Settlement Risk Due to Insolvency of a Participant

This chapter explains what happens when any of the participants in a Nexus payment goes into insolvency (a default) whilst a payment has not reached legal finality yet. These scenarios relate to a party going into insolvency in the window of time between settlement finality in the first leg of the payment and the settlement finality in the second leg of the payment.
Settlement Finality is a legal concept, and this chapter does not address the variety of legal implications in the various jurisdictions where Nexus might operate. An assessment of local legislation in each jurisdiction is necessary to conclude on exact settlement risks. This chapter merely provides an overview of the general legal concepts within the context of Nexus.
In practice, the scenarios below would be rare, and impacts are likely to be limited, because:
It is rare for a bank to declare insolvency and cease operating; a rescue that allows the bank to continue operating is more likely

If the scenario does occur, it will affect payments that were initiated before the insolvency was announced and have not yet been completed. Because most Nexus payments would achieve finality simultaneously with the processing of the payment in IPS and the processing completes within 60 seconds, this is a very small window and would affect a limited number of payments by that specific bank (or Liquidity Provider). (This assumes that the insolvent bank ceases sending new Nexus payments as soon as it declares insolvency.)

In most IPS schemes, a pre-funding arrangement means that even if a bank does fail, there are funds set aside to cover that banks” payment. In these cases, the Recipient may suffer a delay to the payment, but not a total loss.
 Finality achieved in Source IPS before Destination IPS
This is the most likely case, where settlement finality is obtained in the first leg of the payment (in the Source Currency), before settlement finality is achieved in the second leg in the Destination country. The following scenarios take place while the payment is in flight between the Source IPS and Destination IPS (ie processed and settled in the Source IPS, but not yet processed or settled in the Destination IPS).
Party declaring insolvency
Implications
Source Bank
No issues in Happy Flow: Source Liquidity Provider has received funds or a settlement obligation through Source IPS. The settlement obligation (in a Deferred Net Settlement scenario) will be backed by pre-funding or another collateral scheme so the Source Liquidity Provider will not incur losses. The second leg of the payment can proceed in Destination IPS
Non-Happy Flow: if settlement in the Destination IPS fails, (eg due to operational issues) it may not be possible for Source Liquidity Provider to make the return payment back to the Source Bank. Manual processing may be needed to resolve this.
Source Liquidity Provider
Assuming that the FX Provider is not also the Source Liquidity Provider, then the second leg of the payment should continue as normal.
The FX Provider has an exposure to the Source Liquidity Provider and may incur losses as the Source Liquidity Provider is liquidated or restructured. This risk is inherent to the relationship between the FX Provider and the Source Liquidity Provider.
If an operational failure in the Destination IPS means that the payment is returned, it will not be possible for Nexus to initiate the return payment from the Source Liquidity Provider. The funds will be held at the Destination Liquidity Provider and manual processing will be needed to complete the return payment.
FX Provider
If the Source IPS leg has completed but the Destination IPS leg has not started, then the Source IPS leg should be reversed. Funds will be returned from the Source Liquidity Provider to the Source Bank. The Source Bank will not debit the Sender. No losses are incurred.
If the Destination IPS leg has already started, the payment can complete as normal. The Destination Bank will receive funds or a settlement obligation from the Destination Liquidity Provider. The settlement obligation will be backed by pre-funding or other collateral. The Destination Bank will credit the Receiver.
The Destination Liquidity Provider depends on the balance of the FX Provider’s account with them:
 If the FXP had a positive account balance, then the Destination Liquidity Provider is not exposed and does not incur losses.
If the FXP had a negative balance (ie the Destination Liquidity Provider extended credit to the FX Provider) then the Destination Liquidity Provider is exposed to potential losses as the FX Provider is liquidated or restructured. This risk is inherent to the business of extending credit to the FX Provider and a bilateral issue between the two parties – not part of the Nexus arrangement.
Destination Liquidity Provider
If the second leg of the payment has not been initiated in Destination IPS, it will not be possible to initiate the payment. The payment will be reversed automatically.
If the second leg of the payment has already been initiated in Destination IPS, then the Destination Bank will have received funds or a settlement obligation from the Destination Liquidity Provider. The settlement obligation will be backed by pre-funding or other collateral, so the Destination Bank should not be exposed to any risk of loss. The Destination Bank can credit the Recipient.
Both Liquidity Providers (or both LPs are part of same banking group)
This is problematic as the first leg will complete successfully, but the second leg cannot be initiated. The funds from Source Bank will be held at the Source Liquidity Provider and may constitute part of their assets under liquidation.
Although this scenario is likely to be extremely rare, Nexus rules need to specifically address how this situation would be resolved.
Destination Bank
In this case the second leg of the payment cannot be processed in Destination IPS. Payment will be returned automatically.
Finality achieved in Destination IPS before Source IPS
In the scenario where legal finality is obtained in the Destination IPS prior to the Source IPS, the situation and risks may change. This scenario can occur if the Source IPS is on a deferred settlement cycle without a comprehensive pre-funding or collateral regime to cover insolvency of a member. As the Destination Bank has successfully credited the Destination Bank account holder in this scenario, returns are not applicable.
Party declaring insolvency
Implications
Source Bank
As the second leg of the payment is settled, the Sender and Recipient are not affected. However, as the settlement in the Source IPS will fail, the Source Liquidity Provider will not ultimately receive funds from the Source Bank. Depending on their legal agreement, this is a risk for the FX Provider (as it is unable to retrieve the funds from the Source Liquidity Provider).
Source Liquidity Provider
The settlement will fail in the Source IPS and the claim on the funds will be part of the assets under liquidation. There is no impact on the actual payment processing.

Destination Liquidity Provider
The settlement in the Source IPS can continue as normal, as the payment is final in the Destination IPS.
Both Liquidity Providers (or both are part of the same banking group)
The settlement in the Source IPS will fail and the Source Liquidity Provider will have a claim on the funds. The claim is part of the assets under liquidation. The payment processing is not affected.

Destination Bank defaults
As the funds have settled, the Source IPS can finalize its payment, to enable the Source Liquidity Provider to honour its agreement with the FX Provider. In this scenario, the Destination Bank account holder has a claim on the Destination Bank, but this sits outside of the scope of Nexus.
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