Full Compliance Summary

Luxembourg was among the first wave of countries that migrated to the Trans-European Automated Real-time Gross Settlement Express Transfer (TARGET) 2 in November 2007. Prior to joining to TARGET2, the two important payment systems in the country were the Luxembourg Inter-bank Payment System (LIPS-Gross) and the Luxembourg Inter-bank Payment System-Netting (LIPS-Net), both of which observed the Committee on Payment and Settlement Systems' Core Principles for Systemically Important Payment Systems (CPSIPS). LIPS-Gross was discontinued once Luxembourg joined TARGET2. LIPS-Net, on the other hand, was discontinued in 2006, and transactions settled through this system are now being processed on STEP2 (the pan-European platform operated by the Euro Banking Association. TARGET2 provides harmonized payment services under a single shared platform across its member countries. In May 2009, the European Central Bank (ECB) released an assessment of TARGET2's design against the CPSIPS. The report concludes that TARGET2 fully observes all relevant CPSIPS, although it does make certain recommendations pertaining to Principles III and VIII. It is generally believed that the system is an improvement over its predecessor, TARGET, and its component systems. The ECB in its function as the overseer of TARGET2 aims to ensure continued compliance of the system with the CPSIPS, and will regularly monitor the implementation of its recommendations by the system. The Organic Law of the Central Bank of Luxembourg (BCL) is somewhat vague in addressing its roles and responsibilities in the area of payment systems, although other laws do address these issues. Furthermore, the ECB asserts that the BCL follows the guidelines on payment systems set by the European System of Central Banks.

General Overview

In 2007, TARGET2 replaced Luxembourg’s previous payment system, the Trans-European Automated Real-time Gross settlement Express Transfer (TARGET), and its component system, the Luxembourg Inter-bank Payment System (LIPS-Gross). Thus, TARGET2 is now the only systemically important payment system (SIPS) in the country. TARGET2 was phased into its member countries' systems in three groups -- November 2007, February 2008, and May 2008. Luxembourg was part of the first group of countries. In 2009, the European Central Bank (ECB) released an assessment of TARGET2’s compliance with the Core Principles for Systemically Important Payment Systems (CPSIPS) developed by the Committee on Payment and Settlement Systems. With the exception of one principle, which was not applicable due to the Real Time Gross Settlement’s (RTGS) nature of TARGET2, all core principles were deemed to be “observed”.

The 2007 ECB report titled "Payment and Securities Settlement Systems in the European Union: Euro Area Countries," (hereafter referred to as 2007 ECB report on Euro Area Countries) states that, TARGET2 provides a harmonized service level with a single technical platform, called the Single Shared Platform (SSP) across its member countries, as opposed to the decentralized structure of its predecessor, TARGET. The 2007 report by the ECB titled "Fifth Progress Report on TARGET2 - Annex 2: User Information Guide to TARGET2 Pricing," (hereafter referred to as the 2007 ECB TARGET2 - Annex 2 report) notes that the Bundesbank (German central bank), Banca d'Italia (Italian central bank), and Banque de France (French central bank) provide TARGET2 participants with the SSP. The report further indicates that despite the SSP, "TARGET2 is legally composed of national components governed by the national legislation of each participating member state. [Thus] the business relationship with the users and their accounts remain with the national central banks" (p. 4). Furthermore, national central banks (NCBs) are permitted to continue processing payments via their Proprietary Home Account (PHA) application instead of the SSP for a four-year transitional period from when the country migrates to TARGET2, so as to allow participants more time and facilitate their change-over to the SSP.

Despite the transition to TARGET2, member countries' NCBs still have supervisory authority, and national legislation still holds significance. According to the 2007 ECB report on Euro Area Countries, "central banks monitor developments in the field of payment and settlement systems in order to assess the nature and scale of the risks inherent in these systems,” and “they define principles and standards for the promotion of safe, sound and efficient payment and settlement systems. They analyze and assess the extent to which the systems comply with these principles and standards" (p. 19), the report notes. Per the same report, the Governing Council of the ECB adopted the CPSIPS as one of the standards the Eurosystem (the ECB and the national central banks of the euro area) must apply when performing its oversight role.
Luxembourg does not have an all-encompassing law that governs all aspects of payment systems, according to the 2007 ECB report on Euro Area Countries. Instead, the report states that the Civil Code addresses certain general provisions on payments, and lists the various forms of payment. The report also notes that, in general, issues relating to payments are covered by private contracts between financial institutions, customers, and retailers; and issues that relate to checks, bills of exchange, collateral, and the supervision of the financial sector are covered by specific laws. The same report notes that the relevant provisions for regulating the European Union (EU) area payment systems are put forth in the Treaty and the Statute of the European System of Central Banks (ESCB). The report also states that the main provisions of the Treaty and the Statute of the ESCB governing payment systems are Article 105(2) of the Treaty, and Article 22 of the Statute of the ESCB.

The Central Bank of Luxembourg (Banque Centrale du Luxembourg, or BCL) is responsible for the oversight of payment systems and in this capacity undertakes routine and ad hoc inspections and audits. According to the BCL's 2006 Annual Report (published in 2007), with the advent of TARGET2, its role has become narrower. Nevertheless, the report indicates that the BCL will continue to oversee the decentralized activities of TARGET2. The BCL, in its 2008 Annual Report (published in 2009) reiterates this point, stating that it “takes part, at the Eurosystem level, in the common oversight of TARGET2, as coordinated by the European Central Bank” (p. 135). A 2002 International Monetary Fund’s assessment of Luxembourg's payment system architecture concluded that the "role, responsibilities, and objectives of the BCL are clearly defined in the Treaty of the ESCB Statutes and the national Law implementing the Directive 98/26/EC on settlement finality in payment and securities settlement systems" (p. 62).

According to the 2007 ECB report on Euro Area Countries, the retail payment systems in the region are to be categorized as systemically important systems; prominently important systems, and other systems, and the Eurosystem ensures that these systems are also overseen by consistent policy. Per the same report, Luxembourg's credit transfers and standing orders are processed on STEP2 (the pan-European platform operated by the Euro Banking Association). Further, since July 2006 checks have been exchanged and cleared between banks on a bilateral basis. STEP2 was categorized as a prominently important retail payment system by the ECB in its 2005 assessment of euro retail payment systems against the CPSIPS. Luxembourg’s retail payments have been processed through STEP2 since 2006 when it discontinued its previous system known as LIPS-Net. The 2005 ECB report noted that STEP2 fully observed all relevant Core Principles as of June 2004. Finally, the Single Euro Payments Area (SEPA) project is also worth mentioning in the context of the EU's integration of its payment systems. The SEPA project "consists of a series of initiatives aimed at the introduction of common instruments, standards and infrastructures for retail payments in euro across Europe" (p. 28). According to the official SEPA website, enabling legislation for the project was expected to come into force across 31 countries in November 2009.

The Principles

FCI. The system should have a well-founded legal basis under all relevant jurisdictions.

In May 2009 the ECB released a report on an assessment of the design of TARGET2 (which as mentioned above is the SIPS operating in Luxembourg) against CPSIPS. The report rates the level of compliance for this principle as “observed.” The document explains that “the legal framework of TARGET2 is clearly designed in a set of legal instruments and arrangements” (p. 5). Of such instruments, the most important in terms of oversight is the Guideline of the European Central Bank on TARGET2, which was adopted by the Governing Council on April 26, 2007. Other important EU regulations relating to payment systems are put forth in the Treaty and the Statute of the ESCB, the Cross-Border Credit Transfers Directive (Directive No. 97/5/EC) of January 27, 1997 and the Settlement Finality Directive (Directive No. 98/26/EC) of May 19, 1998.

As stated earlier in this report, from a legal perspective, TARGET2 is comprised of multiple payment systems, in which the ECB and each of the participating central banks operate their respective component, based on the SSP operated by the three providing central banks (Deutsche Bundesbank, Banque de France, and Banca d’Italia). The 2009 ECB assessment notes that "the ECB and the participating central banks maintain the contractual relationship with their respective participants" and that "detailed verification of the national implementation of the legal documentation in the national rules of TARGET2 component systems did not reveal any substantial concerns with an impact on the compliance with Core Principle I" (p. 5). The EU Settlement Finality Directive, which gives a clear definition of irrevocability and finality, has, according to the assessment, been fully implemented in each jurisdiction of the central banks participating in or connected to the system. Furthermore, arrangements for enforceability of collateral are ensured by means of the national laws implementing the Collateral Directive.

According to the ECB's 2007 Annual Report, the TARGET2 Guideline contains the main legal elements of TARGET2, including governance arrangements and audit rules, as well as transitory provisions on the migration from TARGET to TARGET2. The Guideline was published in the Official Journal of the European Union in September 2007 and it is also available on the ECB’s website in all EU languages. The Guideline has a harmonized set of rules for all TARGET2 participants and allows Eurosystem NCBs to implement these rules in an identical manner, with deviations only if national laws require them. The harmonized conditions also contain relevant alternatives which will enable NCBs to customize their respective implementation in line with the requirements of national law. According to the ECB's 2007 Annual Report, "this approach implements the decision of the Governing Council of the ECB in October 2005 to legally construct TARGET2 as a multiple system, but aiming at the highest degree of harmonization of the legal documentation used by the central banks within the constraints of their respective national legal framework” (p. 27).

As stated earlier, Luxembourg does not have an all-encompassing law that governs all aspects of payment systems, according to the 2007 ECB report on Euro Area Countries. Instead, the report states that the Civil Code addresses certain general provisions on payments and lists the various forms of payment. The report also notes that, in general, issues relating to payments are covered by private contracts between financial institutions, customers and retailers; and issues that relate to checks, bills of exchange, collateral, and the supervision of the financial sector are covered by specific laws. According to the 2007 ECB report on Euro Area Countries "the Organic Law of the Banque Centrale du Luxembourg refers only in very general terms to its responsibilities in the area of payment systems" (p. 288). The report also notes that the BCL acts in accordance with the guidelines and rules set out for the ESCB. The IMF's 2002 report indicated that the BCL's oversight function is laid down in Article 105 of the European Commission's Treaty and Articles 3 and 22 of the Statutes of the ESCB.

A 2008 World Bank publication on payment systems worldwide indicates in its appendix that legal provisions in Luxembourg cover: (1) clarity of timing of final settlement especially when there is an insolvency; (2) legal recognition of (bilateral and multilateral) netting arrangements; (3) recognition of electronic processing of payments; (4) the “non-existence of any zero hour or similar rules;” (5) enforceability of security interests provided under collateral arrangements and of any relevant repo agreements; and (6) protection from third-party claims of securities and other collateral pledged in a payment system.

FCII. 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.

Per the 2009 ECB assessment, TARGET2 “observes” this principle. According to the report, the TARGET2 Guideline “sets out provisions pertaining to the management of financial risks” (p. 5). Other sources of information on financial risks available to TARGET2 users include the User Detailed Functional Specification, the Information and Control Module, the User Handbook, the Manual of Procedures and the Information Guide.

FCIII. 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.

TARGET2 “observes” this principle as reported by the ECB in its 2009 assessment. It further states that "owing to the RTGS nature of TARGET2 – where participants’ accounts are debited and credited simultaneously – no credit exposures among participants arise other than the risk entailed in the original exposures between the parties" (p. 6). Moreover, adequate collateral eliminates any credit risk for the central banks in relation to the provision of intraday credit to the participants. The ECB assessment notes that TARGET2 participants are provided with a number of tools for managing and economizing their liquidity requirements.

The 2007 ECB report on Euro Area Countries notes that "the following sources of liquidity can be used in TARGET2: balances on RTGS accounts, provision of intraday liquidity, and offsetting payment flows (i.e. the use of algorithms to settle a number of queued payments)" (p. 39). The report further states that intraday credit is granted to participants against eligible collateral by the respective national central banks. According to a 2005 report by the Bundesbank, the German central bank, TARGET2 has bilateral and multilateral limits that permit liquidity management for all TARGET2 participants.

FCIV. 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. (Systems should seek to exceed the minima included in this Core Principle.)

According to the 2009 ECB assessment, TARGET2 “observes” this principle. According to the 2007 ECB report on Euro Area Countries, the EU's Settlement Finality Directive of 1998 harmonized laws in member states and thereby ensures that the operations of payment and settlement systems are not stopped by the bankruptcy of a participant. The 2009 assessment further states that "unless instructing participants have indicated the settlement time, accepted payment orders shall be settled immediately or at the latest by the end of the business day on which they were accepted, provided that sufficient funds are available on the payer’s RTGS account and taking into account: (1) any bilateral or multilateral liquidity limits that a participant has set for the use of available liquidity for payment orders in relation to other TARGET2 participants; and (2) liquidity reservations for highly urgent or urgent payment orders" (p. 7). Those payment orders that are unable to be settled by the cut-off times are returned as unsettled.

IIV. 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. (Systems should seek to exceed the minima included in this Core Principle.)

This principle is not applicable to TARGET2, as it is a system that provides RTGS services.

FCVI. 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.

The 2009 ECB assessment concludes that TARGET2 “observes” this principle. The assessment further states that "payments processed in TARGET2 are settled in central bank money in the accounts of the direct TARGET2 participants" (p. 7). The 2008 World Bank publication on payment systems worldwide reiterates this point in its appendix, noting that RTGS payments in Luxembourg have been operated by the central bank since 1999.

FCVII. The system should ensure a high degree of security and operational reliability and should have contingency arrangements for timely completion of daily processing.

The 2009 ECB assessment concludes that TARGET2 “observes” this principle. The objectives of the information security policy for TARGET2 and the tools and procedures for achieving these objectives are defined in the TARGET2 Risk Management Framework (T2RMF). The 2009 ECB assessment states that "the main objective of information security is to protect TARGET2 business processes and any related information from a wide range of threats, whether internal or external, deliberate or accidental, and to minimize the impact on the business continuity of TARGET2 of any threats that, despite all measures taken, do materialize" (p. 8). The T2RMF is comprised of three levels: the first level describes the systems’ high-level security policy principles and requirements, the second level specifies concrete security requirements and controls, and the third level describes in detail the risk management process, including the conduct of regular risk assessments and the reporting structure. The 2007 ECB report on Euro Area Countries notes that "TARGET2 [offers] the highest possible level of reliability and resilience, as well as sophisticated business contingency arrangements commensurate with the systemic importance of the TARGET2 infrastructure" (p. 37).

FCVIII. The system should provide a means of making payments which is practical for its users and efficient for the economy.

As reported in the 2009 ECB assessment, TARGET2 “observes” this principle. The report also notes that TARGET2 meets the business needs of its users, ensures high levels of processing capacity, performance and resilience, and bases its pricing policy on a sound cost methodology. The report further states that "the pricing policy [for TARGET2], which has been agreed by the Governing Council [of the ECB], aims at achieving two main objectives: first, ensuring wide participation in the system, through a pricing scheme which is attractive both for big players and smaller institutions; second, ensuring full cost recovery, taking into account a public good factor" (p. 10).

FCIX. The system should have objective and publicly disclosed criteria for participation, which permit fair and open access.

The 2009 ECB assessment concludes that TARGET2 “observes” this principle. The report further notes that the access/exit criteria for the systems are clearly and explicitly stated and publicly disclosed in the TARGET2 Guideline. Direct participation in TARGET2 is permitted to: (1) credit institutions established in the European Economic Area (EEA); (2) credit institutions established outside of the EEA, provided that they act through a branch established in the EEA; and (3) central banks of EU Member States and the ECB, the report adds. The ECB and the central banks, on an ongoing basis, verify that their respective participants continue to abide by the system's access criteria.

FCX. The system's governance arrangements should be effective, accountable and transparent.

The 2009 ECB assessment concludes that TARGET2 “observes” this principle. The report notes that the ownership, decision-making structure, and operational function are adequately specified in the relevant system documentation. The 2009 ECB report notes that "there are three separate levels of governance for both the establishment and the operational phases of TARGET2 . . . Level 1 (Governing Council of the ECB) has final competence in relation to TARGET2 and safeguards its public function. Level 2 (Eurosystem CBs) has subsidiary competence for TARGET2 in relation to issues left to its discretion by Level 1, while Level 3 (SSP providing CBs) builds and operates the SSP" (p. 11). The Governing Council is responsible for the direction, management and control of TARGET2.

FCA. The central bank should define clearly its payment system objectives and should disclose publicly its role and major policies with respect to systemically important payment systems.

The Maastricht Treaty assigns oversight responsibilities for payment systems in the euro area to the ECB and the NCBs. As stated in the 2007 ECB TARGET2 – Annex 2 report, despite the transition to TARGET2, member countries’ NCBs still have supervisory authority and national legislation remains significant. Moreover, according to a 2008 ECB report on payment systems and market infrastructure oversight "for the purpose of effective and efficient oversight, the Eurosystem shares these responsibilities in a way that allows it to benefit from its decentralized structure, while ensuring coordination of its oversight activities and equal application of its policy stance" (p. 8). As stated in the 2007 ECB TARGET2 -- Annex 2 report, "central banks [in the EU countries] monitor developments in the field of payment and settlement systems in order to assess the nature and scale of the risks inherent in these systems and to ensure the transparency of the arrangements concerning payment instruments and services. Where necessary, they define principles and standards for the promotion of safe, sound, and efficient payment and settlement systems. They analyze and assess the extent to which the systems comply with these principles and standards" (p. 19).

The BCL is responsible for the oversight of payment systems and in this capacity undertakes routine and ad hoc inspections and audits. The 2008 World Bank publication on payment systems worldwide indicates in its appendix that the BCL’s payment system oversight functions are established by law and performed regularly, noting that the oversight activities are segregated from operational activities. The 2002 report by the IMF concluded that the "role, responsibilities and objectives of the BCL are clearly defined in the Treaty of the ESCB Statutes and the national Law implementing the Directive 98/26/EC on settlement finality in payment and securities settlement systems" (p. 62). The BCL acts in accordance with the guidelines and rules set out for the ESCB as noted in the 2007 ECB report on Euro Area Countries. The IMF's 2002 report indicated that the BCL's oversight function is laid down in Article 105 of the European Commission's Treaty and Articles 3 and 22 of the Statutes of the ESCB. With the advent of TARGET2, the BCL's role has become narrower, according to its 2006 Annual Report; nevertheless, the BCL continues to oversee the decentralized activities of TARGET2.

FCB. The central bank should ensure that the systems it operates comply with the Core Principles.

The 2007 ECB report on Euro Area Countries notes that in 2001 the Governing Council of the ECB adopted the CPSIPS as one of the standards the Eurosystem must apply when performing its oversight role. The 2008 World Bank publication on payment systems worldwide indicates in its appendix that Luxembourg performs payment system oversight over all systemically important payment systems.

FCC. The central bank should oversee compliance with the Core Principles by systems it does not operate and it should have the ability to carry out this oversight.

The 2007 ECB report on Euro Area Countries notes that in 2001 the Governing Council of the ECB adopted the CPSIPS as one of the standards the Eurosystem must apply when performing its oversight role. The 2008 World Bank publication on payment systems worldwide indicates in its appendix that Luxembourg performs payment system oversight over all systemically important payment systems.

FCD. The central bank, in promoting payment system safety and efficiency through the Core Principles, should cooperate with other central banks and with any other relevant domestic or foreign authorities.

The 2007 ECB report on Euro Area Countries states that "in order to institutionalize cooperation and the exchange of information regarding large-value payment systems in the EU, banking supervisors and payment system overseers from all EU Member States concluded a memorandum of understanding, which came into force on 1 January 2001" (p. 106). The 2006 Annual Report by the BCL stated that "as a member of the European system of central banks, the BCL has also contributed to the work in the field of oversight of the Payment and Settlement Systems Committee (PSSC) . . . [Similarly], the BCL has contributed to the working out of a methodology for the oversight of TARGET2" (p. 87). The 2008 World Bank publication on payment systems worldwide is less enthusiastic about Luxembourg’s cooperation, stating in its appendix that “cooperation with other relevant authorities occurs mostly in an informal/ad-hoc basis” (p. 234).