO of the LINK Company also attend the NMC,
although neither has the right to vote.  The NMC
has the tools and incentives to pursue the interests
of both the Scheme and its members.  A sound
working relationship between the Scheme and
Company is important in protecting those
interests, but incentives to pursue the interests of
the Scheme and its members could be clearer if a
Company representative did not attend the NMC
for discussion of issues that might present a
conflict of interest between the Scheme and the
Company.  There might, however, be merit in
Company attendance at the NMC if the issue was
of mutual interest.  The independent Chairman of
the NMC provides a tool to pursue the interests of
the system’s wider community of users, and address
the conflict of interest that can be created in a
mutual governance model.  The Bank believes that
there may be merit in the appointment of further
independent representatives on the NMC in due
course.  In 2006 the Scheme plans to introduce a
Consumer Standing Committee, chaired by the
independent Chairman of the NMC, to represent
the public interest and advise the NMC on
consumer -related issues.  While the Committee will
be purely advisory, the NMC will have to respond
to its recommendations and questions.
Governance arrangements of the LINK
Interchange Network Ltd are being considered as
part of the OFT-led Payment Systems Task Force
LINK Access and Governance Working Group,
which the Bank attends as an observer.
The Bank assesses the Scheme broadly to
observe Core Principle X.
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G. UK MAESTRO
UK Maestro is one of the largest debit card
schemes in the United Kingdom.  It enables its
Licensees’ customers (cardholders) to purchase
goods and services at participating merchants.  In
certain cases, cardholders can also obtain cash at
point-of-sale through the scheme (cashback).
The UK Maestro scheme is managed by S2 Card
Services Ltd (S2), a company limited by guarantee.
The UK Maestro scheme came into being on
1 July 2004, when the former ‘Switch’ debit
scheme operated by S2 was rebranded following a
brand migration agreement between S2 and
MasterCard Europe (MCE).  Following a separate
transaction processing agreement between S2 and
MCE, MCE is also now the infrastructure provider
for authorisation, clearing and settlement of UK
Maestro transactions.  In the context of
infrastructure provision, MCE is responsible to S2
as a service provider.
I. The system should have a well-founded legal basis
under all relevant jurisdictions.
The UK Domestic Maestro rules (‘the Rules’), as set
by S2, appear to provide an adequate contractual
basis for the system’s operation in most areas.  UK
Domestic Maestro Licensees (‘Licensees’) are
authorised by MCE, and are not bound to become
members of S2.  Regardless of their membership
status, all Licensees must adhere to the Rules set
by S2 according to the conditions of their
contract with MCE.  S2 can enforce the Rules on
Licensees in its capacity as agent for MCE in
administering the right to use the Maestro Mark in
the United Kingdom.
The Operating Agreement between S2 and its
members, which forms part of the Rules, is a
formal contract, which clearly states the
obligations of its members under the Rules.
Members agree to be bound by their obligations
under the Rules, to take all necessary action in
response to changes to the Rules, and to comply
with all written directions of the S2 Board in
relation to the UK Maestro scheme.  New members
are required to sign a Deed of Accession, which
states that they agree to be bound by the terms
and conditions of the Operating Agreement and the
Rules.  The Operating Agreement also states the
services that S2 provides to the members,
including granting access to the Rules, and
providing advice in relation to the interpretation
of the Rules.  English law applies to the Operating
Agreement.
UK Maestro Licensees also enter into bilateral
agreements with MCE for branding and
transaction processing purposes, tailored to the
services requested by the Licensee, and not seen
by S2.
(1) An umbrella agreement also applies
between S2 and MCE, which states that English
law must apply to these individual agreements.
In the event of a Principal Licensee default, MCE
guarantees to complete the multilateral net
settlement cycle using MasterCard Incorporated’s
pool of resources and credit lines.  But while the
Rules define the point by which members will be
notified of their daily net settlement position,
there is no defined point of final settlement in the
Rules.  As a result, there is no defined final point
by which the key financial risk has transferred
from a MCE guarantee to a deposit at the
settlement agent.  It is possible therefore that the
scheme’s arrangements for dealing with the
insolvency of a member could be subject to legal
challenge.
The Bank assesses UK Maestro partly to observe
Core Principle I.  UK Maestro could improve its
observance by defining the point of final
settlement in its rules.
II. The system’s rules and procedures should enable
participants to have a clear understanding of the
system’s impact on each of the financial risks they
incur through participation in it.
The UK Maestro scheme is a deferred multilateral
net settlement system, operating on a ‘same-day’
clearing and settlement basis.
(2) Principal
Licensees (Licensees who do not access the
scheme through another Licensee) of UK Maestro
are not exposed to financial risks from other
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(1) MCE does not process ‘on-us’ transactions (where the merchant and cardholder use the same Licensee).  ‘On-us’ transactions are processed by the Licensee.
(2) The clearing and settlement cycle is same-day.  However, the time from initiation of the transaction at the point-of-sale to  settlement will normally be at least
one day, as there is a short time lag between the initiation of the transaction, and the merchant uploading the details to thei r bank.

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Principal Licensees in the clearing and settlement
process, as MCE undertakes to complete
settlement in the event that a Principal Licensee
fails to discharge its settlement obligation, using
MCE’s own resources.  Principal Licensees do incur
potential financial risks from any Affiliate
Licensees (Licensees who access the scheme
through the Principal Licensee) that they sponsor.
The Operating Agreement clearly explains the
financial risks arising from Affiliate Licensees that
the Principal Licensee is responsible for meeting.
However, the Rules do not define a point of final
settlement (the commentary at Core Principle I
provides further details on this).
The Rules explain that following the settlement of
a transaction, an acquiring Licensee (a merchant’s
bank) may be later subject to a ‘chargeback’ , where
an equal and opposite transaction is applied by an
issuing Licensee (a cardholder’s bank).  The Rules
clearly specify both the circumstances in which a
chargeback is permitted (for example, fraud
performed on a ‘Chip and PIN’ card when the
merchant was not ‘Chip and PIN’ compliant), and
the procedures and timescales for initiating,
handling and settling a chargeback, as well as
procedures for resolving a dispute between an
issuing Licensee and acquiring Licensee regarding
a chargeback.
The Bank assesses UK Maestro broadly to
observe Core Principle II.  UK Maestro could
improve its observance by defining the point of
final settlement in its rules.
III. The system should have clearly defined procedures
for the management of credit risks and liquidity
risks, which specify the respective responsibilities
of the system operator and the participants and
which provide appropriate incentives to manage
and contain those risks.
As UK Maestro transactions are cleared through
MCE platforms, MCE undertakes to complete
settlement if a Principal Licensee fails to meet its
settlement obligations.  This essentially eliminates
credit and liquidity risks between the participants,
or between the participants and S2 as UK Maestro
governance authority.
MCE assesses the risk that Licensees pose to it
using MasterCard International’s member risk
assessment framework.  Licensees are required,
among other things, to provide current audited
financial statements and meet minimum credit
ratings.  Where a Licensee is deemed to pose an
excessive credit or liquidity risk to MCE, MCE can
take measures to reduce the size of the potential
risk from the Licensee.
UK Maestro settlement arrangements operate on a
‘direct debit’ basis;  Licensees are required to
pre-fund their settlement accounts, except where
they have sufficient overdraft facilities on their
accounts as part of a commercial relationship with
the settlement agent, HSBC.  In the event of a
Principal Licensee defaulting, MCE uses first its
overdraft facility at HSBC, and then MasterCard
Incorporated’s pool of liquid resources to complete
settlement (and repay the overdraft).  There are no
formal penalties for a failure to pre-fund accounts.
The Bank assesses UK Maestro broadly to
observe Core Principle III.
IV. The system should provide prompt final settlement
on the day of value, preferably during the day and
at a minimum at the end of the day.
The Bank does not have sufficient information to
conduct an assessment of UK Maestro against
Core Principle IV.
V. A system in which multilateral netting takes place
should, at a minimum, be capable of ensuring the
timely completion of daily settlements in the event
of an inability to settle by the participant with the
largest single settlement obligation.
As processor of transactions between Licensees,
MCE guarantees to complete settlement in the
event of operational problems or default by a
Principal Licensee.  It does this through overdraft
facilities available to it at the settlement agent and
access to MasterCard Incorporated’s $1.4 billion
pool of liquid resources (as at end-September
2005) available for managing operations.  Given
Principal Licensees’ typical and peak settlement
positions, this pool should be sufficient to cover
the UK Maestro Principal Licensee with the largest
net debit settlement position.  However, in the
event that this pool were not sufficient, for
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Payment Systems Oversight Report 2005

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example if the Principal Licensee also had a large
net debit position in the MasterCard UK credit
card scheme, and/or there had been other recent
member defaults which had depleted the pool,
MCE has access to MasterCard Incorporated’s
legally committed $2.25 billion agreed credit
facility in order to complete settlement.
The Bank assesses UK Maestro to observe Core
Principle V .
VI. Assets used for settlement should preferably be a
claim on the central bank:  where other assets are
used, they should carry little or no credit risk and
little or no liquidity risk.
Following the change in arrangements in
September 2005 from bilateral payments over
CHAPS, settlement is now performed on a
multilateral net basis over accounts held at HSBC.
While this is not a central bank asset, HSBC is a
highly creditworthy institution.  In addition,
positive balances held at HSBC during the
settlement process are relatively small compared
with positive balances held at settlement agents in
other payment systems.  The Bank therefore
believes that these commercial assets provide an
appropriate settlement asset for the UK Maestro
scheme.  Indeed, as stated in the Bank’s settlement
accounts policy,
(1) the Bank would not seek to
become settlement agent for systems such as UK
Maestro.
The Bank assesses UK Maestro broadly to
observe Core Principle VI.  However, the Bank
sees little benefit from a risk-reduction perspective
in UK Maestro seeking to strengthen observance
of Core Principle VI further, and so does not
encourage this.
VII. The system should ensure a high degree of
security and operational reliability and should
have contingency arrangements for timely
completion of daily processing.
MCE is responsible to S2 for the authorisation,
clearing and settlement platforms on which UK
Maestro operates.  A system specification
document details the responsibilities of MCE to S2
as a service provider, the service level objectives
and targets that MCE is expected to meet, and
arrangements and responsibilities for monitoring
and reviewing performance against these targets.
The objectives include minimum operational
availability of the inter -member network,
transmission time targets for the payment
authorisation system, and targets for the
production and transmission of clearing files to
members.  In the event that MCE fails to meet
these targets, MCE is obliged to correct the fault
and arrange additional resources as necessary to
meet the service levels at no cost to S2 members.
S2 also specifies service targets for Licensees,
covering issues such as availability of the
Licensees’ authorisation systems, and notice
periods to S2 and MCE of planned system
downtime.
As service provider, MCE is also responsible for
business continuity arrangements for the systems.
MCE has worked hard to ensure that there are no
single points of failure in the systems.  For critical
systems there are strong contingency
arrangements in place, with both duplicate servers
at the primary site, as well as a distant secondary
site.  Contingency arrangements exist in case MCE
is unable to deliver clearing files to members by
the usual time.
The Bank therefore assesses UK Maestro to
observe Core Principle VII.  However, it must be
noted that this assessment focuses solely on the
authorisation, clearing and settlement process.
VIII. The system should provide a means of making
payments which is practical for its users and
efficient for the economy.
Debit cards in general are one of the most popular
payment instruments in the United Kingdom by
volume.  In 2004, there were approximately
5.8 billion debit card transactions, including
2.6 billion using the Switch and Maestro schemes.
Switch and Maestro volumes have recorded
consistent significant growth over the past decade.
Where on-line authorisation of a payment is
conducted, the response time of the MCE
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Payment Systems Oversight Report 2005
(1) Bank of England (2002), Bank of England Settlement Accounts, available at:
www.bankofengland.co.uk/financialstability/paymentsettlementsystems/pdf/boesettleaccs02 1 1 28.pdf.

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authorisation system(1) is in nearly all cases less
than a second.  The recent transfer from magnetic
stripe and signature authentication to ‘Chip and
PIN’ authentication, co-ordinated by APACS, has
so far proceeded smoothly.  Maestro cards can also
be used for payments abroad, although for these
transactions, the rules of MCE apply rather than
the S2 scheme rules.  This suggests that the UK
Maestro system is practical for its users.
In terms of cost efficiency, the costs of processing
transactions are balanced between Licensees
through a Payment Guarantee Charge (PGC).  This
is similar to what is known in other systems as an
‘interchange fee’ .  PGCs are negotiated and agreed
bilaterally between Licensees, rather than set
centrally, and are not seen by S2.  However the
Rules do include arbitration procedures that must
be followed in the event of deadlock in these
negotiations, and provide interim PGC rates while
an independent arbitrator resolves the dispute.
The OFT will look further into efficiency issues
affecting the UK Maestro scheme through the S2
Access and Governance Working Group, one of the
OFT’s Payment Systems Task Force’s working
groups.  This working group is due to meet in the
second half of 2006.
Initial membership fees for UK Maestro begin at
€ 10,000 for new Licensees with small expected
volumes.  This is significantly lower than the initial
set-up cost of the previous Switch scheme that UK
Maestro replaced.  Following the reduction in
membership costs and completion of transfer to
MCE platforms, a number of smaller banks and
building societies are in the process of joining the
scheme.
While it is not straightforward to assess the
efficiency of a payment system, the Bank assesses
the UK Maestro scheme to observe Core
Principle VIII.
IX. The system should have objective and publicly
disclosed criteria for participation, which permit
fair and open access.
Under the agency and licensing agreement
between S2 and MCE, MCE (as brand owner) is
responsible for licensing the Maestro brand in the
United Kingdom, although S2 is currently
appointed as Sole Agent to administer licensing.
MCE will grant licences to entities that meet the
relevant eligibility criteria, the most important of
which are to be a body duly authorised and
regulated as a credit institution in a country in
Europe, or at least 90% owned by such a body.
MCE then applies MasterCard International’s
member risk assessment framework, designed to
assess the potential risk that the Licensee could
pose to the system.  Less creditworthy institutions
are eligible to join, provided that they are able to
meet MCE’s minimum financial standards, or can
offer other protective arrangements to cover the
credit and liquidity risks that their membership
poses to MCE, as settlement guarantor.  The
MasterCard International member risk assessment
framework is not published.  However, Maestro
applicants are given a range of information when
applying to join the scheme.  The Rules also
explain the processes and procedures for Licensees
to withdraw from the scheme.
In terms of other financial risks, the Rules explain
that S2 members are expected to contribute to the
costs of running S2, and define the basis on which
the costs are divided between members of the
scheme.  The Rules also state the fixed costs that
Licensees incur in the case of chargebacks under
certain circumstances, and for duplicate or
erroneous transactions.  For many services,
Licensees are free to agree charges bilaterally;
however, the Rules state a set of standard charges
if Licensees are unable to agree charges.
Once an institution has obtained a Maestro
licence to issue cards or acquire merchants in the
United Kingdom, it automatically participates in
the UK Maestro scheme as a Licensee.  It need not
become a member of S2, although it must abide by
the Rules set by S2.
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Payment Systems Oversight Report 2005
(1) This time is defined as the transmission time between the acquirer and MCE, MCE and the issuer, the issuer and MCE, MCE and the acquirer, plus the MCE
processing time.

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The Bank assesses UK Maestro broadly to
observe Core Principle IX.  However, the Bank
sees little benefit from a risk-reduction perspective
in UK Maestro seeking to observe more fully Core
Principle IX, which could be achieved through
having a publicly disclosed set of criteria for
participation in the scheme.
X. The system’s governance arrangements should be
effective, accountable and transparent.
S2 is responsible both for setting and modifying
the rules of the UK Maestro scheme.  S2 is
independent of both MCE and MasterCard
Members Forum UK Ltd.
(1) It is able to determine
Rules independently from MCE, although with a
proviso that the new rules do not discriminate
against international Maestro cardholders, damage
the Maestro mark, or undermine the international
Maestro rules.
(2) There are also certain
circumstances under which this proviso does not
apply, such as setting interim PGCs, where S2 has
full control of the Rules.  S2 is responsible for
notifying MCE of rule changes, and MCE is given
30 days to object.
The UK Maestro scheme is governed by the S2
Board, which is responsible for setting and
modifying its rules.  Members receive voting rights
in proportion to their transaction volumes;  these
rights are recalculated annually.  Each member of
S2 (or member group) with at least one of the
100 votes is an ‘entitled’ member, and allowed to
appoint one director to the S2 Board.  However,
since the Board is limited to twelve members, if
there are more than twelve members with at least
one vote, only the eleven members with the
highest number of votes appoint directors.  The
remaining members jointly appoint a ‘minority
director’ .
Reporting to the S2 Board is the Business
Management Committee (BMC), which is
responsible for managing the UK Maestro
operations, and agreeing and implementing
business requirements, within policies established
by the Board.  The BMC delegates certain elements
of its responsibilities to one of four committees
(rules and compliance, fraud, operational,
technical), which all report to it.  All of the
committees consist of nominated representatives
of members.  The powers, duties, responsibilities,
rules and procedures of each of S2’s committees
are described in the constitutional rules and
procedures under which the committees must
operate, and the Terms of Reference for the
committees, all of which are included in the UK
Maestro Operating Regulations.  A separate
document defines detailed operating rules and
procedures.
The clear responsibilities and reporting lines of
committees to the Board, and limited size of the
Board, assist in ensuring that governance
arrangements are effective, accountable and
transparent.  However, this voting rights structure,
and composition of committees and the Board,
may not be appropriate in the future if a number
of new small members join the scheme and
principal membership increases to more than
twelve, as planned.  This is because the scheme
would then become more under the control of the
larger incumbent members.  S2 has indicated to
the Bank that it would review the governance
arrangements if it were felt that with a change in
membership structure the larger members had
excessive control in the scheme.
Governance arrangements of UK Maestro will be
considered as part of the OFT Payment Systems
Task Force UK Maestro Access and Governance
Working Group in the second half of 2006.
Given the current arrangements and limited
membership of the scheme, the Bank assesses UK
Maestro broadly to observe Core Principle X.
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Payment Systems Oversight Report 2005
(1) MasterCard UK Members Forum Ltd manages the MasterCard credit card scheme in the United Kingdom.
(2) The fact that UK Maestro rules differ from the international Maestro rules does not itself count as ‘undermining’ .

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90
Payment Systems Oversight Report 2005
Glossary of terms
Term Description
Business risk Business risk is the risk that the payment system or any of its components —
eg an infrastructure provider serving it — cannot be maintained as a going
concern in the face of adverse financial shocks.
Central counterparty
An entity that interposes itself between counterparties to contracts traded 
in one or more financial markets, becoming the buyer to every seller and 
the seller to every buyer.
Core Principles
The ten Core Principles for Systemically Important Payment Systems provide 
a set of minimum standards for risk management in systemically important
payment systems.
Deferred net settlement
Under deferred net settlement, a payment system releases details of 
payments to the receiving bank prior to interbank settlement.
Designation Designation under the SFD/FMIRs provides additional assurance of the
enforceability of a system’s default arrangements.
Exposure The maximum loss that might be incurred if assets or off-balance sheet
positions are realised, or if a counterparty (or group of connected
counterparties) fail to meet their financial obligations.
Financial Markets and
Insolvency (Settlement
Finality) Regulations
These Regulations — 1 999 (SI 1 999/2979) (FMIRs) — implemented into
UK law the EU Settlement Finality Directive.
Governance
Corporate governance is the method by which an organisation is directed,
administered or controlled.  The corporate governance structure specifies 
the distribution of rights and responsibilities of the board, managers, any
shareholders and other stakeholders, and spells out the rules and 
procedures for making decisions on organisational affairs.
Legal risk
The risk that unexpected interpretation of the law, or legal uncertainty, 
leaves payment system participants and users with unforeseen financial
exposures.
Operational risk
The risk of loss resulting from inadequate or failed internal processes or
systems, people or external events.
Principal risk The risk that one party loses (up to) the full value of the trade if it satisfies 
its obligation but the other party does not.
Settlement Finality Directive
The EU Directive on Settlement Finality in Payment and Securities Settlement
Systems (Directive 98/26/EC);  implemented into UK law by the FMIRs.
Settlement risk The risk that a participant in a system cannot or does not meet its financial
obligations when, under the rules of the system, they fall due, or that 
another institution that facilitates the settlement of this obligation — 
such as the settlement agent — becomes insolvent.

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APACS Association for Payment Clearing Services
ATM automated teller machine
BIS Bank for International Settlements
BPSL BACS Payment Schemes Ltd
C&CC The Cheque and Credit Clearings
C&CCC The Cheque and Credit Clearing Company Ltd
CCP central counterparty
CESR Committee of European Securities Regulators
CHAPS Clearing House Automated Payment System
CHAPSCo CHAPS Clearing Company Ltd
CLS Continuous Linked Settlement
CMA Cash Memorandum Account
CMBCG Cross Market Business Continuity Group
CPSS Committee on Payment and Settlement Systems
CRESTCo CREST Company Ltd
CSD centralised securities depository
DNS deferred net settlement
DvP Delivery versus Payment
ECB European Central Bank
ESA Euroclear SA/NV
ESCB European System of Central Banks
FMIRs Financial Markets and Insolvency (Settlement Finality) Regulations
FSA Financial Services Authority
GDP gross domestic product
IOSCO International Organization of Securities Commissions
I/O swap Inside/Outside swap
MMLG Money Markets Liaison Group
MoU memorandum/memoranda of Understanding 
OFT Office of Fair Trading
OMO open market operation
PPS Protected Payments System
RCH Recognised Clearing House
RSSS Recommendations for Securities Settlement Systems
RTGS Real-Time Gross Settlement
SAS 70 Statement on Auditing Standards Number 70
SFD Settlement Finality Directive
SLA service level agreement
SSE Single Settlement Engine
SWIFT Society for Worldwide Interbank Financial Telecommunication
TARGET Trans-European Automated Real-time Gross settlement Express Transfer
Abbreviations
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92
Payment Systems Oversight Report 2005
The Bank of England publishes information on
all aspects of its work in many formats.  Listed
below are some of the main Bank of England
publications.  For a full list, please refer to
our website
www.bankofengland.co.uk/publications/index.htm.
Financial Stability Review
The Financial Stability Review is published twice a
year, in June and December.  Its purpose is to
encourage informed debate on financial stability;
survey potential risks to financial stability;  and
analyse ways to promote and maintain a stable
financial system.  The Bank intends this
publication to be read by those who are
responsible for, or have interest in, maintaining
and promoting financial stability at a national or
international level.  It is of special interest to
policymakers in the United Kingdom and abroad;
international financial institutions;  academics;
journalists;  market infrastructure providers;  and
financial market participants.  It is available from
SRAD, HO-3, Bank of England, Threadneedle
Street, London, EC2R 8AH and on the Bank’s
website at
www.bankofengland.co.uk/publications/fsr/
index.htm.
Quarterly Bulletin
The Quarterly Bulletin provides regular commentary
on market developments and UK monetary policy
operations.  It also contains research and analysis
and reports on a wide range of topical economic
and financial issues, both domestic and
international.
Summary pages of the Bulletin from February 1 994,
giving a brief description of each of the articles,
are available on the Bank’s website at
www.bankofengland.co.uk/publications/
quarterlybulletin/index.htm.
Inflation Report
The Bank’s quarterly Inflation Report sets out the
detailed economic analysis and inflation
projections on which the Bank’s Monetary Policy
Committee bases its interest rate decisions, and
presents an assessment of the prospects for UK
inflation over the following two years.
The Report starts with an overview of economic
developments;  this is followed by five sections:
G analysis of money and asset prices;
G analysis of demand;
G analysis of output and supply;
G analysis of costs and prices;  and
G assessment of the medium-term inflation 
prospects and risks.
The Minutes of the Monetary Policy Committee
meetings are available on the Bank’s website at
www.bankofengland.co.uk/publications/
minutes/mpc.
Publication dates
Financial Stability Review publication dates for 2006
are 28 June and 1 5 December.  Copies are
available from SRAD, HO-3, Bank of England,
Threadneedle Street, London, EC2R 8AH;
telephone 020 7 60 1 3009;  fax 020 7 60 1 3 804;
email fsr_enquiries@bankofengland.co.uk.
Copies of the Quarterly Bulletin and Inflation Report
can be bought separately, or as a combined
package for a discounted rate.  Publication dates
for 2006 are:
Quarterly Bulletin
Spring 1 3 March
Summer 1 9 June
Autumn 25 September
Winter 1 1 December
Inflation Report
February 1 5 February
May 10 May
August 9 August
November 1 5 November
These two publications are available from
Publications Group, Bank of England,
Threadneedle Street, London, EC2R 8AH;
telephone 020 7 60 1 4030;  fax 020 7 60 1 3298;
email mapublications@bankofengland.co.uk.
Other Bank of England publications

PDF PAGE 95

Working papers
Working papers are free of charge;  a complete list
is maintained on the Bank of England’s website at
www.bankofengland.co.uk/publications/
workingpapers/index.htm, where abstracts of all
papers may be found.  Papers published since
January 1 997 are available in full, in portable
document format (PDF).
External MPC Unit discussion papers
The MPC Unit discussion paper series reports on
research carried out by, or under supervision of,
the external members of the Monetary Policy
Committee.  Papers are available from the Bank’s
website at
www.bankofengland.co.uk/publications/other/
externalmpcpapers/extmpcpaper0000n.pdf
(where n refers to the paper number).
Monetary and Financial Statistics
Monetary and Financial Statistics (Bankstats)
contains detailed information on money and
lending, monetary and financial institutions’
balance sheets, banks’ income and expenditure,
analyses of bank deposits and lending, external
business of banks, public sector debt, money
markets, issues of securities, financial derivatives,
interest and exchange rates, explanatory notes to
tables and occasional related articles.
Bankstats will continue to be published monthly on
the internet but paper copies will be available on a
twice-yearly basis.  Paper copies will be published
for the January and July editions published on
hard copy on Wednesday 1 February 2006 and
Tuesday 1 August 2006 respectively, the price per
annum in the United Kingdom will be £40, or £20
per copy.  It is available on a monthly basis free of
charge from the Bank’s website at
www.bankofengland.co.uk/statistics/statistics.htm.
All these data and more are available on the Bank’s
Statistical Interactive Database at
www.bankofengland.co.uk/mfsd/iadb/
NewIntermed.asp.  The Statistical Interactive
Database provides the latest and long runs of
statistical data.  The site has comprehensive search
options and the ability to download the data in a
variety of formats, and covers the series found in
this publication and some additional data eg daily
exchange rates.
Economic models at the Bank of England
The Economic models at the Bank of England book,
published in April 1 999, contains details of the
economic modelling tools that help the Monetary
Policy Committee in its work.  The price of the
book is £10.  An update was published in
September 2000 and is available free of charge.
The Bank of England Quarterly Model
The Bank of England Quarterly Model, published in
January 2005, contains details of the new
macroeconomic model developed for use in
preparing the Monetary Policy Committee’s
quarterly economic projections, together with a
commentary on the motivation for the new model
and the economic modelling approaches
underlying it.  The price of the book is £10.
Practical issues arising from the euro
This is a series of booklets providing a London
perspective on the development of
euro-denominated financial markets and the
supporting financial infrastructure, and describing
the planning and preparation for possible future
UK entry.  Copies are available from Public
Information and Enquiries Group, Bank of
England, Threadneedle Street, London, EC2R 8AH
and at the Bank’s website at
www.bankofengland.co.uk/publications/
practicalissues/index.htm.
General enquiries about the Bank of England
should be made to 020 7 60 1 4444.
The Bank of England’s website is at:
www.bankofengland.co.uk.
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