Hong Kong Dollar Clearing House Automated Transfer System (HKD CHATS)

Assessment of Compliance with the Core Principles for Systemically Important Payment Systems

December 2010 Hong Kong Monetary Authority

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Table of Contents

A Introduction............................................................................................................4 B Background of HKD CHATS ................................................................................5 C Oversight................................................................................................................9 D Assessment Methodology ......................................................................................9 E Assessment of Each Core Principle .....................................................................10 I. Core Principle I: Legal Basis ...............................................................................10

I.1. Assessment of compliance...................................................................10 I.2. General statues and regulations ...........................................................10 I.3. Clearing and Settlement Systems Ordinance (CSSO) ......................... 11 I.4. Contractual provisions and regulations................................................12 I.5. Other applicable laws...........................................................................13

II. Core Principle II: Understanding of Financial Risks...........................................14 II.1. Assessment of compliance...................................................................14 II.2. Documentation for understanding financial risks ................................14 II.2.1. Scope of rules and procedures .............................................................14 II.2.2. Governance process for amendments to rules and procedures ............15 II.3. Financial risks addressed or presented by the HKD CHATS ..............15 II.3.1. Settlement risk .....................................................................................15 II.3.2. Credit risk.............................................................................................16 II.3.3. Liquidity risk........................................................................................16 II.3.4. Operational risk....................................................................................16 II.4. Notification of operational issues affecting the system .......................17

III. Core Principle III: Management of Credit and Liquidity Risks ..........................18 III.1. Assessment of compliance...................................................................18 III.2. Management of credit risk ...................................................................18 III.2.1. Credit risk to the SI ..............................................................................18 III.2.2. Credit risk to participants.....................................................................18 III.3. Management of liquidity risk...............................................................19 III.3.1. Liquidity risk to the SI .........................................................................19 III.3.2. Liquidity risk to participants ................................................................19 III.4. Tools for managing credit and liquidity risks ......................................19 III.4.1. Participation criteria.............................................................................19 III.4.2. Throughput guideline...........................................................................20 III.4.3. System design and features..................................................................20 III.4.4. System devises for managing liquidity ................................................21 III.5. Incentives to manage credit and liquidity risks....................................22 III.5.1. Free intra-day liquidity ........................................................................22 III.5.2. No loss sharing in case of a failure of settlement of a payment ..........22 III.6. Enhancement/Improvement area(s) .....................................................23

IV. Core Principle IV: Prompt Final Settlement ........................................................24 IV.1. Assessment of compliance...................................................................24 IV.2. Settlement finality and irrevocability...................................................24 IV.3. Processing of payments and system cut-off times ...............................25 IV.3.1. Submission of payments and cut off times ..........................................25 IV.3.2. Payment settled on an RTGS basis ......................................................25 IV.3.3. Re-sequence and cancellation of payment instructions .......................26

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IV.4. Payments settled on multilateral netting basis .....................................26 V. Core Principle V: Settlement in Multilateral Netting Basis .................................28

V.1. Assessment of compliance...................................................................28 V.2. Completion of settlement in the event of bank default ........................28 V.3. Enhancement/Improvement area .........................................................28

VI. Core Principle VI: Settlement Assets...................................................................30 VI.1. Assessment of compliance...................................................................30 VI.2. Settlement in central bank money........................................................30

VII. Core Principle VII: Security and Operational Reliability....................................31 VII.1. Assessment of compliance...................................................................31 VII.2. Arrangements of the SI ........................................................................31 VII.3. Arrangements of the SO.......................................................................31 VII.3.1. Security policy objectives ............................................................31 VII.3.2. Overall security controls ..............................................................32 VII.3.3. Physical and logical access controls ............................................32 VII.3.4. Operational reliability ..................................................................33 VII.3.5. Business continuity arrangements................................................34 VII.3.6. Manpower contingency................................................................35

VIII. Core Principle VIII: Efficiency............................................................................36 VIII.1. Assessment of compliance...................................................................36 VIII.2. Economic benefits................................................................................36 VIII.3. Service practicality and system flexibilities ........................................36 VIII.4. Pricing policy .......................................................................................37 VIII.5. Cost efficiency measures .....................................................................37 VIII.6. User consultation .................................................................................37

IX. Core Principle IX: Access Criteria.......................................................................38 IX.1. Assessment of compliance...................................................................38 IX.2. Access to the HKD CHATS.................................................................38 IX.3. Exit from the HKD CHATS.................................................................39 IX.4. Public disclosure of access to HKD CHATS .......................................39 IX.5. Enhancement/Improvement area(s) .....................................................40

X. Core Principle X: Governance .............................................................................41 X.1. Assessment of compliance...................................................................41 X.2. Governance Structure of the HKD CHATS .........................................41 X.2.1. Hong Kong Monetary Authority..........................................................41 X.3. Hong Kong Interbank Clearing Limited ..............................................41 X.3.1. Board Responsibilities .........................................................................42 X.4. Accountability of the SO .....................................................................42 X.5. Transparency of the HKD CHATS ......................................................43 X.6. Enhancement/Improvement Area(s) ....................................................43

F Overall Assessment Summary .............................................................................44 Annex 1 Annex 2

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A Introduction

Hong Kong Dollar Clearing House Automated Transfer System (“HKD CHATS”) is the interbank payment system in Hong Kong for settling Hong Kong dollar (“HKD”) transactions. The system, which is owned by the Hong Kong Monetary Authority (“HKMA”), enables participants1 to effect payments in central bank money under Real Time Gross Settlement (“RTGS”) mode. The system commenced operation on 9 December 1996. The HKD CHATS was deemed designated under the Clearing and Settlement Systems Ordinance (“CSSO”) on 4 November 2004 and was granted a certificate of finality under the CSSO to provide settlement finality within this system. Since then, all transactions settled through the HKD CHATS are irrevocable and final, and have statutory backing to settlement finality. Apart from complying with the safety and efficiency requirements under the CSSO, the HKD CHATS is also encouraged to comply with internationally recognized standards on the payment and settlement systems (e.g. the Core Principles for Systemically Important Payment Systems issued by the Committee on Payment and Settlement Systems of the Bank for International Settlements (“Core Principles”) in January 20012. The objective of this assessment is thus, based on the available information up to end-September 2010, to evaluate how best the HKD CHATS comply with the Core Principles. This assessment report is published in full with a view to further enhancing the transparency of the HKD CHATS operation and oversight activities conducted by the HKMA. The report is organised as follows: Section B briefly summarizes the background of the HKD CHATS. Section C explains the oversight of the system. Section D explains the assessment methodology, and Section E contains the detailed assessment of the HKD CHATS against each Core Principle. Where appropriate, the PSO team will recommend on areas suggesting enhancement/improvement. Section F is an overall summary of the HKD CHATS’ compliance with the Core Principles. Annex 1 provides the list of abbreviations used in this report and Annex 2 provides the list of references.

1 Participants and member banks are interchangeable descriptions in this assessment. 2 Information regarding the Core Principles can be found at http://www.bis.org/publ/cpss43.htm.

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B Background of HKD CHATS

Overview B.1 The HKMA exercises authority delegated by the Financial Secretary (“FS”) of the Hong Kong Special Administrative Region (“HKSAR”), among other things, to maintain monetary and banking stability in Hong Kong. One of the mandates of the HKMA is to enhance the efficiency, integrity and development of the financial system, particularly payment and settlement arrangements. Over the years, Hong Kong has developed a sound financial infrastructure expediting economic transactions and financial intermediation in the region based on a multi-currency, multi-dimensional platform, and introduced a number of improvements to smooth payment flows and enable banks to use liquidity more efficiently. B.2 The HKD CHATS commenced operation on 9 December 1996. It is a Hong Kong dollar payment system which can be used for settling both interbank and retail payments. B.3 The HKD CHATS is deemed designated under the CSSO on 4 November 2004, and thus the settlement of transactions made through the system is final and irrevocable. Effective on the same date, the system was also granted a certificate of finality, in view of its compliance with the safety and efficiency requirements under section 7(1) of the CSSO. The certificate of finality provides statutory backing to the finality of settlement for transactions settled through the system. This finality is protected from insolvency laws and other laws by the CSSO. Settlement institution and system operator B.4 The settlement institution (“SI”) for the HKD CHATS is the HKMA through its Payment Systems Operation Division (“PSOD”) of the Financial Infrastructure Department (“FID”). The SI in turn appoints Hong Kong Interbank Clearing Limited (“HKICL”), which is jointly owned by the HKMA and Hong Kong Association of Banks (“HKAB”), as the system operator (“SO”) of the HKD CHATS. The HKAB is the association of the banks in Hong Kong which represents the interests of the banking community. Participation B.5 The participation of HKD CHATS is mandatory to licensed banks in Hong Kong, which are required to maintain a settlement account with the HKMA. As stipulated in Section 3A(1) of the Exchange Fund Ordinance (“EFO”), the FS may by notice require an authorized institution in Hong Kong to open a settlement account with the HKMA. The account is required to be

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maintained and operated on the terms and conditions considered appropriate by the FS. The FS has delegated this power to the HKMA. Restricted licence banks are also allowed to access to HKD CHATS, provided that they have demonstrated a business need to do so. The HKMA can also exercise discretion to approve other financial institutions to access to the HKD CHATS. Only one discretion was made by the HKMA to allow CLS Bank to maintain a settlement account with the HKMA to facilitate the HKD to be one of the eligible settlement currencies in the CLS system. The HKD CHATS has been operating smoothly. There have been no court proceedings since the inception of the system. As of end-September 2010, there were 143 entities have settlement accounts with the HKMA directly participating in the HKD CHATS. Types of payments B.6 The system can be used for settling both interbank and retail payments. Interbank payments are settled continuously in RTGS mode on a deal-by-deal basis across the book of the HKMA without netting. In addition to settling large-value transactions, the HKD CHATS also provides clearing and settlement of bulk clearings of stock market transactions (known as the CCASS items 3 ), paper cheques, and low-value electronic payment items (including auto-pay items, EPSCO items, JETCO items and credit card items (hereafter collectively referred as “bulk items”). All the bulk items (except same day auto-credit items, EPSCO and JETCO items) are settled on the next working day (a day other than a Saturday and general holiday) and on a multilateral netting basis. System structure B.7 The system is composed of a Settlement Account Processor (“SAP”), an Inter-bank Fund Transfer Processor (“IFTP”), which is interfacing with a currency-oriented Cross Currency Payment Matching Processor (“CCPMP”), and the multi-currency Central Moneymarkets Unit Processor (“CMUP”). IFTP is a computer system designed to real time process interbank fund transfer transactions. SAP holds settlement accounts for all member banks. All interbank fund transfer transactions are processed by IFTP and then routed to SAP for posting and settlement. CCPMP is used to facilitate the matching and settlement of foreign exchange transactions on a payment versus payment (“PvP”) basis. The HKD CCPMP handles USD/HKD, EUR/HKD and RMB/HKD foreign exchange PvP transactions. The linkage with the CMUP is to support intra-day and overnight repo transactions through which members can obtain intraday liquidity or overnight funding if needed. 3 There are two types of payment instructions for CCASS items: one for CCASS participants which

are mainly financial institutions and another for individual CCASS investor account holders (“IAH”) generated by the Hong Kong Securities Clearing Company Limited (“HKSCC”).

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B.8 The participants of the HKD CHATS have to connect to the SWIFT network in order to access HKD CHATS to initiate/receive payment instructions. The participants are also required to access the eMBT provided by the HKICL to perform payment control, payment enquiry and other administrative functions. The communication between the HKD CHATS and its participants is based on SWIFT4 messaging standards and services. eMBT is a browser-based system, which can be accessed through SWIFT Browse and InterAct service.

System links B.9 The HKD CHATS has established system linkages with Central MoneyMarkets Unit (“CMU”), a debt securities clearing and settlement system operated by the HKMA, and other foreign currency CHATSs in Hong Kong to provide delivery-versus-payment (“DVP”) and PvP settlement services respectively. Other than the DvP and PvP links, the system has some form of linkage arrangements with other payment systems in the Mainland and Macau. In particular, it has established arrangements with Shenzhen and Guangdong settlement centres for cross-border funds transfer and HKD cheque payments in Guangdong. The system has also established a HKD cross-border payment arrangement with China’s domestic HKD payment system located in the Mainland since March 2009, through which the cross-border HKD payments can be made in a more structural and efficient manner5. Specifically, the People’s Bank of China appointed one commercial bank in the Mainland as the “SI in the Mainland” (“MSI”) for China’s domestic HKD payment system to settle HKD payments with receiving/beneficiary banks in the Mainland. This MSI in the Mainland, in turn, appointed one agent bank in Hong Kong to settle HKD payments sent to or received from it via the agent bank’s settlement account maintained at HKD CHATS. The agent bank in Hong Kong in relation to the link will be to act as both (i) the agent for the MSI and (ii) as the correspondent bank of the banks in the Mainland making or receiving payments. Operations

4 SWIFT is Society for Worldwide Interbank Financial Telecommunication. 5 To facilitate fund transfer and settlement services to the participating banks in the Mainland and

Hong Kong, a linkage between the HKD CHATS in Hong Kong and China’s domestic HKD payment system in the Mainland has been established since March 2009. These are not PvP links. The People’s Bank of China appointed one commercial bank in the Mainland as the “SI in the Mainland” (“MSI”) for China’s domestic HKD payment system to settle HKD payments with receiving/beneficiary banks in the Mainland. This MSI in the Mainland, in turn, appointed one agent bank in Hong Kong to settle HKD payments sent to or received from it via the agent bank’s settlement account maintained at HKD CHATS. The agent bank in Hong Kong in relation to the link will be to act as both (i) the agent for the MSI and (ii) as the correspondent bank of the banks in the Mainland making or receiving payments. The type of linkages are essentially a correspondent banking payment arrangement with no interdependency between the HKD payment made within the HKD CHATS in Hong Kong and its subsequent HKD payment to the Mainland.

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B.10 The system operates from 08:30 to 18:30 hours Hong Kong time (GMT+8) on all business days from Monday to Friday.6 Interbank payment instructions are settled immediately if there is sufficient balance in the settlement accounts. Banks without sufficient credit balances in their settlement accounts have their payment instructions queued in the system. Alternatively, the banks can make use of the seamless interface between the HKD SAP and the CMUP to sell and repurchase their Exchange Fund (“EF”) papers during the day in the form of intraday repo transactions to obtain interest-free liquidity from the HKMA. EF papers, including EF bills and EF notes, are debt securities issued by the HKMA on behalf of the HKSAR. Provision of System Liquidity B.11 While no daylight overdraft is allowed, participants of the system can arrange with the HKMA to obtain liquidity through an intraday repurchase (“repo”) facility. Within the day, if participant does not have a sufficient balance to effect outgoing payments but has sufficient holdings of EF paper, the system can automatically trigger an intraday repo transaction to generate the required amount of credit balance to cover the short position. The repo can be repaid at any time during the day up to 18:30 hours. Intraday repos not being repurchased before the close of business will be rolled over into overnight borrowing under the Discount Window (“DW”)7, in which interest is charged by the HKMA. Apart from this facility, a member bank can make use of the EF paper to arrange overnight repos with the HKMA through the DW if required. Pricing Policies B.12 The HKD CHATS adopts a user-pay principle without subsidies. The service fee (i.e. tariff) is charged on a transaction basis with a minimum monthly amount. The SO collected the tariff on behalf of the SI. The tariff is determined mainly to aim at recovering the actual costs incurred in the provision of services. The tariff is being reviewed annually. Governance B.13 The SI, SO and the system participants are required to strictly adhere to the rules and operating procedures as stipulated in the HKD Clearing House Rules (“Rules”) and the Operating Procedures (“Procedures”). In addition, the participants are required to comply with the terms and conditions in the account opening form and other documents as specified by the SI and the 6 During the above operating hours, participants can settle their payments. Nonetheless, the HKD

CHATS is available around-the-clock during Monday to Sunday for transaction input, except during pre-scheduled system housekeeping tasks.

7 In Hong Kong, Discount Window is the facility through which banks can borrow Hong Kong dollar funds overnight from the HKMA through repurchase agreements using eligible securities as collaterals.

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SO. Separately, as the HKD CHATS is designated under the CSSO, all parties of the system also have to adhere to the relevant provisions under the CSSO. Major system changes: Migration to SWIFTNet platform B.14 All domestic designated systems in Hong Kong, including the HKD CHATS, have migrated to the SWIFTNet platform from the proprietary platform since July 2010. The migration is to make use of the messaging infrastructure and message standards provided by the SWIFT, a global messaging carrier. The migration helps to improve compatibility with other overseas payment and settlement systems and makes it more convenient for overseas financial institutions to participate in Hong Kong’s payment and settlement systems. It can achieve economies of scale as one set of messaging infrastructure and standards can be used for both local and overseas payments and securities transfers. System Turnover B.15 In the first nine months of 2010, the system settled, on a daily basis, an average of about 21,000 RTGS transactions involving a total value of HKD513 billion and 800,000 bulk items involving a total value of HKD177 billion. Of the bulk items, the daily turnover volume and value of paper cheque accounted for around 57% and 16% respectively of the total turnover volume and value of bulk items.

C Oversight

C.1 HKD CHATS was deemed designated under the CSSO on 4 November 2004 and is subject to the statutory oversight of the HKMA (via the Payment Systems Oversight (“PSO”) team) of the Payment Systems Oversight and Licensing Division (“PSOLD”)). The PSO team oversees the HKD CHATS through off-site reviews, continuous monitoring, on-site examinations, meetings with management, etc. In addition to the compliance with the requirements as stipulated under the CSSO, the HKD CHATS is encouraged to comply with internationally recognized standards related to the payment and settlement systems.

D Assessment Methodology

D.1 The assessment of the HKD CHATS in this report is made against the Core Principles. A list of abbreviations used in this report is provided in Annex 1. The assessment is prepared with reference to the relevant documents (Annex 2) provided by the SI, the SO and through other

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public sources based on available information up to end-September 2010. In addition to the Core Principles, the assessment also makes reference to the “Guidance Note for Assessing the Observance of Core Principles for Systemically Important Payment Systems” issued by the International Monetary Fund and the World Bank, and the payment systems oversight experience accumulated by the HKMA over the years. In making the assessment, information and views have been sought from both the SI and the SO.

E Assessment of Each Core Principle

I. Core Principle I: Legal Basis

The system should have a well-founded legal basis under all relevant jurisdictions. I.1. Assessment of compliance The HKD CHATS observes Core Principles I. Hong Kong laws provide a comprehensive, well-established and publicly disclosed legal framework for the HKD CHATS. The statutes, regulations and contractual provisions clearly define the rights and obligations of each party to the system. The legal framework also provides participants statutory assurance for the settlement and finality of funds settled in the HKD CHATS. I.2. General statues and regulations The laws of Hong Kong form the legal basis to the operations of the HKD CHATS, supplemented by other statutes, regulations and contractual provisions. All the relevant documents are governed by Hong Kong laws and are legally binding and enforceable. I.2.1. Exchange Fund Ordinance The EFO provides the legal basis for establishing and accessing to the HKD CHATS. One of the mandates of the HKMA is to help maintain Hong Kong’s status as an international financial centre, including the maintenance and development of Hong Kong’s financial infrastructure. Appointed under the EFO, the Monetary Authority (“MA”)8 exercises authority delegated by the FS of the HKSAR to perform various functions as stipulated at the EFO, including the maintaining and promoting Hong Kong’s financial infrastructure. The

8 The Exchange Fund Ordinance empowers the Financial Secretary to appoint a Monetary Authority

and staff to assist him. The office of the Monetary Authority is known as the Hong Kong Monetary Authority, and the Monetary Authority as the Chief Executive of the Hong Kong Monetary Authority.

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establishment of the HKD CHATS in 1996 by the HKMA is one of these initiatives with a view to further promoting the safety and efficiency of the clearing and settlement of HKD payments. According to section 3A(1) of the EFO, the FS may by notice in writing served on an authorized institution requires that institution to open a settlement account with the MA for the account of the Exchange Fund. As such, a notice has been issued to each licensed bank requiring them to open a settlement account with the MA for the account of the Exchange Fund. All settlement is effected across the books of the MA in accordance with such terms and conditions as the FS of the HKSAR considers appropriate (having regard to how the Exchange Fund may be used under the EFO.) I.3. Clearing and Settlement Systems Ordinance (CSSO) The CSSO was enacted in 2004 and empowers the HKMA to designate and oversee clearing and settlement payment systems that are material to the monetary or financial stability of Hong Kong, or to the functioning of Hong Kong as an international financial centre. Since the enactment of the CSSO, the HKD CHATS is deemed designated and subject to the oversight of the HKMA (via its PSO team). I.3.1. Certainty of irrevocability and settlement finality Under the CSSO, the settlement finality regime is to provide statutory protection of the transfer orders settled through eligible designated systems from the insolvency and other laws in Hong Kong, and, where private international law rules of Hong Kong are applicable, from the equivalent laws of a place outside Hong Kong. This is to ensure that transfer orders settled through such a designated system are irrevocable and will not be reversed by the insolvency of a participant in such system, whereas any rights resulting from the underlying transaction of any such transfer order will be preserved. The HKMA will issue a certificate of finality to a designated system if the ultimate settlement of transfer orders is effected within the system and the system is in compliance with the safety and efficiency requirements of the CSSO. The HKD CHATS is deemed designated under the CSSO on 4 November 2004 and a certificate of finality was issued to the HKD CHATS on the same day. Notwithstanding any law to the contrary, a court in Hong Kong shall not recognize or give effect to an order of a court exercising jurisdiction under the law of insolvency in a place outside Hong Kong or an act of a person appointed in a place outside Hong Kong to perform a function under the law of insolvency there, in so far as the making of the order or doing of the act would be prohibited under the CSSO for a court in Hong Kong or a relevant insolvency office-holder in Hong Kong. In other words, Hong Kong courts

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will not recognise or give effect to an order of a foreign court, or an act of a foreign insolvency office-holder relating to the bankruptcy, winding up or insolvency of a person where a court or relevant insolvency office-holder in Hong Kong is prohibited from making such order or doing such act. Therefore, all transactions settled through the HKD CHATS are irrevocable and final, and enjoy statutory backing to settlement finality from 4 November 2004 onwards. The Rules state the time and conditions of irrevocability and finality of a transfer order. Once a payment is debited or credited to the settlement account, it shall be deemed made, completed, irrevocable and final. I.4. Contractual provisions and regulations I.4.1. Contractual provisions between SI and SO The SI appointed the HKICL as its SO of the HKD CHATS to operate the HKD CHATS. The appointment of the SO was made known to the general public. The terms and conditions of the clearing arrangements are specified in the Services Agreement and various addendums (“Services Agreement”) signed between the HKMA and the HKICL. An addendum would be made available when there are changes to the Services Agreement, usually arising from the introduction of new services and/or new technical systems and infrastructure. The amendment being made to cater for the migration of the HKD CHATS from a proprietary platform to SWIFT infrastructure in July 2010 was an example. I.4.2. Contractual provisions with system participants As a condition of participating to the HKD CHATS, participants are obliged to comply with the operating and technical requirements as stipulated by the SI and SO. As mentioned in paragraph B.5, the FS may require banks in Hong Kong to join the system and maintain a settlement account with the SI on a mandatory basis while restricted licence banks in Hong Kong may apply for participation on a need basis. The respective duties and obligations of the SI and the participants in respect of the settlement accounts are set out in the “Conditions Governing Access to the RTGS Payment System”. Each HKD CHATS participating bank (“CHATS participant”), the SI and the SO are bound by the Rules. The Rules constitute a contract among the SI, the SO, and each CHATS participant and among the CHATS participants, and set out the rights and obligations of each party. Each CHATS participant is required to sign a confirmation agreeing to be bound by the Rules before it can access to the system. The Rules may be amended from time to time, and all amendments to the Rules have to be approved by the SI and the HKMA (via the PSO team) as the overseer of the system. Furthermore, the Rules specify that the SO is entitled to issue Procedures to specify the detailed procedures for the operation of the HKD CHATS. The Procedures, on the other hand, specify in

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plain language and in detail the system features, operating schedules, contingency measures, etc. The Procedures form part of the Rules and are legally binding among the SI, the SO, and each CHATS participant and among the CHATS participants. The Rules specify that each CHATS participant, the SI and the SO shall comply with all obligations under CSSO and all directions and regulations made by the HKMA as the overseer of designated systems under the CSSO, as may be applicable to each of them. The legal status of the CHATS participant is ensured as the EFO states that only banks in Hong Kong are entitled to become members of the system. All the CHATS participants, which are banks in Hong Kong, are indeed subject to the supervision by the HKMA under the Banking Ordinance (“BO”). Non-bank institutions or banks located overseas can join the HKD CHATS and would be considered by the SI on a case-by-case basis. I.4.3. Contractual provisions for liquidity The SI provides liquidity for CHATS participants of the system through repo arrangements. In order to obtain liquidity from the SI, each CHATS participant of the HKD CHATS enters into “Master Sale and Repurchase Agreements” with the SI, which allow a CHATS participant to obtain liquidity from the SI through repo arrangements. The agreements set out the terms and conditions for intraday repo and overnight repo transactions. I.5. Other applicable laws I.5.1. Provisions for electronic transactions The HKD CHATS operates in an electronic mode. The Electronic Transactions Ordinance (“ETO”) in Hong Kong facilitates the use of electronic transactions for commercial and other purposes. It gives electronic records and digital signatures used in electronic transactions the same legal status as that of their paper-based counterparts. Section 9 of the ETO provides that subject to any rules of evidence an electronic record shall be admissible in evidence in any legal proceeding. There is no provision in Hong Kong insolvency law equivalent to the “zero-hour” rule9 or similar rules which would result in the member banks or the HKD SI being required to reverse a debit from or credit to the member banks’ HKD settlement accounts with the SI. 9 The zero-hour rules in the context of a payment system refer to a provision in the insolvency law of

some countries whereby all transactions of a bankrupt participant that have taken place after the start of the day of the bankruptcy (or similar even) may be retroactively rendered ineffective.

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II. Core Principle II: Understanding of Financial Risks

The system’s rules and procedures should enable participants to have a clear understanding of the system’s impact on each of the financial risks they incur through participation in it. II.1. Assessment of compliance The HKD CHATS observes Core Principles II. The rules and procedures and other relevant documents are clear and permit participants to understand the financial risks resulting from participation in the system. These documents define the rights and obligations of the involved parties and are available to the participants. II.2. Documentation for understanding financial risks The Rules and Procedures, Conditions Governing Access to the RTGS Payment System and the Master Sale and Repurchase Agreements permit CHATS participants to understand the financial risks resulting from participation in the HKD CHATS. These documents set forth the obligations and responsibilities of, and therefore the financial risks to, each CHATS participant, the SI and the SO relating to participation in the system. The documents are made available to each CHATS participant when joining the system. A new version will be distributed to all CHATS participants and posted to the secure website of the SO when there are amendments being made to the Rules and/or Procedures. II.2.1. Scope of rules and procedures The Rules establish the overall legal framework that governs the clearing and settlement arrangement of the various types of services provided in the HKD CHATS. Among other things, the Rules specify: (i) the responsibilities and indemnity of HKICL as the SO for the HKD

CHATS; (ii) rights and responsibilities of participants for participating in the system,

and conditions and deadlines to re-sequence and/or cancel payments; (iii) conditions for settlement of payments; (iv) reasons for which the SO may refuse providing and/or suspend clearing

facilities for a clearing house member; (v) circumstances to extend system cut-off time and trigger other

contingency measures; (vi) the flow to process bulk items, and default arrangements for bulk items;

and (vii) commencement times for various bulk item settlement runs and various

cut-off times of the system.

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The Procedures form part of the Rules and are also issued by the SO. The documents specify the detailed procedures for the operation of the CHATS and describe in detail the system features, operating schedules, and the contingency arrangements of the HKD CHATS. Specifically, the Procedures contain detailed description of each component and each function of the eMBT. The eMBT provides a platform for participants to perform payment enquiry, payment control and administrative functions. The layout of the screens, reports and other system messages are provided with explanation down to field by field level in the Procedures for eMBT. Moreover, each type of the bulk settlement run provided by the HKD CHATS has its own set of operating procedures, which describes comprehensively the processing flow for clearing and settlement of the bulk item, payment instruction and data file formats, contingency measures for each settlement run, etc. II.2.2. Governance process for amendments to rules and procedures Amendments to Rules and Procedures are subject to strict and formal requirements. The Rules and the Procedures will be amended (if necessary) to cater for new system features before a new system function is being introduced to the HKD CHATS. After consultation with legal professionals, the SO will provide the draft revised version and the necessary supporting documents where appropriate for review and approval by all the involved parties including the SI, HKAB and the PSO team. Following any amendments to the Rules and the Procedures, a revised version will be sent to the CHATS participants to keep them informed of the amendments and the effective date. The documents are also uploaded to SO’s website which is accessible to the CHATS participants. II.3. Financial risks addressed or presented by the HKD CHATS Participation in the HKD CHATS may inherently present financial risks. Apart from the legal risk as mentioned in the response to Core Principle I, the HKD CHATS may address or present other financial risks (including settlement risk, credit risk, liquidity risk and operational risk). In view of the existence of the financial risks, system design and/or contingency measures are in place to mitigate the financial risks. CHATS participants are expected to be aware of the possible financial risks of the HKD CHATS. The specified risks of the system are discussed as follows. II.3.1. Settlement risk The HKD CHATS mainly settles single leg large value transactions and PvP transactions. Retail payment items (including cheques, auto-pay transactions, low-value bulk electronic payment items (such as EPSCO and auto-credit), and low-value automatic teller machine transfers such as JETCO items) are also

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processed on a netting basis in the system. The single leg interbank payments are settled on RTGS basis without netting. As such, settlement risk is not applicable to this type of interbank payments as they are single type HKD payments without a corresponding payment of any kind made or settled (or to be made or settled). Through the established linkages with the USD, Euro and RMB CHATS in Hong Kong, the HKD CHATS provides PvP settlement for multi-currency foreign exchange transactions involving the HKD and DvP settlement of HK dollar denominated securities. Given these transactions are either settled in PvP or DvP mode, the settlement risk is eliminated. II.3.2. Credit risk The HKD CHATS is an RTGS system. The real-time processing feature and the nature of immediate finality insulate receiving CHATS participants from credit risks. In the other words, system inherent credit risks to the receiving CHATS participants (due to bankruptcy of the paying CHATS participants) do not exist. Given the SI is a monetary authority which performs the functions of a central bank, CHATS participants are deemed to be exposed to no credit risk when funds of the CHATS participants are held in their settlement accounts. The SI is virtually not exposed to credit risk as it only provides intra-day and overnight liquidity to CHATS participants via collateralised repo arrangements. The SI does not provide intra-day or overnight uncollateralised overdraft for CHATS participants. II.3.3. Liquidity risk CHATS participants are exposed to liquidity risk in the RTGS environment. Each participant has to ensure its settlement account has sufficient liquidity for settlement throughout the entire business day. The main sources of liquidity of a CHATS participant include the opening balances in the settlement accounts, incoming payments and intraday repo transactions. Nevertheless, liquidity may be exhausted if the CHATS participants failed to receive cover funding. The system design of the HKD CHATS and the various means of functions built in the system can help mitigate the liquidity risk. They are elaborated in the response to Core Principle III. II.3.4. Operational risk Operational problems, whether occur in the HKD CHATS itself or by the CHATS participants, may contribute to operational risk. Although the possibility of having an operational problem is mitigated by the system design and architecture (see response to Core Principle VII), an operational problem could lead to payment delays or necessitate operating-hour extension. The Rules and Procedures clearly specify the roles and responsibilities of CHATS participants, the SI and SO in exceptional situations, including the occurrence of different kinds of operational problems.

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II.4. Notification of operational issues affecting the system The CHATS participants are promptly informed of operational problems affecting the HKD CHATS, including changes to the operational timeline (such as an extension of system cut-off time) or problems experienced by the system or affecting numerous CHATS participants. This information is communicated to the CHATS participants by the SI or the SO in accordance with established procedures. Depending on the nature and time sensitivity of the information, the SI and/or the SO can make use of different means to communicate to the CHATS participants, including on-line real-time information via the eMBT, issuance of circulars, etc.

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III. Core Principle III: Management of Credit and Liquidity Risks

The system should have clearly defined procedures for the management of credit risks and liquidity risks, which specify the respective responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those risks. III.1. Assessment of compliance The HKD CHATS observes Core Principle III. Credit and liquidity risks to participants are managed principally through immediate payment finality and the provision of intra-day repo facility. In addition, the system design and a number of liquidity tools are in place to help participants managing liquidity. Furthermore, through monitoring and collateralisation requirement and interest charge on overnight borrowing, the SI provides incentives for efficient management of financial risks of the system. III.2. Management of credit risk III.2.1. Credit risk to the SI With a view to ensuring there is ample liquidity in the system, the SI provides intraday liquidity to CHATS participants through repo arrangements. The CHATS participants are required to enter into both a Master Sale and Repurchase Agreement for the purpose of providing intraday liquidity (“Master Intraday Repo”) and a Master Sale and Repurchase Agreement for use in connection with the operation of the Discount Window (“Master DW Repo”) before it can conduct repo transactions with the HKMA. The HKMA accepts only EF papers, which are issued by the HKMA on behalf of the HKSAR government which are deemed to bear no credit risk, as collaterals for intraday repo transactions. The actual amount of liquidity can be obtained by the borrowing CHATS participant is calculated based on the mark-to-market value of the collaterals and haircuts will also be applied at appropriate level. III.2.2. Credit risk to participants The RTGS nature of the HKD CHATS helps eliminate credit risks to participants. A payment instruction will be settled in central bank money with immediate finality if the paying participant has sufficient funds in its settlement account. As a result, credit risk to receiving participants is eliminated. All CHATS participants in Hong Kong (except CLS Bank) are subject to the on-going prudential supervision of the HKMA under the BO.

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III.3. Management of liquidity risk III.3.1. Liquidity risk to the SI The SI is a monetary authority which performs the function of a central bank and does not expose to liquidity risk. III.3.2. Liquidity risk to participants CHATS participants are able to manage their liquidity risks mainly through three different means - the usage of system liquidity management tools (which will be further discussed below); maintaining sufficient balance in their settlement accounts; and obtaining liquidity through arranging intraday repo transactions with the SI. With regard to intra-day repo transactions, they can be triggered either automatically or manually.10 Through the seamless linkage of the HKD CHATS to the CMU, an intraday repo transaction will be automatically triggered at a pre-set maximum amount if a CHATS participant is short of funds to effect payments, provided that there are sufficient collaterals. A CHATS participant can also arrange a manual intraday repo facility with the SI even when it has sufficient funds in its settlement account. A CHATS participant can re-purchase its securities under any outstanding intraday repo transactions at any time up to the conversion time, which is currently at 18:30 hours on Mondays and Fridays, on the same business day. If there is intraday repo(s) remains outstanding after the conversion time, the outstanding repo(s) will be automatically converted into “Discount Window Repo Transactions”, and the CHATS participant is required to pay interests at a pre-set rate. III.4. Tools for managing credit and liquidity risks III.4.1. Participation criteria As mentioned in response to Core Principle I, in normal cases, the CHATS participants of the HKD CHATS are banks in Hong Kong, which are subject to the prudential supervision by the HKMA under the BO. The HKMA is the authority responsible for all authorization matters, which include among others, authorization, suspension and revocation. Institutions which intend to carry on banking business or the business of taking deposits in Hong Kong are required to be authorized by the MA under the BO. While there are no specific financial requirements for participation in the HKD CHATS, an institution has to satisfy various criteria, including capital adequacy and 10 A participant must have signed both a Master Sale and Repurchase Agreement for the purpose of

providing intraday liquidity (Master Intraday Repo) and a Master Sale and Repurchase Agreement for use in connection with the operation of the Discount Window (Master DW Repo) before it can enter into an Intraday Repo Transaction with the MA. Once it has signed such Master Repo Agreements, the borrower can apply for Discretionary Intraday Repo Transactions in addition to the Automatic Intraday Repo facility.

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financial strength, in order to be authorized to conduct banking business in Hong Kong. III.4.2. Throughput guideline To encourage CHATS participants to make their payments in a timely and orderly manner, the SI has issued throughput guideline requesting all CHATS participants to release and settle interbank payments whose aggregate value for the day is not less than 35% by 13:30 hours and 70% by 16:30 hours. The SI will also monitor the payment flow of the CHATS participants. Where necessary, the SI will timely approach the CHATS participant(s) concerned if there are unusual payment activities (e.g. outstanding payments pending for settlement in the system for a long time, outstanding payments accumulated to a relatively high amount as compared to normal level. In case if the unusual situation intensifies, the SI may discuss the matter with other relevant HKMA units and consider whether further action is required. III.4.3. System design and features The HKD CHATS has built-in a number of system features to facilitate liquidity arrangement, among others, which include:

Real-time balance enquiry – a CHATS participant is able to enquire real-time information of payment activities to facilitate its funding arrangement, including settlement account balance, incoming payments pending settlement, outgoing payments pending funds, etc. A hard copy report can be generated for any movement of its settlement account balance (for either an increase or decrease of account balance due to an incoming payment or outgoing payment).

Queue management – the system design allows a CHATS participant

to manage the sequence of payments. Interbank payments can be inputted as either “normal queue” payments or “pending queue” payments. A CHATS participant is able to enquire the queue during the system operating hour and re-sequence the payments in the queue to facilitate its liquidity management. A normal queue payment will be settled immediately on a first-in-first-out queuing algorithm upon sufficient of funds being maintained in the settlement account. A pending queue payment will be held in the queue until it is moved to the normal queue or cancelled by the CHATS participant.

Gridlock detector – the SI can make use of the gridlock detector based

on pre-defined system logics to detect whether there are any payment gridlocks11 in the system. The SI will follow up with the concerned

11 A gridlock is a situation in which a number of banks are unable to settle with each other because

they are all awaiting incoming funds from each other.

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CHATS participants if payment gridlock is identified. Possible solution can be done via splitting payments into smaller values or through re-sequencing the payment queues. If a payment is not settled by the cut-off time of the system, it will be automatically cancelled.

Repo limit setting - each CHATS participant can pre-define the

amount to be triggered for each repo transaction to control the exposure and facilitate its liquidity management.

III.4.4. System devises for managing liquidity The SI has introduced a number of optimisers in the HKD CHATS with the purpose to enhance liquidity and settlement efficiency. These include: (i) RTGS Liquidity Optimiser (RLO), (ii) CHATS Optimiser, (iii) CCASS Optimiser and (iv) Cross-currency CHATS Optimiser. In addition to settling transactions in the conventional RTGS mode, these optimizers can settle RTGS transactions simultaneously on a multilateral offsetting basis, thereby reducing the gross amount liquidity required.12 By means of multilateral and bilateral netting, the optimizers have brought the combined advantages of the instantaneous settlement finality of RTGS systems and the liquidity efficiency of netting systems. A brief summary of the liquidity management mechanisms are discussed as follows:

(i) RTGS Liquidity Optimiser (“RLO”) – the mechanism allows

simultaneous gross settlement of selected transactions on an individual basis. A RLO run is activated automatically about every 30 minutes between 10:45 hours to 18:15 hours on each operating day. The RLO can also be manually triggered by the SI at any time during the system operating hour before CHATS Value Date cut-off at 18:35 hours. The queued payment transactions pending for settlement in the system are snapshot. The RLO will attempt to identify a pattern which can help offset and settle as many of the queued payment transactions as possible subject to pre-set criteria.

(ii) CHATS Optimiser – it aims at optimizing the liquidity of CHATS

participants on relatively high turnover IPO closing and refund days. It is a mechanism that allows settling specific interbank RTGS payments simultaneously in an offsetting manner against paper cheques and other settlement service items such as Autodeit and CCASS IAH items involved in the bulk settlement run at 14:15 hours.13 Paper cheques are

12 Legally, transactions settled on a simultaneously basis are still settled on a gross basis.

Mathematically, this mode of settlement has the effect of offsetting. 13 A participant should submit CHATS Optimiser payments using specific payment code so that the

payments could be extracted and only be settled simultaneously during the paper bulk settlement run.

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settled on each business day on a multilateral netting basis. When the value of paper cheques required to be settled is substantial, CHATS participants, having information on their net position of the amount for cheques settlement, can make use of the CHATS Optimiser to arrange offsetting CHATS payments to their counterparties during the paper cheque bulk settlement run. Such arrangement can help CHATS participants to manage their liquidity more efficiently and reduce the funding demand for meeting the settlement obligation in the paper cheque bulk settlement run.

(iii) CCASS Optimiser – Similar to the CHATS Optimiser, CCASS Optimiser

is a mechanism that allows settlement of CCASS bulk settlement transactions and specific interbank CHATS payments simultaneously in an offsetting manner during the CCASS bulk settlement run at 09:30 hours processed on each business day.14

(iv) Cross-currency CHATS Optimiser – To cater for the increasing demand

for fund recycling during Initial Public Offer activities and participants’ requirement of arranging foreign exchange transactions to meet their funding needs, Cross Currency CHATS Optimiser (“CCPO”) payment is introduced in HKD CHATS to improve the liquidity efficiency. The CCPO payment is a cross currency payment transaction and the payment will be settled simultaneously together with the paper cheque bulk clearing settlement run at 14:15 hours.

III.5. Incentives to manage credit and liquidity risks III.5.1. Free intra-day liquidity The provision of interest free intra-day repo to CHATS participants is an important measure to provide ample liquidity to the system. In normal situation, CHATS participants who triggered intra-day repo within the day will reverse the outstanding repo as otherwise the intra-day repo will be converted into overnight repo of which interest payment is required. III.5.2. No loss sharing in case of a failure of settlement of a payment There is no loss sharing arrangement in the HKD CHATS. In other words, in case of a failed settlement, the defaulted party will be fully liable for the failed payment. In this connection, each CHATS participant has a responsibility to ensure there is sufficient liquidity to effect their payments in a timely and orderly manner. 14 A participant should submit CCASS Optimiser payments using specific payment code so that the

payments could be extracted and only be settled simultaneously during the specific CCASS settlement run.

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III.6. Enhancement/Improvement area(s) While the SI has issued throughput guideline and CHATS participants are requested to comply with the required throughput ratios as specified in the guideline, the SI is encouraged to further specify any follow-up actions, apart from moral suasion, will be taken, in case a CHATS participant repeatedly failed in complying with these ratios. The follow-up actions (in case if adopted) may consider to be made known to the CHATS participants to further enhance transparency.

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IV. Core Principle IV: Prompt Final Settlement

The system should provide prompt final settlement on the day of value, preferably during the day and at a minimum at the end of the day. IV.1. Assessment of compliance The HKD CHATS observes Core Principles IV. Payments are settled across the book of the SI, which are final and irrevocable once the settlement accounts concerned have been so debited and credited. All interbank payments are settled on an RTGS basis, with payments value today being settled during the day. If a payment value today is not settled by the cut-off time of the value day, it will be automatically cancelled. The cut-off times of the system are clearly stated in the rules and procedures. IV.2. Settlement finality and irrevocability It is discussed in Core Principle I that the CSSO provides statutory settlement finality and irrevocability protection for the HKD CHATS. The HKD CHATS was deemed designated under the CSSO on 4 November 2004 and a certificate of finality was issued. All transactions effected through the HKD CHATS are irrevocable and final and have statutory backing to the settlement finality from 4 November 2004 onwards. The CSSO provides statutory backing to the finality of settlement for transactions made through the system by protecting the final settlement of transactions from insolvency laws or any other laws in Hong Kong. This is to ensure that transfer orders settled through the HKD CHATS are irrevocable and will not be reversed by the insolvency of a participant in the HKD CHATS, whereas any rights resulting from the underlying transaction of any such transfer order will be preserved. The processing of payment instructions at each cycle15 and the various system cut-off arrangements are well-documented. The Rules and Procedures specify the conditions and requirements for processing a payment under normal and abnormal circumstances. The time and conditions of irrevocability and the finality of a transfer order are also specified in the Rules. Specifically, the Rules stipulate that all payments effected through the HKD CHATS shall be settled by debiting or crediting the settlement accounts concerned through the system, and once debited or credited to the settlement accounts, such payments shall be deemed made, completed, irrevocable and final.

15 The processing of a payment instruction at each cycle refers to the processes involved in processing

a payment instruction, which in general include inputting of a payment instruction by a participant to the system, validation checks of the payment, checking availability of funds, settlement and sending confirmation advice to the paying participant and receiving participant respectively.

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IV.3. Processing of payments and system cut-off times IV.3.1. Submission of payments and cut off times The HKD CHATS operates from 08:30 to 18:30 hours Hong Kong time and is available around-the-clock during Monday to Sunday for transaction input (or cancel), except during pre-scheduled system housekeeping tasks. Nonetheless, there is a need to have a cut-off time to distinguish payments for same-day value and payments of the next value day. There are various cut-off times in the HKD CHATS:

i. CHATS Customer cut-off at 18:00 hours Hong Kong time; ii. CHATS Bank cut-off at 18:30 hours Hong Kong time; iii. Cross Currency Payment Matching Processing (“CCPMP”)16 cut-off at

18:30 hours Hong Kong time and iv. CHATS Value Date cut-off (i.e. change of system date) at 18:35 hours

Hong Kong time. During non-operating hours, which is the time after the CHATS Value Date Cut off and before the system start (which is at 08:30 Hong Kong time) of the next business day, CHATS participant can submit payment instruction(s) to the HKD CHATS. The system accepts interbank transaction of current value date and up to 12 calendar days in advance. On a particular working day, only transactions with current value date will be processed for settlement. All accepted forward value date interbank transactions will be processed for settlement after CHATS commencement on the relevant valid forward value dates. IV.3.2. Payment settled on an RTGS basis Payments made through the HKD CHATS are effected on an RTGS basis. All payments submitted to the system will go through a validation process. Payment instructions with input errors will be automatically rejected. All validated transactions will be settled immediately if there is sufficient balance in the settlement account of the paying participant. Otherwise, payment instructions will be queued in the system and settled on a first-in-first-out basis until there are sufficient funds in the respective settlement account. Depending on the types of payments, the outstanding payment instructions value for same day will be automatically cancelled by the system if they remain unsettled after the CHATS Bank cut-off at 18:30 hours or the CHATS Value Date cut-off at 18:35 hours. There is flexibility in the HKD CHATS to amend the pre-defined cut-off times if necessary. Nonetheless, a change to the

16 CCPMP links HKD CHATS, USD CHATS with Euro CHATS in Hong Kong, and provides a PvP

facility for foreign exchange transactions between HKD, USD and Euro.

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system cut-off times has to follow pre-established procedures and subject to the approval of the SI. IV.3.3. Re-sequence and cancellation of payment instructions CHATS participants are able to re-sequence and cancel a valid payment instruction. Real-time status (including submission, validation, acceptance and settlement) of a payment instruction will be automatically updated and can be viewed through the eMBT by CHATS participants. Upon settlement of a payment instruction, the system will automatically generate a SWIFT message to SWIFT, which, in turn, generates a notification message to both the paying and receiving CHATS participants. Both the paying and receiving CHATS participants can also enquire at their own eMBT for the settled transactions at any time during the business day. All settled transactions in the HKD CHATS are final and irrevocable and cannot be unwound. IV.4. Payments settled on multilateral netting basis As mentioned in Section 2, apart from settling interbank large value payments on a RTGS basis, the HKD CHATS also settles payments for Bulk Items (such as CCASS items and paper cheque). Same as the large value payments, the finality protection of the CSSO also applies to the HKD Bulk Items. Specifically, the Bulk Items are the inter-bank type of payments for the clearing and settlement of small-value Hong Kong dollar-denominated transactions on a multilateral netting basis. They are processed on a bulk clearing and settlement basis in batch mode. Such transactions are settled through the same settlement accounts of the CHATS participants maintained with the SI of the HKD CHATS. Since the Bulk Items are part of the services provided under the HKD CHATS and the system itself is designated under the CSSO, the certificate of finality for the HKD CHATS is also applicable to the Bulk Items. As such, the Bulk Items processing through the HKD CHATS and settled across the book of the SI also enjoy the statutory settlement finality protection. The point of finality is explicitly defined in the Rules. While unlike RTGS payments being settled immediately upon sufficient of funds being maintained, the bulk items are submitted to the SO in advance (normally on Day D) for processing, and settled on D+1 (except same day items) according to pre-scheduled daily clearing schedules and system bulk settlement runs respectively. Prior to each settlement run, the system sends each CHATS participant an administrative message informing them their net settlement position – that is, how much they are obliged to pay or due to receive, in the settlement. A CHATS participant in net debit position has to ensure that there are sufficient funds in their settlement account to cover their obligations. There is no partial settlement, either all the involved CHATS participants settle, or the settlement will not be completed. Once a CHATS participant’s settlement account is credited or debited with the net settlement amount, the

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payment is final and irrevocable. Hence, the settlement finality occurs when the ‘presenting’ CHATS participants’ and ‘paying’ CHATS participants’ settlement accounts are credited or debited with their respective net settlement amounts on day D+1 (or on day D for same-day bulk settlement items) since it is at this point when CHATS participants receive value. The Rules and Procedures also provide contingency measures in case of delaying a bulk settlement run due to incidents arising from the system or the CHATS participants themselves. Moreover, the arrangements for each type of Bulk Items in the event of settlement member default are also specified in the Rules and Procedures.

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V. Core Principle V: Settlement in Multilateral Netting Basis

A system in which multilateral netting takes place should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single settlement obligation. V.1. Assessment of compliance Core Principle V is not relevant for RTGS payments. This assessment of this section will focus on payments for Bulk Items which settle on a multilateral netting basis. Settlement of Bulk items in the HKD CHATS observes Core Principle V. V.2. Completion of settlement in the event of bank default While the HKD CHATS mainly settles large value RTGS interbank payments, it also provides clearing and settlement for various types of Bulk Items (including CCASS and paper cheque items) on a multilateral netting basis. This section is only applicable to the clearing and settlement of Bulk Items in the HKD CHATS. The HKD CHATS has established procedures to ensure timely completion of each type of Bulk Items settlement if a CHATS participant fails in a net debit settlement position. Except JETCO and credit card items, settlement of all types of Bulk Items (excluding the insolvent CHATS participant, if any) would take place as soon as practicable after the announcement of the CHATS participant insolvency. If a CHATS participant is unable to come up with sufficient funds for the meeting its bulk settlement obligation, the SO will declare default of the CHATS participant concerned after obtaining approval from the SI. The settlement obligation of other CHATS participants concerned will then be recalculated by withdrawing the transactions related to the defaulted CHATS participant before the bulk settlement run is re-conducted. CHATS participants will be timely informed of the relevant information, including the re-calculated settlement amount and the commencement time of the re-settlement run, through the eMBT. The default arrangements of a CHATS participant are set out in the Rules and are made known to all CHATS participants. As described in Core Principle 3, there is no loss sharing arrangement in the HKD CHATS. In case of a failed settlement, the defaulted party will be fully liable for the failed payment. V.3. Enhancement/Improvement area The Rules and Procedures have specified clearly the handling procedures in the

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case of bank default which is applicable to all participants. The SI is encouraged to consider whether there is a need to distinct between the impact of major participants and non-major participants, and thus consider whether there is room to review the existing procedures to cater for a default of a major participant.

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VI. Core Principle VI: Settlement Assets

Assets used for settlement should preferably be a claim on the central bank; where other assets are used, they should carry little or no credit risk and little or no liquidity risk. VI.1. Assessment of compliance The HKD CHATS observes Core Principles VI. The HKD CHATS effects the transfer of settlement account balances held with the HKMA. Therefore, all HKD transfers are settled in central bank money, which is by definition free of credit and liquidity risk. VI.2. Settlement in central bank money The HKD CHATS settles across the book of the HKMA. As settlement occurs in central bank money, no credit or liquidity risk is deemed to be incurred by CHATS participants with respect to the settlement asset.

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VII. Core Principle VII: Security and Operational Reliability

The system should ensure a high degree of security and operational reliability and should have contingency arrangements for timely completion of daily processing. VII.1. Assessment of compliance The HKD CHATS observes Core Principle VII. The system has high degree of security and operational reliability. Stringent security standards protect the applications of the system and its transactions instructions. Contingency operations are tested on a regular basis and operate effectively. VII.2. Arrangements of the SI The SI has established procedures and controls for the operation of the HKD CHATS. Relevant policies and procedures are in place to govern physical access controls to restricted areas. Access to the premises of the production and backup sites, and data centres is limited to authorised individuals with a legitimate need. Moreover, there are backup arrangements to ensure the SI operation can be recovered in a timely manner during contingency. The SI has policies and procedures in place to set out the arrangements on backup of relevant computer files and the storage arrangement. Vital records are duplicated and properly stored in the backup site of the SI. The SI has maintained a Business Continuity Plan (“BCP”), which aims at maintaining the operation of the HKD CHATS in full services. The BCP is divided into 2 sections. The first section documents the possible disaster scenarios, their contingency measures and the triggering authority. This section has to be read back-to-back with the BCP of the SO (to be discussed below). The second section is mainly on the BCP measures and communications among involved parties for disaster scenarios that may affect the role of the SI. Separately, backup arrangements were also in place for the SI. The backup site is located at a considerable distance from the primary site to mitigate the effects of power outages and they are located at different power distribution networks. Regular drills/tests are performed from time to time to ensure the backup arrangements are maintained in an appropriate manner. VII.3. Arrangements of the SO VII.3.1. Security policy objectives The SO has established relevant security objectives and policies, which aim at ensuring that security measures and features, in terms of confidentiality, integrity, authentication, non-repudiation and availability of information, as well as auditability of processes and procedures that meet industry practices

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have been implemented for the computer systems and related networks. The computer systems and the networks are being operated according to the established objectives and policies. The security objectives and policies are reviewed periodically and any material change to the security objectives and policies has to be approved by the Board of Directors of the SO, which includes representatives of the HKMA and the HKAB. VII.3.2. Overall security controls Following the migration to the SWIFTNet platform, the HKD CHATS runs on SWIFTNet, which conforms to commercially reasonable level in terms of confidentiality, integrity, authentication, availability and audit ability. A dedicated unit of the SO is set up to handle all security administration functions and security related incidents. The security features are tested regularly. The SO conducts regular security risk analyses and proactively monitors technological advances to ensure the system’s security risk analysis is maintained at a satisfactory level. External consultants were engaged to conduct security assessment on the middle-tier system including execution of penetration tests. All CHATS participants are required to use standard SWIFTNet FIN interface for preparing and submitting payment transactions since the Phase 1 implementation of the SWIFTNet project in May 2009. The SWIFTNet FIN interface provides security features for CHATS participants to protect their payment operations and safeguard their payment data. Following the Phase 2 implementation of the SWIFTNet project in July 2010, CHATS participants use the eMBT, which is a web-based application riding on the SWIFTNet InterAct service and SWIFTNet Browse service that provide security features based on Public Key Infrastructure and digital certificates, to perform payment enquiries, payment controls and other administrative functions. In all cases, contingency measures are in place to ensure all CHATS participants can access the system on a continual basis. VII.3.3. Physical and logical access controls The SO has established explicit security requirements and controls. In terms of physical and logical controls, the SO has set up related arrangements to prevent and detect unauthorized access to data, programs and hardware for the operation of the HKD CHATS. The requirements on logical access controls are spelt out in the relevant policies and procedures. The SO has installed access control software to enforce control on access to data, programs and other information resources. The access cards are assigned to each individual for entering into different parts of the premises and access rights are granted to authorized personnel to reflect their functional needs. Formal authorization procedures are established for creating, changing and deleting user profiles. Access to the premises of the production and backup sites is limited to

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authorized individuals with a legitimate need. The access by visitors is properly controlled. Security guards are employed and surveillance system with recording function is installed to monitor access to different restricted areas. The SO has procedures in place to ensure confidential and sensitive information is being protected from access by unauthorized personnel. Inspection will be carried out to ensure relevant data has been deleted before the unused equipment and other electronic media are disposed or for other usages. VII.3.4. Operational reliability The operation of the HKD CHATS is reliable. The system is designed with sufficient capacity, which is monitored and upgraded in line with business requirements. The production capacity for the mainframe system, the servers for the eMBT and the “disk-pack” storage capacity are monitored and reviewed regularly. In the first nine months of 2010, HKD CHATS has maintained 100% prime time and non-prime time system availability except on three days for the prime time and two days for non-prime time. The levels of system availability were well above the 99.9% and 99.5% benchmarks for prime time and non-prime system availability respectively.17 Production incidents are logged, reported and followed up according to the service requirements as defined in the problem management procedures. The system integrity is assured by using the Customer Information Control System (“CICS”) design, application level database reconciliation and cross-system reconciliation arrangement. Data integrity can be enabled by means of reconciliation reporting. Under the SWIFTNet environment, DB2 and MQ, which are IBM’s database and messaging systems respectively, are used to assure data integrity of the middle-tier system. Moreover, the middle-tier system has implemented logic tests such as verification of hash totals, header and trailer records etc. to ensure data integrity. On-site backup facilities (except the mainframe) are in place to deal with failure of the primary computer processing facility. The HKD CHATS maintains a hot secondary backup site, which is designed to allow resumption of technical processing without loss of data within 30 minutes of the decision to switch the live production at the primary site to the secondary site. A computer audit, which reviews the security and reliability of computer system and networks, is conducted annually by an external auditor. Moreover,

17 According to the service agreement between the SI and HKICL, HKICL shall use its best

endeavours to achieve availability rates of 99.9% for prime time (from start-up of processing cycle to cut-off), and 99.5% for non-prime time, in the absence of disastrous events and interruptions caused by an event outside HKICL’s control.

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the operation of SO is subject to a two-year audit cycle. The latest operational audit was conducted in 2010 with no major issue identified. If necessary, specific audit task may be performed from time to time by the SO, say, before launching a large scale enhancement to the HKD CHATS. The SO submits audit reports related to the system performance to the HKMA (through its PSO team) and the HKMA will make use of the reports, amongst others, to help carry out its oversight duties. Where appropriate, the HKMA may request the SI and the SO to review its operational practice and to make enhancements to the system if necessary. VII.3.5. Business continuity arrangements The business continuity procedures are documented in the BCP of the SO. The objectives of the BCP are to provide guidance for the SO to respond to unplanned service disruption arising from failure of critical data centre infrastructure. It is also used to facilitate timely resumption of the HKD CHATS (also applicable to other CHATSs) in the event of a disruption. The BCP covers areas on hardware, software, system network, staff, data replication, etc. The BCP also includes procedures for crisis management and information dissemination, the set up of a command centre to manage recovery, and the procedures to deal with emergency response and external liaison. The BCP is endorsed by the management of the SO. The BCP is subject to regular review and update when necessary. Procedures are in place to ensure that the BCP has reflected the latest system changes or enhancements. BCP drill is conducted annually. The management of the SO as well as the staff concerned, the SI, and the CHATS participants participate in the annual contingency drill. In addition, internal drills of various functions of the system using non-production data are also conducted regularly. The BCP has been revised to extend its coverage to SWIFTNet middle-tier infrastructure according to the production implementation schedule of the SWIFTNet Project. Apart from having on-site backup arrangements (as mentioned in paragraph VII.3.4) at the primary site, the SO has set up a hot backup site and standby arrangement is in place to ascertain timely resumption of services if the primary production site fails to operate. The primary site and the backup site are located at a considerable distance from each other, with one located at the Hong Kong island and the other at the Kowloon side, in order to mitigate the effects of power and telecommunication outages or other distinct disruptions. The risk profiles of the two sites are different. The hot backup site employs real-time mirroring technology to replicate production data from the production data centre to the backup data centre. To minimize the recovery time, the computer hardware in backup data centre is kept running at all times, and can be operated remotely from the production data centre. The real-time mirroring technology mirrors the transaction details at the backup data centre immediately before the process of such transaction is

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completed. In the case that the primary production site or processing environments experience a serious problem or power outage, the HKD CHATS service can be in operation and available for use at the backup site within 30 minutes after declaration of failure at the primary site. Furthermore, the SO has a standby arrangement with IBM, its hardware vendor, as a second level of protection to cater for an extreme situation that either the primary or the secondary site becomes permanently inoperable. In this unlikely situation, the SO will be exposed to the risk of having only one data centre without any backup until a new data centre is ready for use. The standby backup service is therefore implemented as a second level protection. Recently, the SO is considering the establishment of a permanent second backup site. The backup arrangement is being reviewed from time to time in the light of changing conditions. VII.3.6. Manpower contingency To ensure qualified staff members are available at all times, a split team arrangement comprising designated staff members of the SO equipped with essential skills which are capable of providing adequate support to the continual operations of the production systems are deployed to work permanently at the backup data centre. In the unlikely event that the SO loses its facilities and staff at the production data centre, the surviving team together with the off-duty staff members who are away from the production data centre at the time of disaster can resume the operations at the backup data centre. The division heads of the Information Technology Department, who work at the backup data centre on a rotation basis, will be in charge of the operation. The manpower contingency arrangement is reviewed from time to time to take into account the changing conditions.

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VIII. Core Principle VIII: Efficiency

The system should provide a means of making payments, which is practical for its users and efficient for the economy. VIII.1. Assessment of compliance The HKD CHATS observes Core Principle VIII. The system operates efficiently, providing reliable and practical services to participants. In terms of cost, the tariff of the system is reviewed annually to ensure it is set at an appropriate level to recover the actual costs. The SI and SO regularly seek user feedback regarding the system services. Where appropriate, enhancements will be made to further improve efficiency. VIII.2. Economic benefits Since the inception in 1996, the HKD CHATS has met the objectives of providing a reliable and efficient interbank payment system, and maintaining Hong Kong’s competitive edge as an international financial centre. In particular, through immediate finality and settlement in central bank money, the system plays a key public policy role by helping to ensure a stable and reliable payment system and by minimizing systematic risk. Moreover, through its linkages to other foreign currencies payment systems in Hong Kong and the CMU, the system helps enhance payment efficiency of foreign exchange transactions and debt securities related transactions. VIII.3. Service practicality and system flexibilities The SI and SO strive to ensure the efficiency of the system by providing reliable and practical services to participants. As described in the response to Core Principle IV, while the system operates from 08:30 to 18:30 hours Hong Kong time, it is available during non-operating hours (including Saturdays, Sundays and public holidays) for transaction input, except during pre-scheduled system housekeeping tasks. The CHATS participants gain access to the HKD CHATS via electronic means. Depending on the usage, low volume CHATS participants can choose to input and send payment instructions electronically on a one-by-one mode. Alternatively, high-volume CHATS participants can send instructions via ‘straight through processing’, of which a bulk of transactions can be released to the system in a short period of time. The system accepts interbank transactions of current value date and up to 12 calendar days in advance. The queue management facility of the system provides the flexibility for participants to manage their payments during the day. On a particular working day, only interbank transactions with current value date will be processed for settlement. All accepted forward value date transactions will be

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processed for settlement after system commencement on the relevant valid forward value dates. In addition, the migration from local proprietary platform to the SWIFTNet platform in July 2010 has further enhanced efficiency, as the use of SWIFT components (such as software, hardware and network) to interface with the systems of HKD CHATS improves the compatibility with the systems at participants’ local offices, and with their foreign offices and other foreign systems. VIII.4. Pricing policy The HKD CHATS adopts a user-pay principle without subsidies. The service fee (i.e. tariff) is charged on a transaction basis with a minimum monthly amount. The SO collects the tariff on behalf of the SI. The tariff is determined mainly to recover the actual costs incurred in the provision of services. The tariff is reviewed annually. To amend the tariff, approval is required from the Board of Directors of the SO, the SI, and the HKAB. The tariff for the following year will be decided at the fourth quarter of each year and will be made known to all CHATS participants. VIII.5. Cost efficiency measures While there is no direct competitor for the HKD CHATS, the HKMA is keen to maintain the safety and efficiency of the system as one of the key measures to promote the financial infrastructure in Hong Kong, and to maintain Hong Kong as an international financial centre. Since the inception of the system, the SI has undertaken various initiatives with a view to further improving the efficiency of the system. The most recent enhancement to the system is the migration from the proprietary platform to SWIFT platform in July 2010. The migration enhances the interoperability between the HKD CHATS and the global platform, thus further enhancing the efficiency of the CHATS participants. VIII.6. User consultation The SI and SO regularly seek to improve the efficiency and practicality of the HKD CHATS. Specifically, the SI and SO will consult HKAB if appropriate on new initiatives and/or enhancements that will have impact on the CHATS participants. Besides, the SO conducts a bi-annual customer satisfaction survey to obtain feedback from users on the services of the HKD CHATS and identify areas for improvement. CHATS participants may also provide feedback and input on system capabilities, business needs and new features to the SI and/or SO at any time. In addition, the Customer Services Department of the SO provides support and problem resolution related to specific service issues of the system during operating hours.

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IX. Core Principle IX: Access Criteria

The system should have objective and publicly disclosed criteria for participation, which permit fair and open access. IX.1. Assessment of compliance The HKD CHATS observes Core Principle IX. The access policy of the system is based on the EFO. Access and exit criteria and procedures are laid down in the Rules, “Conditions Governing the Access to the RTGS Payment System” and “Operating Procedures for Settlement Accounts”. The access criteria are transparent and the general information of access policy is available to the public. IX.2. Access to the HKD CHATS The system adopts a single-tier membership structure in which eligible financial institutions can join as CHATS participants and open settlement accounts with the HKMA for the HKD CHATS. The EFO sets out the high-level access policy for the HKD CHATS, and the membership criteria are explicitly set out in the HKD Rules. Section 3A(1) of the EFO states that the Financial Secretary may require an authorized institution in Hong Kong to open a settlement account with the MA and to maintain and operate on the terms and conditions as the FS considers appropriate. The FS has delegated the power to the MA. In the light of the delegation of the power, the MA defines the access rules which are disclosed to the public. Specifically, the MA serves a Notice to all licensed banks in Hong Kong specifying that a settlement account should be maintained and operated on the terms set out in “Conditions Governing the Access to the RTGS Payment System” and “Operating Procedures for Settlement Accounts” attached to the Notice and the relevant provisions in HKD Rules. While licensed banks are required to join the system on a mandatory basis, restricted licence banks, provided that they have genuine business needs, may choose to join the system subject to the MA’s approval. The SI may exercise discretion to approve other financial institutions to be a CHATS participant of the HKD CHATS on a case-by-case basis. In December 2004, the SI exercised discretion to allow CLS Bank, the SI and SO of the CLS system18, to open a settlement account with the MA to facilitate

18 The CLS System is a global clearing and settlement system for cross-border foreign exchange

transactions operated by CLS Bank International (CLS Bank). The inclusion of the Hong Kong dollar into the CLS System enables foreign exchange transactions involving the Hong Kong dollar to be settled through the CLS System on a PvP basis, thus removing the settlement risk in these transactions.

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settlement of foreign exchange transactions involving Hong Kong dollar on a PvP basis in the CLS System, as the Hong Kong dollar is one of eligible settlement currencies of the system. The membership requirements and exit procedures are clearly specified in the Rules. The Rules state that “member banks” mean licensed banks, restricted license banks and CLS Bank, which in each case have agreed to be bound by the HKD Rules. The Rules also states that each member bank opens and maintains a settlement account with the MA for the HKD CHATS according to the terms and conditions of the EFO. IX.3. Exit from the HKD CHATS

Arrangements are in place to facilitate a CHATS participant’s exit from the system in an orderly manner. These arrangements are clearly stated in the Rules. A member bank, in general, can voluntarily or involuntarily exit from the system. On voluntary exit, as participation by licensed banks is mandatory, these participants are not allowed to cancel their settlement accounts and exit from the system unless they are accepted by the MA to revoke its banking licence. There are formal rules and procedures in place for handling revocation of an authorization. When approval for revocation is made by the MA, arrangements can be made with the SI and the SO to exit the system in an orderly manner. In involuntary exit, the SO, after having written confirmation from the HKMA, may suspend a CHATS participant from participating in the HKD CHATS. This could be due to cases when the banking licence of the CHATS participant concerned has been revoked, or the CHATS participant has materially breached the Rules or other requirements for participating in the HKD CHATS, etc.

The Rules provides the exit arrangements, which state that a CHATS participant can withdraw membership from the system by giving 90 days’ prior written notice to the SO. After receiving a notice of withdrawal and confirmation from the SI, the SO will work with the CHATS participant concerned to arrange for the exit. IX.4. Public disclosure of access to HKD CHATS The SI and SO have made available certain information regarding the access criteria to HKD CHATS on their respective websites (i.e. websites of the HKMA and HKICL). The Rules, however, are only made available to CHATS participants who have been granted access to the system. The SI and SO have developed an application kit including guidance on what is required in an application and the application kit is available to the newly licensed banks.

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IX.5. Enhancement/Improvement area(s) As a way to further enhance transparency, the SI and SO are encouraged to consider providing more detailed information regarding the access criteria to the HKD CHATS to the public. In particular, the access to the system by non-licensed banks and non-restricted licence banks is being considered on a case-by-case basis subject to business need.

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X. Core Principle X: Governance

The system’s governance arrangements should be effective, accountable and transparent. X.1. Assessment of compliance The HKD CHATS observes Core Principle X. The system’s governance arrangements are effective, accountable and transparent. It has clear governance structure, with the Board of the SO having the ultimate responsibility for the management of the system. The HKICL Board has exercised effective control on the management of HKICL. X.2. Governance Structure of the HKD CHATS The governance structure of the HKD CHATS is effective, accountable and transparent. The governing structure of the system involves the HKMA and the HKICL. The HKMA performs two roles – its PSOD acts as the SI while the PSO team acts as the overseer of the system. The HKICL is the SO of the system being appointed by the SI. Each party performs different roles in terms of the governance arrangement. X.2.1. Hong Kong Monetary Authority The PSOD of the FID of the HKMA carries out the duties as the SI of the HKD CHATS with the objectives to ensure the safety and efficiency operation of the HKD CHATS. The major duties of the SI include: (i) monitoring the payment flow, providing liquidity to CHATS participants if needed, (ii) overseeing the operation of the SO and the CHATS participants to ensure that they comply with the rules and procedures of the system, (iii) reviewing regularly the overall performance of the system and the SO, and (iv) initiating new enhancements/services to the system. Apart from the role as being a SI, a separate unit in the HKMA, the PSO team of the PSOLD is responsible for overseeing the HKD CHATS. As a designated system under the CSSO, the HKD CHATS has to comply with the safety and efficiency requirements as stipulated under the CSSO. The PSO team oversees the compliance of the HKD CHATS on an ongoing basis. Within the HKMA, the FID and the PSOLD have segregation of duties and separate reporting lines including at the Deputy Chief Executive level to ensure there are proper checks and balances between the two functions. X.3. Hong Kong Interbank Clearing Limited HKICL, as the SO of the HKD CHATS, is responsible for the operation and the management of the computer system. It is also responsible for the

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development of the system as well as any equipment upgrade and maintenance in respect of the HKD CHATS. HKICL is operated as a separate legal entity, with its own Board of Directors and management team. X.3.1. Board Responsibilities The HKICL as the SO of the HKD CHATS is responsible for the daily operations and technical development of the system. The Board of Directors of HKICL, which comprises of officials from the HKMA and representatives from HKAB, has overall responsibilities of HKICL, which include setting objectives of the company, overseeing and directing the management, ensuring the compliance of the operations of the HKD CHATS with all legal and regulatory requirements (including the safety and efficiency requirement under the CSSO). The Chief Executive Officer of HKICL reports directly to the HKICL’s Board of Directors. Approvals from the Board of Directors should be obtained for major issues affecting the design and operation of the HKD CHATS. Under the Board of Directors, there is a Board Sub-Committee, which is also formed by officials from the HKMA and representatives from HKAB. Matters are first discussed and reviewed in the Board Sub-Committee, taking into account the views from both the public and private sectors. The matters endorsed by the Board Sub-Committee will be submitted to the Board of Directors for further discussion and approval. The dual process is considered to ensure proper oversight of the decision making process at the Board Sub-Committee. Following the approval from the Board, HKICL is also required to obtain approval for any amendments, such as the introduction of new services or system enhancements, proposed to be made to the HKD CHATS from both the SI and HKAB. If an enhancement/new service involves changes to Rules and Procedures, the proposed amendments to the documents are required to be approved by the SI, HKAB and the PSO team as the overseer of the system. X.4. Accountability of the SO The accountability of the SO is ensured by oversight functions of the Board of Directors of HKICL and the SI, and various independent external audits. The management of the SO regularly provides reports to and holds meetings with the Board of Directors and the SI to ensure proper operations of the system. Apart from ongoing overseeing of the SO, the SI reviews annually the performance of HKICL to consider whether the operations of the HKD CHATS comply with services agreements between the two parties. The computer systems of the HKD CHATS is subject to an annual audit by an external auditor to ensure that the system has adequate controls and complied with prescribed security requirements. The overall operations of the HKICL are also subject to a bi-annual external audit. No major findings of the two audits were noted

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in the past two years, and enhancements proposed by the auditors were duly followed. X.5. Transparency of the HKD CHATS The governance arrangements are transparent to the public. Relevant information of the system, including the board composition and management of HKICL are made available on the websites of the SI or the SO. Moreover, the HKMA provides information related to the system via its annual reports, quarterly bulletins, press releases or other publications from time to time. Information related to the operations, new policies and enhancements of the system are disseminated promptly to participants via various channels, including the rules and procedures, circulars and letters issued by the SO. Participants of the system can also access these documents from the website of the SO. X.6. Enhancement/Improvement Area(s) A proper governance structure to the SO is crucial given the SO, apart from operating the HKD CHATS, also acts as the system operators for other CHATS systems in Hong Kong. To further broaden the profile and mix of skills of the Board of Directors of the SO such that the SO can act in the best interest in fulfilling its role, the SO is encouraged to consider including a sufficient number of independent member(s) in its Board. This will help in further broadening and enriching the knowledge and experience of the SO in fulfilling its role in a more effectively manner. The definition of independent member may vary, but it must be clear and publicly disclosed and would normally exclude parties such as those with competing or material business interests, cross-directorships, significant shareholdings and employees of the group.

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F Overall Assessment Summary

This assessment concludes that the HKD CHATS observes each of nine applicable Core Principles. Core Principle V only applies to the bulk items and does not apply to the RTGS payments because the latter is settled on a RTGS mode. During the assessment process, the PSO team has identified four enhancement / improvement areas, of which the SI and/or SO are recommended to consider and take actions if appropriate. The PSO team considered that these four areas will not pose immediate concerns to the HKD CHATS but the SI and/or SO may consider taking this opportunity to refine the arrangements to further improve the sophistication of the system. Table 1 provides the summary on the compliance of the HKD CHATS with each of the Core Principles and its recommended enhancement/improvement areas.

Table 1. Compliance of the HKD CHATS with Core Principles

Core

Principle Observed Not observed

Not applicable Enhancement/Improvement area(s)

I

II

III

The SI is encouraged to further specify any follow-up actions will be taken in case a CHATS participant repeatedly failed in complying with the throughput ratios. The follow-up actions may consider to be made known to the participants to further enhance transparency.

IV

V

*

The SI is encouraged to consider whether there is a need to distinct between the impact of major participants and non-major participants, and thus consider whether there is room to review the existing procedures to cater for a default of a major participant.

VI VII VIII

IX

As a way to further enhance transparency, the SI and SO are encouraged to consider providing more detailed information regarding the access criteria to the HKD CHATS to the public. In particular, the access to the system by non-licensed banks and non-restricted licence banks is being considered on a case-by-case basis subject to business need.

X

The SO is recommended to consider includingindependent member(s) in its Board of Directors.

* Only applicable to bulk items.

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Furthermore, in the light of the Lehman episode, the supranational institutions, such as the BIS Committee on Payment and Settlement Systems and the International Organization of Securities Commission, are reviewing the various international standards for overseeing the systemically important payment and settlement systems. As a designated system under the CSSO in Hong Kong, the HKD CHATS is expected to meet with any of these revised or new standards to be put in place in the near future. Where appropriate, the HKD CHATS should make amendments to ensure that the system will continue to comply with the new required standards.

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Annex 1

List of Abbreviations

BO Banking Ordinance CCBC China Construction Bank Corporation CSSO Clearing and Settlement Systems Ordinance CMU Central Moneymarkets Unit CMUP Central Moneymarkets Unit Processor CCPMP Cross Currency Payment Matching Processor CCPO Cross Currency CHATS Optimiser DvP Delivery versus Payment EF Exchange Fund EFO Exchange Fund Ordinance ETO Electronic Transactions Ordinance FID Financial Infrastructure Department FS Financial Secretary HKAB The Hong Kong Association of Banks HKD CHATS Hong Kong Dollar Clearing House Automated Transfer System HKICL Hong Kong Interbank Clearing Limited HKSAR Hong Kong Special Administrative Region of the People’s Republic of

China IFTP Inter-bank Fund Transfer Processor MA/HKMA The Hong Kong Monetary Authority. (The Monetary Authority refers

to the person who is appointed under the EFO to assist the Financial Secretary of the HKSAR and perform the functions as the Financial Secretary may direct. The Hong Kong Monetary Authority is the name of the organization responsible for carrying out the functions of the Monetary Authority.)

MBT Member Bank Terminal MSI Settlement Institution in the Mainland PSOD Payment Systems Operation Division PSOLD Payment Systems Oversight and Licensing Division PSO: Payment Systems Oversight PvP: Payment versus Payment RLO RTGS Liquidity Optimiser RTGS: Real Time Gross Settlement SAP Settlement Account Processor SI: Settlement Institution SWIFT Society for Worldwide Interbank Financial Telecommunication SO: System Operator

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Annex 2 References

A. Services Agreements 1. Services Agreement between HKMA and HKICL dated 6 December 1996.

Addendum between HKMA and HKICL to cover the provision of operational services in respect of the SWIFT Gateway and the cessation of the operational services for CMT/PC and MBT/PC dated 13 Nov 2002

Letter Agreements for the Services Agreement between HKMA and HKICL of 6 December 1996 dated 1 August 2003 and dated 23 September 2003

Addendum No. 2 between HKMA and HKICL to CMUP and HKD SAP dated 5 March 2009 Addendum No. 3 between HKMA and HKICL to CMUP and HKD SAP dated 29 June 2010

2. An agreement between HKMA and HKICL – Services Agreement for Cross Currency Payment Matching Processor dated 18 September 2000

3. Amended and Restated Services Agreement between HKMA and HKICL for Cross Currency Payment Matching Processor dated 23 June 2010

4. Amended and Restated Services Agreement between HKMA and HKICL for CMUP and SAP dated 29 June 2010

B. Documents from SI 1. Real Time Gross Settlement: Opening of Settlement Account : Annex A:

Conditions Governing Access to the RTGS Payment System, and Annex B: Operating Procedures for Settlement Accounts

2. A Master Sale and Repurchase Agreement for the Purpose of Providing Intraday Liquidity (“Master Intraday Repo”)

3. A Master Sale and Repurchase Agreement for use in Connection with the Operation of the Discount Window (“Master DW Repo”)

4. Guideline on HKD CHATS Throughput dated 13 October 2008 5. Business Contingency Plan, Payment Systems Section, Payment Systems

Operation Division (version 5, July 2010) C. Documents from SO

Rules and Operating Procedures 1. HKD Clearing House Rules, Rainstorm and Typhoon Procedures 2. HKD Clearing Operating Procedures Electronic Clearing System for Autodebit

and Autocredit 3. HKD Clearing Operating Procedures Electronic Clearing System for CCASS 4. HKD Clearing Operating Procedures Electronic Clearing System for EPS 5. HKD Clearing Operating Procedures Electronic Clearing System for IAH 6. HKD Clearing Operating Procedures Electronic Clearing System for Same Day

Settlement Autocredit Items 7. HKD Clearing Operating Procedures Electronic Clearing System for Special

CCASS Items 8. HKD Clearing Operating Procedures for CHATS Special Posting

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9. HKD Clearing Operating Procedures for Clearing Facilities Suspension 10. HKD Clearing Operating Procedures for Credit Card Bulk Settlement 11. HKD Clearing Operating Procedures for Continuous Linked Settlement (CLS) 12. HKD Clearing Operating Procedures for End-of-day Net Settlement 13. HKD Clearing Operating Procedures for JETCO Items 14. HKD Clearing Operating Procedures for Non-clearing Day 15. HKD Clearing Operating Procedures for Paper Clearing System 16. HKD Clearing Operating Procedures for Paper Clearing System (Appendices) 17. Operating Procedures for Regional CHATS Payment Service 18. Operating Procedures for CHATS - eMBT User Manual for Members 19. Operating Procedures for CHATS - eMBT User Manual for Members

(Appendices) 20. Operating Procedures for CHATS - eMBT User Manual for Central

Organisations 21. Operating Procedures for CHATS - eMBT User Manual for Central

Organisations (Appendices) 22. Operating Procedures for CHATS - Service Description

Others 23. Business Continuity Plan, HKICL (version 20 dated 18 June 2010)