ii. electronic funds transfer - raymond cox qc · ii. electronic funds transfer there are two...

Law of Bank Payments

II. ELECTRONIC FUNDS TRANSFER

There are two categories of electronic funds transfer ("EFT") systems: non-consumer-

activated systems and consumer-activated systems.81

Non-consumer-activated EFT systems

are those systems designed to be used by banks and certain other financial institutions for the

inter-bank transfer of funds. In some cases, the bank's corporate or institutional customers are

given direct access to these systems. By contrast, the bank's consumer customers, i.e. its

personal account holders, do not have direct access to these systems. The main non-

consumer-activated EFT systems operating in the United Kingdom are the services operated

by BACS Ltd ("BACS") and the payment systems run by the CHAPS Clearing Company Ltd,

called CHAPS and Faster Payments. TARGET 2 is the Eurosystem mechanism enabling

participants to move funds throughout the EU in real time. Inter-bank Euro payments can also

be made using a variety of other means, including the EBA Clearing's clearing and settlement

systems.82

All these systems are considered in this section of the Chapter together with the

new continuous linked settlement (CLS) foreign exchange real-time system which came into

operation in September 2002. The messaging system operated by SWIFT (the Society for

World-wide Interbank Telecommunications) which is often used to send payment instructions

between banks is considered at para.3-008 above.

Consumer-activated EFT systems have been developed to give the bank's consumer

customers direct and easier access to their funds. Examples of consumer-activated EFT

systems include the use of automated teller machines, the electronic transfer of funds initiated

from point-of-sale terminals, electronic pre-payment cards, teleshopping and home banking.

Almost all of these systems are activated through the use of a plastic card, together with a

personal identification number and are considered with other card payment systems in

Chapter 4. Internet payments are dealt with in Chapter 5.

We here deal with:

(1) BACS;

(2) CHAPS;

(3) Faster payments;

(4) CLS (continuous linked settlement);

(5) TARGET2;

(6) EURO1, STEP1 AND STEP2; and

(7) SEPA credit transfers and debits

(1) BACS83

BACS operates an automated clearing house which provides bulk electronic clearing for

sterling credit and debit transfers, especially standing orders and direct debits.84

Typically,

BACS deals with high volume, but low-value, transfers of funds. It is commonly used for the

81

Saxby (ed.), Encyclopedia of Information Technology Law (London: Sweet and Maxwell, 1990) Ch.5.

Alternatively, EFT systems may be classified according to whether they are wholesale (large-value) or retail

(low-value), whether they involve same-day clearing or multi-day clearing, and whether they are net or gross. 82

The EBA's Euro clearing and settlement system is a same-day value, but end-of-day net settlement system. It

is considered in detail at paras 3-045 to 3-048, below. 83

See generally BPSL Innovation Working Group Report (OFT, May 2005. OFT789b), a comprehensive report

by the Payment Systems Task Force. chaired by the OFT (see para.7-067) on the BACS system; also BACS

Access and Governance Working Group Report (OFT, March 2006, OFT836), a report prepared by the OFT on

the governance of BACS. 84

On January 4, 1999 BACS introduced a service for Euro denominated credits (there is no BACS service for

Euro direct debits). Items remain in their original currency as they pass through the BACS system, with the

receiving bank making the conversion where the receiving account is held on a different currency.


payment of salaries, wages, dividends and pensions, and the collection of regular payments,

such as utility bills, VAT payments, credit card payments, insurance premiums and mortgage

repayments.

The two main services provided by BACS are BACS direct credits, and direct debits.

BACS direct credits are payments which are initiated by the payer, as compared to direct

debits which are initiated by the payee.

The first clearing system in the United Kingdom based on the electronic transfer of funds

was established in 1968. It was run by the Inter-Bank Computer Bureau until 1971 when a

separate company, the Bankers' Automated Clearing Services Limited, took over the

operation. In 1986, following the recommendations of the Child Committee, the company

changed its name to BACS Limited ("BACS"). In 2004 BACS Limited separated into two

companies: a company responsible for the provision and development of services which

adopted the name BACS Payments Schemes Limited, and a company to operate the

infrastructure, which retains the name BACS. BACS later became Voca Limited, and is now

called VocaLink Limited (VocaLink), a company which is owned by 18 banks and building

societies.85

VocaLink also provides the infrastructure for other payment systems including

debit card and ATM payments, and Faster Payments.

There are currently 15 BACS member banks and building societies.86

Each member has

direct access to the BACS system and will supply BACS with credit and debit instructions as

computer data ("input data") for processing. Members may also sponsor their non-personal

customers (i.e. non-member banks and building societies, and corporate customers) to submit

their own input data to BACS, either directly or through a computer bureau. However,

sponsored customers remain the responsibility of their sponsor and any transfer which they

initiate must still be processed by the sponsoring member.

The rules governing the operation of the system are set out in procedural manuals, called

BACS Users Manuals, and in various extensive agreements reached between the BACS

members themselves.

In 2009, BACS processed some 5.6 billion individual payments, of which some 56 per

cent were direct debits, 40 per cent were direct credits and 0.2 per cent were standing orders.

Direct credits and standing orders accounted for some 77 per cent by value of all BACS

payments, and direct debits for some 23 per cent.87

On average more than 22 million

instructions are dealt with each day. Approximately 115,000 businesses use BACS payments.

The main criticism of BACS has been that payment takes three days. The overall volume

of BACS transactions remained static in 2009 compared to 2008 because of the increasing

use of the Faster Payments system which offers a near real time alternative for low value

payments.

(a) The BACS payment cycle

The BACS payment cycle currently takes three working days.88

Day "T" - input day (the day that a BACS transaction is initiated) Transactions

submitted to BACS by 22:30 Monday to Friday are validated by VocaLink to ensure they

meet technical requirements and are processed overnight. This is when the sorting of payment

information between collecting and paying accounts occurs. However, BACS has a data

storage facility so that non-urgent credit and debit instructions can be despatched to BACS by

85

http://www.vocalink.com [Accessed August 26, 2010]. 86

In 2010: http://www.bacs.co.uk [Accessed August 26, 2010]. 87

Annual Summary of Payment Clearing Statistics, 2009 (Payments Council, January 2010). 88

This description is largely based on BPSL Innovation Working Group Report (OFT, May 2005, OFT789b),

Appendices, p.107.

http://www.bacs.co.uk/


members and their sponsored customers up to 71 days in advance of the required payment

date.

Day T +1 - processing day

The sorted payment information is sent by VocaLink to member banks by 06.00. Member

banks also receive reports confirming their submissions. Member banks process the payment

data so that payments are ready for overnight posting to their customers' accounts. VocaLink

net the totals of payments due to and from each member bank to produce single multilateral

net amounts and transmits these net amounts to the Bank of England for settlement the

following day.

Day T +2 - entry day

Direct debits, direct credits and balancing entries are applied to accounts as cleared funds,

(i.e. without the risk of repayment because the payer has insufficient funds). The precise time

when accounting entries are posted to customer accounts is a matter for individual banks,

although typically customers' accounts are credited and debited with the relevant payments by

09.30. Banks generally pay interest (where this is offered as part of the bank account) from

this day. Unapplied and unpaid transactions are normally returned on this day. The net values

of payments are settled over the member banks' accounts at the Bank of England. This occurs

at 09.30 each day by posting multilateral net amounts directly to members' settlement

accounts using the Bank of England real-time gross settlement processor.89

Users submit electronic files of payment instructions to BACS either via their own bank,

or using an internet-based service known as BACSTEL-IP which provide a secure channel

for the submission of input data to BACS by its members and sponsored customers and

enables them to receive reports electronically as well as maintain their information online.90

BACS is an immediate payment system in the sense that debiting of the payer's account

and crediting of the payee's account occur simultaneously at the start of business on Day 3 of

the payment cycle. However BACS is not a true immediate electronic funds transfer system

because the order to pay, or collect, must be made at least two days before the payment date.

(b) BACS direct credits

The following example illustrates a series of credit transfers being made using the BACS

system. Redbrick University banks at the X branch of A Bank in Oxford. The University

wants to pay its staff by direct credit transfer into their bank accounts. Half the staff bank at

the Y branch of B Bank in Headington and the other half bank at the Z branch of C Bank in

Banbury. A Bank, B Bank and C Bank are all members of BACS and the University is a

sponsored customer of A Bank. The University prepares a file of payments setting out details

of the amount of each salary payment, the identity of the payee, his bank, branch and account

number. This data, together with instructions to credit the bank accounts of the listed

employees and to debit the University's account, is then transmitted to BACS using

BACSTEL-IP. Computers at the BACS processing centre sort the items so that all those

relating to the customers of A bank are transferred to an output file for transmission to that

bank and all items for customers of B bank and C Bank are put onto output files for each of

those banks. The files are then transmitted via BACSTEL-IP to the central computer centres

of A Bank, B Bank and C Bank, where the items are grouped by branch and transmitted to the

appropriate branches. A credit transfer through BACS is illustrated in Figure 3.7.

Where direct credit payment instructions are submitted directly to the infrastructure

89

Red Book, p.411. 90

APACS Annual Review 2002, p.13.


provider, VocaLink (as is the case with many corporate users) the payment value is not

debited from the payer's bank account until Day T + 2; i.e. the same day that cleared funds

are received in the beneficiary's account. Where direct credit payment instructions are

submitted by a bank, the timing of when the payer is debited depends on the bank and service

offered. Generally, for consumers and small businesses this occurs at T.

Standing order payments are submitted to VocaLink by banks (although many standing

orders are now executed using Faster payments). Generally, though not in all cases, banks

debit the payer's account on Day T to ensure funds are available for settlement on Day T + 2.

Whether interest is paid on the payment amount for the two days between day T and T + 2

depends on the individual bank.

A standing order or direct credit can be recalled by the remitting or sponsoring bank

respectively (e.g. on behalf of the payer or payee). The recall request must be completed by

15.30 on Day T + 1 of the processing cycle. Some banks may impose an earlier cut-off time.

A timely recall instruction will result in either the credit being stopped prior to reaching the

beneficiary's account, or reversed from the account upon receipt; this depends on the timing

of the request and individual bank processes for handling recalls. The payer's/originator's

account is reimbursed in full, subject to any charge levied by the remitting/sponsoring bank

for the cancellation service.

BACS introduced a direct credit Euro service with the launch of the new currency in 1999.

Payment files may be submitted in Euros or Euros and sterling. The receiving bank carries

out all necessary currency conversion.91

(c) BACS direct debits

It has already been noted that the important distinction between credit and debit transfers is

that whereas a credit transfer is initiated by the payer and involves a "push" of funds from his

account into the payee's account, a debit transfer is initiated by the payee pursuant to the

payer's authority and involves a "pull" of funds from the payer's account into the payee's

account. In the case of a direct debit, the payer's bank must receive prior authorisation from

its customer, the payer, before it will execute a debit instruction received from the payee.

The procedure for the collection of direct debits using BACS is similar to that for the

payment of credit transfers. For example, if Redbrick University wanted to collect covenant

payments from its alumni using direct debits, it would supply BACS with data identifying the

amounts and bank accounts to be debited. BACS would then process the data and transmit

debit instructions to the banks of the various alumni. This process is illustrated by Figure 3.8.

The direct debit scheme operated by the major UK banks and building societies uses

BACS for processing. The scheme is governed by its own set of rules.92

An organisation

which wants to collect payments under the direct debiting scheme ("the originator") must be

sponsored by one of the banks or building societies which operate the scheme ("the

sponsor").93

91

BPSL Innovation Working Group Report (OFT, May 2005, OFT789b), p.24. 92

The Originator's Guide and Rules of the Direct Debit Scheme (Version 2.0, Nov. 2003) (hereafter "Guide &

Rules"). 93

Guide & Rules, para.2.1. It is also possible for an "agency bank" to nominate their customers to participate in

the scheme by being sponsored by one of the sponsoring banks. An agency bank is a bank participating in the

scheme which is not a sponsor itself, but which has a nomination arrangement with a sponsoring bank. Where an

agency bank nominates a customer as an originator, the agency bank must provide the sponsor with an

indemnity for that customer.


Sponsorship is dependent on the sponsor being satisfied as to the contractual capacity,

financial status and administrative capability of the originator.94

The originator must also

have a registered address in the United Kingdom and a UK sterling bank account.95

Furthermore, before being accepted into the scheme, the originator must provide all banks

and building societies operating the scheme with an indemnity against any loss, including

consequential loss, that may be caused to them, unless the loss was due to the bank or

building society's own fault.96

Once accepted into the scheme, the originator must provide the branch of the payer's bank

which holds the payer's account with an authority from the payer authorising the collection of

direct debits from his account. The payer's authority is called the "Direct Debit Instruction"

("DDI"). The originator must submit a DDI to the payer for completion. The DDI must

follow a standard format and must include such information as the originator's name and

address, the originator's identification number, the heading "Instruction to your Bank or

Building Society to pay Direct Debits", the name and address of the bank branch where the

payer's account is held, the name of the account holder, the sort code of the payer's branch,

his account number, the date and the account holder's signature. All DDIs used under the

direct debit scheme must be variable in terms of amount, date and frequency.97

Paperless

direct debits have now been introduced, and it is possible for a payer to sign up to a paperless

direct debit on the telephone, through the internet and interactive television.98

When the DDI is completed and signed by the payer it must be returned to the originator,

who lodges the DDI with the payer's bank.99

Lodgment can occur through the physical

deposit of the DDI with the payer's bank, although it is increasingly common for the

originator to keep the DDI itself and electronically transmit details of the DDI to the payer's

bank using a scheme called AUDDIS (Automated Direct Debit Instruction Service) operated

by BACS.100

It became mandatory for new business users to use AUDDIS from January

2008.101

The DDI must be lodged with the payer's bank at least 10 working days before the

first direct debit is collected.102

The originator must also give the payer at least 10 working

days' notice103

(unless a shorter period of notice has been agreed) of the amount and date of

the first direct debit and of any subsequent change to the amount and date of the direct

debit.104

The originator must then collect the direct debit payment on or within three working

days after the specified due date as advised to the payer; failure to do so results in the

originator having to give the payer further notice of the new collection date.105

Collection of

the direct debit payment is through BACS. As BACS operates on a payment cycle

94

Guide & Rules, para.2.1. 95



Guide & Rules, para.3.1. Although the originator may indicate in its "official use box" the dates on which

payments are intended to be made, the contents of this box will not be read or monitored by the payer's bank. 98

BPSL Innovation Working Group Report, (OFT, May 2005,OFT789b), p.24. 99

Guide & Rules, para.3.6. A DDI can only be lodged with the payer's bank by the originator and not directly by

the payer himself. 100

See, generally, Guide & Rules, paras 15.0-15.20. The originator must provide a copy of the DDI to the

payer's bank within seven working days if requested to do so (ibid. para.15.11) 101

BACS Annual Review 2008. 102


Plus postal time. 104


Guide & Rules, para.4.2.


of three working days,106

the originator must submit an input file to BACS at least two

working days before due date of the direct debit payment. The payer's account is debited and

the originator's account is credited simultaneously on the third day (T + 2) of the processing

cycle.

The payer's bank is authorised to make payment against a direct debit processed by BACS

only where the direct debit complies with the terms of the payer's authority (i.e. his DDI).

However, the payer’s bank may refuse to pay the direct debit for various reasons, for example

through lack of funds or the payer's countermand of his authority.107

The originator is usually

advised of the unpaid direct debit and the reason for this by the payer's bank through an

automated system called ARUDD (Automated Return of Unpaid Direct Debits) operated by

BACS. Exceptionally, the payer's bank may advise the originator of the return of the unpaid

direct debit directly by post. An unpaid direct debit may be re-presented for payment within

one month of the date on which first presentation was made.108

The payer may amend or

cancel his authority at any time by informing his branch of his bank. The originator will be

advised of this by the payer's bank in writing, or, as is more usual, through an automated

system called ADDACS (Automated Direct Debit Amendment and Cancellation Service)

operated by BACS.109

Under the terms of the direct debit scheme, the payer is guaranteed a full and immediate

refund from his bank should there be an error in the direct debiting process by the originator

or the payer's own bank.110

This would apply, for example, where a direct debit was made

from the payer's account after he had cancelled his authority, or where more than the notified

sum was debited from his account, or the debit was made on the wrong date.111

Where the

error is due to the fault of the originator, the payer's bank can claim a refund from the payee's

bank, which in turn claims from the payee under the terms of its indemnity.112

The indemnity

must be settled within 14 days of receipt.113

However, no claim can be made under the

indemnity where the error is due to the fault of the payer's bank itself.

It is not possible within the BACS system for a payee to revoke an individual item within a

submitted direct debit file. However, a payee can request that a whole direct debit file is

extracted up to 22.30 on Day T. This ensures that none of the direct debits are delivered to the

destination banks. Requests received after 22.30 on Day T are considered by the payee's

sponsoring bank, which can authorise BACS to reverse the file up to T + 7, such that payer's

accounts are refunded up to T + 9.

(2) CHAPS

The Clearing House Automated Payment System, better known as CHAPS, is a system for

making virtually immediate (real time) payments, in sterling. There are no minimum or

maximum limits on the amount of a CHAPS transfer. Although low value (retail) payments

do pass through the system, CHAPS is most frequently used for high-value sterling

transactions (particularly since the introduction of Faster Payment). The online electronic

operation of CHAPS means that funds can be between settlement banks almost immediately

(if liquidity is available). How quickly funds move between the accounts of payers and payee

106

See para.3-028, above. 107

See, generally, Guide & Rules, paras 8.0-8.7. 108



Guide & Rules, para.3.3. The payer will have been given notice of the guarantee by the originator, either on

the DDI form submitted to the payer for completion, or when the originator gave the payer advance notice of the

amount and date of payment of the first debit, or by other correspondence. 111

CHAPS Rules (Version 2.0), 2009, r.1.5. 112


Guide & Rules, para.11.5.


depends on the arrangements settlement banks have with the payer and payee, or their banks.

In some cases, transfers between the payer and payee can also be almost immediate (an

arrangement known as straight through processing). It is this feature which also distinguishes

CHAPS from BACS, as a BACS payment instruction must be made at least two days before

the payment date.

CHAPS is the dominant cashless transfer system in the United Kingdom in terms of value.

In 2009, 32 million sterling transactions, with a value of some £64,616,956 million passed

through the system.114

CHAPS is run by the CHAPS Clearing Co Ltd.115

The operations of the CHAPS Clearing

Co Ltd are overseen by the Payments Council (see generally para.7-046) with which CHAPS

Clearing Co Ltd has entered into a contract, under which it is responsible, among other

things, for the development of CHAPS in a manner consistent with the objectives and

decisions of the Payments Council, and for using its best endeavours to procure the

compliance of its members with any decision of the Payments Council affecting CHAPS.

CHAPS started operation as a same-day value electronic sterling credit transfer system on

February 9, 1984. On April 22, 1996, CHAPS changed from being a same-day system,

subject to end of day multilateral net settlement, to become a real-time gross settlement

(RTGS) system. On January 4, 1999, CHAPS became able to handle Euro, as well as sterling,

credit transfers under two systems: CHAPS Sterling and CHAPS Euro. On August 27-28,

2001 CHAPS Sterling and CHAPS Euro were consolidated into a new dual-currency RTGS

system (originally called NewCHAPS). However, in 2008 the CHAPS Euro system was

terminated following the decision of the Bank of England not to join TARGET2, and

alternative methods of transferring Euros now exist CHAPS uses the SWIFT technical

infrastructure and is governed by the CHAPS Rules.116

All payments made through the

system are denominated in sterling and settled on an individual basis in real time across the

relevant members' settlement accounts.117

Membership of CHAPS is open to any financial institution that (a) holds a sterling and/or a

Euro settlement account at the Bank of England which the Bank of England has agreed may

be used for the purposes of settling CHAPS payment obligations; (b) has the ability to

comply on a continuous basis with the technical and operational requirements of the CHAPS

systems (c) is a shareholder of CHAPS Clearing Co Ltd; and (d) pays the appropriate entry

fee.118

There are currently seventeen settlement members of CHAPS Sterling: they are all

banks.119

(a) Detailed operation of CHAPS

The main features of the operation of CHAPS are these:

(1) Settlement members, CHAPS and the Bank of England use SWIFT messages and

systems to communicate.

(2) Every payment is settled across the payer's bank's and the payee's bank's accounts at

the Bank of England before any payment notification is sent to the payee's bank.

(3) The paying settlement member acting in a principal capacity sends a SWIFT message

to the receiving settlement member (within a specified group of recipients, known as a closed

user group, or CUG).

114

Annual Summary of Payment Clearing Statistics, 2009, Payments Council, January 2010. 115

Formerly called the CHAPS and Town Clearly Company Limited until the closure of the Town Clearing

system. 116

CHAPS Rules (Version 2.0), 2009, r.1.3.1. 117

CHAPS Rules (Version 2.0), 2009, r.1.3.2. 118

CHAPS Rules (Version 2.0), 2009, r.1.4. 119

In 2010: http://www.chapsco.co.uk.

http://www.chapsco.co.uk/


(4) A SWIFT proprietary process holds the message and strips off an extract containing

essential details which is sent to the Bank of England RTGS system.

(5) If there are sufficient funds in the paying settlement member's RTGS account at the

Bank of England, the payment is settled by the Bank of England by debiting the paying

settlement member's account and crediting the receiving settlement member's account.

(6) Once the Bank of England system responds to SWIFT acknowledging that the

relevant funds have been transferred between the two Bank of England accounts, the SWIFT

system releases the original message to the receiving settlement member.

In addition, the following details may be added to that summary:

(1) Customers may use a variety of means to instruct their branch to issue a CHAPS

Sterling payment message, e.g. by telephone, telex or in writing. Some companies use

proprietary electronic systems or SWIFT. It may be expected that the remitting branch will be

provided with the account details of the Ordering Customer, the Beneficiary Customer name,

account number and details of the bank and branch where the funds are to be transferred.

(2) Communications between settlement members use the SWIFT network. Each

settlement member has its own internal system which enables the settlement member's

branches to access its payment processing system. Each CHAPS Sterling payment message is

settled across members' accounts at the Bank of England before full payment data is sent to

the receiving bank.120

The SWIFT Y-Copy service ensures that a settlement request derived

from each payment message received by the CHAPS Sterling Closed User Group is sent

initially to the Bank of England. If there are sufficient funds in the sending member bank's

account,121

the Bank of England settles the transaction by debiting the sending member bank's

account and crediting the receiving member bank's account in the same amount. Thereafter a

form of confirmation is added to the full message stored by the SWIFT Y-Copy service is

related to the receiving settlement member. On receipt of the full payment message, the

receiving bank has the assurance that the relevant funds have been credited to its settlement

account. Figure 3.9 illustrates how the CHAPS Sterling system operates.122

(3) For each payment message, settlement takes place in real time against sufficient funds

in the sending bank's account. To lubricate this process, settlement members prime their

settlement accounts with liquidity prior to the start of the day. The Bank of England facilitates

this process by providing the CHAPS banks with intraday liquidity so that they can maintain

an even flow of funds through the system. This is achieved by purchasing from the settlement

banks certain high-quality assets under sale and repurchase agreements. Incoming funds also

provide liquidity. In the unlikely event of gridlock,123

a circles processing facility has been

developed which allows the simultaneous settlement of payments queued on behalf of

different banks which would largely set off each other.124

120

This may be the payee's bank itself, but where the payee's bank is not a settlement member the receiving bank

will be a settlement member employed by the payee's bank to act as its agent. 121

The sending bank may be the payer's bank or some other bank acting as a correspondent of the payer's bank. 122

This diagram is adapted from one which appears in the Office of Fair Trading Report, UK Payment Systems

(May 2003), p.160. See also A Guide to the Bank of England's Real Time Gross Settlement System, Bank of

England (May 2010). 123

In a gross settlement system gridlock can occur when one or more direct members either, defer the

performance of their settlements until such time as they have received sufficient credits from their bilateral

counterparts within the system, or, sufficient overall liquidity is not made available, thereby preventing the

system from starting or continuing to work. See M. Giovanoli, "Legal Issues Regarding Payment and Netting

Systems" in J. Norton, C. Reed and I. Walden (eds) Cross-Border Electronic Banking 1st edn (London: LLP,

1995). p.224. 124

Becher, Galbiati and Tudela, The Timing and Funding of CHAPS Sterling Payments, FRBNY Economic

Policy Review, September 2008.


(4) CHAPS provides a central scheduling and queue management facility for CHAPS

members at the Bank of England. A CHAPS settlement request is received by the central

scheduler from a CHAPS member. The central scheduler enables members to prioritise

payments, hold individual payments, or schedule payments by value and/or counterparty, so

long as that counterparty is also a CHAPS member. However many banks prefer to control

the release of instructions to the Bank of England instead.125

(5) Payments are released from the central scheduler to the RTGS settlement process.

There payment requests are either queued awaiting funds or settled immediately if funds are

available. Banks are able to allocate a priority to a payment, which determines the queuing

order once payments are forwarded to the RTGS processor. Nevertheless, the bank may

amend that priority or cancel the payment at any time up to settlement. Banks are even able to

reserve part of their liquidity to enable urgent payments to be settled without waiting for the

arrival of funds from other CHAPS members.

(6) Banks are able to track the status of individual payments as they progress through the

scheduler and the RTGS settlement process through a computer based enquiry service called

"Enquiry Link".

(7) The CHAPS Rules provide that payments made through CHAPS must be

unconditional,126

and also that a payment message cannot be revoked from the point at which

the members' settlement account is debited.127

Furthermore, each member must give same

day value to all payments denominated in sterling received within a timetable set out by the

CHAPS Clearing Co Ltd.128

It is arguable that the payee who is due to receive such a sterling

125

A guide to the Bank of England's Real Time Gross Settlement System, Bank of England, May 2010, p.12. 126

CHAPS Rules (Version 2.0), r.3.1. 127

CHAPS Rules (Version 2.0), r.3.2.1. When the CHAPS system is operating in RTGS By-Pass mode, the

payment message is considered irrevocable from the point at which the sending member is unconditionally and

irrevocably liable to pay the receiving member the amount specified in the message (r.3.2.2). As to completion

of payment see para.3-130 below. 128

CHAPS Rules (Version 2.0), r.2.2.3.


payment may have a right of action against his own bank for breach of contract should it fail

to give same day value as provided by the CHAPS Rules.129

(8) In the case of payment instructions given by overseas banks to their UK

correspondents, the instructions will usually be received over SWIFT. Where the UK

correspondent is CHAPS settlement member, it will normally debit the account of the

overseas sender and then use CHAPS in order to make a sterling payment to the beneficiary's

bank or its correspondent.

(9) CHAPS sterling settlement members may also enter into separate contractual

agreements with their corporate or institutional customers (e.g. a bank which is not a

settlement member) allowing them to participate in the CHAPS Sterling system. These

participants are treated like branches of the settlement member and may be linked, via a

computer system or an existing SWIFT connection, to the settlement member's payment

processing system. The participant cannot access the CHAPS system directly, but must

always go through its settlement member. As with all CHAPS payment messages transmitted

through its SWIFT interface, the settlement member acts as a principal, and remains

responsible for the authenticity of any payment message transmitted by the participant.

(3) Faster Payments130

Faster Payments is a system which enables electronic credit payments to be completed to UK

banks within a few hours of sending. Faster Payments was introduced in May 2008,

following work by the Payment Systems Task Force, chaired by the OFT.131

Faster Payments is run by the CHAPS Clearing Co Ltd.132

The operations of the CHAPS

Clearing Co Ltd are overseen by the Payments Council (see generally para.7-046) with which

CHAPS Co Ltd has entered into a contract, under which it is responsible, among other things,

for the development of CHAPS in a manner consistent with the objectives and decisions of

the Payments Council, and for using its best endeavours to procure the compliance of its

members with any decision of the Payments Council affecting CHAPS.

The Faster Payments system is operated by CHAPS. The central network for Faster

Payments is provided by Immediate Payments Limited ("IPL"), a company established by

VocaLink (see para.3-023).

(a) Instruments

The types of payments that can be processed through the Faster Payments Service are:

Single immediate payments. These are typically given on the telephone or through an

Internet banking service, with a request for the transaction to be made straight away.

These types of payment can be made all day, every day.

Forward-dated payments. These are individual, one-off payments set up by a customer

to be made at a future date. A customer may for example, arrange to pay all bills at the

129

By arguing that r.2.2.3 represents the reasonable usage of bankers and as such constitutes an implied term of

the payee's contract with his bank (Hare v Henty) (1861) 10 CBNS 65, 142 ER 374, 379). The payee could not

rely on the Contracts (Rights of Third Parties) Act 1999 to enforce a term of the CHAPS Rules against his bank

as the Act is expressly excluded by the wording of the CHAPS Rules themselves, although this exclusion is

made "without prejudice to any right or remedy of the third party which may exist or be available apart from the

Act" (r.11.1.1). 130

See further para.5-013. 131

BPSL Innovation Working Group Report (OFT, May 2005, OFT789b). Faster payments is described in detail

in Direct Corporate Access user guide, version 1.0 (APACS (Administration) Limited, March 2009) and at

http://www.chapsco.co.ukfaster_payments/ [Accessed August 26, 2010]. This summary is large drawn from

those sources as at August 2010. 132

Formerly called the CHAPS and Town Clearly Company Limited until the closure of the Town Clearing

system.

http://www.chapsco.co.ukfaster_payments/


beginning of the month, setting the payments up in advance, but having the money

debited on a specified date in the future.

Standing orders are regular payments made on a specific date for the same amount, to

the same person or beneficiary. However, the services offered may differ between banks.

(b) Participation

Users of the Faster Payments Service can participate in a numbers of ways.

Members

Faster Payments Service membership is open to credit institutions with a settlement account

at the Bank of England, and who can connect their payment system to the central

infrastructure 24 hours a day, 7 days a week. Members can send and receive all types of

payments processed through the system, although they will decide which payments are

provided to their customers. Members are responsible for settlement of funds through the

Bank of England and can sponsor other participants into the service that do not wish to have

settlement commitments for the Faster Payments Service. Members are responsible for the

settlement of all payments submitted by participants that they sponsor.

Agencies

Financial institutions who do not want or need to be full members of the Faster Payments

Service, or who do not meet membership criteria can choose to become agency participants.

Agencies are able to send and receive all types of payments processed through the service in

the same way as a member, but they must be sponsored by one or more members who will

provide inter-bank settlement facilities for those payments made and accepted by the agency.

The settlement member is wholly responsible to other settlement members for payments

made by an agency it sponsors.

Third-party beneficiaries

Companies such as credit card issuers can connect to the Faster Payments Service, in order to

be able to receive information regarding payments directly, rather than having them sent via

their bank. Third-party beneficiaries must be sponsored by one or more members who will

provide inter-bank settlement facilities for those payments accepted by the third-party

beneficiary. Currently, about half of all the bill payments made by telephone or by banking

online are to pay a credit card bill.

Corporates

From July 2009 companies have been able to submit files of payments directly into the

system in much the same way as through BACS. For example a company may pay a large

number of employee expenses. Companies are sponsored by a bank that is already either a

member or an agency within the Faster Payments Service.133

Consumers and business customers, as well as financial institutions who do not connect

directly to the Faster Payments Service infrastructure, may make Faster Payments via a bank.

(c) Operation

A customer wishing to make a payment will communicate the payment instruction to his

bank, possibly by telephone or online. Some paying banks may for example restrict

instructions to telephone only. The paying bank will determine whether or not the payment is

eligible to be sent by Faster Payments. With effect from September 6, 2010, the maximum

133

Direct Corporate Access user guide, version 1.0 (APACS (Administration) Limited, March 2009).


limit is £100,000 per payment, although individual banks may well impose a lower limit.

Individual payments may be processed by the Faster Payments system 24 hours a day,

seven days a week. Standing orders are only processed on bank working days.

The paying member bank sends a message to the Faster Payments network service (called

a Faster Payments switch) run by IPL. From this moment the payment cannot be cancelled.

After ensuring that the payment message is properly formatted, and has all details required,

the Faster Payments switch sends a message confirming the payment instruction to the

receiving member bank and the paying member bank.

The receiving member bank will ensure that the payee account exists and will send a

message to the Faster Payments switch stating whether or not the payment is accepted. If the

payment is accepted the switch will arrange for the amount of the payment to be incorporated

into the relevant net settlement amount. The Faster Payments switch will also send a message

to the paying bank to confirm that payment has been made.

Individual payment messages are sent in accordance with the ISO 8583 standard using a

secure Internet service approved by BACS. Files of payment instructions may also be used.

Where a corporate user or agency bureau has direct access to Faster Payments, the user

will submit payment requests in files to the Faster Payments switch. The user will use a

security key (called public key infrastructure or PKI) in relation to the sending and receipt of

messages, held on a smartcard. The Faster Payments switch sends a message to the sponsor

member for a corporate user. The sponsor must authorise payment before the payment

process may continue.

(4) Continuous Linked Settlement

Continuous Linked Settlement ("CLS") is a foreign exchange real-time gross settlement

system which came into operation in September 2002.134

It is a global financial industry

initiative designed to eliminate Herstatt (settlement) risk that arises from foreign exchange

transactions.135

The system is centred on CLS Bank International, New York ("CLS Bank"), an Edge Act

corporation organised under the laws of the US, and chartered and supervised by the Federal

Reserve. CLS Services Ltd ("CLS Services") is a limited company incorporated under the

laws of England and Wales that provides operational and back office support to CLS Bank

and its affiliate companies. CLS Services is owned by a holding company in Switzerland

which in 2008 was owned by 71 financial institutions as shareholders.136

The CLS system

rules and procedures are governed by English law, and overseen by the countries whose

currencies are settled in CLS.

In addition to 61 CLS Bank Members, there were 9,060 participants using the CLS Bank

service, including 470 banks, corporates and non-bank financial institutions and a further

8,590 investment funds.137

CLS Bank settled an average of 1 million instructions per day,

with an average daily value of some US $4.2 trillion.138

CLS eliminates the main risk that one leg of a foreign exchange transaction would be

settled, and the other would not, by providing for simultaneous settlement on its books of

both legs of a foreign exchange transaction on the basis of payment versus payment ("PVP").

134

Further information about CLS can be found at http://www.cls-services.com [Accessed August 26, 2010].

CLS is described in detail in Progress in reducing foreign exchange settlement risk, Committee on Payment and

Settlement Systems, Bank for International Settlements (May 2008) section 3 and Annex 4, which are heavily

drawn upon in the summary that follows. 135

As to which, see para.3-019, above. 136

Committee on Payment and Settlement Systems, Progress in reducing foreign exchange settlement risk

(Bank for International Settlements, May 2008) Annex 4, p.77. 137

http://www.cls-services.com (August 2010) [Accesses August 26, 2010]. 138

http://www.cls-services.com (May 2010) [Accessed August 26, 2010].

http://www.cls-services.com/




To enable such multicurrency operations to take place, CLS maintains an account at each of

the central banks whose currencies it settles. The currencies that are currently settled are US

dollar, Euro, sterling, yen, Swiss franc, Canadian dollar, Australian dollar, Swedish krona,

Danish krone, Norwegian krone, Singapore dollar, Hong Kong dollar, New Zealand dollar,

Korean won, South African rand, Israeli shekel and Mexican peso.

CLS Services receives, validates and matches foreign exchange settlement instructions and

determines whether they are eligible for settlement at CLS Bank. On the day prior to the

settlement (value) date, CLS Services transfers all eligible instructions to CLS Bank.

Instructions to be settled by CLS Bank must normally be submitted by 00.00 Central

European Time ("CET") on the day before settlement. Each CLS Bank settlement member

holds an account at CLS Bank that is divided into sub-accounts for each currency that the

settlement member settles. Beginning at 07.00 CET on settlement day, CLS Bank settles

instructions individually on the members' accounts by simultaneously debiting the sub-

account of the currency being sold and crediting the sub-account of the currency being

bought. These debits and credits are final upon execution of the transfers on the books of CLS

Bank. Throughout the day, as instructions are settled, settlement members accumulate net

debit balances in currencies where they and their customers are net sellers and net credit

balances in those where they and their customers are net purchasers.

Financial institutions can make use of CLS in three ways. "Settlement members" are direct

participants, submitting trades to CLS Bank on behalf of themselves and their customers, and

having responsibility for the funding of the amounts needed to settle the trades. "User

members" can also submit trades directly to CLS Bank, but the funding is the responsibility

of a settlement member selected by the user member. Finally, "third parties" (including

entities that are not financial institutions) have no direct relationship with CLS Bank - they

select a settlement or user member to submit trades on their behalf. Where settlement

members themselves are not direct participants in the payment system of a CLS currency,

they use correspondent banks to make and receive payments.

Settlement members are obliged to submit payments to CLS Bank to provide funds in the

correct currencies to cover projected net debit positions. This can be done either by making a

single payment for the full amount at 07.00 CET or a series of payments in hourly

instalments. Settlement members pay the net funds into the relevant central banks. CLS Bank

continuously receives funds from settlement members, settles instructions across its books

and pays out funds to members. CLS makes payouts throughout the settlement day to

settlement members in currencies in which they have a net credit position, subject to the

caveat that the sum of all currency balances (positive and negative) in a settlement members'

account, converted into US dollars, is not negative. By 12.00 CET the pay-ins and pay-outs

are complete. At this time, if there are no problems, all funds will have been disbursed back

to members. In the normal course, settlement members will have zero balances in their CLS

Bank accounts at the end of each settlement day, and CLS Bank will have zero balances in its

central bank accounts.

To execute pay-ins and pay-outs from CLS Bank's central bank accounts, settlement

members and CLS Bank use each central bank's respective real-time gross settlement system

to transfer funds. The whole process of funding and execution takes place during a five-hour

window (07.00 to 12.00 CET) when the opening times of the relevant RTGS systems overlap

and are open to send and receive funds.

CLS Bank has strict settlement criteria. CLS Bank applies these criteria to the queue of

payment instructions waiting to be settled. Failure to comply with these criteria results in the

instructions being returned to the sender at the end of the settlement day.


(5) Cross border payments in Euros: general

We here set out the background to the development of methods of cross-border and domestic

payment in Euros. Particular methods of payment are then considered in sections (6) to (8).

We also refer to developments in European law which have had a significant impact on funds

transfers.

Since January 1, 1999 the European Central Bank (ECB) has been responsible for

conducting monetary policy for the Euro area (Euro area which consists of the EU countries

that have adopted the Euro).

The Euro area came into being when responsibility for monetary policy was transferred

from the national central banks of 11 EU Member States to the ECB in January 1999. Greece

joined in 2001, Slovenia in 2007, Cyprus and Malta in 2008, and Slovakia in 2009 (see

further para.2-015).

(a) European Central Bank

The Treaty on European Union139

("the TEU") provided for creation of the European Central

Bank, and European System of Central Banks, with powers under the Statute of the European

System of Central Banks and of the European Central Bank ("the ECSB Statute").140

The

ECSB Statute established both the ECB and the European System of Central Banks (ESCB)

as from June 1, 1998. The ECB has legal personality under public international law.

(b) European System of Central Banks

The ESCB comprises the ECB and the national central banks of all EU Member States

(Article 107.1 of the TEU) whether they have adopted the Euro or not. The objectives of the

ESCB include thy promotion of the "smooth operation of payment systems" (art.105.2 TEU).

(c) Eurosystem

Because the ESCB included Member States not in the Euro area, the Eurosystem group was

created which comprises the ECB and the central banks of those Member States that have

adopted the Euro.141

The Eurosystem and ECB are in effect the monetary authority of the

Euro area, and oversee among other things the development of payment systems for the

Euro.142

Eurosystem has developed a real time gross settlement system for the cross border

payment of Euros, now called TARGET2 (see below). Eurosystem is also developing a

system for the settlement of securities within the EU, currently known as TARTGET2-

Securities, or T2S.143

Eurosystem has established a system for the cross border use of

collateral held central banks by counterparties, called the Collated Central Banking Model, or

CCBM, and is currently working on a replacement, called CCBM2 which is intended to be

based on a single platform.144

(d) European Payments Council and SEPA

The European Payments Council ("EPC") is a body established in 2002 by the European

139

[1992] O.J. C191/01,Title II, art.G. 140

Contained in the protocol to the TEU at [1992] O.J. C191/68. 141

The term Eurosystem seems to be a label for the group consisting of the ECB and the Euro area Central

Banks. The term is mentioned in art.282 of the Treaty on the Functioning of the European Union ("TFEU")

[2007] O.J. C306/01. 142

The European Central Bank, The Eurosystem, The European System of Central Banks, ECB and Eurosystem

(2010). 143

T2S (unlike TARGET2) is being designed as a multi-currency system, incorporating non-eurozone central

banks. At the time of writing it is not known if the Bank of England will participate. 144

http://www.ecb.int at Payments and Markets (2010) [Accessed August 26, 2010].

http://www.ecb.int/


banking industry to co-ordinate policy in relation to payments.145

In practice, the EBA

concentrates on retail euro payments, in particular SEPA payments. Its members consisted in

2010 of some 76 banks and banking associations in the EU, including the Payments Council

(see para.7-046), Barclays, HSBC, Lloyds TSB, RBS.

In 2001 the EU adopted a regulation which required that charges for cross border

payments in Euros up to €50,000 should be the same as those for payments within a member

state.146

Following that regulation the EPC developed a scheme to establish a single Euro

payments area (SEPA) within which credits and debits in Euros can be transmitted

electronically domestically and across borders (see para.5-008). The EPC also intends to

extend the SEPA to card payments, and payment by mobile telephone.

(e) The European Banking Association and EBA Clearing

The European Banking Association (EBA) was established in 1985 by European banks and

the European Investment Bank to promote the predecessor of the Euro, the ecu. In 1998 the

EBA created the ABE clearing S.A.S. ("EBA Clearing") to operate a new payment systems

for large amounts of Euros, EURO1 (see para.3-063). In 2000 EBA Clearing established a

system for low value payments in Euros, STEP1; and in 2003 it introduced a system for mass

payments in Euros, STEP2.

(f) The European Commission and the Payment Services Directive

In 2007 the EU adopted a directive on payment services, which sets out comprehensive

requirements in relation to the regulation of payment service provides, and the conduct of

business in relation to information provided and the rights and obligations of the parties in

relation to payment (see further paras 1-026 and 5-009). The Directive has been implemented

in the Payment Services Regulations 2009,147

and applies to payments in sterling as well as

Euros, and domestic payments as well as cross-border.

(5) TARGET2 TARGET2 is a system developed by Eurosystem for the payment of Euros between

participant banks in different countries in real time or at by the end of the day, with

immediate settlement (i.e. real time gross settlement or "RTGS"). TARGET2 is the successor

to a system called TARGET (Trans-European Automated Real-time Gross-settlement

Express Transfer) which was originally introduced in 1999 to facilitate transfers of Euros

between participants in different member states using the new currency. Under the TARGET

system, a payment instruction would be directed to, and authorised by an individual national

central bank and transmitted using TARGET to national central bank of the payee.

TARGET2 retains a national structure, but consolidates processing on a Single Shared

Platform (SSP). The SSP is used for RTGS between participants, and some other accounts are

maintained on it. The SSP is effectively partitioned, so that, for example, RTGS accounts of

French participants held in the books of the Banque de France are subject to French law and

jurisdiction, whereas accounts of German participants in the books of Deutsche Bundesbank

are subject to German law and jurisdiction. However, to ensure maximum uniformity, a set of

harmonised terms and conditions have been developed for use by national central banks in

their contracts, with participants for whom they hold accounts.

Another major difference between TARGET1 and TARGET2 is that with one or two

145

http://www.europeanpaymentscouncil.eu [Accessed August 26, 2010]. 146

Regulation 2560/2001 of the European Parliament and Council on cross-border payments in euro [2001] O.J.

L344/13 (now replaced by Regulation 924/2009 on cross-border payments in the Community which extended

the principle to direct debits [2009] O.J. L266/11); see para.5-008, below). 147

SI 2009/209.

http://www.europeanpaymentscouncil.eu/


minor exceptions payment messages are transmitted directly between T2 participants by

SWIFT utilising a similar Y-Copy mechanism for settlement as is described above in relation

to CHAPS.

All countries which are members of the Euro participate in TARGET2. In addition, it is

possible for the central banks of other countries to choose to participate, and in 2009 six had

done so.148

The Bank of England does not participate in TARGET2, and for its own

transactions accesses TARGET2 via De Nederlandsche Bank (the Dutch national Bank) to

make and receive Euro payments.149

Commercial banks may participate directly in

TARGET2 by holding an account with a Euro area national bank.

TARGET2 is managed by a governing council, Eurosystem, and the three national central

banks which provide the single shared platform.150

TARGET2 is the dominant method of large value Euro payments, with 89 per cent of the

market in 2009, representing some a total of 88 million payments with a value of €551,174

billion.151

We now deal with the details of payment using TARGET2.152

(a) Instruments

TARGET2 applies to credit transfers, direct debit instructions (in respect of certain wholesale

transactions) and liquidity transfers.153

Payment orders may be submitted up to five business

days before the specified settlement date (also called warehouse orders).

(b) Participation in TARGET2

TARGET2 essentially consists of individual payment systems operated by each central bank

for a country participating in TARGET2, and the SSP. Each separate system is called a

"payment module". A bank (or other permitted institution) participates in TARGET2 by

participating in an individual payment module operated by a particular central bank and the

SSP.154

The central bank will open at least one account for each user, called "the PM

account".155

The PM account is a RTGS account.156

Liquidity for payments to be made by a

participant may come from a variety of sources including existing funds on its RTGS

account, finance provided by a central bank against eligible collateral, incoming payments

and funds arising from commercial operations such as swaps. In addition, TARGET2 benefits

from a number of highly sophisticated liquidity optimisation features designed to avoid

148

The six are Denmark, Poland, Estonia, Latvia, Lithuania and Bulgaria. In addition there were 17 euro area

central banks: Austria, Belgium, Finland. France, Germany, Greece, Ireland, Italy, Luxembourg, Portugal,

Slovenia, Spain, the Netherlands, Malta, Cyprus, Slovakia and the ECB: Target Annual Report 2009 (ECB),

p.11. 149

Payment Systems Oversight Report 2007 (Bank of England), Para 2.2. 150

Information Guide for TARGET2 Users (ECB, October 2009), p.11. 151

Target Annual Report 2009, p.15-16. 152

What follows is largely derived from the 2007 ECB Guideline for TARGET2, ECB/2007/2, and the ECB

Information Guide for TARGET2 Users. 153

Information Guide, p.16. 154

Harmonised Conditions (referred to at para.3-062 below), art.3. 155

Harmonised Conditions, art.12. 156

Laurinavicius, Lober and Weenink, "Legal Aspects of TARGET2", [2008] J.I.B.F.L. 15 at p.20. Although

legally TARGET2 consists of a number of separate national systems, it operates an integrated system which,

with one or two minor exceptions, treats the euro area as a single payment zone. This in turn allows multi-

country banks to centralise payment processing in euros. An example would be where Bank A (located in

country A) and Bank B (located in country B) both have branches in country C. However, both Banks A and B

have centralised payment processing in their respective head offices. It follows that a TARGET2 payment from

Bank A's branch in country C to Bank B's branch in country C would be transmitted through TARGET2 from

Bank A's head office in country A to Bank B's head office in country B. Funds would be transferred between

Bank A's account with the central bank of country A and Bank B's account with the central bank of country B.


gridlock if a particular participant is short of available funds due to payment not being

received from another participant.

A user of TARGET2 may be a direct participant or an indirect participant. Banks

established in the European Economic ("EEA"), or with a branch there, are eligible for direct

participation in a payment module if they comply with entry requirements. In addition, a

central bank may allow other institutions to participate, such as treasury departments of

government, public sector bodies. investment firms established in the EEA and organisations

providing clearing or settlement services.157

TARGET2 may also be used to settle sums owing under other systems (called ancillary

systems), such as retail payment systems, large value payment systems, foreign exchange

systems, money market systems, clearing houses and securities settlement systems).158

Settlement may be in real time, or in batches.

The sole point of contract for a user is the TARGET2 desk at the central bank responsible

for the account of the participant bank concerned.159

(c) TARGET2 payment process

A participant, D, who wishes to make a payment to another participant, C, will send a SWIFT

message in the prescribed form (MT 103 for a company payment, MT 202 for a payment by a

bank and MT 204 for a direct debit).160

The SWIFT message will be received by C following

a successful transfer of funds in the SSP.

In the case of a direct debit, the user authorises another user to issue a direct debit order,

and informs its central bank.161

Customer payments may be made between 07.00 and 17.00, while interbank payments

may be made between 07.00 and 18.00. All times are European Time ("CET").

Participants may specify an earliest debit time, or latest debit time, after or before which

settlement must take place; otherwise payment instructions are settled immediately, or at the

end of the business day on which they were accepted, provided that sufficient funds are

available in the payer's account.162

If funds on D's account are insufficient, payment instructions are put in a queue in

accordance with the priority established by the participant. The participant may also prescribe

liquidity limits in relation to other participants, which will reserve liquidity for more urgent

payments.

The SSP will debit the PM account of D, credit the PM account of C, and send a message

to SWIFT authorising release by C of the payment.

Once a payment has been debited to the PM account it is irrevocable.163

Each user has a separate contract with SWIFT in relation to the communication services

provided by it; the central bank providing the payment module to the user has no liability in

respect of the acts or omissions of SWIFT.164

157

Harmonised Conditions, art.4. Direct participants may authorise branches within a group to have direct

access (multi addressee access) and a direct participant may direct payments for it to a correspondent or branch

(using a bank identifier code or BIC): Information Guide, p.23-24. 158

Target Annual Report 2009, p.44. These are six ancillary mechanisms known as ASI (ancillary system

interface). 159


See generally Information Guide, p.14, 16. 161


Harmonised Conditions, art.20. 163

Guideline, art.22, (ECB/2007/2; 2007/600/EC; [2007] O.J. L237/1) and Settlement Finality Directive

98/26/EC, art.3(1). Payment orders which are included in an algorithm in a computer program may not be

revoked while the algorithm is running. 164

Harmonised Conditions, art.41.


(d) Legal framework165

The legal framework for TARGET2 is mainly set out in the 2007 Guideline of the ECB on

TARGET2.166

This sets out the conditions which are to be applied by every participating

central bank to its relations with every user (the Harmonised Conditions in Annex II). In

effect the Harmonised Conditions set out a code governing all aspects of the use of

TARGET2. A feature of the scheme is that any claim by a user will only be made against the

central bank for the payment module used, and not against the single shared platform

providers.167

The Guidelines also set out rules governing the technical requirements for

communications, charges, liability, compensation and the governing law and jurisdiction.

(6) EBA Clearing: EURO1, STEP! and STEP2 payment systems

On January 1,1999 the ECU ceased to exist and was converted into the new European single

currency (the Euro) at a conversion rate of 1:1.168

The existing ECU clearing and settlement

system was replaced by a new Euro system originally run by the Euro Banking Association

(EBA), formerly the ECU Banking Association. The various Euro payment systems, EURO1,

STEP1 and STEP2, and now managed and operated by ABE Clearing S.A.S. (EBA

Clearing), a company incorporated under French law, with 66 banks as shareholders. The

EBA's same day value Euro clearing and settlement system (EURO 1) provides volume

clearing facilities for all EU Member States through over 66 major banks operating in

Europe. The EURO1 system offers a cheaper alternative than using TARGET2169

to make

large value cross-border payments in Euro.170

Since then EBA Clearing has introduced a

system for payment of Euro payments (STEP1), and a system for bulk payments (STEP2).

(a) EURO1 payment process171

A member bank sends a SWIFT payment message which is identified as an EBA Clearing

payment and copied to the EBA Clearing processor (also operated by SWIFT).172

On receipt

by the EBA Clearing processor the payment is assessed against the relevant sending and

receiving bank limits. Where the payment is within the relevant limits it is processed and

transmitted, via the SWIFT network, to the receiving bank. The payment message may be

revoked by the sending bank up until the time it is processed by the EBA Clearing processor.

Where a message would cause a relevant limit to be breached the message is queued by the

EBA Clearing processor until such time that other processed payments create the necessary

headroom under that limit. The EBA Clearing monitors member banks’ net positions and

queues in real-time, and there is a facility to prevent gridlock (invoking a circles processing

procedure). Each member bank has a multilateral debit and credit limit, which under EBA

Clearing's legal framework (the Single Obligation Structure) represents the maximum

allowed single obligation of claim of that member towards the group of all other members.

The limits are binding throughout the operating day, and are each capped at a maximum of €1

billion.

165

Laurinavicius Lober and Weenink, "Legal Aspects of TARGET2" [2008] J.I.B.F.L. 15. 166

ECB/2007/2; 2007/600/EC; [2007] O.J. L237/1. It is binding on euro area central banks: art.14.3 of the

ESCB Statute (see para.3-049). The Guideline is expected to be revised in late 2010. 167

Guideline, art.3. 168

Regulation 1103/97 art.2 adopted pursuant to art.235 of the Maastricht Treaty, which became law in all EU

Member States on June 20, 1997. 169

See para.3-055, above. 170

N. O'Neill, "Cross-Border Payment Arrangements for the Euro" [1998] J.I.B.F.L. 123 at p.124. Certain large

payments such as those with monetary policy counterparts are required to be made through TARGET2. 171

http://www.ebaclearing.eu, EUR01, Operational Basis (2010) [Accessed August 26, 2010]. 172

For detailed discussion of the SWIFT messaging system, see para.3-008, above.


(b) EURO1 single obligation structure

The 1 Euro clearing system operates using a form of net settlement—the "Single Obligation

Structure".173

Under the single obligation structure, the member banks are bound by a

contractual agreement, governed by German law, whereby, at any given time during the

processing day, there is only one payment obligation or claim of each member with respect to

the group of all other members. Under this arrangement clearing between member banks will

occur continuously as messages are exchanges between them, with the eventual single

obligation being settled at the end of the day. The end-of-day payment will act as settlement

of the final obligation due between each member and all other members, as calculated at the

end of the clearing day. Settlement is via accounts with the ECB which treats EURO1 as an

ancillary system. In other words, through the cumulative combination of all of a member

bank's payments and receipts throughout the day, each member bank is considered to owe to,

or to be owed by, all other member banks a single net amount - only at the end of the day, or

upon intra-day default by a member bank, will the single net obligation crystallise into a debt

owed to or by the other members of the system.174

There has been some concern over whether the single obligation structure involves a form

of multilateral netting which may not be enforceable under the laws of all EU Member States

on the insolvency of one of the member banks. Under English law, for example, a multilateral

netting arrangement may be challenged by a liquidator of a participant on the grounds that it

allows set-off of claims in relation to which there is no mutuality and that it infringes the pari

passu principle.175

However, it appears that the EBA Clearing has obtained favourable legal

opinions from all EU jurisdictions (including England) and from all non-EU jurisdictions

where major international banks are incorporated (i.e. the US, Japan and Switzerland) to the

effect that the single obligation structure is robust and could not be challenged following the

insolvency of a member bank incorporated in those jurisdictions.176

Implementation in EU Member States of the EC Directive On Settlement Finality In

Payment And Securities Settlement Systems has clearly reinforced the robustness of the EBA

Euro clearing system in this respect.177

The directive provides, inter alia, that (i) transfer

orders and netting are to be legally enforceable and binding on third parties, even in the event

of insolvency proceedings, provided the transfer orders were entered into the system before

the moment of opening of the insolvency (art.3(1)); (ii) there is to be no unwinding of a

netting because of the operation of national laws or practice which provide for the setting

aside of contracts and transactions concluded before the moment of opening of insolvency

proceedings art. 3(2)); (iii) a transfer order is not to be revoked by a participant in a system

nor by a third party, from the moment defined by the rules of that system (art.5); and (iv)

insolvency proceedings are not to have retrospective effect on the rights and obligations of a

participant arising from, or in connection with, its participation in a system earlier than the

moment of opening of such proceedings (art.7). The moment of opening of insolvency

proceedings is the moment when the relevant judicial or administrative authority handed

173

Practical Issues Arising from the Introduction of the Euro (Bank of England.Issue No.6, December 10,

1997), pp.22-23; Practical Issues Arising from the Introduction of the Euro (Bank of England, Issue No.10,

December 14, 1998). p.75. 174

N. O'Neill, "Cross-Border Payment Arrangements for the Euro", [1998] J.I.B.F.L. 123 at p.124;

http://www.ebaclearing.eu, EURO1 Takes Advantage Of An Innovative Legal Structure (2010) [Accessed

August 26, 2010]. 175

See British Eagle International Airlines Ltd v Compagnie Nationale Air France [1975] 2 All E.R. 390 HL. 176

http://www.ebaclearing.eu, EURO1 Takes Advantage Of An Innovative Legal Structure (2010) [Accessed

August 26, 2010]. N. O'Neill, "Cross-Border Payment Arrangements for the Euro" [1998] J.I.B.F.L. 123 at 124. 177

EC Directive 98/26 of May 19, 1998, implemented in the UK through the Financial Market and Insolvency

(Settlement Finality) Regulations 1999, SI 1999/2979 (see para.3-087, below); Gullifer, Goode on Legal Aspects

of Credit and Security, 4th edn (London: Sweet & Maxwell, 2009), para.6-35.

http://www.ebaclearing.eu/



down its decision (art.6(1)).

(c) EURO1 settlement process178

Before June 2010, settlement under the EURO1 system took place via accounts with the

ECB. However, delays sometimes occurred if all payments in were not received promptly.

Consequently, in June 2010 EURO1 became an ancillary system under TARGET2. At the cut

off time for sending payment instructions to EURO1 (16.00 Central European Time), the

EURO1 processes all outstanding instruction and sends it to EBA Clearing. EBA Clearing

sends a file to TARGET2 using the ancillary system with the amounts to be debited and

credited to participants RTGS accounts. This allows processing by the TARGET2 cut off

time of 18.00 CET. The debts are processed first, followed by credits. Once all debits and

credits have been processed, TARGET2 sends a confirmation to EBA Clearing. Settlement

normally takes less than 5 minutes. EBA Clearing then notifies all participants of completion

of settlement.

The ECB holds a liquidity pool of about €1 billion on behalf of the EBA and its members,

which acts as an emergency source of liquidity in case an EBA member should fail to make

its end-of-day settlement payment into the settlement account. Each member bank contributes

an equal share to the liquidity pool. In the event of multiple failure in excess of the size of the

liquidity pool, the surviving members are contractually bound to make up the shortfall

according to an agreed loss allocation formula.

(d) STEP1 Euro payments

The EURO1 system is only open to banks meeting minimum credit requirements. In 2001

EBA Clearing made it possible for all banks operating in the EU to participate indirectly in

the EURO1 system, through the account of a bank which does participate in EURO1.179

Essentially, the STEP1 bank communicates payment instructions by SWIFT to a EURO1

bank by 14.30 in order that the EURO1 bank may include them in that day's instructions for

EURO1 payments.180

(e) STEP2 credit transfers

STEP2 is family of payment systems for electronic funds credit transfers or payment of direct

debits. STEP2 has operated since January 2008 to enable credit transfers to be made

throughout SEPA in accordance with the requirements for SEPA credit transfers (see below).

The system is based on SWIFT messages from the payer to the central platform, and from

that central platform to the settlement provider, TARGET2, and the payee. Key features of

the systems are that settlement takes place before the payment instructions are delivered, and

settlement takes place on a multilateral basis. Files may be submitted for clearing overnight,

or by 13.00 for settlement at 14.00. Settlement is therefore not in real time.

STEP2 has also operated since November 2009 to enable direct debits to be paid

throughout SEPA in accordance with SEPA direct debit requirements.

(7) SEPA Credit Transfers And Direct Debits SCT and SDD

The European Payments Council ("EPC") has developed standards and rules for credits and

debits in Euros (known as SCT and SDD payments; see generally para.3-052). The central

idea is that it should be as easy to send electronic payment to a recipient in any SEPA State as

to a payee in the same State, and for the same cost.

178

http://www.ebaclearing.eu EUROI, Settlement Process [Accessed August 26. 2010]. 179

http://www.ebaclearing.eu, STEP1, Features and Functioning (2010) [Accessed August 26, 2010]. 180

See generally STEP2 SEPA Credit Transfer Service, EBA Clearing 2010, and STEP2 SEPA Direct Debit

Service, EBA Clearing 2010.



The SEPA area encompasses all EU Member States (currently 27) and Iceland,

Liechtenstein, Norway, Switzerland and Monaco.181

The SEPA credit scheme was launched on January 28, 2008. By May 2010, SEPA credit

transfers accounted for some 8 per cent of the total of cross-border Euro payments.182

The

SEPA direct debit scheme was launched on November 2, 2009.

(a) The infrastructure

Essentially the EPC has developed uniform rules and standards for credit transfers and direct

debits, to which participants adhere (the Scheme Layer). The infrastructure is a matter which

is left to the participants (the Infrastructure Layer). It is envisaged there may be a number of

different providers of a clearing and settlement mechanism (CSM), and competition between

such CSM providers. However, the EPC has set out a framework of principles with which

providers of CSM services must comply. The main requirements include a requirement that

it must be possible for a payment to reach any account which complies with the SEPA

requirements in any SEPA State (called reachability), and that systems used in the clearing

and settlement of SEPA payments must be interoperable. This model of infrastructure is

called a Pan European Automated Clearing House (or PE-ACH). The framework principles

are called the PE-ACH CSM framework.

(b) SEPA credit transfer

The rule book for SEPA credit transfers183

is: "a set of rules, practices and standards to achieve interoperability for the provision and

operation of a SEPA payment instrument agreed at interbank level".184

For a diagram of how a SEPA credit transfer is made see the diagram below. Participants

in the scheme adhere by way of an agreement.185

The rulebook is governed by Belgian law, as

is the adherence agreement.

SEPA credit transfers may only be made in Euros (r.2.2). The rulebook does not impose

any limit on the amount of a transfer, though banks may impose them (r.2.5). The full sum

transferred must be received into the payee account, although charges may be levied on the

payer and the payee (r.4.2.4).

Messages between banks comply with IS020022. The remittance data field is limited to

140 characters. There is a single standard for identifying a bank account.

It is intended that the scheme may be applied to internal as well as cross-border payments,

and to bulk as well as individual payments.

Transfers must be received within two business days of the payment instruction being

accepted. From January 1, 2012 the payment must be received within one business day

(r.4.2.3).

A transfer can be returned within three business days of the settlement date if it cannot be

credited on the basis of the information in the payer's instructions (r.4.4). A transfer can be

recalled within ten business days after the execution date by the paying bank on behalf of a

customer for these reasons only: "duplicate sending", Technical problems resulting in

erroneous "transfers, and "Fraudulent originated Credit Transfer" (r.4.4)

181

Pendulum-ACH Framework (Document EPC170/05, version 1.2, June 24, 2008). 182

EPC Newsletter Issue 7 (July 2010). 183

SEPA Credit Transfer Scheme Rulebook (EPC125-05, Version 4.0, October 30. 2009). In June 2010 the

European Parliament and the Council proposed a regulation for setting up essential requirements for credit

transfers and direct debits in Euros: COM/2007/0856. If made final the regulation will have a significant impact. 184

SEPA Credit Transfer Scheme Rulebook, r.0.3. 185

SEPA Credit Transfer Scheme Rulebook, r.0.5.3 and r.5.


SEPA credit transfer

The paying bank should ensure the "authenticity and validity" of the transfer instructions

(r.5.7) and check the destination details.

A paying or receiving bank may be liable to compensate the other for breach of the

rulebook, negligence or operational failure (r.5.9). However, liability is limited to the amount

of the transfer except in cases of "wilful intent" (r.5.9).

(c) SEPA Direct Debit

The SEPA rulebook for direct debits186

applies to the collection of funds from a payer's

account which is initiated by a payee based on the authorisation or mandate given by the

payer to the payee (r2.2). Participants in the scheme adhere by way of an agreement (r.1.4).

The rulebook is governed by Belgian law, as is the adherence agreement. The mandate must

be governed by the law of a State in the SEPA area. For a diagram of how a SEPA direct

debit is made see the diagram below.

186

SEPA Core Direct Debits Scheme Rulebook (EPC016-06, Version 4.0, October 30, 2009).


SEPA direct debit

Direct debits can be recurrent or one off. The scheme only applies to debits in Euros.

There is no limit on the value of a debit under the scheme, though banks may impose limits

on customers.

There is a strict timetable for the submission of direct debit instructions (r.4.3). In general,

the debit should be settled and paid on the same day as due (r.4.3.1). The paying bank may

reject a direct debit for technical reasons, or when unable to process it (r.4.4). The payer may

for any reason request that the paying bank not pay a direct debit (r.4.4). A payee may request

a reversal of a payment, although the receiving bank is not obliged to recredit the payer

(r.4.4).

A paying or receiving bank may be liable to compensate the other for breach of the

rulebook, negligence or operational failure (r.5.9). However, liability is limited to the amount

of the transfer except in cases of "wilful intent".

There is an optional scheme for electronic direct debit mandates at Annex VII to the

rulebook, and a separate scheme for business to business direct debits.

ii. electronic funds transfer - raymond cox qc · ii. electronic funds transfer there are two...

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