UPDATE 1-ECB defends payments system in Iran sanctions debate

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FRANKFURT Feb 21 (Reuters) - The European Central Bank defended its payments system on Thursday, after a newspaper reported that the U.S. Congress is preparing new Iran sanctions to target the ECB's system for settling cross-border payments.

The proposed bill is aimed at pressing the ECB to do more to prevent Iranian firms and banks from using the Target2 payments system to conduct transactions involving euros, the Financial Times reported.

The ECB said it complied with European Union sanctions against Iran.

"The ECB ensures that no illegitimate transactions are cleared in Target2," a spokesman for the euro zone's central bank said. "But any sanctions are EU sanctions and not an ECB competence."

The United States and the European Union have imposed sanctions on Iran that aim to slow funding to Tehran's nuclear program. The West says the program is developing nuclear weapons, a charge Tehran denies.

ECB representatives are due in Brussels at the start of March for working discussions on various Iran sanctions issues, EU sources said, though the meetings were not specifically to discuss Target2.

In an opinion piece published in the Wall Street Journal on Monday, Jonathan Schanzer and Mark Dubowitz from the Foundation for Defense Democracies said the Target2 system was crucial to restricting Iran's access to euros and that U.S. legislators were ready to give European regulators a "legislative push to do what they know is right".

The Financial Times, citing congressional aides, reported that the U.S. legislation under preparation could seek to impose penalities on financial institutions that conduct transactions using Target2 that ultimately benefit Iranian entities.

Last year, the Belgium-based SWIFT electronic payment system, which facilitates the bulk of global cross-border payments, disconnected designated Iranian financial firms from its messaging system after European regulators ordered the company to do so.

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