Denmark
Financial Sector Assessment Program-Detailed Assessment of the Core Principles for Systemically Important Payment Systems

This paper discusses key findings of the Detailed Assessment of the Core Principles for Systemically Important Payment Systems for Denmark. The main counterparties for the assessment were Danmarks Nationalbank and the Danish Financial Supervisory Authority Finanstilsynet. The assessment recommends that the system should have a well-founded legal basis under all relevant jurisdictions. 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.

Abstract

This paper discusses key findings of the Detailed Assessment of the Core Principles for Systemically Important Payment Systems for Denmark. The main counterparties for the assessment were Danmarks Nationalbank and the Danish Financial Supervisory Authority Finanstilsynet. The assessment recommends that the system should have a well-founded legal basis under all relevant jurisdictions. 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.

I. Introduction

A. General

1. The assessment of the observance of the Core Principles (CP) for Systemically Important Payment Systems (CPSIPS) developed by the Committee for Payments and Settlement Systems (CPSS) dated January 2001 was carried out as part of the first Financial Sector Assessment Program mission to Denmark, November 7—18, 2005.1

2. The main counterparties for the assessment were Danmarks Nationalbank and Finanstilsynet, the Danish Financial Supervisory Authority (DFSA), whose staff were very open and informative and whose full cooperation and diligence are greatly appreciated.

B. Scope of the Assessment

3. Two payment systems are declared systemically important by the Danish authorities: (i) KRONOS, the real-time gross-settlement (RTGS) system for large-value payments; and (ii) Sumclearing, a multilateral netting system for the clearing and settlement of retail payments. Sumclearing is defined as systemically important primarily because it is the only retail payment system in Denmark and it also handles relatively large payments. The infrastructure for retail payments has a “pyramid shaped structure” in the sense that it consists of two sub-clearings and their results (sum totals) are netted in the Sumclearing. In this assessment, the infrastructure for retail payment is seen as a complex and interdependent set of procedures, encompassing the whole common infrastructure that is used for initiating and processing to the final settlement and reporting. This infrastructure is described in the Aftalebog and the Håndbog for Betalingsformidling (payment system manual) of the Danish Bankers Association (DBA), the owner of Sumclearing.

C. Information and Methodology used for Assessment

4. The assessment was performed using the assessment methodology as described in the Guidance Note for Assessing Observance of Core Principles for Systemically Important Payment Systems of the IMF/World Bank.

5. The assessment relied on the thorough and comprehensive self-assessments of the two systems performed by the overseers and on in-depth interviews with the staff of the Payment System Department of Danmarks Nationalbank and of the DFSA staff in charge of overseeing the systems. Very informative meetings were also held with the Accounting Department of Danmarks Nationalbank, which operates KRONOS, the DBA, the owner of Sumclearing, and with different users of the two systems. Furthermore, the assessor met with staff from different departments of Danmarks Nationalbank discussing the relations between payment system, monetary, and information technology (IT) security policies, and crisis management.

6. Prior to the mission, Danmarks Nationalbank provided all the necessary documentation in the form of relevant laws, articles, brochures, and guidelines and the completed questionnaire on payment systems. In addition, two books published by the Nationalbank were made available: Monetary Policy in Denmark, June 2003, and Payment Systems in Denmark, 2005.2 The latter provides a thorough description of the infrastructure for the settlement of payments and securities and the risks therein.

7. During the mission, the assessor also carried out an assessment of the observance of the CPSS/IOSCO Recommendations for Securities Settlement system of Værdipapircentralen (VP), the Danish Central Securities Depository (CSD).

8. The assessor did not face any problem potentially limiting the assessment process.

D. Institutional and Market Structure—Overview

9. The payment system infrastructure in Denmark is highly developed and technologically well advanced. A broad variety of payment instruments are processed varying from checks and paper-based credit transfers to card transactions. In 2005, around 1.1 billion payments with a value of DKr 5,027 billion were processed in the Sumclearing infrastructure. With around 670 million payments by cards in 2005, Denmark had the highest number of card transactions per capita in Europe. Especially the use of Dankort, a common debit card product of the Danish banks, is very popular and widely accepted by Danish retailers. Credit cards have only a minor market share due to the differences in price policy. A large amount of recurrent bills for telephone, utilities, and other services (168 million in 2005) are paid via direct debits, with 9 out of 10 households using the services of Payment Business Services (PBS). A similar service is developed for private and public business enterprises for paying for good and services bought from other firms.

10. E-banking is intensively used in Denmark, while the use of checks is declining. About 2.7 million Danish citizens have opened an e-banking account and send in their payment orders via the internet. Checks are especially used for fulfillment of larger payment obligations (average value per transaction cleared through the Sumclearing in 2005 was DKr 22.850). The number and value of payments by checks have been halved since the introduction of more modern payment instruments as the direct debit and Dankort in the beginning of the 1980s. It is likely to decline further. Recent initiatives have made it possible for government agencies to increase their use of electronic credit transfers at the expense of checks, when making payments to citizens, since all citizens are obliged to have a bank account.

11. Despite the increasing use of electronic payment instruments, banknotes and coins issued by Danmarks Nationalbank remain an important means of payments. Banknotes and coins are put into circulation via a number of decentralized banknotes holdings placed with banks in various parts of Denmark. These holdings are owned and operated by the banks that supply local banks with cash. Danmarks Nationalbank grants the banks in question an interest free loan corresponding to the banknotes held. The loan is fully collateralized.

12. A Danish characteristic is the high degree of cooperation within the financial sector in relation to the technical infrastructure. The main parts of the infrastructure for the clearing of retail payments and securities are owned by the banks collectively. This cooperation has resulted in unified systems handling all types of retail payments. All banks have access to the common infrastructure. Accordingly, smaller banks can offer their clients a full range of payment services. All banks can influence the decision taking process on development, pricing and other relevant issues.

E. Payment Systems Infrastructure

13. The infrastructure for retail payments comprise three parts: two sub-clearings (the electronic clearing and truncation system and the PBS clearing); and the Sumclearing. The results of the sub-clearings are combined and cleared in the Sumclearing and the final result is settled via the accounts participants have opened at Danmarks Nationalbank.

14. In both subsystems, payments are submitted continuously 24 hours a day. The electronic clearing and truncation system processes checks, credit transfers, and cash withdrawals by clients of other banks. Banks transmit the checks and the other categories of payments they receive in paper form or electronically to their data processing center. These data processing centers are interbank service providers that normally provide services to different banks. Only the larger banks have their own processing center. The datacenters exchange bilaterally information and prepare a list of debit and credit balances for each of their participants vis-à-vis every other participant in the subsystem. In the evening these balances are sent into the Sumclearing. The PBS clearing processes direct debits and EFTPOS transactions with a debit or credit card and cross-border card transactions.

15. The PBS clearing is a common infrastructure, owned by the banking industry and provides services to all Danish and foreign banks active in the Danish market. It calculates bilateral positions for all its participants and sends this into the Sumclearing, which settles the positions together with the position of a participant in the electronic clearing and truncation system. The Sumclearing settles payments in both kroner and euro.

16. Transactions in the financial markets are cleared via VP, the Danish CSD, and the Futures and Options Clearing House (FUTOP), the clearinghouse for derivatives.3Denmark’s capital market is dominated by bonds with active trading in mortgage bonds and government securities. Although, most of the bonds are listed on the Copenhagen Stock Exchange (CSE), most of the trading is carried out over-the-counter in the informal interbank telephone market.

17. The KRONOS, Sumclearing, and VP settle via clearing accounts their participants have opened with Danmarks Nationalbank. In addition to the settlement for the aforementioned ancillary systems and FUTOP, KRONOS also settles the kroner leg of foreign exchange transactions that are cleared via the Continuous Linked Settlement (CLS) system. It is also the channel for the execution of monetary policy transactions and interbank large value transactions. KRONOS is a multicurrency system that settles transactions in Danish kroner and euro. For the settlement of euros, KRONOS is linked to TARGET, the large-value system of the European System of Central Banks (ESCB). In addition, the system settles transactions in Swedish kroner and Icelandic kroner, however only in connection with the settlement in VP of securities denominated in these currencies.

18. Denmark has a sound legal infrastructure for payments and securities settlement transactions. It covers issues as finality, netting, and delivery-versus-payment (DVP). The enforceability of collateral arrangements is well regulated. The electronic signature and use of electronic data is recognized in court and all contractual relationships are enforceable. A zero hour rule does not exist and finality of payments is ensured in case of bankruptcy. The separate laws for certain payment instruments also regulate consumer protection with respect to electronic and card payments.

19. Payment systems are overseen by the DFSA and Danmarks Nationalbank, which cooperate closely. The oversight powers of the two institutions are regulated in the Securities Trading Act (STA). The cooperation and consultative arrangements between the two overseers are laid down in a memorandum of understanding (MOU) that is publicly available. The STA was amended effective March 1, 2006, which further clarifies the oversight authority. There is a narrow cooperation between central banks and banking supervisory authorities with respect to crisis management in the Scandinavian countries and in the European Union (EU).

20. The developments in the payment infrastructure and payment instruments are mainly market driven. A major payment system reform has not taken place since the introduction of KRONOS in November 2001, and no major changes are planned for the near future.

II. Assessment of the Core Principles and Central Bank Responsibilities

Table 1.

Detailed Assessment of Observance of KRONOS of the CPSS Core Principles for Systemically Important Payment Systems

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Table 2.

Summary Observance of KRONOS with the CPSS Core Principles

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Table 3.

Recommended Actions to Improve Observance of KRONOS with the CPSS Core Principles

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Table 4.

Detailed Assessment of Observance of Sumclearing of the CPSS Core Principles for Systemically Important Payment Systems

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Table 5.

Summary Observance of the Sumclearing of the CPSS Core Principles

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Table 6.

Recommended Actions to Improve Observance of the Sumclearing of the CPSS Core Principles

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Table 7.

Assessment of Observance of Danmarks Nationalbank of the Responsibilities of the Central Bank in Applying the Core Principles

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Table 8.

Summary Observance of Danmarks Nationalbank of the Responsibilities of the Central Bank in Applying the Core Principles

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Table 9.

Recommended Actions to Improve Observance of the Responsibilities of the Central Bank in Applying the Core Principles

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21. Information on other assessments of systemically important payment systems in other industrialized countries can be found in Table 10.

Table 10.

Observance of Core Principles for Systemically Important Payment Systems in Selected Industrialized Countries1/

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Based on 35 assessments of different payment systems in 25 industrialized countries, excluding Denmark. The figures may not add up due to rounding.

Some principles may not be applicable.

Authorities’ response

Large-value payment system (KRONOS)

22. The assessments and recommendations for improvements in relation to KRONOS essentially reflect the findings of Danmarks Nationalbank.

23. With regard to the recommendation to renegotiate with the system operator, the legal binding maximum restart time so that it can be reduced from four to two hours, please note that numerous tests in recent years consistently have shown that KRONOS can in practice be restarted in less than one and a half hours. Nevertheless, Danmarks Nationalbank agrees with the recommendation and has started negotiations with the system operator with the aim of resolving the issue.

24. Regarding the recommendation to further analyze the system’s efficiency, Danmarks Nationalbank notes that the large number of direct participants shows that an appropriate balance between security and efficiency seems to have been reached. The cost recovery in the system is less than full, but seems adequate and in line with similar RTGS-systems in other small- to medium-sized European countries.

Retail payment system (Sumclearing)

25. The assessments and recommendations for improvements in relation to the Sumclearing are broadly in line with the findings of Danmarks Nationalbank and the DFSA. However, we would like to emphasize that the participants generally have far more eligible collateral than needed for their daily net payments in not only the Sumclearing, but also in the VP settlement and CLS.16

26. Danmarks Nationalbank and the DFSA agree to the recommendation that the practice of booking retail payments in customer accounts before the settlement of the payments are final should be terminated. Therefore, Danmarks Nationalbank and the DFSA will start discussions with the banking sector with the aim of changing this practice.

27. Danmarks Nationalbank and the DFSA take note of the recommendation to lower the financial risks in the system by implementing additional measures such as loss-sharing agreements or pools of collateral or by lowering the net positions settled, for instance, by restructuring the settlement cycle and introduce new settlement blocks during the day. These proposals will in the near future be further analyzed. Danmarks Nationalbank will start discussions with the system owner with a view to identifying costs and benefits associated with the various proposals.

28. The supervision of settlement agents and the indirect participants as well as possible concentration risks related to such indirect participation lies primarily with the DFSA. The DSFA has taken note of the recommendation to gather information on possible concentration risk, etc., and analyze the consequences for smaller banks and the trust in the system in case of a default of one of the larger settlement banks. As the DFSA has already considered these questions as part of its supervision of settlement banks, the DSFA’s understanding of the recommendation is that such supervision, in the opinion of the IMF, should be carried out on a more formalized and recurrent basis. Steps will be taken to this effect.

Central bank responsibilities

28. The recommendations to further strengthen the oversight of the Danish payment and settlement systems are consistent with the self-assessment done by Danmarks Nationalbank. It should be noted though that important steps towards full observance of the international standards on central bank oversight have already been taken. The legal basis, for instance, has been strengthened by an amendment to the STA, which has become effective from March 1, 2006. Following this amendment, the “memorandum of understanding between Danmarks Nationalbank and the Danish Financial Supervisory Authority concerning payment systems and clearing centres” will be revised with a view to further enhancing the cooperation between the two authorities. In addition, Danmarks Nationalbank will take the necessary steps to broaden the oversight of the retail payment system (Sumclearingen) with a view to cover all major components of the system, including different payment instruments and sub-clearings. High priority will be assigned to formalize the oversight task through written procedures and guidelines. Thus, full observance is expected to be achieved in 2006.

1

The assessment was performed by Jan Woltjer, Monetary and Financial Systems Department (MFD), International Monetary Fund (IMF).

2

The two books are available on the website of Danmarks Nationalbank: http://www.nationalbanken.dk/dnuk/specialdocuments.nsf.

3

FUTOP was taken over by OMX Group AB in Sweden in 2005. It does no longer operate under the umbrella of a Danish license and regulations. However, derivative contracts in Danish kroner are still settled on the accounts in Danmarks Nationalbank.

4

For an extensive overview of the legal basis for Danish payment systems, see Clearing and Settlement in Legal Perspective by Niels. C. Andersen, Danmarks Nationalbank Working Papers 2004–20, July 2004. (Available on: http://www.nationalbanken.dk/dnuk/specialdocuments.nsf.)

5

For a description of the legal basis for Danmarks Nationalbank’s role as an overseer, see Detailed Assessment of the Securities Clearance and Settlement Systems—Denmark, IMF, July 2006, pp. 41–43.

6

For an extensive overview, see The Provision of Collateral to Danmarks Nationalbank in a Legal Perspective by Niels C. Andersen and Kirsten Gürtler, Danmarks Nationalbank Monetary Review, 3rd quarter 2003, pp. 49-64. (Available on: http://www.nationalbanken.dk/dnuk/specialdocuments.nsf.)

7

See Payment Systems in Denmark, Danmarks Nationalbank, Copenhagen, June 2005 which is available on the website of Danmarks Nationalbank: http://www.nationalbanken.dk/dnuk/specialdocuments.nsf.

8

The balances in the Sumclearing and CLS settlement accounts are first used to redeem the loans obtained under the automatic collateral agreement. The remaining balances are transferred to the current account of the participant involved.

9

For an extensive overview of the legal basis for Danish payment systems, see Clearing and Settlement in Legal Perspective by Niels. C. Andersen, Danmarks Nationalbank Working Papers 2004—20, July 2004. (Available on: http://www.nationalbanken.dk/dnuk/specialdocuments.nsf.)

10

See Payment Systems in Denmark, Danmarks Nationalbank, Copenhagen, June 2005. (Available on: http://www.nationalbanken.dk/dnuk/specialdocuments.nsf.)

11

Banks have concluded agreements with their customers to the effect that payments that have booked prior to final settlement can be reversed in case of a default by the payer or payer’s bank.

12

See also Systemic Risk in the Danish Interbank Netting Systems by Morten Linnemann Bech, Bo Madsen and Lone Natorp, Danmarks Nationalbank Working Papers 2002-8, Copenhagen, November 2002, page 13. (Available on: http://www.nationalbanken.dk/dnuk/specialdocuments.nsf.)

13

The lot settlement method is used by Interpay, the Dutch clearinghouse for retail payments. For a description, see for instance, Quarterly Bulletin, De Nederlandsche Bank, December 2001, page 24-26 (available on the website of the Dutch Central Bank: http://www.dnb.nl/dnb/pagina.jsp?pid=tcm:13-35755-64). Lots can be calculated and settled for each bank individually or by first calculating a multilateral netting and then settling in the RTGS-system.

14

The processing of the retail government payments are outsourced to a commercial bank but not the settlement.

15

See also Systemic Risk in the Danish Interbank Netting Systems by Morten Linnemann Bech, Bo Madsen and Lone Natorp, Danmarks Nationalbank Working Papers 2002-8, Copenhagen, November 2002, pp. 16-17 Available on: http://www.nationalbanken.dk/dnuk/specialdocuments.nsf.)

16

In a study triggered by this assessment, it was demonstrated that in 2005, all larger banks’ eligible collateral significantly exceeded their total net payment obligations in all systems—even when the participant with the largest net payment obligation was withdrawn from the settlement on every day during 2005 and all the remaining participant’s net positions were recalculated. Among the minor banks, however, only a handful of banks had recalculated net positions, which on very few days surpassed the value of their eligible collateral. However, this reflects flaws in the methodology used in the study that tends to exaggerate the effects on small banks and does not include the fact that banks can pledge securities for intraday credit already in the settlement cycle in which the securities are received. The study “Protection of Settlement in Danish Payment Systems” can be found in Financial Stability 2006 published by Danmarks Nationalbank (Copenhagen). It is available on: http://www.nationalbanken.dk/.