79188 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The World Bank does not guarantee the accuracy of the data included in this work. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. The material in this publication is copyrighted. FINANCIAL SECTOR ASSESSMENT PROGRAM PEOPLE‘S REPUBLIC OF CHINA CPSS CORE PRINCIPLES FOR SYSTEMICALLY IMPORTANT PAYMENT SYSTEMS DETAILED ASSESSMENT OF OBSERVANCE MARCH 2012 INTERNATIONAL MONETARY FUND THE WORLD BANK MONETARY AND CAPITAL MARKETS DEPARTMENT FINANCIAL AND PRIVATE SECTOR DEVELOPMENT VICE PRESIDENCY EAST ASIA AND PACIFIC REGION VICE PRESIDENCY Contents Page Glossary ........................................................................................................................................2 Executive Summary ......................................................................................................................4 I. General.......................................................................................................................................8 II. Information and Methodology Used for Assessment ...............................................................8 III. Payment Systems Infrastructure Overview .............................................................................9 IV. The CPSS Core Principles ....................................................................................................19 V. Authorities‘ Response ............................................................................................................47 Tables 1. Statistics for Selected Large Value Transfer Systems in 2008 .............................................11 2. Payments Systems in China (Volume and Value, 2008 and 2009) ......................................11 3. FX Denominated Transactions Handled by China Domestic Foreign Currency Systems ....................................................................................................14 4. FX Transactions Handled by China Foreign Exchange Trade System.................................14 5. Detailed assessment of observance of CPSS Core Principles for SIPS—High Value Payment System part of the China National Advanced Payment System...................................................................................................23 6. Central Bank Responsibilities in Applying the CPs .............................................................37 7. Summary observance of CPSS Core Principles and Central Bank Responsibilities China High Value Payment System (HVPS) and Central Bank Responsibilities ...............................................................................................42 8. Recommended Actions to Improve Observance of CPSS Core Principles and Central Bank Responsibilities in applying the CPs China High Value Payment System ..............................................................................43 Figures 1. China National payments System .........................................................................................10 2. Percentage Growth of Value and Volumes in Selected Large Value Transfer Systems from 2007 to 2008 .........................................................................11 3. China Foreign Exchange Trade System ................................................................................16 4. International Remittance Inflows (US$ million) ..................................................................18 Boxes 1. Bulk Electronic Payment System (BEPS)—Clearing and Settlement ..................................20 2. CPSS – Principles for Co-operative Oversight of Payment and Settlement Systems ..........41 Appendix I. Self-Assessment of China Domestic Foreign Currency Payment System (FCPS)...............49 2 GLOSSARY ACH Automated Clearinghouse ATM Automated Teller Machine BEPS Bulk Electronic Payment System BIS Bank for International Settlements BOB Bank of Beijing BOC Bank of China BOEA Bank of East Asia CCB China Construction Bank CCDC China Central Depository & Clearing Co., Ltd. CDB China Development Bank CIS Cheque Imaging System CCP Central Counterparty CFETC China Foreign Exchange Trade Center CFETS China Foreign Exchange Trade System CNCC China National Clearing Center CNAPS China National Advanced Payment System CNPS China National Payments System CPs Core Principles CPSS Committee for Payment and Settlement Systems CPSIPS Core Principles for Systemically Important Payment Systems CSRC China Securities Regulatory Commission CUP China Union Pay CY Chinese Yuan FCCPC Foreign Currency Clearing Processing Center FCPS China Domestic Foreign Currency Payment System FSAP Financial Sector Assessment Program FX Foreign Exchange G-8 Group of Eight G-20 Group of Twenty GDP Gross Domestic Product HVPS High Value Payment System ICBC Industrial Commercial Bank of China IMF International Monetary Fund IOSCO International Organization of Securities Commissions LCP Local Processing Centers MBFEs Member Bank Front Ends MOF Ministry of Finance MoU Memorandum of Understanding NBFI Nonbank Financial Institution 3 NPC National Processing Center OTC Over-the-Counter PBC People‘s Bank of China PMIS Payment Management Information System POS Point of Sale PRC People‘s Republic of China RCCP Recommendations for Central Counterparties RSSS Recommendations for Securities Settlement Systems RTGS Real-Time Gross Settlement SAFE State Administration of Foreign Exchange SC State Council SD&C China Securities and Clearing Corporation Limited SSS Securities Settlement Systems WB World Bank 4 EXECUTIVE SUMMARY 1. In recent years, the People’s Bank of China (PBC) has carried out a major and comprehensive reform of the China National Payments System (CNPS). The PBC implemented the China National Advanced Payment System (CNAPS), which consists of the High-Value Payment System (HVPS) and the Bulk Electronic Payment System (BEPS). The HVPS system currently operates in a tiered way (multi-entry point) with a national processing center (NPC) and 32 local processing centers (LCPs). The HVPS system is interconnected to many trading, payments, and securities settlement systems (SSS) to allow for central bank money settlement. In addition, there are numerous cheque clearing houses around the country administered by the PBC local offices or delegated to banks. China Union Pay (CUP) handles the clearance of cards transactions whose balances are settled in the HVPS. Also automated clearinghouses (ACHs) and other systems handle clearance and settlement for a variety of payment instruments. 2. The HVPS is a systemically important payment system, as it is the backbone of the national payments system in China. The HVPS handled transactions for a value of CY 804 trillion in 2009, approximately 24 times the GDP value. Thus, the HVPS is being assessed against the ten Core Principles for Systemically Important Payment Systems (CPSIPS) of the Committee for Payment and Settlement Systems (CPSS) and the four responsibilities of the central banks in applying the CPSIPS. The BEPS is not currently a systemically important payment system. However, its importance for an efficient settlement of the interbank payment system is growing. 3. The cheque clearinghouses around the country also handle an important value of transactions. The gross value of cheques issued in 2009 reached a value of CY 248 trillion in 2009, about 7.4 times the GDP. However, of this amount, 350 million cheques are interbank cheques valued at about CY 62.5 trillion. This means that the majority of the cheques issued in the country are ―on us‖ cheques. Also, ACHs handled CY 69 trillion in 2009, about two times the GDP, relatively important (though not major) for a big country like China. Thus, neither the cheque clearinghouses nor the ACHs have been considered systemically important in this assessment but their relative importance has been taken into consideration in the assessment of Responsibility B and C. 4. Domestic foreign exchange (FX) transactions are mostly executed at the China Foreign Exchange Trade Center (CFETC). The majority of participants settle their transactions bilaterally while 21 participants use a net clearing model and the CFETC acts as central counterparty (CCP). Settlement of the CY leg occurs through the HVPS and settlement of the foreign currency leg with domestic settlement banks, at which participants hold FX accounts. The mission was not provided with complete data of the transactions cleared and settled through the multilateral arrangement nor has the PBC conducted an assessment of this payment system. However, in light of the nature of these transactions and the potential systemic importance of the 5 system, the PBC is urged to assess the compliance of this system with international standards as soon as possible. 5. The China Domestic Foreign Currency Payment System (FCPS) was launched in April 2008 to handle the clearing and settlement of domestic foreign currency denominated transactions. The FCPS is a Real-Time Gross Settlement (RTGS) system and currently handles payment transactions in seven foreign currencies. The values settled in the system do not show a systemic importance of the system. Nonetheless, the PBC conducted a self assessment of the system whose main conclusions are reported in Appendix I. 6. The assessment of the HVPS against the CPSIPS concludes that the system observes (observed or broadly observed) all the Core Principles (CPs) except CP I (legal basis). However, there are improvement opportunities in several areas:  Legal foundation: complete the legal and regulatory framework through: (i) enactment of a payment system law to give full protection to settlement finality and netting arrangements; (ii) interpretation of the ―Enterprise Bankruptcy Law‖ to avoid a ―zero-hour rule‖; (iii) upgrade of payment systems rules and procedures to the level of PBC regulation.  Understanding and management of risks: in addition to clarify with participants the potential legal risk associated with settlement finality, it will be important to further monitor credit and liquidity risk through: (i) more comprehensive queuing and accounting monitoring functions; (ii) application of more active mark-to-market mechanisms; and (iii) as liquidity conditions evolve, maintain flexibility in the conditions applied for intraday collateralized credit and consider the removal of charging.  Security, operational reliability and contingency arrangements: implement as soon as possible the second-generation payment system that will further: (i) improve the real-time operation monitoring function; (ii) improve the risk warning capability, effectively analyzing the potential risks of the system and giving timely warning; (ii) realize automatic handling of system failures to the maximum degree; and (iv) reduce the system maintenance work load, increasing the operation monitoring efficiency and upgrading the operation maintenance level.  Efficiency and practicality of the system: notwithstanding the important progress achieved since the launch of the CNAPS, it will be important to increase efficiency and practicality to the users through: (i) a ―single access point‖ feature of the system; (ii) ensuring high value electronic transactions are not perceived as relatively more expensive vis-à-vis large value cheque transactions; and (iii) considering extending operating hours reflecting the growing importance of the system. 6  Governance of the Payments System: the PBC is already addressing most of the existing shortfalls of the system and should be commended for the extraordinary effort to launch and operate a sophisticated and reliable payment system, which constitutes the backbone of China‘s financial system. Going forward, it will be important to involve more and more system participants in the ―second generation‖ project and, eventually creating a formal users‘ group that could facilitate cooperation and foster the systems‘ performance over time. Also, it is advisable to conduct regular rehearsal of crisis procedures for all types of emergency occurrences and not just for operational matters. Over time, the PBC should strive to achieve full observance of the other CPs. 7. The assessment of the Central Bank Responsibilities in applying the CPs concludes that PBC broadly observes all of them but there are improvement opportunities in several areas. The main ones are:  The PBC should clarify in detail its policy stance in payment system oversight in a publicly available document, which would expand on the scope of its actions and its plans to achieve its public policy objectives in payment system matters.  The oversight policy document should also cover in detail the PBC major policies and instruments. Major policies would touch upon the main aspects of payment systems including, risk control, access, governance, transparency, pricing, system reliability and business continuity, efficiency, etc. Instruments would range from moral suasion to on-site inspections, from regulation to cooperation, from sanctions to the direct provision of payment services.  The oversight document should elaborate on the criteria used to determine when a system is systemically important. A list of these systems should be provided and constantly monitored and updated.  Also, the policy document should elaborate on institutional arrangements and cooperation in the payment system arena.  The mission team considers that a more proactive oversight by the PBC over the China Foreign Exchange Trade System (CFETS) and the ACHs might be advisable. In particular, an assessment of the safety and efficiency of these systems with relevant international standards is recommended.  The PBC should consider a further refinement of its cooperative framework at the domestic level, by activating and implementing Memorandum of Understanding (MoU) on payment and settlement issues and a structured oversight working framework with all relevant authorities and creating the China National Payment and Clearing Association. 7  Finally, at the international level, the PBC is encouraged to continue its commendable effort of cooperation with relevant central banks and international organizations. A thorough application of the CPSS cross-border cooperative framework is also recommended. 8. Regarding the use of payment instruments, China is evolving to a more intensive use of non-cash payment instruments, especially cards. The relationship of cash (M0) to GDP has been declining since the beginning of the 2000 from a level of 16.7 percent of GDP in 2001 to 11.4 percent in 2009. Cards issuance has been increasing at a high pace and approximately 1.8 billion cards had been issued at end 2009, of which 1.65 billion were debit cards. The mission has not conducted a detailed assessment of retail payment systems as it was outside the context of this mission but it may be advisable for the PBC to formally include retail payments as an element of its oversight scope. In particular:  The PBC might want to clarify that its oversight extends beyond the two traditional main objectives of efficiency and reliability of payment systems to a wider set of issues including the promotion of competition in the payment services market and the protection of consumer interests. With regard to the scope of its oversight role, the oversight policy document may explicitly state the PBC decision to apply its powers over all payments and SSS in the country including retail payment systems and services, since the latter are especially important in supporting economic activity, broad access to payment services and the public trust in money. 9. China receives the biggest inflows of remittances worldwide after India. The World Bank (WB) estimates that US$47,553 million was sent to China in 2009, representing 1.1 percent of China‘s GDP. Notwithstanding the relevance of the inflows, it is very expensive to send money to China. According to the WB Remittance Prices Worldwide database, the average total cost of sending US$200 to China from selected sending countries was 12.55 percent. Even though this value has decreased over the last two years, China is still among the 20 most expensive receiving countries globally. In order to reduce the cost of remittances:  It is suggested that Chinese authorities implement the CPSS-WB General Principles for International Remittance Services and proactively embrace the G-8 and G-20 Global Objective of reducing remittance costs by 5 percentage points in five years. 8 I. GENERAL 10. The present document is the assessment of the systemically important payment systems in the People’s Republic of China (PRC) based on the CPSS CPSIPS. The document also contains an analysis of some developmental issues related to the reform of the payments system as a whole. The assessment was conducted in the context of the first field mission of the Financial Sector Assessment Program (FSAP) to the PRC (June 2010). 11. The assessors of the CPSIPS were Massimo Cirasino and Mario Guadamillas. 1 An assessment of the CPSS-IOSCO Recommendations for SSS and CCP was conducted by the same assessors on a follow-up FSAP mission in September 2010. During the September mission, the assessors were able to discuss as well some matters relevant to the CPSIPS assessment. II. INFORMATION AND METHODOLOGY USED FOR ASSESSMENT 12. The information used included all relevant laws, rules and procedures governing the systems, the abundant material available on the issue inside and outside the central bank.2 In addition, extensive discussions were held with regulators—PBC, Ministry of Finance (MOF), China Securities Regulatory Commission (CSRC), China Banking Regulatory Commission (CBRC), and State Administration of Foreign Exchange (SAFE); several stakeholders in the Chinese Payments System, including the big four commercial banks, joint stock commercial banks, city commercial banks, policy banks, foreign banks, and rural banks,3 funds management companies, the card operator (China Union Pay), the CFETC and securities depositories—China Central Depository & Clearing Co., Ltd. (CCDC) and China Securities and Clearing Corporation Limited (SD&C). A self assessment by the PBC of the country‘s SIPS with the CPSS Core Principles as well as of the central bank‘s responsibilities in applying the CPs was provided prior to the mission. The self-assessment was prepared by the PBC Payment and Settlement Department, in close consultation with the major stakeholders of the CNPS. 13. In addition to the 2001 CPSS-CPSIPS Report, the methodology used follows the Guidance Note for Assessing Observance of CPSIPS prepared by the IMF and the WB in collaboration with the CPSS in August 2001. For SSS, the 2001 CPSS-IOSCO Report on 1 Massimo Cirasino is Head of the Payment Systems Development Group of the Financial and Private Sector Development Vice Presidency (FPD) at the World Bank. Mario Guadamillas is the FSAP Manager in FPD at the World Bank. 2 The China Payment System Development Reports, 2007, 2008, and 2009, prepared by the PBOC Payment and Settlement Department were particularly relevant. 3 Bank of China (BoC), Industrial Commercial Bank of China (ICBC), China Construction Bank (CCB), Agricultural Bank of China (ABC), Bank of Beijing (BOB), China Development Bank (CDB), Bank of Communication, Shanghai Pudong Development Bank, Standard Chartered Bank, HSBC, Bank of East Asia (BOEA), JP Morgan-Chase, and Shandong United Rural Cooperative. 9 Recommendations for Securities Settlement Systems (RSSS), the 2002 CPSS-IOSCO Assessment Methodology for the RSSS and the 2004 CPSS-IOSCO Report on Recommendations for Central Counterparties (RCCP) were the references used. III. PAYMENT SYSTEMS INFRASTRUCTURE OVERVIEW 14. In recent years, the PBC has carried out a major and comprehensive reform of the CNPS. The PBC implemented the CNAPS, which consists of the High-Value Payment System (HVPS) and the BEPS. The HVPS is the backbone of the CNPS and is a RTGS system, mainly used for large value transfers. It is used to provide fast, efficient, secure, and reliable settlement services to banking institutions, private and public entities and financial markets. Currently, the system has more than 1,600 direct participants. In 2009, the HPVS processed 247 million transactions amounting to CY 760 trillion. The complex architecture of the National Payment System in China is depicted in Figure 1. 15. The HVPS registered an impressive growth over the last few years, especially when compared to other systems of major economies (see Figure 2). For example, the number of transactions processed through the system increased of 24.5 percent from 2007 to 2008. The growth of the total value processed was even higher (38.9 percent). However, as shown in Table 1, the value processed by the HVPS is still relatively low when compared to China‘s GDP, suggesting significant margins for further growth. 16. Domestic payments are handled through a very diverse variety of payment systems, mainly operated by the PBC, except for cards and some local clearing houses. The payments system backbone is the High Value Payments System (HVPS) launched by the PBC in 2005. The HVPS system currently operates in a decentralized way (multi-entry point) with a NPC and LCPs in each of the 32 provinces, autonomous regions and cities having province-level status. The HVPS system is interconnected to many trading, payments and SSS to allow for central bank money settlement. Embedded into the HVPS the PBC runs a payments systems for retail transactions (defined as 1000 km) from the main station and has independent different communications and power lines. Upon completion of a normal day, various city processing centers file all the business data handled during the day and send them to the backup center. The backup center shall use the business data filed by various city processing centers on the day of occurrence of the disaster as the basis for restoring the lost data. The mainframe of the payment system uses highly reliable equipment. System designs should use redundancy technologies such as quantum hot backup and multiple processes in parallel, etc., and fully consider the need of the future disaster backup system. The nodes should not have single failure points and critical computer equipment must have sufficient fault tolerant and disaster tolerant capabilities. Real time back up of business data is adopted between a backup center and an operating center. 32 Auditing The PBC internal auditing department performs regular audits on equipment, network and system security, generates complete auditing reports and evaluates operating risks. The PBC arranges for professionals to perform audits on the IT system and makes improvements to the system security performance based on the audit results. Assessment Observed Comments The system‘s framework to support business continuity and operational reliability is robust and safe. In principle, the segmented nature of the HVPS would increase operational risk. However, the PBC has managed this feature properly. The PBC is aware of the natural cycle of IT systems and has planned a major up-haul of HVPS operations to be launched in 2011 (so called ―second generation‖). The new system is expected to maintain a high degree of security and operational reliability. CP VIII – The system should provide a means of making payments, which is practical for its users and efficient for the economy. Description Since it entry into operation, the HVPS has been providing banking institutions and financial markets with efficient and secure clearing and settlement services. With respect to practicability, all functions predefined in system requirements analysis have been deployed and are running to satisfactorily meet needs of system participants and users; and with respect to efficiency, the system is running cost-effectively with technical performance and risk controls as designed to enable service provision and offer services at expected prices. Fund transfers are completed in less than a minute. The HVPS is connected to multiple systems, such as the payment systems within various financial institutions of the banking industry, the government securities depository (CCDC), the bankcard payment system, the CY interbank lending and FX trading system, etc. Thus, it provides secure and efficient settlement services for financial institutions of the banking industry and the financial market. The cost of the system builder and operator includes: investment in system development and construction; the cost of system operations and maintenance (mainly comprising the cost of equipment, sites and modifications, the cost of depreciation, networks and communications, water and electric bills, personnel payroll and office expenses); and the cost of system equipment repairs. The cost of system participants has three major components: first is the expense by the system participants in handling their operations, mainly the transfer fees paid to the PBC; second are other costs for the system participants, mainly comprising depreciation of fixed assets, personnel payroll and operating cost (line lease, vouchers and office products), etc.; third is the fund cost borne by the participants, including the opportunity cost for settlement account funds and collaterals, as well as the financing cost incurred by participants in raising sufficient clearing settlement account funds. HVPS designs, operations and management meet the need for efficiency mainly from the 33 following aspects: first, compliance with technical indexes such as the business handling capacity, business handling time, the system response time and system reliability, etc.;12 second, facilitation of access at low cost for small and medium-sized financial institution in correspondent and settlement business. 13 The initial investment in the development and construction of the system has been advanced by the financial authorities of the central government and it is gradually recovered based on the business volume. The cost of system operations and maintenance is recovered through fees based on the business volume. In light of these considerations and according to the principle of ―total revenue = total cost,‖ the PBC has determined that the HVPS charge CY 5.5 per transaction and the feeds for the BEPS. The HVPS is operated on the legal work days of the country. The system divides each work day into four time segments: daytime business operating hours, settlement window operating hour, end of day operating hours and business preparation hours.  8:30 to 17:00 are the daytime business operating hours; 17:00 is the cutoff time of operations. At this time, if the settlement account has no operations in the queue, then the system handles end of day operations; if the settlement account has operations in the queue;  17:00 to 17:30 is the settlement window operating hour, used to clear the funds raised in various settlement accounts;  the end of the day operations are handled at 17:30; and  upon completion of the handling of the end of day operations, the business preparation hours for the next work day are entered. 12 First, in terms of operational capacity, the peak volume of the HVPS is about 460,000 transactions / hr. The intercity peak volume of the low value payment system is about 9.6 million transactions / hr. In terms of the operational handling time, the time for handling a transaction through the HVPS is less than 60 seconds at its fastest. There are two types of business handled for the low value payment system; batch and real time. The time for handling batch business in the same province is less than 30 seconds; for cross province batch business, less than 60 seconds. The real time in the same province is processed in less than10 seconds; for cross province, in less than 20 seconds. In terms of system response time, the log on time to the high value and low value payment system is 3 seconds at a maximum; from entry of a message or file into the system to receipt return or system response, the time does not exceed 5 seconds. Finally, in terms of system reliability, the availability of both the high value and low value payment systems cannot be less than 99.9 percent of the total operating hours at a minimum; the average time for restoration does not exceed 20 minutes. 13 For participants with a low operating volume (such as rural credit cooperatives), several choices for low cost access methods are available. First is the centralized small front end processor method. This method allow rural credit cooperatives to operate as direct participants through a small front end processor system, that directly connects to the payment system front end processor, with various rural credit cooperatives within the province as indirect participants, where the small front end processor client end sends and receives payment transactions. The small front end processor system is an internal network system designed for rural credit cooperatives that have not set up a province wide comprehensive business system or acceptance system. Second is a shared front end processor method. This method refers to connection of the front end processor with the payment system, with multiple financial institutions connected to the shared front end processors, and operations are entered through the shared front end processors. The third choice is the payment settlement correspondent model. A financial institution may choose the local branch and sub-branch agency of a financial institution of the banking industry or a local branch or sub-branch of the PBOC as a correspondent bank to handle payment settlement business. 34 The work day and operating hours may be adjusted based on managerial need and are posted by the PBC in advance. The PMIS does not support real time verification by the participant of an account balance, but a participant may, through HVPS, launch an inquiry message to inquire about its settlement account balance in real time. The system is segmented in that financial institutions hold accounts with different branches of the PBC. In particular, HVPS participants have to maintain different settlement accounts with various payment systems operated by PBC, and cannot concentrate their liquidity in these settlement accounts. Moreover, there are many local payment and settlement systems that settle on the HVPS. Differences in risk management procedures of these local systems become a source of financial risks to the HVPS. Finally the SSS are equally fragmented and adds to the complexity of liquidity management in the overall payments system as well. 14 Furthermore, in some regions, there are limitations in terms of basic infrastructure and access to financial services. This results in great discrepancies across the countries in operating conditions and business capabilities. Such limitations have caused some resistance to nationwide promotion of the payment system. Based on the actual conditions in the above regions, such as a poor environment for payment settlement and weak financial institutions, etc., the PBC adopted the method of providing participants in those regions with free front end processors to facilitate their access, in order to open the local access to payment settlement transfers. System capacity is enhanced through system upgrades. In order to handle the growing volume of business, the PBC has upgraded all nodes of payment system in phases. Currently, a round of upgrading has been completed with all city processing centers. The NPC has completed several system upgrades and capacity expansions as needed. It is estimated that the system capacity now exceeds peak business volume by 1/3. Assessment Broadly Observed Comments Notwithstanding the important progresses achieved since the launch of the CNAPS, some features might be adjusted to increase efficiency and practicality to the users, such as:  The ―multiple access point‖ feature of the system might impact the efficient management of liquidity and adds to the cost of participating in it.  High value electronic transactions might still be perceived as relatively more expensive vis-à-vis large value cheque transactions, although it is noted that commercial banks are gradually switching their customers to other electronic payment options.  Operating hours could be extended to reflect the growing importance of the system. The PBC is aware of most of these shortfalls and has designed the second generation system to address these issues, in particular by envisaging a single entry point and enhanced capacity. In particular, it must be noted that the multi-entry point was also a result of the lack of preparedness of participants to connect to a central facility. So, in this regard, the PBC worked to meet the needs of the users. New technologies and the several years of operations of the system might guarantee r a smooth transition to a new more centralized system. 14 SSS will be assessed in detail in the context of the CPSS-IOSCO assessment during the second FSAP mission. 35 CP IX – The system should have objective and publicly disclosed criteria for participation, which permit fair and open access. Description The PBC promulgated the Rules for Participating and Quitting Payment Systems by Banking Institutions, which specifically define criteria for system participation, participation process and exit process. These Rules have been issued as a formal regulatory document to all banking institutions, and have been publicly disclosed through brochures, publications, websites and other channels. These Rules reflect the fact that the PBC is committed to fairness and competitiveness in system participation and applying the same set of criteria to all banking institutions that apply for system participation; and in order to maximize competitiveness, the PBC has been accommodative in setting criteria for system participation, and seeks to control risks through system design, service procedures and operational controls. In particular, the PBC has issued the Methods for the Administration of the Joining of and Withdrawal from the Payment System by Institutions of the Banking Industry to monitor constant compliance by participants with the access requirements.  Financial institutions of the banking industry that join the payment system as direct participants should meet the following conditions: (1) handle CY settlement with approval from the banking regulatory authority; (2) open an CY deposit account with the PBC; (3) meet the technical and security indexes for joining the payment system; (4) have a sound internal control system; (5) have a feasible plan for preventing and eliminating settlement risks; and (6) other conditions specified by the PBC.  Conditions for financial institutions of the banking industry that join the payment system as indirect participants are determined by direct participant that clear funds on their behalf. This administrative method has been disclosed to the public through channels such as publicity flyers, official publications and official websites, etc. At the same time, the PBC may compel participants with a poor credit to withdraw from the payment system. For example, those that seriously create disruptions to clearing and settlement procedures; those who, starting from the day they join the payment system, have caused the payment system settlement window not to close during the scheduled hours for three cumulative times due to a lack of liquidity; and other conditions that affect the safe and stable operations of the payment system, etc. Assessment Observed Comments - CP X – The system’s governance arrangements should be effective, accountable and transparent. Description The PBC makes it a central function to govern and oversee operations of the HVPS and the system participants. Internal functions of the PBC, including the Payment and Settlement Department , IT Department , Internal Auditing Department, and CNCC, are assigned to clearly delineated roles and responsibilities so they are making resolute and prompt decisions and communicating smoothly, clearly, timely and completely. Since its entry into operations, the HVPS has been running securely, smoothly and efficiently with ever increasing volume of transactions and a growing number of participants. Information related to the system and its operations is available through multiple channels :  The PBC uses multiple methods, such as holding workshops/conferences, television appearances, press conferences and through public speeches of its leaders, payment 36 system briefings and payment clearing communications, etc., to publish information on payment system decision making and regularly circulate information on system operations.  The PBC regularly publishes a Development Report on China‘s Payment System, China‘s Financial Yearbook and Annual Report of the PBC, to publicly disclose basic information on the development of China‘s payment system, relevant data and future policy orientation.  Through publications, its official website (www.pbc.gov.cn) and other public media, the PBC publicly discloses information related to the HVPS and BEPS. For example, the published Compilation of China‘s Payment Settlement System presents all the relevant features of the system; each quarter, important data on the payment system is made public on the official website and The Financial Times. The PBC engaged the relevant stakeholders in the construction of the system and has open channels of communication with system participants on relevant matter. No formal users‘ group is established for participants to provide regular feedback o n systems‘ operation. Participants are also not fully aware so far of the details of the ―second generation‖ project. However, the PBC organizes meetings and workshops on a regular basis with payment system stakeholders. Regarding unexpected incidents, a Plan for Emergency Handling of Crises in the Payment Settlement System has been specifically formulated. It provides clear stipulations regarding the decision making and command processes by system managers after the occurrence of an unexpected incident. Most unexpected incidents can be summarized into the following three categories:  Failure of a system or any of its nodes caused by natural disasters, disaster incidents or unexpected public security incidents;  Operation of any payment settlement system is seriously hindered as a result of human resource limitations caused by unexpected public health incidents or public security incidents; and  Failure of any payment system that cannot be recovered within a tolerable length of time. The system does not fully observe all the CPs for SIPS. Assessment Broadly observed Comments As mentioned, the PBC is already addressing most of the existing shortfalls of the system and should be commended for the extraordinary effort to launch and operate a sophisticated and reliable payment system, which constitutes the backbone of China‘s financial system. Involving more and more system participants in the ―second generation‖ project and, eventually creating a formal users‘ group will facilitate cooperation and foster the systems‘ performance over time. Also, the regular rehearsal of crisis procedures for all types of emergency occurrences and not just for operational matters, both within different departments of PBC and with system participant, would certainly increase the PBC capacity to respond to unforeseen events. Over time, the PBC should strive to achieve full observance of the other CPs. 37 Table 6. Central Bank Responsibilities in Applying the CPs Responsibility A – The central bank should define clearly its payment system objectives and should disclose publicly its role and major policies with respect to systemically important payment systems. Description The main objectives and roles of the PBC in payment systems are clearly stated in the legislation. They are further elaborated through PBC bylaws and system rules and procedures. The legal basis for oversight by the PBC on interbank and government SSS are derived from the PBC Law. In particular, Article 4 of PBC Law provides that the PBC assumes the following functions“…issue the currency and administer its circulation; regulate and supervise the interbank lending market and interbank bond market; execute FX administration, regulate and supervise the interbank FX market; ensure normal operation of the payment and settlement systems.‖ Article 27 provides that ― Th e PB C shall organize or assist in organizing a clearing system among banking financial institutions, coordinate clearing arrangements among them and provide settlement services. The detailed rules for such systems shall be formulated by the PBC. The PBC shall formulate rules on payment and settlement together with the banking regulatory authority under the State Council (SC).‖ Article 32 provides that the PBC shall have the power to inspect and supervise financial institutions, other organizations and individuals in their compliance with regulation of the inter-bank lending market and the inter-bank bond market, FX markets, and clearing and settlement. T he P B C publicly discloses its role and responsibilities over p a yme n t a nd S S S:  it regularly releases reports on the development of the national payments system of China;  it covers these aspects in the central bank annual report;  it holds press conferences and other public interventions by its leaders;  it uses the official central bank website and other media such as newspapers and magazines; and  finally, it publishes ad hoc official documents and research papers. The PBC has played a major catalyst role in the reform of payment and settlement systems and in doing so has broadly consulted with system participants and the general public. A comprehensive document on payment system oversight covering in detail the public policy objectives of the PBC on payment system oversight, its instruments and institutional arrangements is not available both to major stakeholders in the payment system and the general public. Finally, it is not clear what are the criteria and analysis used by the PBC assess the systemic importance of payment systems in China. Assessment Broadly Observed Comments The PBC should clarify in detail its policy stance in payment system oversight in a publicly available document, which would expand on the scope of its actions and its plans to achieve its public policy objectives in payment system matters. With regard to policy objectives, the PBC might want to clarify that its oversight extends beyond the two traditional main objectives of efficiency and reliability of payment systems to a wider set of issues including the promotion of competition in the payment services market and the protection of consumer interests. With regard 38 to the scope of its oversight role, the oversight policy document would explicitly state the PBC decision to apply its powers over all payments and SSS in the country. That is, over systemically important systems but also retail systems, since the latter are especially important in supporting economic activity, broad access to payment services and the public trust in money. The oversight policy document would also cover in detail the PBC major policies and instruments. Major policies would touch upon the main aspects of payment systems including, risk control, access, governance, transparency, pricing, system reliability and business continuity, efficiency, etc. Instruments would range from moral suasion to on-site inspections, from regulation to cooperation, from sanctions to the direct provision of payment services. Also, the oversight document should elaborate on the criteria used to determine when a system is systemically important. A list of these systems should be provided and constantly monitored and updated. Finally, the policy document would elaborate on institutional arrangements and cooperation in the payment system arena (see Responsibility D below). Responsibility B – The central bank should ensure that the system it operates comply with the CPs. Description With respect to oversight of HVPS and FCPS, the PBC has been applying the CPSIPS through pre-launch stages and post-launch stages to: design, build and, as appropriate, upgrade these systems; develop and refine policies and procedures related to these systems; and conduct periodic assessments to fully understand how payment systems are operating and providing services, and take actions to resolve identified risks. Yet, to date, the above systems do not fully observe all the CPSIPS. The PBC also operates the cheque clearing system, which is a combination of a national (cheque image) mechanism and a variety of local clearing systems. The volumes and values of cheques in China are significant, although are noted the vast majority of cheques is ―on us.‖ Yet, the moving of all large value payments from the cheque clearing to the HVPS is still to be completed. To ensure effective oversight, the PBC has structured its organization to segregate oversight responsibilities from operation responsibilities with respect to payment systems. The roles of the Payment and Settlement Department and the Internal Audit Department in overseeing operations of payment systems are defined by POBC Office of Organizational Structure, Staffing Control and Position Review in its policy statements No. [2001]-11 and No. [2010]-7. The Payment and Settlement Department is responsible for ―leading and coordinating the development of PBC-operated interbank payment systems, and formulating and implementing rules and procedures for administering systemically important payment systems.‖ The Internal Audit Department is responsible for ―performing audits on PBC Head Office, PBC Shanghai Headquarters, PBC Branches (Regional Offices), enterprises and non- enterprise institutions directly governed by PBC and SAFE with respect to development, operations, internal controls of computer-based information systems as well as governance of system infrastructure and overall technology management.‖ Assessment Broadly Observed Comments The HVPS does not fully observe al CPSIPS and actions to achieve its full compliance should be completed by the PBC as a priority. A thorough evaluation of the risks associated with the cheque clearing and proactive actions 39 to remove large value payment items from the cheque clearinghouse should be carried out as a matter of urgency. Some clarification of the roles of the Payment and Settlement Department and the internal audit department in the oversight of PBC operated payment systems might be necessary. Responsibility C – The central bank should oversee observance with the CPs by system it does not operate and it should have the ability to carry out this oversight Description As mandated by The PBC Law and Methods for the Administration of Payment Services of Non-financial Institutions (PBC Decree [2010]-2), PBC conducts son-site and off-site supervision for payment systems not operated by PBC; defines strict criteria for system operators and requires the latter to develop complete risk management measures and contingency plans and provide final settlement services. In particular, the PBC exercises oversight on the payment systems and services it does not operate or provide, such as Bankcard Interbank Payment System, intra-bank systems of banking institutions, Bank Draft Processing System for City Commercial Banks, the CFETS, and, more recently, third party payment service providers. The PBC ensures its ability to oversee such payment systems by establishing full-time oversight teams with appropriate skills and expertise; regularly convening consultative meetings with system operators, participants and other relevant stakeholders; conducting onsite examinations and periodic assessments. The PBC can also oversee these systems in its capacity as payment system operator and settlement provider for some of their clearing services (e.g., CUP). Assessment Broadly Observed Comments The mission considers that a more proactive oversight by the PBC over the CFETS and the ACHs might be advisable. In particular, an assessment of the safety and efficiency of these systems with relevant international standards is recommended. Responsibility D – The central bank, in promoting payment system safety and efficiency through the CPs, should cooperate with other central banks and with any other relevant domestic or foreign authorities. Description The PBC is the primary payment system overseer in China. However other authorities have oversight and supervisory responsibilities over some aspects of the payment and settlement systems. For example, the S ecu ri tie s La w (Article 179) gives the C S RC authority to perform the following functions and duties regarding the supervision and administration of the securities market: (1) Carrying out the supervision and administration of the issuance, listing, trading, registration, custody and settlement of securities. (2) Carrying out the supervision and administration of the securities activities of securities registrations and clearing institution. The Securities Law also provides that CSRC may perform on site inspections of securities registration and settlement institutions in accordance with law, conduct interrogations and inquiries of their workers and adopt measures including requesting corrective action, imposing fines, requiring shutdown or revoking securities service and business permits, etc., for actions in violation of the law. 40 The PBC maintains effective coordination and information sharing with other financial regulators. For example, it builds information-sharing mechanisms and promote cooperation with such authorities as the National Development and Reform Commission (NDRC), MOF, National Audit Office (NAO), China Banking Regulatory Commission (CBRS) and China Insurance Regulatory Commission (CIRC); and it has an effective framework for working with China Banking Regulatory Commission (CBRC), CSRC, China Insurance Regulatory Commission (CIRC) and other financial regulators to ensure security and efficiency of the overall payment system. The PBC cooperation with relevant authorities in the area of payment and settlement is not structured through formal MoU or other pre-defined cooperative working mechanisms. 15 Regarding cooperation with stakeholders, no formal cooperative arrangement, such as a National Payments Council, is currently in place. The PBC, however, is currently working to create a national payment clearing association. As a nationwide self-regulatory organization for the payment service industry, the Association is intended to act as a self regulatory body of the payment service industry and promote the safe development of the payment systems in China. The PBC is increasingly strengthening its cooperation and exchanges of information with foreign central banks and regulatory authorities. It has signed Memoranda of Understanding or other agreements with a number of foreign authorities. The PBC is also a member of international cooperation organizations such as the CPSS and the Executives ‘ Meeting of East Asia and Pacific Central Banks (EMEAP) at both the Governors‘ level and the Working Group on Payment and Settlement Systems (WGPSS). It also participates actively in the debate surrounding the international arena of payment and settlement systems, by attending seminars, conferences, courses, etc. Foreign currencies are transacted, cleared and settled in the Chinese domestic financial markets. This would require the activation of the CPSS cooperative cross-border oversight framework (see Box 2). However, it is not clear whether the framework has been followed consistently in all circumstances. Assessment Broadly Observed Comments The PBC should consider a further refinement of its cooperative framework at the domestic level, by activating and implementing Memoranda of understanding and a structured oversight working framework with all relevant authorities and creating the China National Payment Association. At the international level, the PBC is encouraged to continue its commendable effort of cooperation with relevant central banks and international organizations. A thorough application of the CPSS cross-border cooperative framework is also recommended. Several benefits would accrue to the PBC and the Chinese financial system of such enhanced cooperation. These include, for example, (1) the ability to tap into the 15 However, the PBOC has invited the CSRC and other organizations to conduct joint reviews on securities clearing and settlement and in particular on the settlement of the cash-leg of securities transactions. 41 knowledge, experience, and perspectives of the central banks of issue to support the PBC's analysis of the soundness of the settlement (and failure-to-settle) arrangements that involve their respective currencies; and (2) avoiding situations where the central banks of issue would have insufficient knowledge of a system in China and, hence, would not be in a position to be supportive of its use by institutions in their respective jurisdictions. Box 2. CPSS – Principles for Co-operative Oversight of Payment and Settlement Systems In May 2005, the Committee on Payment and Settlement Systems (CPSS), at the BIS published the ―Central bank oversight of payments and settlement systems‖ report. This report identifies ten principles to guide central banks in their oversight activities, five of these principles specifically pertain to co-operative oversight. The five principles for co-operative oversight are relevant for oversight of payment and settlement system activities of transnational and multi-national payment system operators. The five principles for co-operative oversight identified in this report are listed below. 1. Cooperative Oversight Principle 1. Notification Each central bank that has identified the actual or proposed operation of a cross-border or multi-currency payment or settlement system should inform other central banks that may have an interest in the prudent design and management of the system. 2. Cooperative Oversight Principle 2. Primary responsibility Cross-border and multicurrency payment and settlement systems should be subject to oversight by a central bank which accepts primary responsibility for such oversight, and there should be a presumption that the central bank where the system is located will have this primary responsibility. 3. Cooperative Oversight Principle 3. Assessment of the System as a Whole In its oversight of a system, the authority with primary responsibility should periodically assess the design and operation of the system as a whole. In doing so it should consult with other relevant authorities. 4. Cooperative Oversight Principle 4. Settlement Arrangements The determination of the adequacy of a system‘s settlement and failure-to-settle procedures in a currency should be the joint responsibility of the central bank of issue and the authority with primary responsibility for oversight of the system. 5. Cooperative Oversight Principle 5. Unsound Systems In the absence of confidence in the soundness of the design or management of any cross-border or multicurrency payment or settlement system, a central bank should, if necessary, discourage use of the system or the provision of services to the system, for example by identifying these activities as unsafe and unsound practices. 42 Table 7. Summary observance of CPSS Core Principles and Central Bank Responsibilities China HVPS and Central Bank Responsibilities Assessment grade Principles grouped by assessment grade Count List Observed 6 Core Principles II,III,IV,VI,VII,IX Core Principle VIII and X, Central Bank responsibilities A, Broadly observed 2+4 B, C, D Partially observed 1 Core Principles I Non-observed - - 1 Not applicable Core Principle V 43 Table 8. Recommended Actions to Improve Observance of CPSS Core Principles and Central Bank Responsibilities in Applying the CPs China HVPS Reference Principle Recommended Actions Legal foundation Chinese authorities should accelerate the legislative process to CP 1 complete the reform of the legal and regulatory framework for payment and securities settlement. This will include:  The enactment of a payment system law to give full legal protection, among other things, to settlement finality and netting arrangements.  The introduction of the Interpretation of Enterprise Bankruptcy Law or revision of the Enterprise Bankruptcy Law to exempt the payment system sector from the ―zero - hour rule.‖  The upgrade of payment system rules and procedures to the level of PBC regulation. Understanding and management of risks As it is not clear whether participants are fully aware of the CPs 2 and 3 potential legal risk associated with settlement finality, the PBC might want to inform participants about the measures it took to mitigate this risk and the projects under way to eliminate it. The PBC should further monitor the credit risk and liquidity risk of the system by improving relevant rules and building the second-generation payment system. Relevant actions mainly include:  Provide participants with more comprehensive queuing and account monitoring functions, ―package‖ liquidity real -time inquiry functions and large-value payment system queuing matching.  Apply more active mark-to-market mechanisms for the collateral used in the intra-day liquidity facility.  As liquidity conditions evolve, maintain flexibility in the conditions applied to intra-day liquidity facilities and consider the removal of charging for collateralized credit. Settlement - CPs 4, 5, and 6 Security and Operational Reliability, and The second-generation payment system will have a more efficient Contingency Arrangements operation and maintenance mechanism, which realizes automatic CP 7 upgrading of the system application software; it will further:  improve the real-time operation monitoring function, which carries out comprehensive and automatic monitoring of the IT resources of the payment system; 44 Reference Principle Recommended Actions  improve the risk warning capability, effectively analyzing the potential risks of the system and giving timely warning;  realize automatic handling of system failures to the maximum degree; and  reduce the system maintenance work load, increasing the operation monitoring efficiency and upgrading the operation maintenance level. The second-generation payment system will provide the backup system with enhanced features, such as a complete production recovery capability, business switching capability and data searching capability on the framework of the production center, remote backup center and the data backup center in the same city to ensure the continuous processing of payment and the security and integrity of information and data in case of emergency. The above measures are strongly encouraged. Efficiency and Practicality of the System Notwithstanding the important progresses achieved since the CP 8 launch of the CNAPS, some features might be adjusted to increase efficiency and practicality to the users, such as: 1) The ―multiple access point‖ feature of the system might impact the efficient management of liquidity and adds to the cost of participating in it. 2) High value electronic transactions might still be perceived as relatively more expensive vis-à-vis large value cheque transactions, although it is noted that commercial banks are gradually switching their customers to other electronic payment options. 3) Operating hours could be extended to reflect the growing importance of the system. Criteria for Participation To further strengthen supervision and management of the CP 9 payment system participants and guarantee the secure and stable operation of the payment system, PBC plans to revise the Administrative Measures for Accessing to and Exiting the Payment System by Banking Financial Institutions. For instance, it plans to specify and detail the mode for examining the access applicants in the Administrative Measures:  testing relevant personnel on knowledge about the payment systems;  onsite check of the payment settlement processing environment; and  calling the top management together for prudent talks so as to increase the operability of access review and approval. 45 Reference Principle Recommended Actions These measures are strongly encouraged. Governance of the Payment System As mentioned, the PBC is already addressing most of the existing CP 10 shortfalls of the system and should be commended for the extraordinary effort to launch and operate a sophisticated and reliable payment system, which constitutes the backbone of China‘s financial system. Involving more and more system participants in the ‗second generation‖ project and, eventually creating a formal users‘ group will facilitate cooperation and foster the systems‘ performance over time. Also, the regular rehearsal of crisis procedures for all types of emergency occurrences and not just for operational matters, both within different departments of PBC and with system participant, would certainly increase the PBC capacity to respond to unforeseen events. Over time, the PBC should strive to achieve full observance of the other CPs. Central Bank Responsibilities in Applying The PBC should clarify in detail its policy stance in payment system the CPs oversight in a publicly available document, which would expand on Central Bank Responsibility A, B, C, and D the scope of its actions and its plans to achieve its public policy objectives in payment system matters. With regard to policy objectives, the PBC might want to clarify that its oversight extends beyond the two traditional main objectives of efficiency and reliability of payment systems to a wider set of issues including the promotion of competition in the payment services market and the protection of consumer interests. With regard to the scope of its oversight role, the oversight policy document would explicitly state the PBC decision to apply its powers over all payments and SSS in the country those that are systemically important and retail systems, since the latter are especially important in supporting economic activity, broad access to payment services and the public trust in money. The oversight policy document should also cover in detail the PBC major policies and instruments. Major policies would touch upon the main aspects of payment systems including, risk control, access, governance, transparency, pricing, system reliability and business continuity, efficiency, etc. Instruments would range from moral suasion to on-site inspections, from regulation to cooperation, from sanctions to the direct provision of payment services. Also, the oversight document should elaborate on the criteria used to 46 Reference Principle Recommended Actions determine when a system is systemically important. A list of these systems should be provided and constantly monitored and updated. Finally, the policy document would elaborate on institutional arrangements and cooperation in the payment system arena (see Responsibility D below). The HVPS does not fully observe all CPSIPS and actions to achieve its full compliance should be completed by the PBC as a priority. A thorough evaluation of the risks associated with the cheque clearing and proactive actions to remove large value payment items from the cheque clearinghouse should be carried out as a matter of urgency. Some clarification of the roles of the Payment and Settlement Department and the internal audit department in the oversight of PBC operated payment systems might be necessary. The mission considers that a more proactive oversight by the PBC over the CFETS and the ACHs might be advisable. In particular, an assessment of the safety and efficiency of these systems with relevant international standards is recommended. The PBC should consider a further refinement of its cooperative framework at the domestic level, by activating and implementing Memoranda of Understanding on payment and settlement issues and a structured oversight working framework with all relevant authorities and creating the China National Payment Association. At the international level, the PBC is encouraged to continue its commendable effort of cooperation with relevant central banks and international organizations. A thorough application of the CPSS cross-border cooperative framework is also recommended. 47 V. AUTHORITIES’ RESPONSE The Chinese authorities welcome and support the CPSS assessment as an opportunity for reflection and improvement for China payment and settlement system according to international standards. The assessment team has undertaken an excellent task, demonstrating high quality, professionalism, dedication and the ability to cut through complex issues in a constrained timeframe. The authorities appreciate the opportunity to provide the following comments. Over the past decade, China has continuously pushed forward the development of China payment and settlement system, which constitute the backbone of China‘s financial system. We have built a payment network consisting of the central bank inter-bank payment systems, the banking institutions‘ internal payment system, the security settlement system, the FX settlement system, the bankcards payment system and other retail payment systems run by private sectors. Non-cash payment instruments have been widely used and met various payment requirements. Commercial drafts have been underwritten and transferred in an electronic way. Bankcards penetration ratio has been on a fast track and bankcards have been the most widely used payment instrument by Chinese residents. Online payment, mobile payment and telephone payment have been developing dramatically. The application of non-cash payment instruments has greatly facilitated economic production and civil life, reduced cash circulation and transaction costs. Payment providers have been diversified. These include the central bank, banking institutions, nonbanking institutions and securities settlement institutions as payment organizations. The payment services have been market-driven. Modern payment means have also found their way in rural areas. The pilot cross-border trade settlement in RMB has developed in an orderly way. The management system of bank settlement accounts has improved on a gradual basis. The PBC has promulgated regulations on bank settlement accounts and established the bank settlement account management system to implement regulations. At the same time, the PBC launched a nationwide identity authentication system of accounts with the Police Bureau to implement the ―know your customer‖ scheme. The payment system oversight has been strengthened, with safety and efficiency as the priority. The PBC has also improved supervision techniques and realized the DVP mode in the bond market. The Large Value Payment System (LVPS) run by the PBC has been designated as the systemically important payment system and has been assessed against the CPs. The assessment concluded that the system observes (observed or broadly observed) all the CPs except CPI (legal basis). The PBC pays high attentions to the assessment results and appreciates valuable recommendations of the IMF and the WB. In implementing the recommendations, the PBC has realized one point entry in CNAPS1, e.g., the treasury centralized booking system and China postal savings bank‘s internal payment system have been connected to CNAPS1 from one point and settled their transactions with one account. Measures will be taken to strengthen our legal foundation, management and supervision of China payment systems, so as to improve its practicality and efficiency in the future. 48 1. CP I legal Foundation. The PBC has been aware of the shortcomings in the legal framework, and has decided to draft a payment system act to avoid the effects of the ―zero hour rule‖ and give the legal recognition of netting arrangements and settlement finality. But the process of establishing legislation will take time and may involve many authorities. 2. CP VIII Practicality and Efficiency. The PBC is launching the 2nd generation of CNAPS to increase efficiency and practicality. CNAPS2 will be designed to extend the opening hours of settlement to meet the needs of users in different areas and various financial markets. 3. CP X Governance. The PBC has decided to improve management, upgrade the payment system and conduct a regular drill of emergency procedures, with an aim to achieving full observance of the CPs. Central Bank Responsibilities A, B, C and D. The PBC fully agrees with the recommendations and will take proper measures to ensure full observances of all CPs. The PBC will clarify in detail its policy stance in the payment system oversight in a publicly available document, and extend its oversight over all payments and securities settlement systems, including the systemically important systems and retail payment systems. The PBC will assess the safety and efficiency of the CFETS and the ACHs with relevant international standards. Besides, the PBC is about to establish the China National Payment Association and strengthen cooperation with relevant authorities, foreign central banks and international organizations. 49 APPENDIX I: SELF-ASSESSMENT OF CHINA DOMESTIC FOREIGN CURRENCY PAYMENT SYSTEM (FCPS) The PBC conducted a self assessment of the FCPS, which was provided to the FSAP team. The main features are summarized below.  Legal and Regulatory Framework The general legal framework applicable to the FCPS is described in the HVPS assessment. Rules and procedures for the FCPS include, among other things: Administrative Procedures for Domestic Foreign Currency Payment System, Procedures for the Administration of Settlement agents in Domestic Foreign Currency Payment System, Operation Procedures for Domestic Foreign Currency Payment System, Operational Procedures for Domestic Foreign Currency Payment System, Contingency Plan for Domestic Foreign Currency Payment System, and Circular of The PBC concerning Matters to Transaction Processing in Domestic Foreign Currency Payment System (PBC Doc [2008]-387).  Management of Financial Risks Credit Risk. Article 10 of the Administrative Procedures for the FCPS stipulates that the system ―processes payment instructions individually in real-time and settles each payment to its full value. Any payment sent by a participant or specially authorized participant shall become final upon settlement.‖ Article 51 stipulates that the system ―shall calculate available quotas by currency for all participants in real time as a way to safeguard against credit risk.‖ Liquidity Risk. Article 53 of the Administrative Procedures states that ―Participants shall maintain sufficient available quotas at Foreign Currency Clearing Processing Center (FCCPC) to ensure that foreign currency payments are timely cleared.‖ Article 54 stipulates that ―Upon being informed by FCCPC that their payments have been placed in a queue for settlement, specially authorized participants shall timely notify and urge relevant participants to raise funds. In the event that any relevant participant fails to raise sufficient funds before the Settlement Window is closed, specially authorized participants shall ensure foreign currency payments are timely settled in the system by accessing risk deposit and risk-sharing mechanism.‖ Article 55 stipulates that ―Settlement agents shall provide participants with liquidity support such as overdraft facilities and pledge financing as a way to safeguard against liquidity risk.”  Settlement As a RTGS system, the FCPS settles payment instructions denominated in each of the currencies in real time upon receipt of such payment instructions from any participant provided that such participant has sufficient available quotas. 50  Settlement Asset Commercial bank currency is used by the FCPS for settlement, which means that participants uses the foreign currency inter-bank deposit they maintain with settlement agents to complete settlement. Currently, major settlement agents designated by the FCPS are: Industrial and Commercial Bank of China (Euro & Japanese Yen), BOC (U.S. Dollar), CCB (Hong Kong Dollar), Shanghai Pudong Development Bank (Pound Sterling, Australia Dollar, Canadian Dollar & Swiss Franc). While the FCPS uses commercial bank money as its settlement asset, it employs mechanisms for settlement agent selection, system oversight and governance, settlement assets conversion and other areas, which address the credit and liquidity risk of the settlement assets. They include: First, the Administrative Procedures for settlement agents in Domestic Foreign Currency Payment System calls for the settlement agents to be financially robust and carry no or little liquidity risk. For example, Article 13 stipulates that ―a bank may apply for status of a settlement agents for a certain foreign currency when: (1) It is a corporate domestically registered for more than 10 years; (II) It has all licenses necessary for a FX service provider and has appropriate capacity for providing FX services; (III) It is operationally and financially healthy with strong ability to raise funds in foreign currencies; (IV) It owns an appropriate number of domestic branches and an appropriate number of overseas branches or a complete international network of correspondent banks; (V) It has an appropriate number of managers and operators that are familiar with foreign currency payment services and foreign currency payment system; (VI) It has safe and efficient internal operational systems; and (VII) It has a sound governance program for controlling its foreign currency settlement services.‖Second, the portfolio of settlement agents should be capable of ensuring that settlement assets be liquid and maintained at a high credit rating level. Third, the PBC monitors and keeps track of the liquidity and credit rating levels of the settlement agents.  Operational Reliability and Business Continuity The FCPS meets the security policies and operational service levels agreed by the system operator and participants. In particular, a portfolio of business procedures and technical safeguards have been implemented to ensure security and reliability with a 99.9 percent of system operational reliability and a recovery time objective of 120 minutes. Security: Security policies for the FCPS conform to the security standards centrally set for China's banking industry. The system is mandated to attach digital signatures to payment transaction information and establish a process for verifying digital signatures. So, the system is capable of ensuring integrity, authentication and non-reputability of payment instructions. Primary backbone communications lines are protected by IP encryption to ensure confidentiality of data throughout the transmission over backbone networks. The PBC periodically conducts security tests and assessments of FCPS. 51 Operational reliability: The FCPS has been built with full account given to computer and network redundancy by installing hot backup systems at FCCPC, shared member bank front ends (MBFEs) and settlement banks to avoid single-point failures; regarding network communications, backup communications lines are also deployed. In preparation for infrastructure failures and natural disasters, The PBC has built offsite backup centers for the FCCPC and shared MBFEs for switching production to backup centers in the event of emergencies. Performance tests show that the FCCPC is capable of processing 70,000 payments per hour, meeting operational requirements and being sufficient for supporting actual workloads. Business continuity: In late August 2009, the NPC successfully implemented emergency drills of the payment settlement system (including domestic foreign currency payment system). The system switched over to the emergency center and operated for a week under emergency scenarios, thus demonstrating the validity of the business continuity plan. Real time backup technology for business data is used between the disaster backup center of the FCCPC and the shared front end processors and the operating center. There is a one minute lag time between the business data of the disaster backup center and the business data of the operating center. The distance between the backup center and the main station is greater than 500 km and it uses communications and power lines that are different from those of the operating center.  Pricing Currently, the FCCPC uses the method of cost covering pricing and the settlement agents use the method of market pricing. Based on the existing pricing, when participants process each transaction, the maximum cost they pay to the FCCPC and settlement agents is 16 Yuan to 26 Yuan, depending on the currency, whereas before the FCPS was launched, the cost for a bank that used a correspondent bank as the agent bank for foreign currency settlement in China was about 35 Yuan to 140 Yuan. Therefore, the construction of the FCPS has lowered the cost of banking institutions in processing foreign currency payments and increased the competitiveness of banking institutions.  Access Criteria Article 18 of Administrative Procedures for the FCPS stipulates that: ―A bank that joins the foreign currency payment system as a direct participant should meet the following conditions: (One) Have qualifications as a financial entity in China; (Two) Have qualifications as approved by the banking supervision and management authority of the SCl for processing the relevant foreign currency business; (Three) Have an appropriate number of management and operations personnel familiar with the foreign currency payment business and foreign currency payment system; (Four) Meet the applicable technical and security requirements for joining the foreign currency payment system; (Five) Have a sound internal management system related to the foreign 52 currency payment system; (Six) Have an effective and feasible plan for preventing and eliminating foreign currency payment risks.‖ Article 19 stipulates that ―A foreign currency settlement institution that joins the foreign currency payment system as a specially designated participant should meet the following conditions: (One) Have qualifications as approved by competent state authorities to process foreign currency settlements; (Two) Meet the applicable technical and security requirements for joining the foreign currency payment system; (Three) Have a sound internal management system related to the foreign currency payment system; (Four) All of its members are participants in the foreign currency payment system or may authorize participants in the foreign currency payment system to perform settlements; (Five) Have a sound risk bond system and have signed a risk sharing agreement with all members; and (Six) Have an effective and feasible plan for preventing and eliminating foreign currency payment risks.‖  Exit Criteria Article 68 of Administrative Procedures for the FCPS stipulates that ―In the event that a participant engages in any of the actions below, the PBC may, depending on the circumstances and impact, publicly circulate information thereon, suspend its foreign currency payment system business and order it to withdraw from the foreign currency payment system. (One) Provides false application materials and join the foreign currency payment system by deceptive means; (Two) Processes transactions through the foreign currency payment system that do not comply with state policies and regulations related to foreign currency control; (Three) Fails to verify and reply or fails to verify and reply in a timely manner after receipt of an inquiry; (Four) Fails to process a foreign currency refund after receipt of an application for a foreign currency refund in accordance with the applicable provisions; (Five) The available limit is insufficient, causing the foreign currency payment system to repeatedly open the settlement window; (Six) Has major a risk hazard that affects the secure and stable operations of the foreign currency payment system; and (Seven) After the occurrence of a foreign currency payment system failure or unexpected incident, fails to report same according to the applicable provisions or fails to actively take effective measures, thus affecting the secure and stable operations of the foreign currency payment system.‖ Article 69 stipulates that ―In the event that a specially designated participant engages in any of the actions below, the PBC may, depending on the circumstance and impact, publicly circulate information thereon, suspend its foreign currency payment system business and order it to withdraw from the foreign currency payment system: (One) Provides false application materials and join the foreign currency payment system by deceptive means; (Two) Processes transactions through the foreign currency payment system that do not comply with state policies and regulations related to foreign currency control; (Three) Fails to perform risk control over the net offset balance business launched thereby, causing the foreign currency payment system not to be able to settle normally at the end of the day; (Four) Has major a risk hazard that affects the 53 secure and stable operations of the foreign currency payment system; and (Five) After the occurrence of a foreign currency payment system failure or unexpected incident, fails to report same according to the applicable provisions or fails to actively take effective measures, thus affecting the secure and stable operations of the foreign currency payment system.‖ Article 71 stipulates that ―Participants and specially designated participants that have been ordered by the PBC to withdraw from the foreign currency payment system shall not apply for joining the foreign currency payment system for a period of 2 years from the date of withdrawal. A bank whose qualifications as settlement agents for a certain currency have been terminated early by the PBC shall not apply for becoming a settlement agent for such a currency for a period of 2 years from the date of termination of such qualifications.‖ Article 72 stipulates that ―In the event that participants, specially designated participants, settlement agents and the FCCPC fail to process foreign currency payment business in accordance with the applicable provisions, thus causing any fund loss, they shall undertake the liability for damages in accordance with law; should such failure constitute a crime, criminal liability shall be pursued in accordance with law.‖ Voluntary withdrawal from the system: Article 30 of Administrative Procedures for the FCPS stipulates that: ―In the event that a participant and specially designated participant needs to withdraw from the foreign currency payment system, it shall submit a written application to the PBC in accordance with provisions of Article 20 of these methods, where the participant should revoke all of the information related to its sending or receiving bank number in advance through the foreign currency payment system. For a participant and specially designated participant that meet the conditions for withdrawal, the head office of PBC shall determine the effective date of its withdrawal from the foreign currency payment system and shall make same public through the foreign currency payment system.‖  Governance Arrangements Major decisions affecting the FCPS are all made after the opinions of the relevant parties are sought and after careful consideration. For example, during the designs and construction of the system, the PBC sought the opinions of policy banks, state owned commercial banks and nationwide commercial banks on major issues, such as whether to set up the systems, the ownership structure, system framework and business scope, etc. Some of the more relevant governance arrangements are as follows: (1) The core system of the FCPS includes the FCCPC and settlement agents, where the FCCPC is operated by the PBC NPC. As a public institution under the aegis of the PBC, the NPC is a non-profit organization. 54 (2) The NPC and the settlement agents have, in strict compliance with the applicable regulations and provisions of the FCPS, provided professional knowledge training for the relevant management personnel, business supervisors, technical support personnel and operations personnel, etc., of FCPS. They have the skills necessary for achieving the goal of the system and can take responsibilities for system operations. (3) Ownership information of the FCPS is publicly available. Information on management structure is issued in the form of official documents to settlement agents and all participants. The appointment procedures of senior management personnel are publicly available. (4) The Crisis Response Plan for the FCPS provides a detailed explanation of decision and notification procedures and timetables for handling abnormal situations. No formal users‘ group is established for participants to provide regular feedback on systems‘ operation. Participants are also not fully aware so far of the details of the ―second generation‖ project. However, the PBC organizes meetings and workshops on a regular basis with payment system stakeholders.