At Fnality, we are working to make the settlement of payments among global financial institutions cheaper, faster and safer. We will achieve this by establishing a Fnality Payment System (“FnPS”) in each key global currency for a wide range of wholesale market participants.
In this blogpost, we look at some of the key legal, regulatory and policy considerations in the establishment of FnPSs.
- The settlement asset
In each FnPS, it is important to define the nature of the settlement asset that is used by participants to settle payments among themselves. Principle 9 of the Principles for Financial Market Infrastructures (“PFMI”) requires that an FMI should conduct money settlements in central bank money where practical and available. As only central banks can grant settlement in central bank money, for a privately operated payment system such as FnPS, the goal is to create a settlement asset that replicates the key features of central bank money, i.e. no credit or liquidity risk.
Each FnPS is underpinned by deposits funded by participants that are safekept in an account at the relevant central bank. Accordingly, for each FnPS, the approach to defining the nature of the settlement asset depends on finding a suitable account model at the relevant central bank. It also depends on designing legal arrangements under applicable local law that maximise the mitigation of risks associated with the possible insolvency or other dysfunction of the system operator, the relevant account holder(s), or participants.
- The oversight model
Given the potential of FnPSs to become systemically important, there is a legitimate public interest in the appropriate oversight of each FnPS’s operations. For systemically important payment systems, central banks perform their oversight role pursuant to powers conferred in legislation, rather than rely on moral suasion as the basis for oversight. In some jurisdictions, this could involve steps such as the designation of the FnPS by the treasury or finance ministry under a statutory regime for the oversight of financial market infrastructures (“FMIs”).
- Settlement finality
Each FnPS must enable legal finality of settlement of payments by its participants. Key to settlement finality is the FnPS’s rulebook: a multi-lateral contract that binds the system operator and all participants and sets out the common rules and procedures governing the settlement of payments. Where relevant, it must also be aligned to the underlying distributed ledger technology (“DLT”) and related operational processes which are designed to ensure that immutable records of settlements are maintained on distributed nodes.
In some jurisdictions, local laws establish various insolvency carve-outs for designated FMIs and provide for finality of settlement (e.g. Settlement Finality Directive in the EU). For the FnPSs in such jurisdictions, we will also seek designation under local law.
- The participation criteria
Our aim is to permit as broad access to wholesale market participants to each FnPS as is possible on the basis of objective, published participation criteria, as this would help maximise the risk reduction and operational efficiency benefits of the Fnality Global Payments initiative. However, in practice, participation to each FnPS will have to be in line with account access policies of the in-scope central banks. We also need to have regard to applicable local laws that could affect the scope of the participation criteria, e.g. settlement finality laws.
- Entity structure of the system operator and governance arrangements
For each in-scope currency, an independent Fnality Local entity will be established in the relevant jurisdiction or currency area to assume the role of system operator and be accountable to overseers and regulators for the safe and effective operation of their FnPS. We are designing the entity structure for each Fnality Local entity to best align the interests of its owners with system participants and with the operators of the validator nodes underpinning each FnPS, and to ensure robust governance.
- Applicability of financial regulation
As each FnPS is a payment system that has potential to become systemically important, we are designing and building each FnPS to meet all applicable principles in the PFMI and any additional local law requirements on FMIs. Given the novelty of the DLT that underpins FnPSs, the relevant standard setting bodies are assessing whether the PFMI and related regulatory tools under domestic law remain adequate in their current form. Fnality is working with policy makers to ensure appropriate levels of regulatory scrutiny over FnPSs to address concerns about the deployment of new technologies for the next generation of wholesale payment systems.
- Oversight of links with other FMIs
In addition to enabling single currency payments, each FnPS will also be interoperable with each other to achieve Payment-versus-Payment settlement (“PvP”) of foreign currency transactions. The interoperability protocol used by each FnPS will also enable, at a later stage, interoperability with a wider range of third-party business platforms to achieve Delivery-versus-Payment settlements (“DvP") of securities transactions.
In each case, the link with other FMIs requires appropriate oversight by relevant overseers or regulators to mitigate spillover risks, i.e. incidents arising in one system that could spillover and cause harm to the linked system and its participants. This requires dialogue and the development of an oversight model with relevant central banks (in the case of PvP settlements between each pair of interoperating FnPSs) and with relevant securities regulators as well (in the case of DvP settlements).
Although the above is not an exhaustive list, it should offer a flavour for the range of legal, regulatory and policy considerations that Fnality is navigating in our mission to launch FnPSs. It is an exciting endeavour indeed; one in which Fnality looks forward to continue working in a spirit of collaboration with central banks and relevant government authorities in 2021 and beyond.