Settlement Risk Due to Insolvency of a Participant
This chapter explains what happens when any of the participants in a Nexus payment goes into insolvency (a default) whilst a payment has not reached legal finality yet. These scenarios relate to a party going into insolvency in the window of time between settlement finality in the first leg of the payment and the settlement finality in the second leg of the payment.
Settlement Finality is a legal concept, and this chapter does not address the variety of legal implications in the various jurisdictions where Nexus might operate. An assessment of local legislation in each jurisdiction is necessary to conclude on exact settlement risks. This chapter merely provides an overview of the general legal concepts within the context of Nexus.
In practice, the scenarios below would be rare, and impacts are likely to be limited, because:
- It is rare for a bank to declare insolvency and cease operating; a rescue that allows the bank to continue operating is more likely
- If the scenario does occur, it will affect payments that were initiated before the insolvency was announced and have not yet been completed. Because most Nexus payments would achieve finality simultaneously with the processing of the payment in IPS and the processing completes within 60 seconds, this is a very small window and would affect a limited number of payments by that specific bank (or Liquidity Provider). (This assumes that the insolvent bank ceases sending new Nexus payments as soon as it declares insolvency.)
- In most IPS schemes, a pre-funding arrangement means that even if a bank does fail, there are funds set aside to cover that banks” payment. In these cases, the Recipient may suffer a delay to the payment, but not a total loss.
This is the most likely case, where settlement finality is obtained in the first leg of the payment (in the Source Currency), before settlement finality is achieved in the second leg in the Destination country. The following scenarios take place while the payment is in flight between the Source IPS and Destination IPS (ie processed and settled in the Source IPS, but not yet processed or settled in the Destination IPS).
In the scenario where legal finality is obtained in the Destination IPS prior to the Source IPS, the situation and risks may change. This scenario can occur if the Source IPS is on a deferred settlement cycle without a comprehensive pre-funding or collateral regime to cover insolvency of a member. As the Destination Bank has successfully credited the Destination Bank account holder in this scenario, returns are not applicable.