CPMI Publishes Final PvP Report
Posted by Colin Lambert. Last updated: March 28, 2023
The Committee on Payments and Market Infrastructures (CPMI) has published its final report on facilitating increased adoption of payment-versus-payment (PvP) solutions in financial markets, however while it reiterates its desire to advance the concept, the report itself offers little new – instead focusing on the responses to its 2021 “call for ideas” and the various solutions available.
First raised by the Bank for International Settlement in 2019, the identification of the so-called “settlement gap” in FX markets has spurred several initiatives in both private and public sectors, and after issuing the call for ideas, the CPMI conducted a full consultation in August 2022.
As part of this process, the committee engaged with interested vendors and providers in the payments sector and the final report offers a broad description of the various ideas, prototypes and models. The CPMI received 16 responses to the call for ideas and consultation, 11 from providers of what it terms “concrete solutions”, two from interested third parties, two provided conceptual proposals and the last suggested how its existing service could assist in enabling PvP. Of these, two were CBDC projects conducted by the BIS Innovation Hub, but only Baton Systems is live on a global basis, to work alongside CLS, which provided insight into its “alternative PvP service”. The CPMI stresses that it does not endorse any individual proposal or solution.
The proposed solutions and ideas in development largely focused on extending the length of settlement windows, including some proposing to operate 24/7; better access for smaller participants; instant settlement and netting options to help manage intraday liquidity; and integrating the payment with the associated FX trade.
Some providers prefer a centralised model in which the settlement takes place on the ledger of a single institution, others a decentralised model in which the settlement takes places on the individual ledgers of the participating institutions and is synchronised by either a settlement agent or the institutions themselves.
On the latter model, the CPMI notes,” In decentralised models, the settlement rules and procedures across multiple settlement institutions aim to ensure that final settlement of one currency leg is conditional on final settlement of the other currency leg. Further, to observe the PFMI, any PvP arrangement should take reasonable steps to confirm the effectiveness of cross-border recognition and protection of cross-system settlement finality, which generally necessitates a well-reasoned legal opinion.”
While this report does not seek to determine the systemic importance of the solutions, the CPMI expects any financial market infrastructure (FMI) determined as systemically important by relevant authorities to observe the Principles for Financial Market Infrastructures
The CPMI says existing PvP arrangements have been successful at reducing settlement risk for much of the FX market, but, as highlighted by the BIS in 2019, certain growing market segments remain exposed to settlement risk. It also observes that PvP is not available for all emerging market and developing economy (EMDE) currencies, may not be practicable for settling certain trades, or are deemed too costly by some users.
Both existing PvP arrangements and new proposed solutions face similar barriers to broader adoption, however. Among those barriers, the CPMI cites weak incentives for market participants to settle FX trades using PvP; technical challenges for PvP providers to access and interoperate with real-time gross settlement (RTGS) systems during operating hours that meet user demands; and legal challenges for PvP providers to reconcile differences in national legal and regulatory frameworks (e.g. regarding settlement finality, the enforceability of netting and related insolvency protections).
It further observes that private sector entities can align nostro operating hours and processes, explore potential changes to conventions for an international value date, and promote integration and interoperability between legacy and emerging systems. Central banks and other public authorities could play a role in assessing any operational and regulatory barriers, and sharpening regulatory incentives for market participants to settle FX trades using PvP.
Specifically, the CPMI says they can evaluate the benefits, risks and barriers in expanding access to central bank accounts for PvP providers; consider extending and aligning operating hours of RTGS systems in support of PvP arrangements; explore new functionalities in RTGS systems and promote interoperability where practical; and ease liquidity constraints on PvP settlement where practical. Finally, it says central banks can use their convening power to help catalyse private sector engagement and solutions for addressing structural problems in FX markets.
One of the challenges associated with delivering a new solution is the level of oversight required for what is widely regarded as a critically important market infrastructure. In the report, the CPMI indeed observes that most of the new solutions, if implemented, could increase in systemic importance over time. “While this report does not seek to determine the systemic importance of the solutions, the CPMI expects any financial market infrastructure (FMI) determined as systemically important by relevant authorities to observe the Principles for Financial Market Infrastructures,” it states.
Following the publication of the report, Alex Knight, head of EMEA at Baton Systems, observes, “From a risk management perspective, it’s imperative that solutions are expanded to account for new currencies for which volumes are growing but where safe settlement is not possible, such as the offshore renminbi. It’s not just non-PvP currencies, however, that need to be examined. There are currencies eligible for settlement on existing PvP platforms that settle with difficulty, and sometimes fail, due to liquidity related concerns. Liquidity constraints in currencies such as Hungarian forint or South African rand can create significant challenges for banks that are required to fulfil obligations in the context of a single daily settlement batch. There is, therefore, a heightened need for greater flexibility in PvP settlement cycles to better accommodate liquidity fluctuations in challenged currencies.”
Knight also points out, “Not all PvP systems are the same, with some bringing flexibility and sophistication for when and how market participants trigger a settlement session, depending on their needs. Bi-lateral PvP can offer greater flexibility for when you settle, speed of settlement and the ability to break up a trade through splitting. For example, if the notional to be settled, as a result of netting or single trade, exceeds a pre-defined threshold, it can be automatically split into smaller sizes. This is especially useful for more illiquid currencies, giving market participants greater flexibility and reducing the potential for a liquidity impasse.”