Payment and Settlement Systems (Finality and Netting) (Amendment) Bill

Order for Second Reading read.

3.50 pm

The Minister for Education (Higher Education and Skills) and Second Minister for Defence (Mr Ong Ye Kung): Mr Deputy Speaker, I beg to move, "That the Bill be now read a Second time."

One of the Monetary Authority of Singapore's (MAS’) key supervisory objectives is to ensure that critical payment and settlement systems function smoothly during times of disruption. Disruption can occur, for example, when a participant in a payment and settlement system becomes insolvent. A case in point was in 1995 when the insolvency of Barings transmitted its financial losses to counterparties in the European Monetary Union clearing system.

When a participant in a payment and settlement system becomes insolvent, the liquidator of the insolvent participant may try to reverse or “claw back” payments made by that participant, even if the transaction was put through before the participant declared insolvency. This may have a knock-on impact on systemic stability and create significant uncertainty and risk for other participants.

Fifteen years ago, MAS enacted the Payment and Settlement Systems (Finality and Netting) Act (FNA) to address this problem. FNA made provision for the protection of payment and settlement systems from disruptions that may generate systemic risks in the financial system. FNA was designed to be technology-neutral, allowing MAS to designate critical payment and settlement systems regardless of technology used. A designated system (DS) consists of (a) participants, which are financial institutions; (b) a settlement institution that maintains the participants’ accounts and settles funds, usually MAS; and (c) an operator to run the system, such as Banking Computer Services Ltd.

Five payment and settlement systems have been designated so far: (a) the Continuous Linked Settlement System (CLS) – the international foreign exchange settlement system; (b) the New MAS Electronic Payment System (MEPS+) – our nation’s sole large value Singapore Dollar real-time gross settlement system used by banks and financial institutions; (c) the Singapore Dollar (SGD) Cheque Clearing System; (d) the United States Dollar (USD) Cheque Clearing and Settlement System; and (e) the General Interbank Recurring Order (GIRO) System. All these systems are critical to the functioning of Singapore’s financial and payments landscape.

Since the enactment of FNA 15 years ago, there has been a proliferation of faster payments systems with different settlement models and longer business hours. Taking these developments into account, the Bill aims to achieve the following: (a) enhance the protection of payment transactions by extending the period during which transactions enjoy finality and, hence, protect a wider range of transactions from insolvency law in a liquidation event; (b) set out clear criteria for MAS to designate such systems; and (c) strengthen MAS’ administrative powers. The amendments take into account foreign and domestic developments since 2002 in the areas of insolvency protection and regulatory controls for DSs. We have incorporated feedback from a public consultation exercise conducted in August 2017.

To clarify, the scope of the FNA and the Bill does not directly cover the regulation of customer-facing retail payment or remittance service providers. Such activities are currently regulated under two separate Acts – the Payment Systems (Oversight) Act (PSOA) and the Money-Changing and Remittance Businesses Act respectively. In November 2017, MAS commenced a separate public consultation exercise proposing to streamline the regulation of payment and remittance service providers under a single and new Payment Services Bill. MAS aims to introduce this new Payment Services Bill in Parliament for First Reading in late 2018, after considering feedback from the public consultation.

Mr Deputy Speaker, I will now go through the main amendments proposed in the Bill.

First, enhanced insolvency protection. The key components of a transaction are: (a) the transfer order – a payment instruction from a participant, such as a bank; (b) netting – which is the process of calculating net debit or credit amount from the multitude of transfer orders sent and received by the participant; and (c) the settlement – the discharge of payment obligations.

Currently, FNA does not protect a DS if it continues to process, net or settle transactions beyond the calendar day on which a participant becomes insolvent. Such transactions may be affected by the application of insolvency law and this poses financial risks to the participants.

The Bill introduces an amendment to mitigate this risk by extending insolvency protection of the key elements in a payment cycle – transfer orders, netting and settlement – by one business day beyond the day on which a participant becomes insolvent. This will cater to systems which operate in multiple time zones or where an insolvency of a participant occurs close to the end of a day and spans into the next day.

For example, if on 2 January, a participant’s foreign parent bank goes into insolvency in a foreign jurisdiction at, say, 10.50 am New York time, that is same day 11.50 pm Singapore time. The operator of the DS may be unaware of the insolvency of its participant’s foreign parent bank since this occurred outside office hours on 2 January, almost during bedtime. In a 24/7 payment system, transactions from the now insolvent participant would continue into 3 January, whereupon transactions from this participant would be settled. Without the amendment, the settled transactions on 3 January could be unravelled by liquidators since it is after the date of insolvency. This amendment will provide finality and added protection to the participants’ transactions.

Credit risk arises when a participant pays out funds to customers in real-time but receives funds from its counterparty in interbank settlement on a deferred basis. An example is the Fast and Secure Transfer System (FAST) where customers receive funds immediately while the participants only settle with one another twice a day on weekdays. Such risks are mitigated by having participants provide collateral to the DS so that this collateral can be drawn upon for settlement in the event of any default by a participant. The Bill introduces amendments to extend insolvency protection to DSs which use collateral.

The Bill also introduces amendments to provide that an operator, settlement institution, collateral holder of a DS or an officer or employee of such an entity will not incur liability for any act or omission which was done with reasonable care and in good faith in the execution or purported execution of any relevant function, duty or power under FNA.

Second, clarity in designation. The Bill introduces criteria for designation, to provide greater clarity to the industry and stakeholders. Designation will focus on critical systems, where a disruption in the operations of such a system may transmit further disruption to its participants, or to the wider financial system or affect public confidence in other payment systems. MAS intends to designate FAST and Network for Electronic Transfers (NETS) Electronic Funds Transfer at Point-Of-Sale (EFTPOS) debit card system in 2018, as they meet the criteria for designation.

The amendments will also prohibit an operator or a settlement institution of a non-DS from claiming to be an operator or settlement institution of a DS. Holding out to be an operator or settlement institution of a DS could mislead participants to think that there is statutory protection from insolvency law. The penalty will be a maximum fine of $100,000, or imprisonment for a term of up to two years, or both.

Third, strengthened administrative powers. The Bill introduces amendments that will strengthen MAS’ administrative powers over a participant, operator, settlement institution and collateral holder. These include MAS’ powers to obtain information and issue directions to rectify outstanding issues. The participant, operator, settlement institution and collateral holder of a DS will have an obligation to notify MAS in the event of a potential insolvency. The Bill will also introduce a requirement for a DS to seek approval from MAS before rules which govern the essential roles, responsibilities and operations of a DS can be implemented or amended.

In conclusion, this Bill will enhance the insolvency protection of designated payments systems. Together with the improved administrative powers conferred on MAS, the Bill will help maintain confidence in DSs and preserve the stability of Singapore’s financial system. Mr Deputy Speaker, I beg to move.

Question proposed.

Mr Deputy Speaker: Mr Saktiandi Supaat.

3.55 pm

Mr Saktiandi Supaat (Bishan-Toa Payoh): Mr Deputy Speaker, Sir, I am pleased to note that the amendments to the Bill reflect our endeavour to strengthen Singapore’s status as a regional financial centre as well as a financial technology (fintech) hub. They are also in line with the recent changes to the Securities and Futures (Amendment) Bill that I spoke on last year. These enhancements will ensure that our national systems and cross-border systems are further protected. They will enhance and promote systemic stability in the financial system as well as give MAS a more robust oversight. This will happen through improved stability of the key systems and a more secured cross-border system. For the banks and financial institutions, this means greater confidence and transparency, and greater readiness for collateral-based systems.

The amendments see several significant changes which will translate into desirable outcomes. One of these changes is the penalty clause. Should key officers, including senior executives, fail to take reasonable care or play a key part in the commission of offence, they will have to face the consequences. Holding key officers accountable is really important as, according to CEO Today magazine, leadership shortcomings will often emerge as a principal underlying cause for bank failures.

Next, with some more precise designation criteria, the industry and stakeholders will benefit from greater clarity. It will also prevent non-DSs from making illicit claims of being a DS, which some are doing to benefit their business, but with the consequence of misleading and disrupting systemic stability. This has become considerably more important, in light of another policy change concerning DSs.

Currently, DS does not have any protection under the 2002 FNA should they continue to process, net or settle transactions beyond the calendar day on which a participant becomes insolvent. This creates undue financial risks to the participants. Considering that more transactions are occurring globally on a daily basis for both commercial entities and individuals, and the nature of businesses that operate across multiple time zones, this risk is greatly multiplied.

The new amendments offer protection of transfer orders, netting and settlement and is extended by one business day beyond insolvency day, providing certainty and finality to DS transactions. This will certainly be a welcome move for financial institutions. For the DS which utilises collateral as part of their netting and settlement processes, the introduction of collateral security and collateral holder will help extend further insolvency protection and mitigate credit risks.

Having said that, I would like to raise some concerns regarding these enhancements. Can the Minister inform the House where would these changes take place for Singapore compared to other jurisdictions? By this, I mean to ask if any study or consultation has been done on the DS of other countries. The rise of fintech has brought about many new technologies and innovations that are vastly different from traditional financial methods in the delivery of financial services. How forward-looking are the enhancements in ensuring that transactions via these new technologies are adequately protected? These days, block chain technologies, cryptocurrencies and quick response (QR)-based solutions are growing in popularity. If these technologies are also covered under the amendments, then how does this reconcile with the prevention of illicit claims to be a DS?

Next, I also note that under the proposed amendments, MAS is to be exempted from certain sections of FNA. Can the Minister elaborate further on this self-exemption? In what aspects of the insolvency law are carved out by virtue of FNA?

The security of domestic operators of DS is another matter or aspect to consider. Banking Computer Services Pte Ltd (BCS) handles the SGD Cheque Clearing System, USD Cheque Clearing System and the Interbank GIRO. And the settlement institution for the USD Cheque Clearing System is Citibank NA (Citi), a foreign bank. What are the contingencies made in the case of insolvencies of a foreign bank in this instance or, for that matter, domestic operators, such as BCS, should they be affected by other operational risks?

Finally, moving towards a cashless society means we should anticipate more sophisticated payment systems, and it is important to constantly review the relevant policies. The Bill, when passed, will provide greater security and mitigate risks for the designated payment and settlement systems through systemic and prudential means, which would be a welcome move for financial institutions in Singapore. Sir, I support the Bill.

Mr Deputy Speaker: Mr Louis Ng.

4.00 pm

Mr Louis Ng Kok Kwang (Nee Soon): Sir, I stand in support of this Bill. Given the rapid development in fintech, we need to ensure our laws and regulations keep up. I have comments and queries on one specific aspect of the Bill and, more broadly, to request for an illustration.

I refer to the Consultation Paper MAS shared dated 3 August 2017 which listed the objectives of the amendments in this Bill. The objectives are to bring Singapore’s laws on this subject matter up to date with international developments to enhance Singapore’s position as a major financial centre and to incorporate global best practices from leading jurisdictions, like the United Kingdom (UK) and the European Union (EU).

As such, to try and understand the Bill, I have looked into the EU Settlement Finality Directive 98/26/EC, which has been since amended by two other directives in 2009 and 2010 and two regulations in 2012 and 2014.

The main rule in Article 3(1) is that transfer orders and netting shall be legally enforceable, even in the event of insolvency proceedings against a participant and shall be binding on third parties provided that transfer orders were entered into the system before the moment of opening of insolvency proceedings.

In this Bill, I note that clause 9, which amends section 8 of FNA does not prescribe the same degree of certainty as to whether a transfer order or any other transactions in the section 8(1) list will be legally enforceable and binding on third parties as long as a transfer order or any other list of matters is entered before an opening of an insolvency proceeding. Can the Minister clarify why this is so?

Prescription of this timing is important to my mind, as cross-border payment settlement and netting seem especially vulnerable to insolvency laws in different jurisdictions.

I understand that this insolvency carve-out is dealt with in clause 9 of the Bill, which amends section 8 of FNA. Section 8 of FNA states that transfer orders and the transactions in section 8(1) list "shall not be regarded as to any extent invalid on the ground of inconsistency with the law for distribution of the assets of a person on bankruptcy or winding up, or on the appointment of a receiver, receiver and manager or equivalent officer".

I appreciate that this has the implied effect of ensuring transactions made through DSs are final, irrevocable and cannot be reversed or challenged by insolvency laws or a liquidator.

MAS Consultation Paper also states in paragraph 2.2 that the proposed amendments are consistent with the laws of the EU.

However, neither does the Bill expressly address the timing issue stated in Article 3(1) of the EU directive on whether such transactions have to be entered into before the commencement of the insolvency event, nor address what happens if transactions are entered into the system after the commencement of an insolvency event, regardless of whether a DS has actual or constructive knowledge of the commencement of the insolvency event.

In fact, clause 12 of the Bill, which amends section 12 of FNA, makes it clear that the DS operator may effect netting of all obligations owed to or by the participant up to and including one business day after. Can the Minister clarify if it is the intention of the Ministry to not draw a distinction and provide a blanket prioritisation and finality of transfer orders and transactions in section 8(1) of FNA?

If so, can the Minister further clarify if this may be open to abuse in any way, such as by a company disposing of its assets even after commencement of winding up, contravening section 259 of the Companies Act by effecting transfer orders into a DS?

Additionally, can the Minister provide specific examples for Members and the public to understand the practical implications of these amendments, specifically the extension of insolvency protection for transfer orders, netting and settlement in a DS amendment? For example, what transactions would not have previously fallen under FNA which will now fall under the revised FNA once the Bill is passed?

I appreciate that this is a highly technical Bill, but it is precisely such Bills that require illustrations and explanations. Alternatively, will MAS be publishing guidelines to help the affected parties, such as the DS operators, settlement institutions, financial institutions and the public, better understand the revised FNA? Sir, notwithstanding the above queries, I stand in support of the Bill.

Mr Deputy Speaker: Minister Ong.

4.04 pm

Mr Mr Ong Ye Kung: Mr Deputy Speaker, I thank the Members for their support of the Bill and their questions.

Mr Saktiandi Supaat asked if any study or consultation had been done on the DSs of other countries. MAS studied a variety of jurisdictions, such as Australia, Canada, Europe, Hong Kong, New Zealand and the UK, to distil the best practices. The proposed amendments are also in line with international standards, such as the Principles for Financial Market Infrastructures, set by the Committee on Payment and Market Infrastructures of the Bank for International Settlements and the International Organisation of Securities Commissions. In addition, MAS consulted financial institutions extensively and drew on our experience administrating the FNA over the last 15 years. With this Bill, MAS will be among other leading jurisdictions in the area of insolvency protection for DSs.

Mr Louis Ng enquired about the differences in the timing of insolvency protection between the EU Settlement Finality Directive and the proposed Bill. He also sought clarification on the potential abuse of the extended insolvency protection.

The EU's regime takes a different approach from this Bill. It protects transfer orders that are entered into the system after the moment of insolvency provided that a central counter-party or clearing house demonstrates that they were not aware, nor should have been aware of the commencement of insolvency proceedings.

We have chosen not to emulate the EU Directive, but instead provide for a window – one business day – for transactions to be protected even after insolvency is declared. There are three insolvency scenarios envisaged by MAS that will require this. I have briefly mentioned one of them in my Second Reading speech but will elaborate.

First, a system that spans multiple jurisdictions across numerous time zones, such as the CLS system which needs more than one day to settle transactions in a distress situation as the distressed participant may face difficulty paying its obligations, usually in multiple currencies.

Second, a system that originates transfer orders on the day of insolvency but settles the next business day. For example, FAST transactions which occur on late Friday evening which will be settled between the banks only the next Monday morning, these transactions would now be protected.

And, as I mentioned in my earlier speech, if a foreign bank branch in Singapore has its parent bank go insolvent close to midnight, Singapore time, the operator of the DS may be unaware of the insolvency of its parent since this occurred outside office hours, until the next business day, whereupon transactions from this participant was already settled. The Bill will ensure the DS participants’ transactions, including the foreign bank branch’s transactions, are honoured and protected.

In the EU’s case, the operator would have to prove that they were not aware, nor should have been aware of the insolvency proceedings. MAS has assessed that the challenges in proving this will create significant uncertainty which will defeat the very purpose of giving operators and participants certainty of finality of transactions and then protect the system as a whole. Hence, we decided not to subject the operator to such a burden of proof but, instead, provide for a short window where there is certainty.

Notwithstanding, there are safeguards to prevent abuse of this protection. We expect DSs to have rules in place to exclude an insolvent system participant from the DS as soon as it is aware of the insolvency and to stem any outflow of funds which abuse the protection.

Mr Saktiandi Supaat asked a pertinent question about the adaptability of the Bill to future technologies, especially given the robust developments in the payments space. FNA is technology-neutral and allows MAS to designate systems which meet the fundamental criteria for designation, where a disruption in the operations of such a system may transmit further disruption to its participants, or to the wider financial system or affect public confidence in other payment systems. Hence, as long as the designation criteria are met, whether a system is based on block chain, QR code or biometrics or something we have not seen, MAS will be able to designate the system. DSs will be gazetted and publicly listed on MAS’ website. This allows any consumer or business to cross-check the system’s legitimacy of being a DS.

Mr Saktiandi Supaat asked about the exemptions for MAS from certain provisions of FNA. This is because MAS operates MEPS+, our nation’s large value SGD real-time gross settlement system and a DS under FNA.

The amendments provide for MAS to be exempted from the provisions which are administrative in nature, and MAS is exempted from these provisions as MAS cannot be invoking such powers upon itself. However, the proposed exemptions for MAS do not affect the insolvency protections provided by FNA for DSs operated by MAS.

Mr Saktiandi Supaat asked about the contingency plans for commercial entities that operate DSs in Singapore, such as BCS and Citi. As a recap, BCS is the DS operator for SGD and USD cheques and Interbank GIRO, while Citi is the DS settlement institution for USD cheques.

MAS recognises the important role that these operators play in the stability of the financial system. The regulation and supervision of payment systems fall under a separate Act, the PSOA. BCS and Citi are regulated under PSOA and, thus, closely supervised by MAS. Both entities are required to have strong risk management controls in place to address key risks, such as credit, liquidity and operational risks. They also need to have business continuity plans and these are validated through industry-wide exercises. As part of ongoing supervision, MAS tracks the financial health of BCS and Citi as well and has resolution tools at our disposal. Mr Deputy Speaker, I beg to move.

Question put, and agreed to.

Bill accordingly read a Second time and committed to a Committee of the whole House.

The House immediately resolved itself into a Committee on the Bill. – [Mr Ong Ye Kung.]

Bill considered in Committee; reported without amendment; read a Third time and passed.