THE WORLD BANK GROUP PHILIPPINES FINANCIAL SECTOR ASSESSMENT PROGRAM August 2019 TECHNICAL NOTE PHILIPPPINE PAYMENT AND SETTLEMENT SYSTEM Prepared by Nilima This Technical Note was prepared in the context of a World Bank Financial Sector Assessment Program Ramteke (FSAP) mission in Philippines during June, 2019 led Finance, Competitiveness, and by Ilias Skamnelos, World Bank, and overseen by the Innovation Global Practice, Finance, Competitiveness, and Innovation Global WBG Practice, World Bank Group. The note contains the technical analysis and detailed information underpinning the FSAP assessment’s findings and recommendations. Further information on the FSAP program can be found at www.worldbank.org/fsap. PHILIPPINES CONTENTS Executive Summary .......................................................................................................................................................... 6 I. Introduction ............................................................................................................................................................ 18 A. Assessor, objectives and scope of the assessment ............................................................................ 18 B. Methodology and the information used for assessment ................................................................ 18 II. Overview of the payment, clearing and settlement landscape .......................................................... 20 A. National Payments System .......................................................................................................................... 20 B. Institutional structure .................................................................................................................................... 24 C. Legal and regulatory framework ............................................................................................................... 24 D. Retail Payment Systems ................................................................................................................................ 26 E. PhilPaSS............................................................................................................................................................... 30 F. The USD-PHP PvP system ............................................................................................................................ 40 G. Oversight framework ..................................................................................................................................... 40 H. Cooperative arrangement ............................................................................................................................ 41 III. GapS and Recommendations ..................................................................................................................... 43 A. Recommendations for PhilPaSS ................................................................................................................ 43 B. Recommendation for USD-PHP PVP system ........................................................................................ 53 C. Recommendation on Responsibilities of authorities......................................................................... 54 Annex 1 .............................................................................................................................................................................. 57 Annex 2 .............................................................................................................................................................................. 59 2 PHILIPPINES Figures and Tables Figure 1: Philippines National Payments System Architecture .................................................................... 20 Figure 2: Philippines National Payments System Architecture .................................................................... 21 Figure 3: National Retail Payment System (NRPS) framework ..................................................................... 27 Figure 4: OCL facility for CICS ................................................................................................................................... 28 Figure 5: PhilPaSS process flow – Schematic diagram .................................................................................... 31 Figure 6: Integrating more payment systems to ensure the integrity of more financial transactions, institutions, and markets .................................................................................................................. 31 Figure 7: BSP Organisational Structure ................................................................................................................. 34 Figure 8: Governance structure ................................................................................................................................ 34 Table 1: Recommendations ....................................................................................................................................... 13 Table 2: Philippine Banking System* ...................................................................................................................... 24 Table 3: Transactions in PhilPaSS ............................................................................................................................ 32 Table 4: PhilPaSS Direct Participants ...................................................................................................................... 33 Table 5: USD-PHP PvP system – settlement in PhilPaSS ................................................................................ 40 3 PHILIPPINES Acronyms and Abbreviations ACH Automated Clearing House BAP Bankers Association of the Philippines BCP Business Continuity Plan BROC Board Risk Oversight Committee BSFI BSP Supervised Financial Institutions BSP Bangko Sentral ng Pilipinas BTr Bureau of the Treasury CCP Central counterparty CFAS Core Financial Accounting System CICS Check Image Clearing System CMS Collateral Management System CSD Central Securities Depository CSO Clearing Switch Operator CTB Chamber of Thrift Banks DDAs Demand Deposit Accounts DLRD Deposit Liabilities & Reconciliation Division DoF Department of Finance DPTSC Digital Payments Transformation Steering Committee EFTIS Electronic Fund Transfer Instruction System EoD End of Day EPCS Electronic Peso Clearing System ERM Enterprise Risk Management FSAP Financial Sector Assessment Program FSCC Financial Stability Coordination Council FSS Financial Supervision Sector GS Government securities GSED Government Securities Eligible Dealer IC Insurance Commission IFC International Finance Corporation IHAP Investment House Association of the Philippines ILF Intraday Liquidity Facility IMF International Monetary Fund ISMS Information Security Management System MoA Memorandum of Agreement NPSA National Payment Systems Act NRoSS National Registry of Scripless Securities NRPS National Retail Payment System OCL Overdraft Credit Line ODG-CSS Office of the Deputy Governor of the Corporate Services Sector PCHC Philippine Clearing House Corporation PDDTS Philippine Domestic Dollar Transfer System PDIC Philippine Deposit Insurance Corporation PDS Philippine Dealing System Group PESONet Philippine EFT System and Operations Network 4 PHILIPPINES PDTC Philippine Depository & Trust Corp. PFA Philippine Finance Association PFMI Principles for Financial Market Infrastructures PhilPaSS Philippine Payment and Settlement System PHP Philippine peso PKI Public Key Infrastructure POS Point- of- sale PPB PhilPaSS Participant Browser PPMI Philippine Payments Management Inc. PSE Philippine Stock Exchange PSMB Payment System Management Body PSO Payments and Settlements Office PSOD Payment System Oversight Department PSSC Philippine Securities Settlement Corp. PVP Payment-versus-payment RAP Risk Action Plan RAR Risk Action Register RBAP Rural Bankers Association of the Philippines RCO Risk and Compliance Office RTGS Real time gross settlement SCCP Securities Clearing Corporation of the Philippines SEC Securities and Exchange Commission SGV SyCip Gorres Velayo & Co. SIPS Systemically Important Payment System SM Senior Management SSS Securities Settlement Systems STP Straight-through-process SWIFT Society for Worldwide Interbank Financial Telecommunication TPPSP Third-party payment service providers WBG World Bank Group 5 PHILIPPINES EXECUTIVE SUMMARY 1 1. The Philippine payment, clearing and settlement infrastructure consists of systemically important financial market infrastructures and retail payment systems. The Philippine Payment and Settlement System (PhilPaSS) is the real time gross settlement (RTGS) system, the fulcrum of the interbank payment system in which interbank, customer payments and the clearing obligations from the various retail payment systems and markets settle in central bank money. The PhilPaSS is owned and operated by the Bangko Sentral ng Pilipinas (BSP). The National Registry of Scripless Securities (NRoSS), a Central Securities Depository (CSD) and Securities Settlement System (SSS) for Government Securities (GS), is owned and operated by the Bureau of Treasury (BTr). The BTr operating the NRoSS is under the supervision of the Department of Finance (DoF). The Securities Clearing Corporation of the Philippines (SCCP), the central counterparty (CCP) operating in the equity market (PSE-listed stocks), is a wholly-owned subsidiary of the Philippine Stock Exchange (PSE) and is under the regulatory supervision of the Securities and Exchange Commission (SEC) of the Philippines. The Philippine Depository & Trust Corp. (PDTC) operates as a Depository and Electronic Book-entry Transfer System (for all kinds of securities or financial instruments)2, a system for the centralized handling of securities which supports the settlement of securities by book-entries in the records of PDTC. The PDTC operates under the rules and regulations of the SEC. The Philippine Domestic Dollar Transfer System (PDDTS) - operated by the Philippine Securities Settlement Corp. (PSSC) [Philippine Dealing System Group (PDS) is the holding company], supports real-time, gross electronic transfers of US dollars domestically and also supports the settlement of domestic interbank US Dollar-PHP trades on a payment-versus- payment (PVP) basis. 2. The PhilPaSS was implemented in 2002 and is operated by the Payments and Settlements Office (PSO) of BSP and the oversight function is with the Payment System Oversight Department (PSOD) of BSP. The amended Rules and Regulations governing the 1 This was a two-step full FSAP with the WB mission and the joint IMF-WB Basel Core Principles (BCP) for Effective Banking Supervision assessment mission taking place during June-July, 2019, prior to the IMF missions. In addition, the WB mission and the joint IMF-WB BCP assessment mission predated the outbreak of the global COVID-19 pandemic. The WB Technical Notes and the BCP Detailed Assessment of Observance have not been updated, but the FSA reflects the relevant policy reforms undertaken since the WB mission, and the findings and recommendations remain pertinent in light of the COVID-19 developments. 2 Source PDTC. Prior to August 2018, PDTC settled PESO GS spot trades as well as USD onshore dollar bonds (ODB) traded and listed with PDEx. Since August 2018, i.e., post the launch of NRoSS, settlement of PESO GS spot trades is being settled in NRoSS. Since February 2019 settlement of ODB trades are done in NRoSS. Repo trades appear to have still not migrated to NRoSS. PDTC as a Depository maintains an account with NRoSS for GS. GS investors are not prevented by BTr to have their securities lodged with PDTC for safekeeping either for purposes of consolidating their GS holdings with their corporate holdings or for purposes of availing PDTC value added products such as collateral management. 6 PHILIPPINES PhilPaSS, May 2019 provide for self-assessment of the PhilPaSS against the Principles for Financial Market Infrastructures (PFMI). 3. The CPMI-IOSCO PFMI have been used in carrying out an assessment of the PhilPaSS. Recommendations for improving the safety and efficiency of PhilPaSS, based on the assessment are given below. Legal, Governance and comprehensive risk management: 4. The rules and regulations for implementation of the National Payment Systems Act (NPSA) have to be notified by the BSP on an immediate basis to provide a high degree of certainty for payment systems in Philippines, including each material aspect of PhilPaSS’ activities. The NPSA (Republic Act No.11127), the Act for Regulation and Supervision of Payment Systems, came into effect in December 2018, but the absence of promulgation of the rules3 and regulations for the effective implementation/ administration of the Act has led to ambiguity and uncertainty in the legal framework. 5. The BSP should obtain the approval of the Monetary Board (MB) for the operations of PhilPaSS as laid down under Section 8 of the NPSA. The Section 8 of the NPSA provides for the BSP to own and operate a payment system if the MB deems it necessary. Accordingly, BSP needs to obtain approval of the MB for operating PhilPaSS. 6. The PhilPaSS existing rules and regulations have to be reviewed, revised and reissued under NPSA after obtaining the approval of the MB. The NPSA provides legal certainty as it explicitly provides on irrevocability and settlement finality. In the absence of this measure, PhilPaSS continues to operate under the existing rules and regulations (not notified under NPSA) and therefore is subject to a “high” degree of legal uncertainty for each material aspect of its operations. 7. It is recommended that BSP issue necessary secondary legislation under the NPSA covering the registration of payment systems. The rules and regulations governing USD-PHP PvP system has to be well laid down and notified, including settlement finality, irrevocability, and other material aspects as per the NPSA. 8. In order to ensure that the current governance framework adequately represents the interests of the relevant stakeholders in PhilPaSS, BSP may take suitable measures such as considering stakeholder representation in the Board Risk Oversight Committee (BROC) or in the Digital Payments Transformation Steering Committee (DPTSC) for direct participants or alternately constitute user committees and undertake a public consultation process. 3 BSP has placed a draft Circular on the registration of payment operators of payment systems in the public domain requesting for comments by April 26, 2019. The same is yet to be finalized and issued. 7 PHILIPPINES 9. The MB should establish a clear, documented risk-management framework that includes the PhilPaSS’ risk policy, assigns responsibilities and accountability for risk decisions, and addresses decision-making in crises and emergencies. It is accordingly recommended that: (i) the Enterprise Risk Management (ERM) Framework to include legal risk, credit risk, liquidity risk, settlement risk, custody risk and reputational risk for PhilPaSS, apart from operational risk; and (ii) consider strengthening the BROC to enable it to also function as a risk committee for PhilPaSS in addition to its existing role. Credit and Liquidity risk 10. PhilPaSS should monitor Intraday Liquidity Facility (ILF) repayment by participants. Participants who frequently fail to repay the ILF should be levied a penal rate of interest when it is converted to overnight repo. The ILF/ Overdraft Credit Line (OCL) can lead to potential future exposures even when the PhilPaSS/ BSP accepts collateral to secure the credit. PhilPaSS/ BSP would face potential future exposure if the value of collateral posted by a participant to cover ILF/ OCL will fall below the amount of credit extended to the participant by the PhilPaSS/ BSP, leaving a residual exposure. 11. The BSP should consider providing liquidity support by way of ILF for all settlement of transactions happening in PhilPaSS rather than using two methods – the ILF and OCL. The ILF is provided against GS whereas OCL is provided against both GS and other assets, including physical assets (unencumbered real estate properties in the name of the bank, mortgage credits, etc.). The acceptance of physical and mortgage credit as collaterals has potential delays in accessing the collateral due to the settlement conventions for transfers of the asset. In case of default by the bank the BSP may have to take legal remedies in order to collect its exposure. 12. BSP should undertake a holistic review and frame a comprehensive collateral policy covering both ILF and OCL facilities. The elements of such a policy should comprise: (i) adopting harmonized collateral valuation practices for valuation of GS by the different departments of BSP; (ii) framing a valuation and haircut methodology taking into account procyclicality and wrong-way risks; adopting the practice of independent validation of haircut methodologies on an annual basis; and (iii) monitoring of concentration limits. 13. PhilPaSS/ BSP should use a well-designed and operationally flexible collateral management system (CMS). To this end the BSP should engage with BTr to develop an action plan for the introduction and operationalization of a revamped and redesigned automated CMS system. Such a redesigned automated CMS system should (i) provide for automated straight- through process (STP) to mitigate operational risk prevalent in the current manual practices; (ii) facilitate implementation of concentration risks, haircut methodologies; and (iii) have the functionality to accommodate the timely deposit, withdrawal, substitution, and liquidation of collateral. The current system is lacking in the above features. 8 PHILIPPINES 14. PhilPaSS should provide clear and certain final settlement of payment obligations on the value date. PhilPaSS rules should prevent backdating of transactions. The BSP has a practice of deferring final settlement to the next day – this can create both liquidity and credit risk leading to settlement and systemic risk and impacting the financial stability. The settlement of the return clearing file from Check Image Clearing System (CICS) and some of BSP’s own transactions are settled on the next business date, but value-dated to the previous day. In line with the PFMI, BSP should adopt the finality of settlement for all settlement in PhilPaSS on an intra-day basis but no later than end of day. 15. BSP should have prompt access to its assets and the assets provided by the participants for ILF/ OCL even in extreme but plausible market conditions. The Memorandum of Agreement (MoA) entered by BSP with the BTr should be reviewed to ensure that the rights of the BSP are secured under all circumstances. PhilPaSS should ensure that collateral management being provided by NRoSS protects the interests of participants and BSP from custody risk. The BSP’s collateralized liquidity support to banks in PhilPaSS is subject to the collaterals transferred by the banks to BSP account in the NRoSS. However, the MoA the BSP has with the BTr for NRoSS has clause for limiting liability, including but not limited to, system or telecommunication problems, power outage, etc. Access to its assets in case of an eventuality is uncertain due to the limiting liability clause. 16. PhilPaSS should provide clear and certain final settlement of payment obligations on the value date. PhilPaSS rules should prevent backdating of transactions. In line with the PFMI, BSP should adopt the finality of settlement for all transactions in PhilPaSS on a real-time basis but no later than at the end of the value date. 17. The USD-PHP system should have a robust framework to manage risk from its participants, settlement bank and liquidity provider. Settlement and default management 18. PhilPaSS rules should clearly define the point after which unsettled payments, transfer instructions, or other obligations may not be revoked by a participant. In the absence of such rules, participants are exposed to liquidity risks. 19. Measures to mitigate principal risk in the existing USD-PHP PvP settlement arrangement should be taken to ensure that the final settlement of one currency PHP occurs if and only if the final settlement of the linked currency obligation in USD also occurs. Under the current arrangement, while the PHP settlement in PhilPaSS is irrevocable and final and happens intra-day, the settlement of the USD leg in the books of the Citibank happens only at the end of the day exposing participants to principal risk. 9 PHILIPPINES 20. The PhilPaSS rules and regulations should cover the action that PhilPaSS can take when a participant defaults to repay the ILF by the end-of-the operating day. There is a need for well laid and documented process for addressing/ handling default. The BSP provides ILF and OCL against acceptable collaterals which the members of PhilPaSS are required to repay by the end-of-day. Operational risk 21. PhilPaSS should establish a robust operational risk-management framework with appropriate systems, policies, procedures, and controls to manage operational risks. Based on the current elements of operational risk management framework, PhilPaSS cover only the following aspects: (i) business interruption, (ii) fraud, (iii) IT Security (unauthorized access or tampering of systems with malicious intent to perpetuate fraud or sabotage), etc. They do not take into account the following: (i) participants, (ii) other FMIs and (iii) the retail payments operator, etc. and interdependency and consequent operational risk. A robust operational risk management framework should encompass all these elements. 22. PhilPaSS should identify, monitor, and manage the risks that key participants, NRoSS, SWIFT and other critical service providers might pose to its operations and action to be initiated. In addition, PhilPaSS should identify, monitor, and manage the risks its operations might pose to other FMIs. For example, the non-availability of BTr could pose problems for the safe and efficient functioning of the PhilPaSS for effective collateral management as well as for completing the DvP settlement in GS. PhilPaSS business continuity plans and its periodic testing should accordingly adopt a holistic perspective and address the non-availability and interdependency scenarios outlined. The existing operational risk management framework is focusing only on the central system and is not addressing these issues. 23. The secondary site should be set up at a geographical distance from the primary site which has a distinct risk profile; operations from the secondary site should be resumed within two hours and with a near to zero data loss. 24. It is necessary to have a holistic BCP plan and conduct BCP exercise covering central system, participants other FMIs and the retail payments operators to take into account for interdependency and consequent operational risk. This should also cover the critical service provider – SWIFT as also the solution provider. The scenarios used for the BCP need to be strengthened to include scenarios like market-wide stress. There should be a mandatory requirement on the participants to test their BCP and operate from DR site to check on its readiness and availability. 25. The BSP should consider subjecting: (i) key elements of PhilPaSS’ operational risk- management framework; and (ii) PKI infrastructure to periodical external audits. BSP should 10 PHILIPPINES also consider adopting the CPMI strategy to reduce the risk of wholesale payments fraud related to endpoint security. Access and efficiency 26. BSP should review and revise its participant access criteria based on appropriate risk consideration to permit fair and open access to PhilPaSS’ services by both direct and indirect participants. The NPSA now provides flexibility to BSP to determine who shall be allowed to participate in payment systems owned and operated by it and who shall be allowed to open an account with it for settlement purposes. Accordingly, BSP may review to see whether more participants can be provided direct access based on appropriate risk criteria – legal, financial and operational aspects. 27. PhilPaSS should establish mechanisms for the regular review of its costs and pricing structure. 28. PhilPaSS should complete regularly and disclose publicly responses to the CPMI- IOSCO Disclosure framework for financial market infrastructures. PhilPaSS should provide comprehensive and appropriately detailed disclosures to improve the overall transparency of PhilPaSS, its governance, operations, and risk-management framework. New RTGS 29. BSP while designing the new RTGS system should provide for sufficient flexibility to respond to changing demand and new technologies and also take into account the recommendations made as part of this technical note. The new system should be well- designed and operated to meet the needs of the participants and the markets it serves. Responsibilities of authorities 30. The authorities (BSP, DoF and SEC) should publicly disclose their policies with respect to the regulation, supervision and oversight of the FMIs under their respective jurisdiction. In addition, the authorities should also publicly disclose their adoption of PFMIs for the safe and efficient functioning of the FMIs – PhilPass, NRoSS (CSD/SSS for GS), PDTC (CSD for all securities) and SCCP – the CCP for corporate securities. 31. The oversight framework for payment systems, should be finalised after public consultation and placed in the public domain by BSP. BSP should expedite the preparation and finalization of the same on a priority basis. 32. There is a need for strengthening capacity building and expertise for the regulation and oversight of PhilPaSS and FMIs and payment systems in general in the PSOD of BSP . The other authorities should also take appropriate measures for strengthening human resources and expertise in their respective organisations. 11 PHILIPPINES 33. BSP, DoF and SEC should cooperate with each other in promoting the safety and efficiency of FMIs. There is currently a MoA between the BTr (as operator of NRoSS) and BSP for the ILF and for Treasury operations of BSP. However, there are no formal arrangement of cooperation between the DoF (the authority under which BTr functions) and BSP and between BSP and SEC (under which PDS operates) for the FMIs regulated and overseen by them. 34. BSP should, as soon as it is practicable, inform Federal Reserve Bank, New York, on the USD-PHP settlement arrangement in Philippines, to promote the safe and efficient operations of this arrangement. The peso leg is settled in PhilPaSS while the USD leg is settled in the books of Citibank. 12 PHILIPPINES Table 1: Recommendations Recommendation Timing/ Entity Priority Theme in bold General organization – PFMI Principles 1-3 The rules and regulations for implementation/ administration of the ST/ High BSP NPSA have to be enacted by BSP on an immediate basis to provide a high degree of legal certainty for each material aspect of PhilPaSS’ activities. The BSP as operator of PhilPaSS should, on an immediate basis, obtain ST/High BSP the approval of the Monetary Board for the operations of PhilPaSS as laid down under Section 8 of the NPSA. The existing PhilPaSS rules and regulations need to be reviewed and ST/Medi BSP reissued after the approval of the Monetary Board, to ensure um consistency with the NPSA. There is inconsistency in the nomenclature of the account designated ST/ High BSP for settlement of transactions in PhilPaSS which needs to be harmonized to ensure enforceability of the underlying contractual settlement obligations. It is recommended that BSP issue necessary secondary legislation MT/ BSP under the NPSA covering the registration of payment system. High In order to ensure that the current governance framework adequately MT/ BSP represents the interests of the relevant stakeholders in PhilPaSS, BSP Medium may take suitable measures such as considering stakeholder representation in BROC or DPTSC for direct participants or alternately constitute user committees and undertake a public consultation process. The Monetary Board should establish a clear, documented risk- ST/ High BSP management framework that includes the PhilPaSS’s risk policy, assigns responsibilities and accountability for risk decisions, and addresses decision making in crises and emergencies. Credit and Liquidity Risk Management - PFMI Principles 4 to 7 PhilPaSS/BSP should monitor ILF repayment by participants. MT/ BSP Participants who frequently fail to repay should be levied a penal rate Medium of interest when it is converted to overnight repo. The BSP should consider providing liquidity support by way of intraday MT/ BSP ILF for all settlement of transactions happening in PhilPaSS rather than High using two methods, ILF and OCL. The BSP for providing routine liquidity support in PhilPaSS should MT/ BSP accept collateral with low credit, liquidity, and market risk. High BSP should undertake a holistic review and frame a comprehensive ST/ High BSP collateral framework policy covering both ILF and OCL facilities. The elements of such a policy should comprise: (i) adopting harmonized 13 PHILIPPINES collateral valuation practices for valuation of GS by the different departments of BSP; (ii) framing a valuation and haircut methodology taking into account procyclicality and wrong-way risks; adopting the practice of independent validation of haircut methodologies on an annual basis; (iii) monitoring of concentration limits. BSP should have prompt access to its assets and the assets provided ST/ High BSP by the participants for ILF/ OCL even in extreme but plausible market conditions. The PhilPaSS/ BSP should secure it rights to the collateral provided by the participants. To this end, the MoA entered by BSP with the BTr should be reviewed to ensure that the rights of the BSP are secured under all circumstances. PhilPaSS should ensure that collateral management being provided by MT/ BSP NRoSS protects the interests of participants and BSP from custody risk. High To this end the suggested review of the MOA should also take into account custody risk issues. PhilPaSS/ BSP should use a well-designed and operationally flexible ST/High BSP CMS. PhilPaSS/ BSP should apply financial penalties to participants that fail MT/Medi BSP to repay intraday credit by the end of the operating day. um PhilPaSS should provide clear and certain final settlement of payment ST/High BSP obligations on the value date. PhilPaSS rules should prevent backdating of transactions. BSP to undertake monitoring the participants for any misuse of the MT/Medi BSP incoming queue viewing facility/ system which impacts the liquidity in um the system. The USD-PHP system should have a robust framework to manage risk ST/High BSP from its participants, settlement bank and liquidity provider. BSP should undertake measures to mitigate credit risk while extending ST/Medi BSP clean liquidity support to participant Japanese banks in PhilPaSS. um Settlement and exchange-of-value settlement systems - PFMI Principles 8 to 12 PhilPaSS rules should clearly define the point after which unsettled ST/High BSP payments, transfer instructions, or other obligations may not be revoked by a participant. The PhilPaSS rules and regulations need to explicitly indicate that for ST/High BSP settlement of InstaPay transactions, the separate designated account (distinct from the regular settlement account) would be used for settlement in PhilPaSS. Default Management (PFMI Principles 13-14) The PhilPaSS rules and regulations should cover the action that MT/Medi BSP PhilPaSS can take when a participant defaults to repay the ILF by the um end-of-the operating day. There is a need for well laid down process 14 PHILIPPINES for addressing/ handling default by way of a well laid down documented plan. General business and operational risk management (PFMI Principles 15-17) PhilPaSS should have prompt access to its assets and information ST/High BSP provided by the participants. PhilPaSS should establish a robust operational risk-management ST/High BSP framework with appropriate systems, policies, procedures, and controls to manage operational risks. PhilPaSS should identify, monitor, and manage the risks that key ST/High BSP participants, NRoSS, SWIFT and other critical service providers might pose to its operations; manage the risks PhilPaSS’ operations might pose to other FMIs. PhilPaSS should have clearly defined operational reliability objectives ST/High BSP and should have policies in place that are designed to achieve those objectives. PhilPaSS’ operational objectives should be periodically reviewed to incorporate new technological and business developments. The secondary site should be set up at geographical distance with a ST/High BSP distinct risk profile; operations from the secondary site should be resumed within two hours and with a near to zero data loss. It is necessary to have a holistic BCP plan and conduct BCP exercise ST/High BSP covering Central system, participants other FMIs and the retail payments operator to take into account for interdependency and consequent operational risk. The BSP should consider subjecting: (i) key elements of PhilPaSS’ MT/High BSP operational risk-management framework; and (ii) PKI infrastructure to periodical external audits. BSP should also consider adopting the CPMI strategy to reduce the risk of wholesale payments fraud related to endpoint security. The manual processes for triggering ILF/ OCL requests have the MT/High BSP potential of high operational risk. The practice if any of two simultaneous sessions operating on a ST/High BSP business day should be discontinued as it has a high potential of operational risk. Access, efficiency and transparency (PFMI Principles 18-23) BSP should review and revise its participant access criteria based on MT/Medi BSP appropriate risk considerations based on legal, financial and um operational aspects to allow for fair and open access to PhilPaSS services by both direct and indirect participants. Such revised access criteria should also provide for rules covering the suspension and orderly exit of a participant. 15 PHILIPPINES BSP should put in place a monitoring mechanism to manage the risks MT/Medi BSP that could emanate from any tiering arrangements. um PhilPaSS should establish mechanisms for the regular review of its ST/High BSP costs and pricing structure. PhilPaSS should meet the needs of its participants and the market. MT/Medi BSP um PhilPaSS should use standardised messaging formats to improve the MT/Medi BSP quality and efficiency of the clearing and settlement of transactions. um PhilPaSS should complete regularly and disclose publicly responses to ST/Medi BSP the CPMI-IOSCO Disclosure framework for financial market um infrastructures. Futuristic – New RTGS BSP while designing the new RTGS system should provide for sufficient ST/High BSP flexibility to respond to changing demand and new technologies. Recommendation for USD-PHP PVP system It is recommended that BSP issue necessary secondary legislation ST/High BSP under the NPSA covering the registration of payment system. Measures to mitigate principal risk in the existing USD-PHP settlement ST/High BSP arrangement should be taken to ensure that the final settlement of one currency PHP occurs if and only if the final settlement of the linked currency obligation in USD also occurs. The USD-PHP system should have a robust framework to manage risk ST/High BSP from its participants, settlement bank and liquidity provider. Credit and liquidity risk arising from the use of commercial bank ST/High BSP money should be strictly monitored to ensure that participants are not exposed to these risks. The PSSC should be overseen by the BSP as a payment system ST/High BSP operator. BSP should advise the operator of the USD-PHP payment system to ST/Medi BSP prepare default rules and procedures for the system. um Responsibilities of authorities The oversight policy framework document under development should ST/High BSP also include adoption of PFMI for the regulation, supervision and oversight of FMIs. The BSP after a process of public consultation should finalise the oversight policy framework document at the earliest and place it in the public domain. BSP should: (i) clearly define and publicly disclose the criteria used to ST/High BSP identify FMIs that will be subjected to regulation, supervision, and oversight; and (ii) publicly disclose its adoption of PFMI for the regulation and supervision of the FMIs under its jurisdiction. The administrative implementation rules and regulations for NPSA ST/High BSP should include adoption of international standards, say the PFMIs. 16 PHILIPPINES There is a need for strengthening capacity building and expertise for MT/High BSP the regulation and oversight of PhilPaSS and FMIs and payment systems in general in the PSOD of BSP. The other authorities should also take appropriate measures for strengthening human resources and expertise in their respective organisations. The PSOD should monitor the settlement of transactions in the USD- MT/High BSP PHP PvP payment system, in order to mitigate credit, liquidity and principal risks. The other authorities DoF and SEC should also take necessary steps as DoF and SEC indicated at 136 (i) and (ii) above. The authorities (BSP, SEC and DOF ) should have sufficient resources MT/High BSP/DoF/SEC to fulfil their regulatory, supervisory, and oversight responsibilities over the FMIs The Financial Sector Forum (FSF) and Financial Stability Coordination MT/High BSP/DoF/SEC Council (FSCC) should ensure coordination and cooperation among the authorities for promoting safety and efficiency of the FMIs in turn containing systemic risk. BSP, DoF and SEC should cooperate with each other in promoting the ST/Medi BSP/DoF/SEC safety and efficiency of FMIs through an appropriately framed MoU um including revising the mandates of FSF and FSCC (if required). The Section 9 of the NPSA provides for cooperation among authorities and should be exercised. BSP should, as soon as it is practicable, inform Federal Reserve Bank, ST/Medi BSP New York, on the USD-PHP operation in Philippines. um Note: Short-term (ST) = within one year; medium-term (MT) = one to three years 17 PHILIPPINES I. INTRODUCTION A. Assessor, objectives and scope of the assessment 35. This technical note is an assessment of the Philippine Payment and Settlement System (PhilPaSS)4 based on the CPSS5-IOSCO Principles for Financial Market Infrastructure (PFMI). This technical note does not provide a detailed assessment of PhilPaSS and the responsibilities of authorities in the form of a Report on Observance of Standards and Codes (ROSC). The assessment was undertaken in the context of the International Monetary Fund and World Bank Financial Sector Assessment Program (FSAP) of the Philippines in June 2019. The assessor would like to thank all the counterparts in the Philippines for their excellent cooperation and generous hospitality during the mission. 36. The objective of the assessment was to identify areas of gaps and the potential risk related to PhilPaSS that may affect financial stability. “While safe and efficient FMIs contribute to maintaining and promoting financial stability and economic growth, the FMIs also concentrate risk. If not properly managed, FMIs can be sources of financial shocks, such as liquidity dislocations and credit losses, or a major channel through which these shocks are transmitted across domestic and international financial markets”6. Scope of the assessment 37. The scope of the assessment covered PhilPaSS, the Systemically Important Payment System (SIPS) in Philippines and the Responsibilities of the authorities based on the PFMI. B. Methodology and the information used for assessment 38. The information used in the assessment includes relevant national laws, regulations, rules and procedures governing PhilPaSS. These include the National Payment Systems Act (NPSA)7, the new Central Bank Act8, Rules and Regulations governing the PhilPaSS9, PhilPaSS Primer10, BSP Manual of Regulations11, responses to the WB questionnaire, the agreements 4The assessor was Nilima Ramteke, Senior Financial Sector Specialist, Payment Systems Development Group, World Bank. 5The CPSS has since been renamed as Committee for Payments and Market Infrastructures (CPMI) in September 2014. 6 Principles for Financial Market Infrastructures, CPMI-IOSCO, BIS, April 2012 7 https://www.officialgazette.gov.ph/downloads/2018/10oct/20181030-RA-11127-RRD.pdf 8 http://www.bsp.gov.ph/downloads/regs/New_Central_Bank_Act.pdf and https://www.officialgazette.gov.ph/downloads/2019/02feb/20190214-RA-11211-RRD.pdf 9 http://www.bsp.gov.ph/payments/PhilPaSSRules.pdf 10 http://www.bsp.gov.ph/financial/payments/PhilPaSS.pdf 11 http://www.bsp.gov.ph/regulations/reg_MORB.asp 18 PHILIPPINES between the BSP and the participants12, agreement with BTr, and information available on the websites of BSP and other stakeholders. At the request of the World Bank, the authorities conducted a self-assessment of the PhilPaSS, which also formed a basis for the assessment. The mission team had extensive discussions with the Payments and Settlements Office (PSO) and Payment System Oversight Department (PSOD) of BSP. Discussions were also held with the Bankers Association of the Philippines (BAP), Philippine Payments Management Inc. (PPMI), Philippines Clearing House Corporation (PCHC), BancNet, Bureau of the Treasury (BTr), Department of Finance (DoF), two commercial banks, a rural bank and a few fintech companies. This technical note assesses PhilPaSS and provides high level recommendations on the Responsibilities of the authorities in Philippines. While this technical note provides an overview of the retail payment systems in the Philippines, the detailed analysis of the retail payment systems is covered in a separate technical note on retail payment systems. 39. This assessment is based on information available as of 15 June 2019. 12 http://www.bsp.gov.ph/downloads/Forms/PhilPaSS/ParticipationAgreement.pdf 19 PHILIPPINES II. OVERVIEW OF THE PAYMENT, CLEARING AND SETTLEMENT LANDSCAPE A. National Payments System 40. The payments, clearing and settlement infrastructure in the Philippines consists of a systemically important payment system – the PhilPaSS as well as other retail payment systems whose final settlements happen in PhilPaSS (Figures 1 and 2). The PhilPaSS launched in November 2002 is the fulcrum of the interbank payment system in which the payments from the various retail payment systems and markets settle in central bank money. The retail payment systems in the Philippines are comprised of: (i) Check Image Clearing System (CICS) - operated by the Philippine Clearing House Corp. (PCHC). PCHC was incorporated by commercial banks to automate the Cheque Clearing System through the medium of MICR-encoded cheques, which over a period culminated in implementation of check truncation technology in the Philippines, (ii) Philippine EFT System and Operations Network (PESONet) - operated by the PCHC is a batch electronic fund transfer (credit) automated clearing house (ACH) that facilitates the fund transfer from one account (payer) to one or several accounts (payee/s), and (iii) InstaPay - operated by the BancNet, is a real-time low value push ACH that facilities real-time electronic fund transfers by enabling the payer to send instruction/s to his financial institution to irrevocably transfer funds held in his account to the account of a payee, who receives the full value immediately. The Box 1 provides the evolution of payment systems in Philippines. Figure 1: Philippines National Payments System Architecture Source: BSP 20 PHILIPPINES Figure 2: Philippines National Payments System Architecture Source: BSP for Figures 1 and 2. Box 1 The evolution to a modern payment and settlement system Under Republic Act No. 7653 (The New Central Bank Act) approved in 1993, the central bank established facilities for interbank clearing with deposit reserves maintained by banks in the BSP used as the basis for the clearing of checks & the settlement of balances. Payment instructions were physically delivered by banks to the then Deposit Liabilities & Reconciliation Division (DLRD) of BSP’s Accounting Department which settled transactions at designated time periods. To address risks & improve processing time that can be made from a manual system, procedures to transmit payment instructions electronically were developed beginning 1997. This included the BSP- Electronic Fund Transfer Instruction System (EFTIS) wherein Authorized Agent Banks send electronic fund transfer (EFT) instructions to the BSP covering revenue collections for the Bureau of Internal Revenue & the Bureau of Customs, for credit to the account of the BTr. The PCHC Multi-Transaction Interbank Payment System (MIPS) was established in year 2000 for interbank lending and borrowing, and the Philippine Domestic Dollar Transfer System for moving US dollars across banks, & several other payments systems. EFTs were generally sent through a clearing unit (e.g., PCHC or the PDS Settlement Highway) & were thereafter electronically transmitted to the BSP for settlement by batch at designated time periods. The handling of payment instructions was transferred from the DLRD to the Demand Deposit Account – Real-Time Gross Settlement unit (DDA-RTGS) of the BSP Accounting 21 PHILIPPINES Department. Banks electronically received updates on the balances of their DDAs at certain time periods (e.g., on an hourly basis). As the financial system became more integrated, sophisticated & more complex, payments & settlements systems became more exposed to risks. International-setting bodies have agreed that an RTGS is a powerful payments infrastructure that can limit risks particularly for large-value transactions as it provides timely & final settlement of time-critical payments on a continuous basis, thus enhancing the integrity of financial transactions & ultimately furthering economic development. In November 2002, the BSP launched the Phase 1 of the Philippine Payment and Settlement System, otherwise known as PhilPaSS, initially covering only interbank lending and borrowing transactions. In December 2002, PhilPaSS was fully implemented by the DDA-RTGS unit. Such system clears & settles on a per transaction basis (rather than by batch), real-time (vs. deferred), & on a gross basis (rather than on a net basis), with finality & irrevocability. To economize on the use of central bank money, PhilPaSS also integrated a deferred netting system or DNS which provides frequent netting of payments within the day for bulk transactions that are not time- sensitive. Further, participants are given a system to enable them to send EFT instructions directly to the BSP and to access their accounts/ records on-line & anytime during the business day. In November 2004, the Accounting Department was expanded to become the Comptrollership Sub-Sector. To provide a better check-and-balance system, the MB converted the DDA-RTGS unit in June 2006 (then under the Comptrollership Sub-Sector) to become the Payments & Settlements Office (PSO). The PSO acts as the operator of PhilPaSS & reported directly to the Office of the Deputy Governor of the Corporate Services Sector (ODG-CSS). Source: PhilPaSS Primer 41. The other FMIs in the Philippines include the central securities depositories/ securities settlement systems (SSS), one central counterparty (CCP) and the foreign currency clearing and settlement system. The National Registry of Scripless Securities (NRoSS) is a Central Securities Depository (CSD) and Securities Settlement System (SSS), for GS, owned and operated by the Bureau of the Treasury. The Philippine Depository & Trust Corp. (PDTC)13 operates a Depository and Electronic Book-entry Transfer System, a system for the centralized handling of corporate securities which supports the settlement of securities by book-entries in the records of PDTC. The PDTC operates under the rules and regulations of the Securities and Exchange Commission (SEC) of the Philippines. The Securities Clearing Corporation of the Philippines (SCCP) is a wholly-owned subsidiary of the PSE and acts as a Central Counterparty (CCP) for the trades executed at the PSE. SCCP is under the regulation and supervision of the SEC. The Philippine 13 Source PDTC. Prior to August 2018, PDTC settled PESO GS spot trades as well as USD onshore dollar bonds traded and listed with PDEx. Since August 2018, i.e., post the launch of NRoSS, settlement of PESO GS spot trades are being settled in NRoSS. Since February 2019 settlement of ODB trades are done in NRoSS. Repo trades appear to have still not migrated to NRoSS. PDTC as a Depository maintains an account with NRoSS for GS. GS investors are not prevented by BTr to have their securities lodged with PDTC for safekeeping either for purposes of consolidating their GS holdings with their corporate holdings or for purposes of availing PDTC value added products such as collateral management. 22 PHILIPPINES Domestic Dollar Transfer System (PDDTS) - operated by the Philippine Securities Settlement Corp. (PSSC), [Philippine Dealing System Group (PDS) is the holding company] supports real-time, gross electronic transfers of US dollars domestically and also supports the gross settlement of domestic interbank US Dollar-PHP trades on a payment-versus-payment (PVP) basis. 42. The NRoSS, is an official registry of ownership, legal or beneficial titles or interest in Government Securities (GS) (Treasury Bills and Treasury Bonds). Upon award of GS to a Government Securities Eligible Dealer (GSED)14 at the auction, the securities awarded are electronically downloaded to the NRoSS system. NRoSS also facilitates secondary market trades executed on Bloomberg and reported for settlement in NRoSS on a Delivery versus Payment (DvP) 1 mode15 with the funds leg settlement taking place in PhilPaSS. 43. The SCCP acts as a central counterparty (CCP) for trades executed at the PSE16. The settlement of trades of listed corporate securities takes place on T+3 basis. The settlement of funds and the transfer of securities is on DvP Model 317 basis. The funds leg of settlement happens in the Clearing Member's cash settlement account in the designated commercial banks and securities in the Clearing Member's securities accounts in the central depository's system i.e. PDTC. 44. The Philippine Securities Settlement Corp. (PSSC), operates the PvP for interbank USD-PHP transactions with the dollar leg settling through PDDTS and the PHP settling through BSP PhilPaSS, the central bank’s own RTGS payment system18. The PDDTS provides the real-time, gross electronic transfers of US dollars domestically and also supports the 14 Government Securities Eligible Dealer (GSED) is a SEC-licensed securities dealer belonging to a service industry supervised / regulated by Government (Securities and Exchange Commission, Bangko Sentral ng Pilipinas or Insurance Commission) which has met the (a) P100 M unimpaired capital and surplus account; (b) the statutory ratios prescribed for the industry, and (c) has the infrastructure for an electronic interface with the Automated Debt Auction Processing System (ADAPS) and the official Registry of Scripless Securities (RoSS) both of the Bureau of the Treasury (BTr) using Bridge Information Systems (BIS), and acknowledged by the BTr as eligible to participate in the primary auction of GS. Source – Bureau of the Treasury http://www.treasury.gov.ph/?page_id=141 15 A securities settlement mechanism that links a securities transfer and a funds transfer in such a way as to ensure that delivery occurs if and only if the corresponding payment occurs. DvP model 1 typically settles securities and funds on a gross and obligation-by-obligation basis, with final (irrevocable and unconditional) transfer of securities from the seller to the buyer (delivery) if and only if final transfer of funds from the buyer to the seller (payment) occurs (CPMI glossary: https://www.bis.org/cpmi/publ/d00b.htm?selection=123&scope=CPMI&base=term) 16 The SCCP is responsible for establishing the cash and securities liabilities and entitlements of its Clearing Members, synchronizing the settlement of funds and the transfer of securities based on the Delivery-versus- Payment Model 3 or Multilateral Net Settlement; guaranteeing the settlement of trades in the event of a trading participant's trade default in order to ensure the finality and irrevocability of all Exchange trades through its Fails Management procedures; and implementing appropriate risk management measures to mitigate risks in the clearing and settlement of Exchange trades and the maintenance and administration of the Clearing and Trade Guarantee Fund ("CTGF"). Source: SCCP - http://www.sccp.com.ph/main/services.html 17 A securities settlement mechanism that links a securities transfer and a funds transfer in such a way as to ensure that delivery occurs if and only if the corresponding payment occurs. DvP model 3 typically settles both securities and funds on a net basis, with final transfers of both securities and funds occurring at the end of the processing cycle. 18 Clearing Services determines the fixed income security and monetary obligations of the trading participants, particularly as to who will deliver or receive either cash or security, in a transaction. It validates and reconciles details of transactions between trading participants prior to Settlement – which is the simultaneous, irrevocable and final exchange of securities and cash. Source: PDS Group http://www.pds.com.ph/index.html%3Fpage_id=756.html 23 PHILIPPINES settlement of domestic interbank US Dollar-PHP trades on a payment-versus-payment (PVP) basis19. The PDDTS20 is governed by the PDDTS Agreement signed by the BSP, Bankers Association of the Philippines (BAP), the PSSC, the PCHC and Citibank Manila. The USD-PHP settlement is designed to operate on a PvP basis with PHP settlement taking place in PhilPaSS, central bank money and the USD leg with Citibank. B. Institutional structure 45. The banking structure in Philippines is complex with multiple categories of banks regulated and supervised by the BSP. The power and functions of the BSP are established in the New Central Bank Act. The BSP provides policy directions in the areas of money, banking and credit. It supervises operations of banks and exercises regulatory powers over non-bank financial institutions with quasi-banking functions. The BSP accordingly has a vision ‘to be recognized globally as the monetary authority and primary financial system supervisor that supports a strong economy and promotes a high quality of life for all Filipinos’ and a mission ‘to promote and maintain price stability, a strong financial system, and a safe and efficient payments and settlements system conducive to a sustainable and inclusive growth of the economy’21. The payment intermediation in the Philippines is largely through the BSP regulated and supervised entities. The Table 2 provides the composition of the banks in Philippines. Table 2: Philippine Banking System* Total as of Share to Total April 2019 Number Universal Banks/ Commercial Banks 43 2.5% Specialized Government Banks 3 0.2% Thrift Banks 53 3.1% Rural Banks 445 25.8% Non-Bank Financial Institutions with Quasi-Banking Functions 9 0.5% Others** 1,175 68.0% Total number of BSP-supervised financial Institution 1,728 100.0% Source: source: http://www.bsp.gov.ph/statistics/statpnnopbs.asp * Head office to represent a unique institution ** "Others" is made up of Cooperative Banks, NBFIs without Quasi Banking Functions, and Offshore Banks C. Legal and regulatory framework 46. The New Central Bank Act (RA No. 7653 of 1993) gives powers to the BSP among others, to establish facilities for interbank clearing under rules and regulations prescribed 19 A settlement mechanism that ensures that the final transfer of a payment in one currency occurs if and only if the final transfer of a payment in another currency or currencies takes place. Source: CPMI Glossary https://www.bis.org/cpmi/publ/d00b.htm?&selection=50&scope=CPMI&c=a&base=term 20 Source: PDS Group http://www.pds.com.ph/index.html%3Fpage_id=3648.html 21 http://www.bsp.gov.ph/about/vision.asp 24 PHILIPPINES by the MB and provide policy directions in the areas of money, banking, credit and payment systems. The BSP accordingly established facilities for interbank clearing with deposit reserves maintained by banks with the BSP being used as the basis for the clearing of cheques and the settlement of balances. The payment instructions were physically delivered by banks to the then Deposit Liabilities & Reconciliation Division (DLRD) of BSP’s Accounting Department which settled transactions at designated time periods. Over a period of time, the electronic funds transfer system was introduced which in November 2002 culminated in the launch of the PhilPaSS. 47. The National Payment Systems Act (NPSA) (RA No. 11127 of 2018), effective from December 2018, provides a legal basis for the safe and efficient functioning of payment and settlement systems in Philippines. The NPSA provides a high degree of certainty for several key material aspects such as settlement finality, irrevocability, and netting under its provisions. Section 15 and Section 18 of the NPSA provide for settlement finality, irrevocability and netting. Section 5 of the NPSA also gives explicit powers to the BSP to regulate and oversee ‘payment systems’ to ensure the stability and efficiency of the monetary and financial system. Section 8 of the NPSA empowers the BSP to own and operate payment systems if the Monetary Board so deems necessary. The NPSA requires an explicit registration from the BSP to be obtained by the entity desirous of operating a ‘payment system’ in the Philippines. The NPSA also fosters coordination with other domestic and foreign regulators for the sound regulation, supervision and oversight of other relevant settlement systems. The salient features of the NPSA are given in Box 2. 48. The NPSA, however, does not explicitly provide for collateral protection, in the event of insolvency/ bankruptcy of the collateral giver as also of the operator of the payment system/ financial market infrastructures (FMIs)22. Box 2 The National Payment Systems Act (NPSA) The National Payment Systems Act was enacted in October 2018 and came into effect in December 2018. The objective of the NPSA is to promote, through the BSP, the safe, secured, efficient and reliable operation of payment systems in order to control systemic risk and provide an environment conducive to the sustainable growth of the economy. In this regard the NPSA explicitly defines netting, payment system, settlement, systemic risk, etc. Some of the salient features of the NPSA which provides for sound legal basis are: • Designating authority for oversight: The BSP has been designated as the authority to oversee the payment systems in the Philippines and exercise supervisory and regulatory powers for ensuring the stability and effectiveness of the monetary and financial system. • Designation of a payment system if BSP determines the payment system as posing or having the potential to pose a systemic risk or if necessary to protect the public interest. 22 The term FMI refers to systemically important payment systems, CSDs, SSSs, CCPs, and Trade Repository (TR). 25 PHILIPPINES • Issue rules and regulations governing (a) the standard of operation of payment systems; (b) adequacy of resources of operators of the designated payment systems; (c) mechanism for the protection of the rights of the end-users and participants to the designated payment systems; (d) principles on setting prices or pricing mechanisms in payment systems; etc. • Issue directives and orders to any participant of a payment system whenever it is necessary to ensure the safety, efficiency or reliability of a payment system or it is in the interest of the public to do so. • Adoption of International Standards and Practices. • The BSP to own and operate payment systems as may be necessary and adopt internal safeguards to ensure appropriate independent oversight of its operator functions. • Coordinate with other government agencies and foreign regulators. The BSP to coordinate with the SEC to facilitate settlement of payment obligations arising from security transactions. The BSP to coordinate with the overseers of payment systems of other countries. • Requirement of registration by the Payment System Operators with the BSP. • Finality of settlement: the settlement effected in accordance with the agreed procedures of a payment system shall be final and irrevocable and shall not be subject to reversal. • Netting: Notwithstanding the provisions of existing laws to the contrary, when an operator receives from the participant a notice pursuant to Section 16, the operator may effect the netting of all payment orders received before such notice in accordance with the agreed procedures of the payment system. The insolvency, bankruptcy, rehabilitation, receivership or liquidation proceedings shall recognize any such netting as valid. • Requirement of notification in case of insolvency of participant in a Payment System: the participant of a payment system to notify the operator upon the issuance of a stay order or the declaration of insolvency, bankruptcy, rehabilitation or placement under receivership or liquidation of the participant on the day of the receipt of the order or resolution issued by the court or quasi-judicial agency. • In order to avert disruptions in payment systems which may adversely affect the country’s monetary and financial stability, the BSP may, designate a manager to manage the operations of a designated payment system. • Provision for levy of penalties and sanctions by the BSP but not to exceed One million pesos (P1,000,000.00) for each transactional violation. D. Retail Payment Systems23 49. The BSP in 2017 adopted the National Retail Payment System (NRPS) Framework (Figure 3). The NRPS is a policy and regulatory framework that aims to provide direction in carrying out retail payment activities through BSP supervised financial institutions (BSFIs) by defining high-level policies, principles, and standards, which when adopted, would lead to the 23 Detailed analysis of the retail payment infrastructure and recommendation for the same are being presented in a separate Technical Note. 26 PHILIPPINES establishment of a safe, efficient and reliable retail payment system.24 With the adoption of NRPS, the BSP created an industry-led self-governing body, the “Payment System Management Body” (PSMB), separating the rule setting for the various retail payment clearing streams from the actual clearing operations. The PSMB is governed by a PSMB Board with multi-stake holder representation to ensure that all interests are adequately represented. The PSMB shall: (a) standardize clearing agreements and ensure all payment streams are covered by a multilateral ACH agreement; (b) ensure compliance of its members with criteria, standards and rules promulgated and adopted by the PSMB; (c) identify and undertake industry initiatives to support the NRPS policy direction; (d) monitor risk on a system-wide perspective; and (e) prepare regular and special reports to facilitate effective oversight. Figure 3: National Retail Payment System (NRPS) framework Source: BSP 50. In January 2018, the BSP recognised the Philippine Payments Management, Inc. (PPMI) as the PSMB25. The BSP and PPMI entered into a memorandum of agreement, whereby the BSP recognized PPMI as the PSMB, while the PPMI recognizes the authority of the BSP as the primary overseer of the retail payment system given its critical role in the financial infrastructure as envisioned under the NRPS framework. 51. Under this framework, the Automated Clearing House (ACH) is a multilateral legally binding agreement that lays down the clearing and participation rules for a particular 24http://www.bsp.gov.ph/payments/nrps_overview.asp 25 BSP Circular Letter No. 2018-005 dated 12 January 2018 http://www.bsp.gov.ph/downloads/regulations/attachments/2018/cl005.pdf 27 PHILIPPINES payment stream to facilitate electronic fund transfers among its participants. Further any two (2) members of the PSMB can come together and create an ACH. This shall be created/ differentiated based on the payment instruments or instructions, business rules and risk considerations. As such, a payment use case can only fall under one (1) ACH. The NRPS framework limits that each ACH shall have only one clearing switch operator (CSO), whose operations shall be limited to clearing and other services that do not compete with services offered by PSMB members. The CSO however can render its services to more than one (1) ACH or multiple ACHs. The ultimate net settlement has to be in PhilPaSS in accordance with the agreed procedures and at such frequencies as decided. 52. The Check Image Clearing System (CICS) operated by PCHC is an images-based clearing and settlement system. The images and payment information of the check is captured electronically and transmitted to the drawee bank, while the paper check is truncated at the branch of deposit. The operations of CICS are governed by the clearing and settlement rules issued by BSP (Circular 681 of 2010), while the detailed rules and procedures are issued by PCHC. The CICS currently has 76 direct participants. The clearing and settlement is on the same day, with final settlement taking place in PhilPaSS for the member banks. BSP has set a ceiling on the amount of overdraft that a member is eligible if it fails to cover its liquidity shortfall through interbank borrowings or repurchase agreements with BSP. The ceiling is defined as the sum of the “clean” OCL provided by BSP (equivalent to 15% of the rediscounting line with the BPS), and the collateralized OCL. The procedure for providing OCL is depicted in Figure 4. The settlement emanating from CICS is not eligible for ILF extended to members in PhilPaSS. Figure 4: OCL facility for CICS The procedure for OCL differs depending on the following: a. Participant has an approved OCL which can cover the clearing loss; b. Participant has an approved OCL but cannot cover the clearing loss; or c. Participant has no OCL. An illustrative example: Source: BSP 28 PHILIPPINES 53. The Philippine EFT System and Operations Network (PESONet), operated by PCHC was launched on 08 November 2017. PCHC is the designated clearing switch operator for PESONet for a two-year transitory26 period beginning from the time of the launch of the system. PESONet replaced the former Electronic Peso Clearing System (EPCS), also operated by PCHC, which was an interbank account-to-account funds transfer system and bulk, recurring, low value payment and collection transactions. The clearing and settlement of PESONet are at batch intervals and currently occurs once a day, but with plan of increasing the frequency to at least three times in a single day. The earlier ambiguity of the final amount that would be received by the beneficiary has been addressed by the BSP Circular No. 980 of 2017 whereby the beneficiary is not charged for receipt of funds in its account. The final settlement of the net obligations between member banks is in PhilPaSS. Once settlement has been successful for all participants for each batch, the inward clearing file is released to the receiving participants, and only upon receipt of this file the participants are able to initiate crediting the beneficiaries. The participation in PESONet is still limited, comprised mostly by universal and commercial banks. 54. The Philippine Domestic Dollar Transfer System (PDDTS) expedites the clearing of US Dollar Drafts representing dollars remitted by Overseas Filipino Workers (OFW) to local beneficiaries. The PDDTS supports transfers of US dollars domestically. The operations of PDDTS are governed by the PDDTS Agreement signed by the BAP, PSSC, PCHC and Citibank Manila. The participating banks transmit their transactions to PCHC which, after the prescribed cut-off time for transmissions, undertakes the netting process and provides the participants with their net positions. The net clearing positions are downloaded by the settlement banks for posting to the participant banks’ respective US Dollar deposit accounts. 55. InstaPay is an electronic fund transfer (EFT) service that allows customers to transfer maximum up to PHP 50,000 funds per transaction almost instantly on a 24x7 basis between accounts of participating BSP-supervised banks and non-bank e-money issuers in the Philippines. However, the flexibility of setting a customer limit is available to the individual 27 participants in InstaPay. BancNet, Inc. is the designated CSO for InstaPay28 for a two-year transitory period beginning from the time of its launch (April 2018). The debit and credit to the end customers would be on a real time basis with the funds settlement between participants happening at a designated time. InstaPay participating institutions that do not have PhilPaSS membership may participate through a sponsorship arrangement with a PhilPaSS member. The 26“The Philippine Clearing House Corporation (PCHC) is the designated clearing switch operator for PESONet for a two-year transitory period beginning from the time of PESONet’s launch.” http://www.bsp.gov.ph/payments/nrps_empowering.asp 27 BancNet is owned by 24 banks, most of which are large universal/ commercial banks. 28“BancNet is the designated clearing switch operator for InstaPay for a two-year transitory period beginning from the time of its launch.” http://www.bsp.gov.ph/payments/nrps_empowering.asp 29 PHILIPPINES settlement of the final obligations between the participants/ sponsoring members would be in PhilPaSS. The participating bank/ sponsoring bank are required to maintain with the BSP a demand deposit account (DDA) which shall be used specifically for the settlement of the participant’s net clearing obligations arising from instant retail payments. This settlement account has to be prefunded with participants/ sponsoring net clearing obligation through the DDA and ensuring that the account can sufficiently cover said obligations at any point during a settlement cycle. Like PESONet, the participation of both banks and non-banks in the system is still very low. 56. The ATM switch in Philippines is also operated by BancNet. The payment network also enables its members’ customers to transact at point-of-sale (POS) terminals, the internet and mobile phones. Apart from the traditional cash withdrawal service at the ATM, BancNet provides services, such as balance inquiry, checkbook re-order, statement request, interbank fund transfer, payment of bills, prepaid phone and Internet reloading, payment of purchases by direct debit to account, and remittance of taxes, Pag-IBIG, Philhealth and Social Security System contribution and loan repayments. Its interconnection with international ATM and POS networks, Diners Club, Discover Card, KFTC, JCB, MasterCard, Union Pay, and VISA, enables foreign cardholders to access their accounts while in the Philippines and vice-a-versa. All large commercial/ universal banks are members of BancNet. Many other thrift/ savings banks as well as cooperative/rural banks participate in BancNet under the categories of “other members” and “subscribers”, respectively. Additional categories of membership include “e-money issuers”, “independent ATM deployers”, and “affiliated switch network”29. The final settlement of net obligations occurs in PhilPaSS. E. PhilPaSS 57. PhilPaSS, the real time gross settlement (RTGS) system, is owned and operated by the BSP. The PhilPaSS was launched in November 2002 initially covering only interbank lending and borrowing transactions. The BSP’s endeavor was to have a more integrated payments and settlement system to allow for more and more financial transactions to be secured and settled in a timely manner, thereby enhancing the integrity of transactions and furthering economic development. (The Figure 5 provides the schematic flow of the PhilPaSS transactions). Towards this, the system which started off with only interbank transactions of commercial and thrift banks, in the succeeding period was enhanced for interbank transactions of other institutions, i.e. settlement from clearing and settlement entities (Figure 6). The settlement of the DNS systems, viz., checks and PHP trades clearing done through the PCHC, ATM transactions through MegaLink and BancNet, and interbank and interdealer repo transactions through PDS were also facilitated in PhilPaSS. Participation of 3rd party entities such as the Philippine Dealing Exchange System for foreign exchange transactions and the BTr for GS respectively enabled PvP and DvP settlement. 29 https://www.bancnetonline.com/BancnetWeb/view/goToMembersPage.do 30 PHILIPPINES Pursuant to the NRPS Framework, the PESONet and InstaPay were implemented as automated clearing houses (ACHs) in November 2017 and April 2018, respectively, with the DNS settlement for these systems taking place in PhilPaSS. Figure 5: PhilPaSS process flow – Schematic diagram Source: BSP Figure 6: Integrating more payment systems to ensure the integrity of more financial transactions, institutions, and markets Source: BSP - Primer 58. The transactions settled in PhilPaSS has been steadily growing but saw a slight decline in the year 2018. The Table 3 and Graph 1 shows the growth in PhilPaSS as also the representation of the PhilPaSS value vis-à-vis GDP. The daily average settlement in PhilPaSS was 31 PHILIPPINES PHP 1.08 trillion which indicates the GDP being turned over in PhilPaSS in around two weeks’ time. The likely reason for the decline in PhilPaSS volume and value could be due to discontinuation of PhilPaSS REMIT in June 201830. The BSP had launched the PhilPaSS REMIT in May 2010 for overseas Filipino remittances. Table 3: Transactions in PhilPaSS (Volume in thousand; Value and GDP PHP trillion) 2014 2015 2016 2017 2018 Volume 1322.69 1406.80 1605.42 1874.43 1716.63 Value 337.84 279.57 469.51 267.54 263.30 GDP 12.63 13.32 14.48 15.81 17.43 Source: BSP; website http://www.bsp.gov.ph/statistics/keystat/sefi.pdf 59. The composition of PhilPaSS membership is given in Table 4 below. Sec. 102 of RA 7653 requires that the deposit reserves shall serve as the basis for the clearing of cheques and settlement of interbank balances. Accordingly, the membership to PhilPaSS was restricted to banks. The PhilPaSS membership was later extended to all banks/ institutions so long as they are BSP-supervised institution. The rules and regulations of PhilPaSS provide details on the requirements for banks and non-bank institutions intending to participate in the settlement operations of PhilPaSS. The primary requirement is that the applicant must be a BSP-supervised financial institution and must have a demand deposit account (DDA) with BSP. The PhilPaSS participants are required to comply with the rules and regulations governing the system. The PhilPaSS does not recognize indirect participants in the system. 30 The PSO presumes that these remittances are now sent to PhilPaSS for settlement via PESONet and InstaPay. The transactions via these channels, however, are transmitted on a net basis whereas remittances via REMIT were processed on a gross basis. PESONet transactions increased by about PHP 0.5 trillion in 2018 vs. 2017. (Source BSP) 32 PHILIPPINES Table 4: PhilPaSS Direct Participants Total as of May Share to Total 2019 Number Universal Banks/ Commercial Banks 41 23.7% Specialized Government Banks 3 1.7% Thrift Banks 38 22.0% Rural Banks 78 45.1% Non-Bank Financial Institutions with Quasi-Banking 9 5.2% Functions Others** 4 2.3% TOTAL NO. OF DIRECT PARTICIPANTS 173 100.0% Source: BSP ** "Others" consist of BSP units and other external institutions such as BTr and PDTC 60. The operations of PhilPaSS are governed by the PhilPaSS Rules and Regulations. The rules and regulations among others cover, (i) membership requirements, (ii) pricing structure, (iii) operating rules, (iv) operating guidelines, (v) liquidity facility, (vi) sanctions, (vii) settlement of disputes, etc. However, the rules do not have any details or references to other regulations/ relevant sections of the Acts covering: (a) roles and responsibilities of the operator and participants, (b) the time and mechanism for reversal for ILF/ OCL or sanctions/ penalty for non- reversal of the ILF/ OCL31, and (c) the likely actions that BSP may take for non-adherence to the rules and regulations, etc. 61. The organization and governance structure of PhilPaSS is depicted in Figure 7 and 8. The PhilPaSS is operated by the Payments and Settlements Office (PSO) and reports to the Deputy Governor in charge of Corporate Services Sector. The oversight function is now vested with the Payment System Oversight Department (PSOD), a unit of the Financial Technology Sub- Sector which reports to the Deputy Governor in charge of Financial Supervisions Sector. The Digital Payments Transformation Steering Committee (DPTSC) created in September 2017, replacing the Payment and Settlement Steering Committee, is the advisory body to the Monetary Board32 on payment and settlement system matter and reviews the policy directions, strategies, standards, rules and regulations on payments and settlements. The DPTSC is chaired by the Deputy Governor, CSS with the Deputy Governor of the Financial Supervision Sector (FSS) as the vice- chairperson. The Committee has representatives from the departments concerned within BSP. 31 The PhilPaSS rules and regulations for instance do not provide any reference to (i) Section 802 and Appendix 25 of the MORB for OCL; and (ii) Section 102 of RA No. 7653 which deals with lending to banks and levying of penal interest rates as a consequence of overdrafts from interbank settlement. 32 MB is composed of seven members appointed by the President of the Philippines for a term of six years. The seven members are: (a) the Governor of the Bangko Sentral, who shall be the Chairman of the MB. Whenever the Governor is unable to attend a meeting of the Board, he shall designate a Deputy Governor to act as his alternate; (b) a member of the Cabinet; (c) five members who shall come from the private sector, all of whom shall serve full- time. Of these 5 members, three members shall have a term of six years, and the other two will have a term of three years. 33 PHILIPPINES Figure 7: BSP Organisational Structure Figure 8: Governance structure 34 PHILIPPINES 62. The Board Risk Oversight Committee (BROC)33 is tasked to recommend policies for approval of the MB. The BROC meets with the members of the Management Committee34 at least annually to discuss the status of implementation and endorse any outstanding policy proposals to the Monetary Board. The PhilPaSS has internal control procedures to help manage operational risk35. 63. The BSP has an Enterprise Risk Management (ERM) Framework for the BSP as a whole. The ERM Framework provides a BSP-wide picture of risks and allows measurement and aggregation on a consistent basis using approved methodologies, systems, procedures, and data. The ERM Framework covers the sources of risks and includes risks from both, internal sources and those arising from interdependencies from internal and external links. This requires the various units and Departments to identify their areas, processes and identify the risks [Risk Action Register (RAR)) and management action plan (Risk Action Plan (RAP)]. The Risk and Compliance Office (RCO) aggregates and evaluates various risk exposures based on the impact and likelihood and reports the risk matrix and interdependencies to the Senior Management (SM). The SM comprises of the Governor and DGs, addresses organizational risk issues. The RCO performs its own independent validation and assessment of risks of the various BSP departments through the conduct of interviews, documentary reviews and oculars. 64. With respect to PhilPaSS, the PSO has identified only operational risk as part of its RAR and RAP. The other risks viz., legal, credit, liquidity, custody, settlement, and reputational risks have not been identified by the PSO and accordingly are not part of the risk management framework. The PSO looks at sources of risks that affect its critical objectives, categorizes these as those that may result in business interruptions and fraud, affect delivery, execution and process management, impede compliance with rules and regulations, and impact IT security. The Business Continuity Plan (BCP) and Disaster Recovery (DR) Plans are tested and reviewed based on specific scenarios on a monthly basis but is confined to operational aspects of BSP only (for PhilPaSS) and does not cover the linked FMIs and participants. Accordingly, the BCP covers the IT and personnel risks within BSP but does not cover the links with the connected infrastructures such as those of the Bureau of Treasury and participants. On an overall basis, the existing RAR and RAP of PhilPaSS under the current ERM framework of BSP is limited in its scope as it does not take into account 33 The functions of the BROC (under Part IV.A. of the BSP Enterprise Risk Management Charter), are: (i) recommend enterprise risk management policies for the approval of the Monetary Board as a whole; and (ii) ensure existence of an effective ERM Framework in BSP. (It is learnt that the BROC comprises of three MB members.) 34 BSP Management Committee is comprised of the Governor and the Sector Heads. 35 The BSP departments viz., Information Technology Office (ITO), Risk and Compliance Office (RCO) and Internal Audit Office (IAO) are tasked with the respective responsibilities of IT, compliance and audit. The ITO monitors the incidents of unauthorized access to the system and fraudulent cases, whereas the RCO develops, recommends, maintains, and amends framework, policies, guidelines, standards, and procedures covering risk management (RM), business continuity management (BCM), and compliance matters and reports directly to Governor while the IAO reviews and appraises the effectiveness of operating control systems of the BSP and makes recommendations to address findings and reports directly to the Monetary Board. 35 PHILIPPINES the risks arising from the participants and the risks that are posed by PhilPaSS to other FMIs and those that PhilPaSS faces from other FMIs and the other systems and participants that settle in PhilPaSS. These risks related to interdependencies and interconnectedness do not form part of the RAR and RAP of PSO and consequently of the overarching ERM of BSP, nor are they monitored by the PSOD36 as part of its oversight mandate. 65. The PhilPaSS operating hours are from 9:00 am to 5:45 pm. Participants use their balances in their respective DDA accounts with BSP for settling transactions in PhilPaSS. (Annex 1 provides the time window for various settlement, including settlement from clearing entities in PhilPaSS). The transactions are settled in PhilPaSS based on the priority and in the order that the transactions are received or on a First-In-First-Out-Basis. However, payments to government accounts i.e. BSP, BTr and government banks have priority over all other interbank transactions. 66. The PhilPaSS Operating Guidelines 3 of the ‘rules and regulations governing the operations of PhilPaSS’, revised in May 2019 provides for settled transactions to be deemed final and irrevocable. The transactions in PhilPaSS are settled on a gross basis and to the extent funds are available in the settlement account. This mitigates credit risk. There is residual risk due to collateralized liquidity support provided by BSP to the participants in PhilPaSS. The transactions once settled are deemed to be final and irrevocable. 67. The PhilPaSS has a built-in queuing mechanism that automatically queues transactions in the event of insufficient balance in the DDA. Queued debit instructions will be settled based on business priorities as indicated by the participant or on First-in-First-Out basis. An optimisation mechanism is automatically triggered whenever two or more queued payment instructions of more than two participants remain unsettled due to the shortage of funds in the DDA of the involved paying participant. This Hybrid optimisation routine ensures smooth and efficient operations and avoids gridlock during the PhilPaSS business hours. The unsettled queued payment instructions are automatically rejected by the system when PhilPaSS closes at 6.00 pm. PhilPaSS also provides for future value-dated transactions which are stored and taken up for settlement on the value date. To effectively manage and monitor the daily liquidity position, participants have been provided access to their respective DDAs through the PhilPaSS Participant Browser (PPB). The PPB provides an onscreen, on-demand access to DDAs and enables participants among others to: a) initiate payments and/ or receive borrowings to/ from counterparties, b) view the status of payments (debits) initiated whether settled, queued, cancelled or rejected, c) view outstanding DDA balances, d) re-prioritize or cancel payments, etc. 68. The BSP to ensure smooth operations and address temporary liquidity needs of the banks provides liquidity support by way of collateralized ILF, Overnight Repo and OCL These three along with the balances of the participants in their DDA account maintained with BSP are 36 The Payment System Oversight Department (PSOD) has been recently established by the BSP. 36 PHILIPPINES the sources of liquidity for the participants in PhilPaSS. The nature and size of the liquidity needs of the participants depend on the daily volume of their payment transactions. The ILF is available to banks for all their gross transactions. ILF is also provided to participants for their clearing obligations from PESONet and BancNet DNS settlements in PhilPaSS, with the exception of cheque clearing obligations for which OCL is provided for settlement in PhilPaSS. The ILF is provided against GS as collaterals and to the extent the collaterals are pledged and available in BSP-ILF Securities Account of the member. In case the PhilPaSS funds settlement account balance of the bank is not sufficient to cover the repayment of ILF at the end of the day, the BSP converts it into an overnight Repo. The OCL is provided both as a clean OCL equivalent to 15% of rediscounting line with the BSP and as collateralized OCL. The clean OCL available to the participants is first exhausted, before BSP extends collateralized OCL. The collateral for OCL includes (i) GS, (ii) unencumbered real estate properties in the name of the bank, (iii) mortgage credits, (iv) hold-out on foreign currency deposits with the BSP based on current (buying) exchange rate and (v) investment grade commercial papers. The OCL can be availed by a member for a maximum period of 5 consecutive clearing days or 5 clearing days within any 30-day rolling calendar period, after which the OCL facility is suspended. Though banks use ILF on a regular basis, there has not been any recent experience of using OCL for cheque clearing (banks generally prefer to borrow in inter- bank market). 69. The BSP faces residual credit risk on account of the collateralised liquidity support provided by it to participants in the PhilPaSS system. The collateral management and access to NRoSS, including valuation of collaterals is still to a large extent manual. The valuation of the collaterals pledged, including application of haircut, etc. are with manual interventions. The framework also does not take care of procyclicality and concentration risk (holding of certain collaterals). PhilPaSS/ BSP accesses the NRoSS system through a web browser for providing ILF and OCL against GS. 70. The PhilPaSS participants initiate payment instructions through the Society for Worldwide Interbank Financial Telecommunication (SWIFT) Network and through PhilPaSS Participant Browser (PPB). The web-based interactive facility PPB is available for non-SWIFT participants. In addition, the PPB provides a contingency arrangement for SWIFT users, should the SWIFT network be unavailable. The 41 large commercial banks use the SWIFT network for connecting to PhilPaSS while the other use the PPB for accessing the PhilPaSS. 71. Value dating of CICS settlement in PhilPaSS. The PCHC – check clearing is posted on day T (PhilPaSS business day) whereas the return clearing is posted on T+1 between 2.00 am – 8.00 am. The PCHC submits the net payment obligations (net of settlement of both inward and outward checks) arising out of the CICS in PhilPaSS towards the end of day between 4.30 – 4.45 pm. on day T. The return clearing window is available from 2.00 am to 8.00 am on T+1. On T+1 day, between 8:01 a.m. to 8:45 a.m., based on the final position, the borrowing participants inform 37 PHILIPPINES PSO on whether they will use interbank call loan (IBCL) or OCL for covering the shortfall in DDA account. The final posting/ settlement of PCHC returns is posted in PhilPaSS with a back value date - value dating to the previous business day. The BSP also posts some of its transactions for day T37 on the next business day T+1 with value dating to the previous business day. 72. The BSP’s own transactions viz., Open Market Operations (Overnight Deposit Facility (ODF), Term Deposit Facility (TDF), Reverse Repurchase (RRP), Repo) are also settled in PhilPaSS. The other transactions affecting the DDAs of financial institutions (FIs) are also performed in PhilPaSS such as deposits and withdrawals of banks from the BSP Cash Department, annual supervisory fees collected by BSP’s Financial Supervision Sector, deposits of maturing loan obligations with the BSP Department of Loans & Credit, settlement of investments in BSP’s short-term liability products, processing fees collected, other penalties, etc. 73. On the business day, there appear to be two simultaneous sessions being active in PhilPaSS, one for processing the current business day’s (T) transactions and another one for value-dating transactions for the previous business day. The PhilPaSS generates the DDA EoD balances as also makes available the statement of accounts to the banks. 74. BSP undertakes review of the systems, policies, procedures and controls related to operational risk including cyber security as part of its overall ERM framework which includes PhilPaSS. This is performed during every risk assessment cycle which is estimated to run within a 2-year period. 75. BSP has set system availability of PhilPaSS at 99.5% as part of its operational reliability and availability objectives. PhilPaSS system performance, capacity and availability are monitored regularly (e.g. minutes, daily, weekly, monthly) by ITIOD ensuring that all resources are functioning within the defined threshold limit of 70 percent of their capacity. Once it reaches the threshold limit, housekeeping maintenance procedures to free-up resources or allocate additional capacity are initiated. IT coordinates with PSO (or vice versa) for any changes in business transaction volumes that may have any possible effects on system performance. Internally, the PSO has an Operations-Level Agreement (OLA) with the ITS which specifies the maximum tolerable period of disruption in PhilPaSS operations to 2 hours and 15 minutes. This however does not take into account the availability of the BSP’s Core Financial Accounting System (cFAS – the general ledger system of BSP). The BSP has a policy for back-up of hardware, software, network facilities at the secondary site with personnel availability at both the primary and secondary sites. BSP is currently reviewing the IT infrastructure available, including the processes and practices. 37 Posting/ settlement of previous day's billing before "open for business". Source PhilPaSS Primer 38 PHILIPPINES 76. Incidents affecting the operations of PhilPaSS are discussed by BROC with the Senior Management and are addressed through suitable remedial measures. Vulnerabilities and threats to the physical facilities of PhilPaSS are addressed in the BCP for PhilPaSS. Consistent with the policies and RAR/RAP processes defined in the BSP ERM, identified information security vulnerabilities and threats are continuously monitored, verified, assessed and rectified through the Vulnerability Assessment and Penetration Testing (VAPT) Management and Patch Management processes. The VAPT Management process adopted the Information Security Management System (ISMS) ISO 27002 code of practice. In August 2014, the operational risk management for PhilPaSS was a subject of a 3rd party assessment facilitated through a technical assistance provided by the Asian Development Bank (ADB). In 2018, ITSs engaged the services of a third-party Security Audit Company (SGV) to conduct security audit of PhilPaSS including its governance. BSP has also carried out a study by engaging an agency for modernization of the infrastructure, including policies and practices which also covers the alternate site and includes enhancements to risk monitoring tools38. The PKI used for PhilPaSS is provided by BSP but no external review of the same has been carried out by BSP. 77. The BSP has an alternate secondary site at a distance with the same risk profile. Switchover procedures are in place and regularly tested, for both personnel including their relocation and infrastructure necessary to ensure smooth operations even during crisis situations. Half of the personnel from PSO’s operating units are assigned at the alternate site while the other half are assigned to attend to incoming inquiries of participants. 78. The BSP conducts an overall BCP exercise covering all its systems including PhilPaSS central system as part of its overall ERM framework. The BCP of PhilPaSS covers specific critical business processes, including preparatory or pre-crisis processes or activities, response procedures, recovery, resumption, restoration and return procedure. An annual integrated enterprise-wide test is conducted with the participants of PhilPaSS. The review and tests of the BCP of PhilPaSS are performed in coordination with participants of PhilPaSS, including the TPSPs. Under this BCP scenario linked FMIs and participants of PhilPaSS connect to the BSP’s/ PhilPaSS’ alternate secondary site. In addition, a component testing or a test of specific system area (e.g. SWIFT only, RTGS only, network connectivity only) is conducted internally within BSP and with its participants. The BCP exercise however does not cover scenarios involving participants connecting from their respective backup / secondary site to the PhilPaSS’s primary as also secondary sites. 79. The PhilPaSS operates on a cost recovery basis. The interbank transaction below PHP 100 is free but all transaction above PHP 100 are charged and the BSP charges vary from PHP 5 to PHP 400 (Annex 2). The banks accordingly charge the customers, which is normally seen to be above PHP 400 for any transaction in PhilPaSS. 38 This is as per discussions with BSP. 39 PHILIPPINES F. The USD-PHP PvP system 80. The PDDTS39 operates the US Dollar-PHP PVP clearing and settlement system. The USD-PHP PvP system is being operated by PDDTS as per the agreement between the various stakeholders viz., BSP, BAP, PSSC, PCHC and Citibank, apart from the participants. The USD/PHP transactions are settled on a gross basis on PvP mode with PHP settlement taking place in central bank money in PhilPaSS, and the US dollar leg of the settlement happening on a notional basis in PDDTS intraday with final settlement in commercial bank money taking place in the books of Citibank at the end of the day (EOD). The details of the volume and value of the USD-PHP settlement in PhilPaSS are provided in Table 5. 81. The TN provides details on the Principal risk arising from the current settlement arrangements of the USD-PHP PvP settlement taking place in PhilPaSS. It accordingly provides recommendations for addressing this risk. The recommendations for USD-PHP settlement arrangement have been provided separately. Table 5: USD-PHP PvP system – settlement in PhilPaSS (figures for volume in actuals and value in PHP billion) Year Volume Value Growth over previous year Volume Value 2018 161711 32,556.60 13.74 20.99 2017 142170 26,907.80 -2.61 -13.41 2016 145984 31,075.82 -0.37 -7.04 2015 146527 33,428.98 -14.82 0.01 2014 172013 33,426.07 G. Oversight framework 82. The NPSA designates the BSP as the authority responsible for the oversight and supervision of payment systems in Philippines. The BSP is in the process of developing an oversight framework for payment systems. The PSO as operator of PhilPaSS was monitoring its operations from an operational and BCP angle only. The oversight and regulatory framework based on the PFMI is yet to be prepared by PSOD, BSP for PhilPaSS. 83. The PhilPaSS rules and regulations, May 2019, state that the BSP-Payment System Oversight Department would conduct regulation and oversight functions over all payments systems, both high value and retail payments, including third party system providers . 84. The operation and oversight of PhilPaSS are under different organisational units within BSP. The PSO - operator of PhilPaSS reports to the Deputy Governor, CSS and the oversight 39 Apart from the USD-PHP PvP settlement, PDDTS provides a real-time, gross electronic transfers of US dollars domestically, which has not been analysed as part of the TN 40 PHILIPPINES department (PSOD) reports to Deputy Governor, FSS. The mandate of the CSS is to ensure the safety and efficiency of PhilPaSS whereas the mandate of the FSS is to ensure the stability of the financial system and financial market infrastructures. 85. The BSP has recognized PPMI as the PSMB for the retail payment systems as envisioned under the NRPS Framework40. The objective of the PSMB under the NRPS Framework is to establish a safe, efficient and reliable retail payment system(s) in the Philippines. The PSMB is a self-governing body with the principle of the separation of the governance of the retail payment system from the actual clearing operations. Under this framework, the BSP will continue to provide guidance to PPMI for alignment of its policies, standards and rules within the NRPS framework. The BSP and PPMI have agreed to share responsibility in monitoring new or emerging trends in the retail payment industry and to notify each other of any relevant information that would warrant appropriate action from either party. They will also engage with each other in policy formulation especially where it impacts the policy and regulatory framework governing BSFIs with respect to their payment system arrangements as well as on common concerns to prevent conflict with any BSP or PPMI action. The PPMI will also monitor and require its members to settle clearing results of automated clearing houses (ACHs) as defined in the NRPS Framework under the PPMI governance structure for each ACH through the BSP’s PhilPaSS. H. Cooperative arrangement 86. The Digital Payments Transformation Steering Committee (DPTSC) was setup under BSP Office Order No. 2989 in September 2017, to recommend and review policy directions, strategies, standards, rules and regulations on payments and settlements . The Committee is chaired by the Deputy Governor, CSS with the Deputy Governor of the Financial Supervision Sector (FSS) as the vice-chairperson. The Committee has members from different internal departments concerned with the payment and settlement systems. This committee provides policy inputs to the Monetary Board on payment and settlement systems related matters. 87. The Financial Sector Forum established in 2004 is the apex level cooperative arrangement in Philippines for the financial sector. The Forum is represented by the Heads of the BSP, Securities and Exchange Commission (SEC), Insurance Commission (IC), and the Philippine Deposit Insurance Corporation (PDIC). Additionally, there is the Financial Stability Coordination Council (FSCC), with representatives from BSP, SEC, IC, PDIC, and the Department of Finance (DOF). The BTr, under the DOF, owns and operates the National Registry of Scripless Securities (NRoSS). 88. There is also cross-border cooperation via the ASEAN Working Committee on Payment and Settlement Systems (WC-PSS and under the ASEAN Economic Community) tasked to lead initiatives that shall ultimately provide an enabling environment that shall 40 http://www.bsp.gov.ph/publications/media.asp?id=4592&yr=2018 41 PHILIPPINES promote regional linkages and payment systems that are safe, efficient, and competitive . Additionally, central banks participate in the Executives Meeting of East Asia and the Pacific – Working Group on Payments and Market Infrastructures (EMEAP-WGPMI). 42 PHILIPPINES III. GAPS AND RECOMMENDATIONS 89. The analyses of the PhilPaSS, the gaps identified and specific recommendations for addressing them are presented in this section. In addition, recommendations on the USD-PHP PvP settlement and responsibilities of authorities are provided in this section. A. Recommendations for PhilPaSS General organization – PFMI Principles 1-3 90. The rules and regulations for implementation/ administration of the NPSA have to be enacted by BSP on an immediate basis to provide a high degree of legal certainty for each material aspect of PhilPaSS’ activities. The National Payment Systems Act (NPSA) (Republic Act No.11127), the Act for regulation and supervision of Payment Systems, has come into effect from February 2019, but the supporting secondary administrative/ implementing regulation are yet to be framed and notified. This has led to ambiguity and uncertainty in the legal framework. Section 21 of the NPSA requires the BSP to promulgate the necessary rules and regulations for the effective implementation of this Act within sixty (60) days from the effectivity of the Act. 91. The BSP as operator of PhilPaSS should, on an immediate basis, obtain the approval of the Monetary Board for the operations of PhilPaSS as laid down under Section 8 of the NPSA. In the absence of such an approval, the operations of PhilPaSS continue to be undertaken under Section 102 of NCBA, which does not extend the same degree of certainty as provided for under NPSA. While this by itself may not pose any hindrances to the operations of PhilPaSS, the high degree of legal certainty for all material aspects of PhilPaSS’ operations that is now provided under NPSA may not be deemed to be applicable to PhilPaSS as approval of the Monetary Board under Section 8 of the NPSA is yet to be obtained. 92. The existing PhilPaSS rules and regulations need to be reviewed and reissued after the approval of the MB, to ensure consistency with the NPSA. The NPSA provides a high degree of legal certainty for material aspects such as, settlement finality, netting, irrevocability, etc. The rules and regulations of PhilPaSS accordingly need to be reviewed to reflect the same so that actions taken by the PhilPaSS under such rules and regulations will not be voided, reversed, or subject to stays. Further the rules and regulations should clearly define the rights and obligations of PhilPaSS, its participants, service providers, customers, etc. The rules and regulations should also include the procedure for storage of future value dated transactions and their settlement on 43 PHILIPPINES the value date. The rules and regulations should also clearly lay down the procedures for the provision of liquidity support (both ILF and OCL), repayment and default provisions. 93. There is inconsistency in the nomenclature of the account designated for settlement of transactions in PhilPaSS which needs to be harmonized to ensure enforceability of the underlying contractual settlement obligations. Different nomenclatures for the settlement account in PhilPaSS have been used in various contractual agreements and in the PhilPaSS process flow. The BSP has signed MOAs with the participants, Bankers Association of the Philippines (BAP), Chamber of Thrift Banks (CTB), Investment House Association of the Philippines (IHAP), Rural Bankers Association of the Philippines (RBAP) and Philippine Franchise Association (PFA) and third- party systems providers (TPSPs) indicating the settlement account in PhilPaSS. However, the nomenclature of the settlement account referred in the MoA does not correspond to the nomenclature in the PhilPaSS rules and regulations. The PhilPaSS rules and regulations states that the PhilPaSS effects the real-time settlement through the Demand Deposit Accounts (DDAs) of the banks maintained with BSP; while the MoAs indicate that the DDA#2 account would be used for settlement of PhilPaSS transactions. Further ambiguity arises as participants in their authorization letters to BSP indicate that they authorize the BSP to set up a PhilPaSS-Demand Deposit Account (DDA) as settlement account for various RTGS-related transactions. The process flow of PhilPaSS (figure 5) shows debit / credit being carried out in banks DDA in PhilPaSS. 94. It is recommended that BSP issue necessary secondary legislation under the NPSA covering the registration of payment system. The USD-PHP PvP system has been in operation with the PHP leg of settlement taking place in PhilPaSS. To establish a sound legal basis for the operations of the USD-PHP PvP settlement, the operator (PSSC) of the USD-PHP PvP system needs to register with BSP as a payment system under the NPSA. The above registration requirements should also include other payment systems whose net settlement obligations are settled in PhilPaSS, as a first step, which should be made as a requirement for all payment systems at a later stage. 95. In order to ensure that the current governance framework adequately represents the interests of the relevant stakeholders in PhilPaSS, BSP may take suitable measures such as considering stakeholder representation in BROC or DPTSC for direct participants or alternately constitute user committees and undertake a public consultation process . In the existing arrangements it is not very evident that BSP/ PhilPaSS is actively engaging with stakeholders in the decision-making processes. 96. The MB should establish a clear, documented risk-management framework that includes the PhilPaSS’ risk policy, assigns responsibilities and accountability for risk decisions, and addresses decision making in crises and emergencies. It is accordingly recommended that: (i) the Enterprise Risk Management (ERM) framework should be reviewed to 44 PHILIPPINES take into account the full gamut of applicable risks in the functioning of PhilPaSS41. These include legal risk, credit risk, liquidity risk, settlement risk, custody risk and reputational risk, apart from operational risk, that could materially affect the ability of PhilPaSS to function in a safe and efficient manner; and (ii) the BSP may also consider strengthening the BROC to enable it to also function as a risk committee for PhilPaSS in addition to its existing role. The BSP could accordingly review the existing composition of BROC and reconstitute it, if required after the review, with a view to ensuring that the BROC has members with sufficient risk management expertise. If feasible BSP may also consider whether the BROC could be chaired by an independent expert member of the MB. The remit of such a reconstituted committee should be to provide a holistic risk management policy framework for PhilPaSS to the MB for its consideration and decision making. Credit and Liquidity Risk Management - PFMI Principles 4 to 7 97. PhilPaSS/BSP should monitor ILF repayment by participants. Participants who frequently fail to repay the ILF should be levied a penal rate of interest when it is converted to overnight repo. Frequent conversions to overnight repo should be discouraged with PSOD, BSP having the right to impose sanctions on such participants, and the PhilPaSS rules providing for the same. 98. The BSP should consider providing liquidity support by way of ILF for all settlement of transactions happening in PhilPaSS rather than using two methods42, ILF and OCL. OCL facility for settlement of CICS balances has the following drawbacks: (i) not fully collateralised (clean OCL equivalent to 15% of rediscounting line with the BSP); (ii) BSP exposed to credit risk; (iii) collateral when obtained includes securities and physical assets – the enforcement of rights and interests on collateral could be a legal issue especially where physical assets are involved, and the length of time required to enforce rights. 99. The BSP for providing routine liquidity support in PhilPaSS should accept collateral with low credit, liquidity, and market risk. The collaterals accepted by BSP for liquidity support by way of OCL for settlement of transactions in PhilPaSS (CICS obligations) has the potential of leading to credit risk. The BSP is accepting physical assets and mortgage credit as collaterals which 41 The BSP departments viz., Information Technology Office (ITO), Risk and Compliance Office (RCO) and Internal Audit Office (IAO) are tasked with the respective responsibilities of IT, compliance and audit. The ITO monitors the incidents of unauthorized access to the system and fraudulent cases, whereas the RCO develops, recommends, maintains, and amends framework, policies, guidelines, standards, and procedures covering risk management (RM), business continuity management (BCM), and compliance matters and reports directly to Governor while the IAO reviews and appraises the effectiveness of operating control systems of the BSP and makes recommendations to address findings and reports directly to the Monetary Board. 42 The BSP has adopted two methodologies for providing liquidity support for settlements happening in PhilPaSS – the ILF and OCL. The ILF is against GS whereas OCL is against GS as also against other assets, including physical assets. For the settlement from CICS, the banks are not eligible for ILF but have to resort to OCL for liquidity support from BSP. Eligibility requirements of banks for the grant of rediscounting line and collateralized OCL are laid down in Sections 281 and 802 of the MORB, respectively. 45 PHILIPPINES has potential delays in accessing the collateral due to the settlement conventions for transfers of the asset. In case of default by the bank the BSP may take legal remedies in order to collect its exposure. In view of this, BSP should move away from accepting assets which are less liquid and subject to market risk as routine collaterals. The provision of accepting such collateral could be on an exceptional basis, which is supported by the current framework for providing liquidity support under OCL43. It is learnt from BSP that the Monetary Board has also advised for moving towards accepting GS in securing BSP credit facilities instead of other assets now being accepted for routine OCL. 100. BSP should undertake a holistic review and frame a comprehensive collateral framework policy covering both ILF and OCL facilities. The elements of such a policy should comprise: (i) adopting harmonized collateral valuation practices for valuation of GS by the different departments of BSP44; (ii) framing a valuation and haircut methodology taking into account procyclicality and wrong-way risks; adopting the practice of independent validation of haircut methodologies on an annual basis; and (iii) monitoring of concentration limits. It is understood that BSP is working on revising the existing collateral management framework for OCL45. 101. BSP should have prompt access to its assets and the assets provided by the participants for ILF/ OCL even in extreme but plausible market conditions. The PhilPaSS/ BSP should secure it rights to the collateral provided by the participants . To this end, the MoA entered by BSP with the BTr should be reviewed to ensure that the rights of the BSP are secured under all circumstances. The BSP’s collateralized liquidity support to banks in PhilPaSS is subject to the collaterals being transferred by the banks to the account of the BSP in the NRoSS. The BTr’s NRoSS as a CSD does not allow reuse of collaterals especially if these are already pledged and earmarked for liquidity support under both ILF as also OCL. However, the MoA the BSP has with the BTr for NRoSS has clause for limiting liability, including but not limited to, system or telecommunication problems, power outage, etc. This brings uncertainty about BSP 43 As per the provisions under the NCBA 44 The collateral valuation by the Treasury of the BSP for GS uses the Value-at-Risk methodology with 99% confidence level and daily yield changes. Stress triggers are applied to account for irregular market movements resulting to higher haircuts during periods of high volatility. Haircuts are calculated, and stress triggers monitored on a daily basis. For OCL the valuation of collateral (GS) is currently based on the Bloomberg valuation as available on the last date of the month (the other assets for OCL are also valued at the end of the month). This leads to the unintended consequence of the same collaterals being valued differently by different Departments within BSP. 45 Please see recommendation made in paragraph 99 advocating adopting ILF facility for all settlements in PhilPaSS. 46 PHILIPPINES having access to collaterals in case of any eventuality. A legal review of the collateral documents under OCL is being conducted to ensure that BSP’s rights are adequately protected. 102. PhilPaSS should ensure that collateral management being provided by NRoSS protects the interests of participants and BSP from custody risk. To this end the suggested review of the MOA should also take into account custody risk issues. The PhilPaSS is dependent on NRoSS46 for providing collateralized liquidity support to banks against GS as collaterals, apart from BSP’s own treasury investments. 103. PhilPaSS/ BSP should use a well-designed and operationally flexible collateral management system (CMS). To this end the BSP should engage with BTr to develop an action plan for the introduction and operationalization of a revamped and redesigned automated CMS system. Such a redesigned automated CMS system should provide for: (i) automated STP to mitigate operational risk prevalent in the current manual practices; (ii) facilitate implementation of concentration risks, haircut methodologies; and (iii) have the functionality to accommodate the timely deposit, withdrawal, substitution, and liquidation of collateral. The current system is lacking in these features. 104. PhilPaSS/ BSP should apply financial penalties to participants that fail to repay intraday credit by the end of the operating day. The BSP provides banks with Intraday Liquidity Facility (ILF) for all transactions (except for CICS net settlement obligations), in PhilPaSS. The BSP should include appropriate provisions in the rules and regulations of PhilPaSS providing for (i) levy of penalties for not repaying ILF during the prescribed time window by the participant/s; and (ii) levying a higher penal rate of interest for conversion of ILF into overnight Repo. 105. PhilPaSS should provide clear and certain final settlement of payment obligations on the value date. PhilPaSS rules should prevent backdating of transactions. In line with the PFMI, BSP should adopt the finality of settlement for all transactions in PhilPaSS on a real-time basis but no later than at the end of the value date47. The practice of backdating is prevalent with the return clearing of CICS taking place on T+1 being back-dated to T. The return clearing file received should be settled on the day it has been inputted into the system and not back dated. 46 The BTr as a central securities depository (CSD) for GS should protect assets against custody risk, including the risk of loss because of the CSD’s negligence, misuse of assets, fraud, poor administration, inadequate recordkeeping, or failure to protect a participant’s interests in securities. 47An FMI’s processes should be designed to complete final settlement, at a minimum no later than the end of the value date. This means that any payment, transfer instruction, or other obligation that has been submitted to and accepted by an FMI in accordance with its risk management and other relevant acceptance criteria should be settled on the intended value date. An FMI that is not designed to provide final settlement on the value date (or same-day settlement) would not satisfy this principle, even if the transaction’s settlement date is adjusted back to the value date after settlement. This is because, in most of such arrangements, there is no certainty that final settlement will occur on the value date as expected. Further, deferral of final settlement to the next-business day can entail overnight risk exposures. For example, if an SSS or CCP conducts its money settlements using instruments or arrangements that involve next-day settlement, a participant’s default on its settlement obligations between the initiation and finality of settlement could pose significant credit and liquidity risks to the FMI and its other participants. 47 PHILIPPINES The existing practice is inconsistent with Principle 8 settlement finality as the current day’s settlement on T is deemed incomplete till return clearing on T+1 is completed. Thus, in the current scenario, participants in PhilPaSS are exposed to credit and liquidity risk as CICS settlement is not deemed final till return clearing is completed. 106. BSP to undertake monitoring the participants for any misuse of the incoming queue viewing facility/ system which impacts the liquidity in the system . The PhilPaSS provides the queue visibility, including incoming payments to the receiving bank. Though visibility of incoming payments is a good feature, this needs to be accompanied by corresponding rules and regulations and monitoring for likely misuse by way of participants delaying their payment transactions in order to economise on their own liquidity needs by relying on the anticipated receipts. 107. The USD-PHP system should have a robust framework to manage risk from its participants, settlement bank and liquidity provider. The PvP is facilitated with the PHP leg of the settlement happening with finality in PhilPaSS, whereas the settlement of USD happens in the Citibank at the end of the day (EoD). This has introduced risk, the plausibility of Principal risk. 108. BSP should undertake measures to mitigate credit risk while extending clean liquidity support to participant Japanese banks in PhilPaSS. It has been gathered during discussions that clean liquidity support is provided to Japanese banks participating in PhilPaSS. The BSP provides explicit guarantee to the transactions undertaken by the Japanese banks under an MoU entered by BSP with Bank of Japan, the central bank of Japan. This guarantee is not against any collateral but under an MoU. BSP should examine the risk emanating from such an agreement. Settlement and exchange-of-value settlement systems - PFMI Principles 8 to 12 109. PhilPaSS rules should clearly define the point after which unsettled payments, transfer instructions, or other obligations may not be revoked by a participant. The rules do not define the point in time after which transactions pending in queue can be unilaterally revoked by a participant prior to their settlement. The lack of such a provision has the potential to create liquidity risks to the other participants. PhilPaSS rules and regulations should accordingly clearly define the point after which unsettled payments instructions, or obligations may not be unilaterally revoked. 110. The PhilPaSS rules and regulations need to explicitly indicate that for settlement of InstaPay transactions, the separate designated account (distinct from the regular settlement account) would be used for settlement in PhilPaSS. The InstaPay settlement is performed in a separate designated account48 maintained at BSP for the purpose which is separate and distinct 48 The member banks need to open a separate account and keep the account funded for settlement of the obligations emanating from InstaPay. 48 PHILIPPINES from the PhilPaSS settlement account. The requirement of a separate designated account for settlement of InstaPay obligation is not part of the rules and regulations of PhilPaSS. Default Management (PFMI Principles 13-14) 111. The PhilPaSS rules and regulations should cover the action that PhilPaSS can take when a participant defaults to repay the ILF by the end-of-the operating day. There is a need for well laid down process for addressing/ handling default by way of a well laid down documented plan. The BSP provides ILF, Repo and OCL against acceptable collaterals which the members of PhilPaSS are required to repay by the end-of-day. However, the PhilPaSS rules and regulations do not provide details on the measures that PhilPaSS can take when a participant defaults in repaying the ILF by the end of the day (apart from a broad provision on application of sanctions by BSP49). The BSP internally has provisions for providing liquidity support under Sec. 702 of RA 7653, Sec. 802 of the MORB, and Sec. 290 of the MORB and Sec. 4278Q of the MORNBFI. However, there appear to be no provisions, processes, and procedures detailing the steps that can be taken when the ILF/ OCL is not repaid such as, the liquidation of the collateral against which liquidity support has been provided. Also, in the event of a member default, there is no mechanism of internal communication with the stakeholders concerned. The plan so prepared as recommended above should be periodically tested involving the participants and other stakeholders and reviewed. General business and operational risk management (PFMI Principles 15-17) 112. PhilPaSS should have prompt access to its assets and information provided by the participants. The BSP’s collateralized liquidity support to banks in PhilPaSS is subject to the collaterals transferred by the banks to the account of BSP in the NRoSS. The BSP is dependent on the NRoSS to provide collateralized ILF/ OCL to banks against GS for ensuring smooth functioning of the PhilPaSS and for GS held. The operational risk, including operational error may lead to non- availability of resources in a timely manner and hamper the functioning of PhilPaSS. 113. PhilPaSS should establish a robust operational risk-management framework with appropriate systems, policies, procedures, and controls to manage operational risks. The current elements of operational risk management framework, PhilPaSS cover only the following aspects: (i) business interruption, (ii) fraud, (iii) IT Security (unauthorized access or tampering of systems with malicious intent to perpetuate fraud or sabotage), etc. They do not take into account the following: (i) participants, (ii) other FMIs and (iii) the retail payments operator, etc. and 49 Provision III Sanctions: “Violations of the PhilPaSS rules and regulations shall subject the participants to sanctions, as may be imposed by the BSP” 49 PHILIPPINES interdependency and consequent operational risk. A robust operational risk management framework should encompass all these elements. 114. PhilPaSS should identify, monitor, and manage the risks that key participants, NRoSS, SWIFT and other critical service providers might pose to its operations; manage the risks PhilPaSS’ operations might pose to other FMIs. Accordingly, action should be initiated on: (i) revamping the RAR and RAP to account for interdependencies and interconnectedness between PhilPaSS and other stakeholders including other FMIs (NRoSS for example), participants and critical service providers and the impact on PhilPaSS’ safe and efficient functioning in the event of any operational risk event at any of these entities; (ii) as indicated above, the MoA between BSP and BTr should take into account the risks posed to each other due to interconnectedness and interlinkages; (iii) external audits of PhilPaSS operations should be undertaken along with the periodical internal audits to assess the level of PhilPaSS operational risk mitigation measures taking into account the interconnectedness aspects as indicated above; (iv) PhilPaSS and participants using SWIFT should comply with SWIFT Customer Security Controls Framework, apart from other measures adopted by BSP, and in addition PhilPaSS should monitor the participants compliance with the same; and (v) analyse the recommendations made in the study carried out for modernization of the infrastructure, including policies and practices and also take into account the above aspects 50. 115. PhilPaSS should have clearly defined operational reliability objectives and should have policies in place that are designed to achieve those objectives. PhilPaSS’ operational objectives should be periodically reviewed to incorporate new technological and business developments. As part of the operational objectives, BSP has set to attain the system availability at 99.5%. This does not cover the link and availability of the cFAS. 116. The secondary site should be set up at geographical distance with a distinct risk profile; operations from the secondary site should be resumed within two hours51 and with 50 The report was not shared with the assessor being confidential but broadly informed that the recommendations are for (i) improvement of the IT infrastructure, and (ii) Environment – DR site to another location, including a third site. 51 Notwithstanding this capability to resume critical operations within two hours, when dealing with a disruption FMIs should exercise judgment in effecting resumption so that risks to itself or its ecosystem do not thereby escalate, whilst taking into account that completion of settlement by the end of day is crucial. FMIs should also plan for scenarios in which the resumption objective is not achieved. Although authorities recognise the challenges that FMIs face in achieving cyber resilience objectives, it is also recognised that current and emerging practices and technologies may serve as viable options to attain those objectives. Furthermore, the rationale for establishing this resumption objective stands irrespective of the challenge to achieve it. The chapter on response and recovery 50 PHILIPPINES a near to zero data loss. The BSP has a secondary site located at a geographical distance which has the same risk profile. The risk management plan does not cover the risk it is exposed to from its participants, FMIs and critical service providers and similarly the risks it poses to them. The BCP exercise also does not cover the clearing entities and participant of the systems (they continue to operate from their respective primary sites). 117. It is necessary to have a holistic BCP plan and conduct BCP exercise covering Central system, participants other FMIs and the retail payments operator to take into account for interdependency and consequent operational risk. This should also cover the critical service provider – SWIFT as also the solution provider. The scenarios used for the BCP need to be strengthened to include scenarios like market-wide stress. The BCP plan also does not fully provide for testing of other manual based procedures in the event of wide-spread IT failures across its main and back-up sites, the same to be considered to be part of the BCP. There should be a mandatory requirement on the participants to test their BCP and operate from DR site to check on its readiness and availability. 118. The BSP should consider subjecting: (i) key elements of PhilPaSS’ operational risk- management framework; and (ii) PKI infrastructure to periodical external audits. BSP should also consider adopting the CPMI strategy to reduce the risk of wholesale payments fraud related to endpoint security52. The operational risk management in BSP is monitored by the Governor but there is no external audit of the effectiveness of the operational risk management plan. The risk assessment is performed within a 2-year period internally. There is no requirement of an external assessment of the adequacy of the operational risk management plan. However, in 2018, ITSs engaged the services of a third-party Security Audit Company (SGV) to conduct security audit of PhilPaSS including its governance. 119. The manual processes for triggering ILF/ OCL requests has the potential of high operational risk. Currently PSO/ banks need to inform the Treasury (BSP)/ OCL department about the liquidity shortfall and the request for liquidity support. A process is subsequently initiated by the Treasury (of BSP) / OCL department, as the case may be, for confirming the collateral pledged, valuation performed before release of IFL/ OCL through manual interventions which are subject to operational errors. 120. The practice, if any, of two simultaneous sessions operating on a business day should be discontinued as it has a high potential of operational risk. provides guidance on how an FMI should respond in order to contain, resume and recover from successful cyber- attacks – CPMI-IOSCO: Guidance on cyber resilience for financial market infrastructures https://www.bis.org/cpmi/publ/d146.pdf 52 CPMI – Reducing the risk of wholesale payments fraud related to endpoint security https://www.bis.org/cpmi/publ/d178.pdf 51 PHILIPPINES Access, efficiency and transparency (PFMI Principles 18-23) 121. BSP should review and revise its participant access criteria based on appropriate risk considerations based on legal, financial and operational aspects to allow for fair and open access to PhilPaSS services by both direct and indirect participants. Such revised access criteria should also provide for rules covering the suspension and orderly exit of a participant. The PhilPaSS rules and regulations detail the eligibility of a participant to become direct member of PhilPaSS, but do not cover the suspension and orderly exit of a participant. The NPSA now provides flexibility to BSP to determine who shall be allowed to participate in payment systems owned and operated by it and who shall be allowed to open an account with it for settlement purposes. 122. BSP should put in place a monitoring mechanism to manage the risks that could emanate from any tiering arrangements. The BSP currently has no such monitoring mechanisms in place. Existing levels of indirect participation in PhilPaSS should be monitored by BSP and a policy decision should be taken as to whether significant indirect participants could be encouraged to become direct participants. 123. PhilPaSS should establish mechanisms for the regular review of its costs and pricing structure. The PhilPaSS pricing structure is on a cost recovery basis and accordingly appear to be on the higher side due to lower volume of transactions. The participants also indicated on the high cost which they pass on to customer which dissuades them from using PhilPaSS. The BSP has recently rationalized its processing charges and now has a graduated pricing structure with the maximum charge capped at PHP 400 for transactions done digitally and PHP 5000 for manual processing of inter-bank transactions. The banks accordingly charge the customers, which is normally seen to be above PHP 400 for a transaction in PhilPaSS. 124. PhilPaSS should meet the needs of its participants and the market. One mechanism PhilPaSS might use to gauge this is by conducting periodic satisfaction surveys of its participants and other relevant stakeholders. PhilPaSS currently does not have any formal arrangements to review the needs of its participants and other stakeholders. The BSP may explore making the task force on the Adoption of ISO 20022 for Philippine Payments which has representatives from both BSP and stakeholders of PhilPaSS as a permanent structure to facilitate participant and stakeholder meetings and consultations. The representation could be expanded to cover other stakeholders, including consumer representation. 125. PhilPaSS should use standardised messaging formats to improve the quality and efficiency of the clearing and settlement of transactions. The BSP should not take the responsibility of converting proprietary message formats through its converter without adequate legal protection as it is exposed to reputational and legal risks under the current arrangement. The 52 PHILIPPINES SWIFT message types MT202 and 103 are the messaging standards currently used by participants to transmit payment instructions to PhilPaSS. 126. PhilPaSS should complete regularly and disclose publicly responses to the CPMI- IOSCO Disclosure framework for financial market infrastructures. PhilPaSS should provide comprehensive and appropriately detailed disclosures to improve the overall transparency of PhilPaSS, its governance, operations, and risk-management framework. 127. BSP while designing the new RTGS system should provide for sufficient flexibility to respond to changing demand and new technologies. Fundamentally, an FMI should be designed and operated to meet the needs of its participants and the markets it serves. An FMI’s efficiency will ultimately affect the use of the FMI by its participants and their customers as well as these entities’ ability to conduct robust risk management, which may affect the broader efficiency of financial markets. The BSP is in the process of replacing the PhilPaSS with a new version and has setup a task force on the Adoption of ISO 20022 for Philippine Payments. The task force has representatives from both BSP and stakeholders of PhilPaSS. B. Recommendation for USD-PHP PVP system 128. It is recommended that BSP issue necessary secondary legislation under the NPSA covering the registration of payment system. The USD-PHP PvP system has been in operation with the PHP leg of settlement taking place in PhilPaSS. To establish a sound legal basis for the operations of the USD-PHP PvP settlement, the operator (PSSC) of the USD-PHP PvP system needs to register with BSP as payment system under the NPSA. 129. Measures to mitigate principal risk in the existing USD-PHP settlement arrangement should be taken to ensure that the final settlement of one currency PHP occurs if and only if the final settlement of the linked currency obligation in USD also occurs. The PSSC provides the clearing and settlement of gross transaction for the USD-PHP system on a PvP basis. The PvP is facilitated with the PHP leg of the settlement happening with finality in PhilPaSS, whereas the settlement of USD happens on a notional basis during the day in the accounts maintained at PSSC (which is not a bank but holds mirror balances of participants actual dollar balances accounts held with Citibank at the beginning of the day) with final settlement happening in the Citibank at the EoD. Thus, in the current scheme of things while the domestic leg of PHP is settled with finality and participants are free to use their balances intraday, as the dollar leg is only settled during the end of day, the participants are exposed to Principal risk with the possibility that the counterparty may fail to deliver USD at the EoD. This has introduced risk, the plausibility of Principal risk53. The BSP should ensure that settlement of one currency (PHP in PhilPaSS) is deemed final and 53 The risk that a counterparty will lose the full value involved in a transaction - for example, the risk that a seller of a financial asset will irrevocably deliver the asset, but not receive payment. 53 PHILIPPINES irrevocable contingent upon the final and irrevocable settlement of the linked currency (USD in Citibank) to ensure that exchange of value takes place without principal risk. 130. The USD-PHP system should have a robust framework to manage risk from its participants, settlement bank and liquidity provider. The PvP is facilitated with the PHP leg of the settlement happening with finality in PhilPaSS, whereas the settlement of USD happens in the Citibank at the End of the Day (EoD). This has introduced risk, the plausibility of Principal risk54. 131. Credit and liquidity risk arising from the use of commercial bank money should be strictly monitored to ensure that participants are not exposed to these risks. The participants are exposed to liquidity and credit risk from the settlement happening in commercial bank. The Citibank also provides overdraft to the members based on request. 132. The PSSC should be overseen by the BSP as a payment system operator . BSP should, to begin with monitor the settlement of the transactions in the USD-PHP PvP payment system. The BSP to review the current procedure facilitating settlement of USD-PHP on a PVP mode to mitigate credit, liquidity and principal risks. 133. BSP should advise the operator of the USD-PHP payment system to prepare default rules and procedures for the system. The risk of a counterparty default and/ or default of the settlement bank needs to be identified and risk mitigation measures put in place for the same. C. Recommendation on Responsibilities of authorities 134. The oversight policy framework document under development should also include adoption of PFMI for the regulation, supervision and oversight of FMIs. The BSP after a process of public consultation should finalise the oversight policy framework document at the earliest and place it in the public domain. The oversight policy framework should be consistent with the NPSA. 135. BSP should: (i) clearly define and publicly disclose the criteria used to identify FMIs that will be subjected to regulation, supervision, and oversight; and (ii) publicly disclose its adoption of PFMI for the regulation and supervision of the FMIs under its jurisdiction. BSP should publicly disclose its adoption of PFMIs for ensuring the safe and efficient functioning of PhilPaSS. The BSP as an operator of PhilPaSS has in the rules and regulations for PhilPaSS, (revised on 20th May 2019) in Section F indicated on the self-assessment against the PFMI. However, BSP as the regulator and overseer of PhilPaSS has not made the adoption of PFMI for regulating and overseeing PhilPaSS against PFMI public. 54 The risk that a counterparty will lose the full value involved in a transaction - for example, the risk that a seller of a financial asset will irrevocably deliver the asset, but not receive payment. 54 PHILIPPINES 136. The administrative implementation rules and regulations for NPSA should include adoption of international standards, say the PFMIs. The Section 9 of the NPSA on coordination with other Government agencies and foreign regulators states that the BSP shall coordinate with the SEC to facilitate the orderly discharge of payment obligations arising from security transactions in securities trading, clearing and settlement systems under Republic Act No. 8799 or “The Securities Regulation Code”. 137. There is a need for strengthening capacity building and expertise for the regulation and oversight of PhilPaSS and FMIs and payment systems in general in the PSOD of BSP . The other authorities should also take appropriate measures for strengthening human resources and expertise in their respective organisations. The BSP should organize the PSOD to have clear focus on framing of policies and regulations and carrying out its oversight function55 including obtaining timely information to induce change. The PSOD should be equipped with well- trained human resources to effectively discharge the oversight function– off-site and on-site. 138. The PSO should monitor the settlement of transactions in the USD-PHP PvP payment system, in order to mitigate credit, liquidity and principal risks. The PSSC is not being overseen by the BSP as a payment system operator. 139. The other authorities DoF and SEC should also take necessary steps as indicated at 136 (i) and (ii) above. 140. The authorities (BSP, SEC and DOF ) should have sufficient resources to fulfil their regulatory, supervisory, and oversight responsibilities over the FMIs. 141. The Financial Sector Forum (FSF) and Financial Stability Coordination Council (FSCC) should ensure coordination and cooperation among the authorities for promoting safety and efficiency of the FMIs in turn containing systemic risk. The Financial Sector Forum (FSF)56 was established in 2004 with Heads of the BSP, Securities and Exchange Commission (SEC), Insurance Commission (IC), and the Philippine Deposit Insurance Corporation (PDIC) as members. The FSF is a voluntary cooperative endeavor of the concerned agencies to provide an institutionalized framework for coordinating the supervision and regulation of the financial system, while preserving each agency’s mandate. The FSF created the Financial Stability Coordination Council (FSCC) on 4 October 2011 to elevate financial issues on a national level. The FSCC is a voluntary inter-agency council among the BSP, DOF, IC, PDIC, and SEC whose key objective is to identify, manage and mitigate the build-up of systemic risks to safeguard the stability of the Philippine financial system. A formal administrative and technical secretariat is established for both FSF and FSCC to facilitate meetings and initiatives. There are also committees on Crisis 55 The Fed Reserve’s organizational chart is available at https://www.federalreserve.gov/aboutthefed/files/RBOPS- org-chart.pdf 56 http://www.bsp.gov.ph/publications/media.asp?id=316&yr=2004 55 PHILIPPINES Management and Resolution guidelines. This includes assigned roles for the regulators, communication procedures, etc. The FSCC meets quarterly and the main agenda item is the Systemic Risk Review57. 142. BSP, DoF and SEC should cooperate with each other in promoting the safety and efficiency of FMIs through an appropriately framed MoU including revising the mandates of FSF and FSCC (if required). The Section 9 of the NPSA provides for cooperation among authorities and should be exercised. There is currently an MoA between the BTr and BSP for the ILF and for Treasury operations of BSP. However, there are no formal arrangement of cooperation between the DoF (under which BTr operates) and BSP and between BSP and SEC (under which PDS operates) for the FMIs operated and overseen by them. 143. BSP should, as soon as it is practicable, inform Federal Reserve Bank, New York, on the USD-PHP operation in Philippines. The BSP is facilitating USD-PHP settlement on a PvP basis. This mechanism has been in operations for some time and functioning smoothly. As per KC 2 of Responsibility E for this multicurrency FMI in Philippines, the BSP should inform Federal Reserve, New York that may have an interest in the FMI’s observance of the CPSS-IOSCO Principles for financial market infrastructures. To determine whether such notification is appropriate, the authority may establish a dialogue to begin with by sharing the mechanism adopted for the USD- PHP settlement. Similarly, the BSP may coordinate with PBC for the Renminbi -PHP settlement which is likely to commence shortly. 57 https://www.dof.gov.ph/index.php/the-financial-stability-coordination-council-issues-2017-financial-stability- report/ 56 PHILIPPINES ANNEX 1 Settlement timelines and cut-off times PhilPaSS operates daily (Monday to Friday) from 9:00AM to 5:45PM. Star Agency Activiti Cut-off t Involve es Time Tim d e Current Day (t+0) 09:00AM PCHC Regular check clearing and processing window 04:30PM 09:00AM Various Start of PhilPaSS business hours Beginning balances generated for PhilPaSS- DDA Regular window for same day interbank transactions Posting/ Settlement of other DDA transactions (i.e. BTr and other Bangko Sentral departments) ▪ Bank payment of OLF converted from ILF availed (t-0) 11:00A ▪ Bangko Sentral ECWS transactions M ▪ Cash deposits with Bangko Sentral Head Office and Regional Offices 01:00PM ▪ ATM transactions 02:00PM ▪ BTr-GS sale/ purchase via DvP 04:00PM ▪ PCHC-EPCS results - do - ▪ PDS Settlement Highway for GS-eDvP - do - ▪ BSP-DLC Collection of OCL availed (value t-0) - do - ▪ PDS Settlement Highway for USD sale/ purchase of Peso-leg) via PvP 05:00P ▪ Interbank borrowing/ lending M ▪ E-Rediscounting 05:45PM ▪ PESONet and InstaPay - do - - do - 05:45P M 09:00AM BTr Banks’ availment of ILF loan 10:00A M 10:01AM BSP-TD Grant/ Credit of ILF loan proceeds to bank’s 05:00PM DDA Collection (on demand) of ILF loan 05:00PM availed 10:00AM BSP-TD Bangko Sentral Monetary Operations: ▪ TDF (bid submission at 9:30AM) 10:30AM ▪ Outright GS purchase and sale 05:00PM ▪ OLF/ Conversion of unpaid ILF to OLF 05:15PM ▪ ODF 05:30PM 10:00AM BSP-PSO PhilPaSS settlement cut-off of Bangko Sentral TDF, Outright GS purchase and 05:45PM sale/ OLF/ ODF 04:30PM BSP-PSO Posting of PCHC ECCS results 04:45PM 04:30PM BSP-TD Bangko Sentral Money Operations – Overnight RRP 05:00PM 04:30PM BSP-PSO PhilPaSS settlement cut-off of Bangko Sentral Overnight RRP 05:45PM 04:45PM BSP-PSO Interbank window for end-of-day liquidity/ reserve position 05:45PM 06:00PM BSP-PSO PhilPaSS close of business 06:00PM BSP-PSO Release of final copy of PhilPaSS DDA balance via MT950 (end-of-day DDA 06:30PM balance before AM returns clearing) 57 PHILIPPINES Release of notice to PCHC of the amount available for settlement fo the bank’s clearing losses, if greater than DDA 06:00PM PCHC Receipt of Bangko Sentral notice of the amount available for settlement of the 06:30PM bank’s clearing losses, if greater than DDA Next Day (t+1) – Normal Conditions 02:00AM PCH Returned COCI receiving window 08:00AM C 06:30AM BSP-PSO Posting/ settlement of previous day's billing before "open for business" 08:55AM 08:01AM BSP-PSO Posting/ settlement of PCHC AM returns (back value t+0) 08:15AM 08:16AM BSP-PSO Interbank trading and settlement window for losses in AM returns (back value 08:59AM BSP-DLC t+0) Availment of OCL by Banks (back value t+0) 08:59AM BSP-TD Bangko Sentral-OLF window for losses in AM returns (back value t+0) 08:45AM 08:16AM BSP-PSO PhilPaSS settlement cut-off of Bangko Sentral OLF (back value t+0) 08:59AM 09:00AM BSP-PSO DDA balances (t+0) available on demand via PhilPaSS Participant Browser (PPB) 09:00AM 09:00AM BSP-PSO PhilPaSS business hours (value t+1) 05:45PM Next Day (t+1) – Abnormal Conditions Extended End-of-Day Procedures 02:00AM PCHC Returned COCI receiving window 08:00AM 08:01AM BSP-PSO Posting/ settlement of PCHC AM returns (back value t+0) 08:15AM 08:16AM BSP-PSO Interbank trading and settlement window for losses in AM returns (back value 09:59AM 08:16AM BSP-DLC t+0) Availment of OCL by Banks (back value t+0) 09:59AM BSP-TD Bangko Sentral Monetary Operations trading window on an extended EOD basis (back value t+0) ▪ Overnight RRP (bid submission at 08:16AM) 09:30AM ▪ OLF 09:30AM ▪ ODF 09:30AM ▪ TDF 09:30AM 08:16AM BSP-PSO PhilPaSS settlement of Bangko Sentral OLF, ODF, TDF and RRP (back-value t+0) 09:59AM 10:00AM BSP-PSO DDA balances (t+0) available on demand via PhilPaSS Participant Browser (PPB) 10:00AM 10:01AM BSP-ITSS Housekeeping procedures 12:59PM 01:00PM BSP-PSO PhilPaSS business hours (value t+1) 05:45PM Source: PhilPaSS Primer 58 PHILIPPINES ANNEX 2 Pricing structure of PhilPaSS Types of Fees Fees A. Transaction Fees Transaction Value Fee per Transaction 1. Interbank (Debits) PhP 1.00 – 100.00 FREE 2. Peso-Leg of USD Trade Transactions 101.00 – 500,000.00 PhP 5.00 (Payment vs Payment) 500,001.00 – 1,000,000.00 PhP 10.00 3. Settlement of GS Trade Transactions (Delivery vs Payment) BTr-GS/ FIE/ Equities Ad Valorem Fee 1,000,001.00 – 39,999,999.99 = Trans. Value x .00001 4. PCHC Transactions (Win/ Loss) (rounded to the nearest Peso) 5. ATM Network Transactions 40,000,000.00 and above PhP400.00 6. Manual Processing of Interbank Transactions PhP1,000.00 + Ad Valorem Fee = TV x 0.00001 or PhP5,000.00, whichever is lower B. Other Fees 1. Membership Fee FREE 2. Smart Card Kit (new/ renewal) PhP 1,200.00 per kit 3. Online Transaction Inquiries Via SWIFT - PhP100.00 per inquiry Via PhilPaSS Participant Browser (PPB) – FREE 4. SOA Request (Printout) Via SWIFT - PhP100.00 per inquiry Via PhilPaSS Participant Browser (PPB) – FREE 5. Third-Party Systems Monthly Access/ Primary Back-up Connection Fee ▪ PCHC FREE FREE ▪ BancNet ▪ PSSC ▪ Bureau of the Treasury Source: PhilPaSS Primer 59