[Federal Register Volume 59, Number 37 (Thursday, February 24, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-3847]
[[Page Unknown]]
[Federal Register: February 24, 1994]
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FEDERAL RESERVE SYSTEM
[Docket No. R-0778]
Federal Reserve Bank Services
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice.
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SUMMARY: The Board has approved an expansion of Fedwire funds transfer
operating hours for the public policy benefits that will result through
the use, over the long term, of the service by banks individually and
through clearing groups. The Board believes that the potential, long
run benefits from offering final payment capabilities that will
strengthen interbank settlements outweigh the costs to the Federal
Reserve of expanding the Fedwire funds transfer service operating
hours. Over time, longer Fedwire funds transfer hours can contribute to
reductions in Herstatt risk through innovations in payment and
settlement practices. As well, the Fedwire funds transfer service will
become a tested tool for managing settlement risk early in the day
during times of financial stress.
Specifically, the Board is announcing that the hours of operation
of the Fedwire on-line funds transfer service will be expanded to 18
hours per day, opening at 12:30 a.m. e.t. and closing at 6:30 p.m.
e.t., five days per week (Monday through Friday) to become effective in
early 1997. A specific implementation date will be announced
approximately one year in advance of the effective date. Intraday
credit from the Federal Reserve will be available during expanded hours
on the same terms that it would be provided from 8:30 a.m. e.t. to 6:30
p.m. e.t. Further expansion of the funds transfer operating day could
be considered following several years of experience with the new
schedule.
In addition, the Board is announcing that current Fedwire
securities transfer operating hours will not be expanded until after
the implementation of new service capabilities that permit receivers of
securities to control the use of securities-related intraday Federal
Reserve credit. Public comment will be sought in 1994 on new service
capabilities that permit users the option to participate in expanded
securities transfer service operating hours and to control the receipt
of securities that are delivered to them during expanded hours. This
request for public comment could be combined with a request for views
on the use of similar service features during regular securities
transfer operating hours. In the case of expanded or regular hours, but
especially in the latter case, a key issue concerns the effects of such
changes on the liquidity and efficiency of the U.S. government
securities market.
FOR FURTHER INFORMATION CONTACT: John H. Parrish, Assistant Director
(202/452-2224), Gayle Brett, Manager (202/452-2934), or Lisa Hoskins,
Senior Financial Services Analyst (202/452-3437), Division of Reserve
Bank Operations and Payment Systems, Board of Governors of the Federal
Reserve System. For the hearing impaired only, Telecommunication Device
for the Deaf (TDD), Dorothea Thompson (202/452-3544), Board of
Governors of the Federal Reserve System, 20th and C Streets NW.,
Washington, DC 20551.
SUPPLEMENTARY INFORMATION: The growth in financial market activity
worldwide, and in foreign exchange market activity in particular, has
heightened attention and sensitivity to settlement and systemic risks.
Market participants, as well as regulators, are particularly concerned
about current methods for settling multi-currency, cross-border
transactions. Data published by the Bank for International Settlements
(BIS) indicate that the daily average value of global foreign exchange
market activity was approximately $880 billion in April 1992.1 The
interbank payments generated by foreign exchange transactions account
for a substantial portion of the total value of payments settled in
many of the industrialized countries.
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\1\See ``Central Bank Survey of Foreign Exchange Market Activity
in April 1992'' published by the Bank for International Settlements,
Basle, March 1993.
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The most significant settlement risks presented by foreign exchange
or other multi-currency contracts involve the risk that a counterparty
to such contracts will pay one currency and not receive payment in the
contra-currency. Concerns about such risks have been prominent since
the failure of Bankhaus Herstatt in 1974, when foreign exchange
counterparties of Herstatt made Deutsche mark payments to Herstatt to
settle foreign exchange contracts, but did not receive contra-payments
in U.S. dollars before the closure of the bank, which occurred at the
end of the German banking day. The settlement risk associated with the
sequential payment of currencies, and involving the potential loss of
the full principal amount of foreign exchange contracts, has come to be
known as Herstatt risk.
Despite the rapid growth of the foreign exchange markets since
1974, foreign exchange contracts are currently settled much as they
were at the time of the Herstatt episode. For example, in the case of
yen-U.S. dollar foreign exchange contracts, the yen amounts due on a
particular banking day would be paid and settled in Tokyo before the
start of that banking day in New York. U.S. dollar contra-payments
would likely be initiated early in the U.S. banking day and settled
with finality at the end of the U.S. banking day, some 18 hours after
the close of business in Tokyo. Similarly, payments in most European
currencies would be made and settled hours before U.S. dollar payments
are either initiated or settled with finality. The overall magnitude of
Herstatt risks associated with these settlement delays has grown
commensurately with the rapid growth in foreign exchange and other
multi-currency transactions.
Over the past few years, there has been a series of central bank
studies aimed at heightening the understanding and awareness of risks
in various international payment and settlement processes. These
studies have also provided a common framework for evaluating both new
and enhanced interbank settlement arrangements, as well as changes in
central bank services, that might be designed to reduce and manage
better Herstatt risk. Working groups from the G-10 central banks have
published reports, under the aegis of the BIS, on such topics as
minimum standards for interbank netting systems, delivery-versus-
payment (DVP) in securities settlement systems, and options for
enhanced central bank payment and settlement services with respect to
multi-currency and cross-border transactions.2
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\2\Report on Netting Schemes, February 1989; Report of the
Committee on Interbank Netting Schemes of the Central Banks of the
Group of Ten Countries, November 1990; Delivery Versus Payment in
Securities Settlement Systems, September 1992; Central Bank Payment
and Settlement Services With Respect to Cross-Border and Multi-
Currency Transactions, September 1993. These reports are available
through the Bank for International Settlements.
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The recent report on central bank services, for example, pointed to
the significant expansion of the operating hours for large-value
payment systems as an important central bank option that could
contribute to reductions in risk in settlement practices. Longer hours
for central bank large-value payment systems would provide the banking
sector3 with additional flexibility in developing innovative
methods to reduce time delays between the settlement of the different
legs of foreign exchange contracts. Such innovations might include the
development of delivery-versus-payment techniques, in which one
currency is paid (settled) when and only when the contra-currency is
also paid (settled), either by individual correspondent banks or by
groups of banks that are members of clearing arrangements. Over the
long run, such arrangements could substantially reduce Herstatt risks
in the settlement of multi-currency contracts.
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\3\For discussion purposes only, references to bank include all
depository institutions, such as commercial banks, savings
institutions, and credit unions. As used in this docket, the term
private-sector bank means any bank (including a Federal Home Loan
Bank) other than a Federal Reserve Bank.
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Even without the development of delivery-versus-payment techniques,
the possibility of greater harmonization of the timing of currency
settlements based on longer operating hours of central bank large-value
payment systems could help reduce time delays and risks in settlements.
Significant advances in information technology have been introduced
to banking and financial markets in recent years. The level of
automation and sophistication of banking systems has increased rapidly
and likely will continue to do so for some time to come. In this
environment, and particularly during a time of increasing volumes,
values, and sophistication of financial transactions, advanced
technology needs to be applied to payment systems so that these systems
can provide for both high efficiency and low risk in the settlement of
all kinds of economic transactions. The adoption and implementation of
this kind of technology, however, requires significant lead times and
careful, advanced planning.
Against this background, and following public comment on the
Board's October 1992 proposal to open the Fedwire funds transfer
service two hours earlier in the morning, the Board directed a staff
task force (Fedwire Study Group, see Appendix A of this notice) to
discuss the issues involving longer Fedwire hours with representatives
of commercial banks and other interested members of the public and to
analyze the associated public policy concerns. These discussions helped
clarify the issues relating to the expansion of Fedwire hours and the
difficulties in devising new techniques to reduce settlement risks.
Consideration of the appropriate operating hours for the Fedwire
funds and securities transfer services must, in the first instance,
take account of the Federal Reserve's responsibilities as a central
bank to support final interbank settlement. The Federal Reserve Banks
provide final interbank payment and settlement services to the banking
system through the transfer of banks' balances (reserves and clearing
balances) on deposit with Reserve Banks. These balances--also called
central bank money--are free of default risk and are an integral part
of monetary arrangements for the U.S. dollar. ``Instantaneous''
intraday final payment in risk-free, central bank money is delivered
operationally to banks through the Fedwire funds and securities
transfer services. The benefits of such instantaneous intraday final
payment in central bank money are, in turn, available to the public
through the payment services provided by banks to their customers. To
achieve this level of finality, Fedwire and similar sophisticated
central bank payment services rely on a processing technique known as
real-time gross settlement. In fact, most G-10 central banks currently
provide, or are in the process of introducing, real-time gross
settlement payment services, along the lines of the Fedwire funds
transfer service.4 (See Appendix B of this notice for a discussion
of the structure of large-value interbank payment arrangements.)
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\4\ The central banks of the European Union have recommended
that every central bank in the European Union install a real-time
gross settlement system. See Report to the Committee of Governors of
the central banks of the member states of the European Economic
Community by the Working Group on EC Payment Systems, ``Minimum
Common Features for Domestic Payment Systems'' (November 1993).
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The following two public policy objectives can be stated for the
Fedwire funds and securities transfer services. These public policy
objectives are useful as a guide to analysis of expanded operating
hours and were used by the Fedwire Study Group to set the stage for
discussions held with the public. Fedwire should:
(1) Provide a means that can be used to enhance the safety and
efficiency of U.S. dollar settlement arrangements, including
arrangements that rely on interbank settlement of netted positions,
particularly during periods of financial stress.
(2) Respond to the needs of both existing and emerging financial
markets, including overseas markets, which depend on the U.S. dollar
and are increasingly reliant on state-of-the-art technology.
Members of the Fedwire Study Group met with representatives of
various commercial banks, broker-dealers, and clearing organizations,
and with a group of corporate treasurers to discuss current problems in
payment and settlement arrangements. The Fedwire Study Group
encountered a diversity of views within the financial industry, and
even within individual organizations, regarding approaches to managing
settlement risk and the use of Fedwire to obtain real-time gross
settlement in central bank money outside of current operating hours.
The diversity of views is, in part, related to the functional
responsibilities of the individuals interviewed. For example, a number
of persons with credit management responsibilities in banks and other
financial firms tended to favor expanded Fedwire hours based on the
potential benefits associated with access to final, that is,
irrevocable and unconditional, settlement using central bank money--
notably, potential reductions in counterparty and systemic risk. In
contrast, individuals with responsibilities for transaction processing
services and information technology within banking organizations tended
not to favor an expansion of Fedwire operating hours because, for
example, (1) they could not identify customer demand for longer Fedwire
hours, (2) there would be costs and operational challenges associated
with ``off hour'' services, and (3) competitive responses by rival
banking organizations would compel them to undertake product and
operational changes. In addition, many of those interviewed also
pointed to the charging of fees for Federal Reserve intraday credit as
creating a disincentive to the use of Fedwire funds and securities
transfer services during both regular and expanded hours of operation.
A main concern raised during the meetings held by the Fedwire Study
Group, particularly by executives and senior credit managers, was that
of settlement risk in foreign exchange dealings, or Herstatt risk.
Those expressing concern noted, however, that while expanded Fedwire
funds transfer operating hours might be useful as a component part of
some new approaches to controlling Herstatt risk, without changes in
overall settlement practices, longer hours would not be able to make a
major contribution to risk reduction. Further, changes in risk
management techniques and settlement practices would need to take
account of a variety of operational and financial factors for different
currencies. Some of these issues are discussed further in appendix C of
this notice.
Given that there is a reduced tolerance for temporal risk in
settlements, especially--but not solely--settlement of multi-currency
transactions, the Board anticipates that efforts to control settlement
risk will continue, with or without the support of central banks. The
Board believes, however, that final, real-time gross settlement through
Fedwire should play an important part in market efforts to control risk
more effectively. As discussed earlier, final settlements in central
bank money are free of default risk and, as a result, settlement in
central bank money provides the highest possible degree of certainty
and liquidity in interbank settlements.
The routine availability of Fedwire on an expanded schedule will
add final interbank payment capabilities that the markets, the Federal
Reserve, and other federal regulatory agencies recognize as being
particularly important during periods of financial stress. Only by
becoming familiar with the use of expanded Fedwire will banks be
prepared operationally and procedurally to use expanded final payment
capabilities effectively. Over time, as the availability and use of
expanded Fedwire capabilities becomes more routine, operating
procedures for using Fedwire earlier in the day will become well tested
and integrated into banks' operations and contingency planning.
In addition, expanding Fedwire operating hours will eliminate an
operational barrier that stifles potentially important innovation in
privately-provided payment and settlement services. Expansion of
Fedwire operating hours will provide opportunities for market
participants to experiment with the use of real-time gross settlement
to meet a variety of market needs. New bank services and settlement
arrangements based on real-time gross settlement will have the
potential to reduce significantly banks' own and their customers'
settlement risks in the foreign exchange and other markets.5 A
particular application could be the development of delivery-versus-
payment settlement techniques either for individual foreign exchange
transactions or for obligations arising from netting arrangements.
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\5\ Examples of private sector initiatives currently underway
include the development of multilateral netting systems for foreign
exchange transactions, such as Exchange Clearing House Organization
(ECHO) and Multinet.
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A Federal Reserve initiative to expand Fedwire funds transfer
operating hours also demonstrates a long-term commitment to increasing
the availability of real-time gross settlement services in the
international financial system. The Federal Reserve is taking a
leadership role in the international financial community in seeking to
stimulate new or enhanced central bank services to facilitate cross-
border, multi-currency payments and settlements. By expanding the
operating hours of Fedwire, the Federal Reserve will make it possible
for banks to settle the U.S. dollar, with finality using central bank
money, during the banking and trading days of major international
financial centers in Europe and the Far East.6 Such a Federal
Reserve initiative looks to private sector banking organizations to
develop improved multi-currency services and settlement arrangements,
in some cases relying on Fedwire.
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\6\ Staff notes that the Bank of Japan recently expanded the
operating hours for its large-value funds transfer system to later
in the Tokyo banking day. Also, as noted earlier, the European Union
central banks have recently endorsed the establishment of real-time
gross settlement systems in all EU countries as well as closer
coordination of operating hours for settlement services.
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Finally, a clearly stated Federal Reserve policy regarding Fedwire
operating hours provides the certainty and stability banks have
indicated that they need to develop their own business and technology
plans. This approach to communicating Federal Reserve policy was
requested both in public comments on the Board's October 1992 proposal
and in meetings with representatives of the industry held by the
Fedwire Study Group. As noted here, expanded Fedwire funds transfer
operating hours are announced three years in advance of implementation.
Banks will have a clear understanding of the Federal Reserve's
intentions with respect to its operating hours and could use the lead
time to incorporate the expanded hours into their strategic plans for
payment services and supporting technical systems.
Fedwire on-line funds transfer operating hours will be expanded to
open at 12:30 a.m. e.t. (5:30 a.m. G.m.t. and 2:30 p.m. Tokyo time) to
support strengthened, interbank settlement for domestic and cross-
border markets. This precedes the opening of the current European
banking day by about three hours and overlaps with current payment
system and money market hours in Tokyo by about two and one-half hours.
This overlap of payment system hours could increase further if, in the
future, the operating hours of other national payment systems were
expanded.
The closing time for the Fedwire funds transfer service will remain
at 6:30 p.m. e.t. (11:30 p.m. G.m.t. and 8:30 a.m. Tokyo time), in
order not to delay inordinately the calculation of U.S. dollar
positions by U.S. banks providing dollar clearing services to clients
operating in the Asian markets, or to disrupt domestic money
management. Further, keeping the closing time at 6:30 p.m. e.t. will
not disturb the reserve management operations of the large number of
smaller U.S. banks that are not active internationally and that are
unlikely to participate in an expanded Fedwire operating day.
The Federal Reserve's estimated incremental costs to operate the
funds transfer service from 12:30 a.m. e.t. to 6:30 p.m. e.t. will be
roughly $2.5 to $4.0 million per year, or about 3 to 5 percent of the
total cost of providing the service in 1993. While the operational
costs incurred by banks using Fedwire during the expanded operating
period are difficult to estimate, such costs would be incurred entirely
voluntarily. Banks could choose to remain closed during the expanded
operating period and thus forego any additional operating costs.
Further, an 18-hour day (beginning at 12:30 a.m. e.t. and closing
at 6:30 p.m. e.t.) provides an adequate six-hour quiet period within
which banks can perform end-of-day processing and provides for
contingency situations. It also provides for a definite period for
measuring reserve positions, a requirement for the conduct of monetary
policy. There are some other minor issues posed by an 18-hour Fedwire
funds transfer day that are discussed in appendix C of this notice.
With respect to Fedwire securities transfer operating hours, under
current DVP arrangements, banks do not have the capability to control
the timing of deliveries of securities and associated debits to their
funds accounts. Accordingly, banks have limited control over the effect
of securities-related debits on their funds positions and their use of
Federal Reserve securities-related intraday credit. These control
limitations could lead to either increased operating costs or increased
use of intraday credit, with accompanying charges, during periods of
expanded hours. (See appendix C of this notice for further discussion.)
In contrast to the Fedwire funds transfer service, therefore, expanding
the operating hours of the securities transfer service would likely
impose unavoidable costs on a large number of banks. Thus, the Board
believes that it is inadvisable at this time to approve an expansion of
the operating hours for the Fedwire securities transfer service.
Competitive Impact Analysis
During expanded Fedwire funds transfer operating hours, the Federal
Reserve Banks will be providing real-time gross settlement in central
bank money. While this service cannot be duplicated in the private
sector, this situation is no different under expanded operating hours
than it is under the existing Fedwire operating hours. Service
providers that provide funds transfer services under a netting
arrangement could expand their operating hours to coincide with Fedwire
operating hours; however, only by setting earlier settlement time(s)
and settling through Fedwire could these organizations provide risk-
free central bank money earlier in the day to their participants.
Service providers that provide real-time gross settlement funds
transfer services across their own books could not solely backstop
these transactions with central bank money and, thus, could be reliant
on their own capital and credit standing to assure participants of
final settlement. Again, this situation is no different under expanded
operating hours than it is under normal Fedwire operating hours.
By order of the Board of Governors of the Federal Reserve
System, February 15, 1994.
William W. Wiles,
Secretary of the Board.
Appendix A--Fedwire Study Group
Bruce J. Summers, FRB Richmond, Chair
Carol W. Barrett, FRB New York
Gayle Brett, Board staff
Paul Connolly, FRB Boston
Lisa Hoskins, Board staff
Dara Hunt, FRB Chicago
Oliver Ireland, Board staff
Barbara Kavanagh, FRB Chicago
Donald R. Lieb, FRB San Francisco
David E. Lindsey, Board staff
Jeffrey C. Marquardt, Board staff
Christopher J. McCurdy, FRB New York
Gerard J. Nick, FRB Chicago
Patrick M. Parkinson, Board staff
John H. Parrish, Board staff
Israel Sendrovic, FRB New York
A. Patricia White, Board staff.
Appendix B--Structure of Large-Value Interbank Payment Arrangements
Most large-value, domestic interbank payments are currently made
via the transfer of money balances on the books of the Federal
Reserve Banks through the Fedwire system. Fedwire is the large-value
payment system operated by the Federal Reserve Banks for the
transfer of funds and delivery of book-entry (electronic) securities
against payment. Fedwire is a real-time gross settlement system that
settles transfers immediately on a transaction-by-transaction basis.
The Fedwire funds transfer service is a credit transfer process.
That is, a bank sends a funds transfer to the Federal Reserve
instructing the Federal Reserve to debit its account for a specified
amount and to credit the account of another bank. In 1993, the daily
average value of transfers originated over the Fedwire funds
transfer system was about $824 billion.
In contrast, the Fedwire securities transfer service, which is
the principal means for transferring and settling U.S. government
securities,\1\ is a debit transfer process that permits the seller
of the securities to send a transfer that will result in the Federal
Reserve withdrawing funds from the account of the receiver of the
securities transfer. The Fedwire securities transfer process is
based on the delivery-versus-payment (DVP) principle, whereby the
final transfer of securities from the seller to the buyer (delivery)
occurs at the same time as final transfer of funds from the buyer to
the seller (payment). Fedwire achieves such simultaneous settlement
by treating the instruction initiated by the seller as both an
instruction to deliver securities to the buyer and an instruction to
debit payment from the buyer's reserve or clearing account. In 1993,
the daily average value of transfers originated through the Fedwire
securities transfer system was roughly $580 billion.
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\1\Netting is performed outside Fedwire through the Government
Securities Clearing Corporation (GSCC) for transactions that settle
on a next day or forward basis, with the netted securities and funds
positions settled on Fedwire.
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Banks may also provide settlement services to their customers
through the final transfer of balances across their books. In
addition, banks also use multilateral clearing and settlement
arrangements to meet some of their large-value payment needs. In
such arrangements, including the Clearing House Interbank Payments
System (CHIPS) operated by the New York Clearing House, payment
instructions may be entered into a netting system throughout a pre-
determined clearing cycle and each participant's net position vis-a-
vis the other participants is determined on an ongoing basis
throughout the cycle. Settlement for the payment instructions occurs
at an agreed upon settlement time. Participants with net debit
obligations may satisfy their obligations by transferring funds on
the books of a ``settlement bank.'' Central banks can serve as a
``settlement bank'' for such interbank netting arrangements and, in
the case of CHIPS, this role is performed by the Federal Reserve
Bank of New York. In this arrangement, CHIPS settling participants
in a net debit position send Fedwire funds transfers to a settlement
account at the Federal Reserve Bank of New York, which, when fully
funded, is the source for payments to participants in net credit
positions. In 1993, the daily average value of transfers originated
through the CHIPS system was over $1 trillion.
Appendix C--Issued Associated With Expanded Fedwire Operating Hours
This appendix analyzes issues associated with expanded Fedwire
funds and securities transfer operating hours. The appendix is
organized in three parts. First, settlement practices in financial
markets are analyzed, with particular attention to Herstatt risk.
Second, the operation of the Fedwire securities transfer delivery-
versus-payment service is analyzed. Finally, other implementation
issues associated with expanded Fedwire hours are analyzed.
Settlement Practices in Financial Markets
The following discussion of settlement practices and risks in
financial markets takes into account (1) the integrity of settlement
during times of financial stress, (2) multi-currency, cross-border
settlements, (3) domestic corporate and interbank markets and the
needs of the futures markets, and (4) the current availability of
bank payment services on a 24-hour basis.
Settlement during times of financial stress. Concerns regarding
the ability of counterparties to meet their payment obligations and
the certainty of settlement are heightened during times of financial
stress. Sudden events that disrupt markets can increase the risk
associated with domestic and, in particular, multi-currency
transactions, and can contribute to uncertainty, payment delays, and
market liquidity problems. If such problems are widespread, systemic
risk may be increased substantially. It is during times of stress in
the financial markets that the certainty associated with interbank
settlement across the books of the central bank takes on added
importance.
In the past, the Fedwire funds transfer service has been opened
early on an ad hoc basis, at short notice, during times of stress in
the financial markets at the request of market participants and
regulatory authorities. For example, the Federal Reserve opened the
Fedwire funds transfer service early on the days following the
October 1987 stock market break and the beginning of the Gulf War.
Experience has shown, however, that market participants are not
prepared operationally to use facilities, such as Fedwire, when
these facilities are made available during ``off-hours'' on an ad
hoc basis at short notice. These difficulties suggest that to be
most helpful during times of financial stress, Fedwire should be
available in the early morning hours on a more routine basis.
Multi-currency settlements. With respect to multi-currency
settlements, the settlement of a foreign exchange contract involves
the settlement of both currencies involved in the contract, such as
the U.S. dollar and the Deutsche mark or the U.S. dollar and the
yen. In such settlements, risk management and efficiency
considerations must take into account payment arrangements in the
country of issue for each currency, including the relative intraday
timing of payments and the finality of payment in the respective
currencies. Settlement risk is incurred by paying final funds in one
currency before receiving final funds in another currency. As a
general matter, the magnitude of settlement risk in the foreign
exchange markets has grown substantially, in large part as a result
of a vast expansion of foreign exchange trading. At the same time,
there has been continued reliance on traditional methods of settling
trades one currency at a time with significant delays before related
payments and contra-payments become final.
Because the large U.S. cities are in the western-most time zones
of the major financial centers, under current settlement
arrangements for multi-currency transactions, the U.S. dollar is
normally the last currency to be settled. The two charts at the end
of this appendix provide information on global time zone
relationships and on the operating hours of selected large-value
interbank transfer systems in different countries.1
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\1\These charts were published in the report on Central Bank
Payment and Settlement Services with Respect to Cross-Border and
Multi-Currency Transactions, Basle, September 1993.
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On an exception basis today, banks may choose to require final
payment of the U.S. dollar leg of a multi-currency transaction
either in advance of, or in certain cases simultaneously with, final
payment of the contra-currency, as a means to protect against risk
of nonpayment.2 Foreign exchange market participants have
indicated that such protective measures are taken, for example, in
special cases where counterparties would exceed their U.S. dollar
credit lines. Banks, however, find these exception procedures to be
very expensive due to the lack of an established mechanism to effect
settlements under these terms (that is, final U.S. dollar payment
before, or simultaneously with, final payment in the other
currency). For exception processing, the parties must negotiate how
the related payments are to be made and closely monitor the
settlement process to ensure that the payment sequence unfolds as
expected.
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\2\In markets for exchange traded derivative instruments, some
settlements are conducted currently using delivery-versus-payment
techniques.
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Substantially earlier Fedwire funds transfer service operating
hours as well as later payment system hours for other major
currencies will increase the opportunity to achieve simultaneous or
near-simultaneous settlements of individual deals involving the U.S.
dollar and European and Asian currencies, where needed. Such
settlements might involve a variety of new institutional designs for
settlements, including private correspondent bank DVP services, new
clearing organization procedures, or innovative arrangements that
are not readily apparent given current payment system constraints.
Current initiatives to reduce Herstatt risk in foreign exchange
transactions point to the need for greater future overlap of final
interbank settlement facilities in Asia, Europe, and North America.
While in the future Asian and European systems may well be open
later during their local banking days, the achievement of a
significant overlap in payment system hours also requires earlier
opening hours for U.S. payment systems, especially to achieve
overlapping hours with Asian markets. With such earlier hours,
opportunities may increase substantially for more nearly
simultaneous settlements of multi-currency transactions, and
associated reductions in Herstatt risk. It should be noted, however,
that although simultaneous or near-simultaneous payment for multi-
currency transactions reduces the temporal dimension of settlement
risk, achieving final payment in one currency against a
simultaneous, but provisional, payment in another currency does not
eliminate fully Herstatt risk. Therefore, to address fully the
problem of controlling Herstatt risk, it is important that the
overlap in operating hours include overlap in systems that provide
final settlement in central bank money.3
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\3\Fedwire in the United States and BOJ-NET in Japan, for
example, currently provide real-time gross settlement services in
the U.S. dollar and yen, respectively. Significant projects to
establish real-time gross settlement systems are now underway in
France, the United Kingdom, and other countries, and legal
developments are occurring that will help ensure the availability of
payment systems in all or most European countries that provide for
final payments on an intraday basis. Thus, in the next few years,
concerns about the lack of intraday final payment capabilities in
major industrialized countries are likely to be reduced
substantially.
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Domestic markets. With respect to domestic markets, there are
relatively few types of transactions for which immediate and final
payment at a particular time during the day is an absolute
requirement. The demand for final payment at a particular time
during the day for corporate customers is currently quite small and
is limited to such things as payments to settle mergers and
acquisitions and the distribution of funds from underwritings of
securities. In general, because banks often make funds available to
corporate customers before final settlement, corporate customers are
largely unaware of the distinctions between final and provisional
payment or when during the day payments are actually settled.
Instead, corporations generally rely on their banks to make
decisions regarding how their large-value payments are originated
and received.
Even in the interbank markets, participants are typically
satisfied with same-day settlement for certain types of
transactions. At present, Federal funds contracts do not generally
stipulate that payment must be made at or before a specific time of
day other than before the close of the Fedwire funds transfer
service. Federal funds contracts are generally settled using the
Fedwire funds transfer system.
For some futures exchange settlements, the convention today is
to accept irrevocable commitments to pay from designated settlement
banks to cover clearing members' settlement obligations prior to the
start of the current day's trading, with the settlement banks
actually fulfilling the obligation via Fedwire funds transfers by 10
a.m. e.t. The futures clearing organizations and the Commodity
Futures Trading Commission (CFTC) have expressed a desire for
settlement to occur in final funds before the commencement of
trading. Such earlier settlement is viewed as reducing risks to
futures exchanges and the financial markets despite some concerns
that it would merely shift risks from the clearing organizations to
their settlement banks. Settlement banks would clearly need to
manage carefully their own cash needs earlier in the day in order to
make settlement payments at an earlier time, which is not necessary
under current arrangements.
Within a few years, there may be a demand for later Fedwire
funds transfer hours from banks that provide services to the futures
and options markets. This demand could arise from two sources.
First, some clearing organizations are progressively moving toward
same-day settlement of margin obligations arising from the current
day's trading activity. Second, some of the exchanges are
contemplating longer trading hours for certain of their products.
The exchanges are beginning to incorporate automated trade matching
and confirmation systems that will permit timely same-day
calculation of all margin obligations. Indications are that these
systems, which will remove a significant obstacle to same-day
settlement, could be widely adopted within three to five years.
Longer trading hours, in combination with the desire for same-day
settlement, would argue for a later Fedwire funds transfer service
closing time.
To date, there has been little evidence of demand for a
materially later closing time for the Fedwire funds and securities
transfer services to meet domestic needs. The most likely source of
demand to make later payments is from the Pacific time zone. Banks
with operations in that time zone, however, have expressed only
slight interest in later Fedwire hours in response to requests for
comment made by the Board of Governors in 1989 and in 1992.
Moreover, many corporate treasurers generally view later-in-the-day
payments activity as disruptive to their primary goal of determining
the amount of money available for investment. This preference is, of
course, conditioned by current conventions in the U.S. money
markets, especially the times at which decisions must be made to
invest or borrow funds.
Bank payment services. Currently, a number of large,
internationally active U.S. banks offer their customers real-time
account balance inquiry and payment services on a 24-hour basis.
Many of these banks offer the capability to originate payment
instructions in up to 60 currencies. Payment orders may be processed
as book transfers or held in an electronic queue until the national
payment system for the currency to be paid is open for business.
Given current queuing practices, there would appear to be some scope
for earlier settlement of queued payments if international clearing
banks find it advantageous to process customer payments earlier in
the day and national payment systems are open to process and settle
such payments.
Fedwire Securities Transfer Service
As mentioned earlier, most interbank transfers of U.S.
government securities are processed through Fedwire. The DVP
capability of the Fedwire securities transfer service increases the
efficiency and integrity of the securities clearance and settlement
process. In fact, the liquidity of the government securities market
is partly a function of the Fedwire securities transfer system
design, whereby the seller is assured of payment at the time the
securities are delivered. While it virtually eliminates settlement
risk, the current design of the Fedwire securities transfer service
may, in some cases, result in significant demands for intraday
credit. Once Fedwire opens in the morning, users of the Fedwire
securities transfer service have no control over the time at which
they may receive securities on a DVP basis. In particular, since the
sellers of securities initiate the DVP transfers, receivers do not
have any operational control over the time during the day when their
securities and funds accounts are credited and debited,
respectively.
Since the inception of the Board's Payment System Risk Reduction
Program, the implications of the cost of intraday credit have taken
on greater significance for participants in the Fedwire DVP
securities transfer service. Receivers of securities, especially
those maintaining relatively low intraday cash balances, are not in
a position to manage their use of intraday Federal Reserve credit
resulting from securities deliveries. Because of the inability to
review transfers prior to receipt, this problem may be compounded if
the securities delivery is not known, or the delivery amounts are
incorrect. Although receivers of securities can reverse transfers
received in error virtually immediately after delivery and payment
occur, they must very actively monitor and manage their activity to
be in a position to do so.
The charging of fees for Federal Reserve intraday overdrafts has
important implications for expanding the Fedwire securities transfer
operating hours. An expansion of such operating hours could impose
significant cost burdens on a potentially large number of banks that
would need to make a choice between staffing their operations to
manage their intraday overdraft positions, or remaining closed and
incurring the costs of intraday overdrafts that might arise from
securities deliveries during ``off-hours.'' In an effort to provide
participants with the tools necessary to manage their operations and
credit costs, the Federal Reserve is designing new Fedwire
securities transfer service features, including receiver controls
(such as receiver-authorized deliveries) and a mechanism allowing
participants to choose whether to use the service during non-
standard business hours. The Board believes that public comment on
these new service features is required because of the impact they
would have on senders and receivers of securities transfers and on
the operation of the U.S. government securities market.
Analysis of a potential expansion of Fedwire securities transfer
service operating hours must also take into account ``free''
transfers of securities, that is, the movement of collateral. The
ability to move collateral during early morning Fedwire operating
hours was identified as a potentially useful measure by several
clearing organizations and banks in their comments on the Board's
October 1992 Fedwire operating hours proposal. The ability to pledge
collateral during early morning hours can reduce settlement
uncertainties and enhance participant liquidity, particularly in
times of financial stress.
The discussion above suggests that careful attention must be
given in the near term to features of the Fedwire securities
transfer service that limit the control users of the service have
over the receipt of securities, particularly if the hours of
operation for the service were to be lengthened. The Board
anticipates that the implementation of new service capabilities,
such as those discussed earlier, could reduce or even eliminate the
involuntary costs imposed on receivers of securities transfers,
especially during expanded operating hours. Under these conditions,
the public benefits of expanding these operating hours could be
significant and would be derived in part from the opportunities to
use securities as collateral, or as a near-cash equivalent, for
purposes of meeting obligations that arise overnight. At present,
however, an expansion of hours would not be advisable. The Board
believes that the issues surrounding the development and use of new
features for the Fedwire securities transfer service can be
effectively addressed through the public comment process during
1994.
Implementation Issues
Because of the aforementioned complications associated with
operating characteristics of the current Fedwire securities transfer
system, the following analysis of implementation issues is limited
to an expansion of Fedwire funds transfer service operating hours.
The key implementation issues addressed in this section are
technology, operational costs, monetary control and reserve
management, overlapping business and calendar days, and the Federal
Reserve's intraday overdraft policy.
Technology issues. Banks as well as other financial and non-
financial institutions are installing or planning to install
advanced technology to support their critical business functions.
For example, many major banking organizations employ real-time
control procedures to manage their own and customer payments over
major large-value electronic payment systems. Many financial
organizations are also continuing to automate major dealing
functions and integrate these with their clearing and payment
systems.
In turn, in order to provide the banking and financial system
with advanced tools with which to design payment and settlement
arrangements using central bank money, the Federal Reserve is
installing advanced computing and communications systems. These
systems will support all of the Federal Reserve's national payment
services and accounting functions. Among other things, this new
technology will enable the Federal Reserve to provide real-time
gross settlement services in central bank money virtually around-
the-clock. Other benefits of this technology are expected to include
greater payments processing efficiency, improvements in the
reliability and availability of critical payment systems, and
enhanced contingency processing capabilities.
Most existing accounting and other back office systems require
that banks, including Federal Reserve Banks, accumulate a wide range
of transactions throughout the day in order to calculate and balance
customer account positions. Traditionally, this ``end-of-day''
processing has been treated as a batch operation for which large
quantities of information are accumulated from a variety of sources
and then processed overnight. For example, information received from
large commercial banks that provide corporate payment services and
U.S. dollar clearing services reveals that their current systems
have been designed to perform end-of-day processing within an
approximate six- to eight-hour window. Most large commercial banks
are either currently changing, or have plans to change, their
systems to move to a two- to four-hour end-of-day processing window,
an evolution which should be completed within about five years.
Contingency processing requirements also need to be considered
in connection with proposals to expand Fedwire funds transfer
operating hours, or bank payment system operations more generally.
Specifically, for large commercial banks, an 18-hour operating day
compresses the current end-of-day processing period, including a
``cushion'' of time to deal with the failure of regular systems or
other unexpected operational disruptions that must be resolved
before opening for the next day's business.
The Board believes that current efforts by banks and other
financial institutions to use technology to improve the efficiency
of end-of-day processing will, over the next several years, reduce
the time necessary to perform these activities. Thus, with a 3-year
lead time, an 18-hour Fedwire day should provide an adequate cushion
of time for end-of-day processing under normal and most contingency
conditions.
Operational costs. The Reserve Bank's incremental costs to
expand operating hours can be estimated fairly accurately. The
estimated incremental costs to the Federal Reserve of lengthening
the current 10-hour funds transfer operating day to 18 hours are
relatively small compared to the total cost of providing the
service. Specifically, the Board estimates that an 18-hour day
beginning at 12:30 a.m. e.t. will add roughly $2.5 to $4.0 million
to annual Fedwire funds transfer operating costs, or about 3 to 5
percent of 1993 total service costs.4 (The Board recently asked
staff to study issues related to Federal Reserve pricing
methodology, which is underway.)
---------------------------------------------------------------------------
\4\The Federal Reserve's estimated incremental costs associated
with providing a near 24-hour operation are significantly higher
than for an 18-hour operation.
---------------------------------------------------------------------------
The incremental costs that would be incurred by banks in using
the Fedwire funds transfer service during expanded hours are
difficult to estimate. In any event, the incremental operational
costs to banks of participating in expanded hours would be incurred
entirely voluntarily. Banks would make individual business decisions
whether to use the Fedwire funds transfer service during expanded
hours.
Monetary control and reserve management issues. The Board
believes that an expansion of Fedwire funds transfer operating
hours, involving a 6:30 p.m. e.t. closing time, does not complicate
reserve maintenance for banks. Also, provided that there is a
sufficient break in time during the operating day for purposes of
measuring reserve holdings, monetary measurement and control
problems do not arise for the Federal Reserve. In the event of full
24-hour operations, both monetary measurement and control issues
would need careful attention.
Overlapping business and calendar days. One complication
associated with a Fedwire funds transfer day that begins earlier
than 3 a.m. e.t. concerns asynchronous business and calendar days
for domestic payments and possibly for cross-border payments as
well. For example, assuming a 6:30 p.m. e.t. closing time and an 18-
hour Fedwire funds transfer day, the 12:30 a.m. e.t. opening time is
9:30 p.m. Pacific Time (p.t.). This means that today's business day,
as defined by the opening of Fedwire, begins on the prior calendar
day in continental United States time zones other than the Eastern
time zone. Some clarification or adjustment in accounting practices
and possibly legal conventions may be necessary to address this
situation. These adjustments do not appear to present large issues
and they can be readily addressed through such things as
modifications in financial reporting conventions and business
practices.
For example, financial reporting conventions that rely on
precise ``as of'' reporting dates and times would appear reasonably
to address most reporting issues. Similarly, more precision may be
needed in financial contracts about when completion of a payment or
other financial transaction must occur. This is a problem that
exists today and that is addressed in contracts by specifying the
location at which payment is to be made and the date (``pay to my
account in San Francisco on x date''). The new problem posed by an
earlier Fedwire opening time could be addressed readily by
specifying when during the day payment is to be made at a particular
location (``pay to my account in San Francisco by close of Fedwire
on x date'').
Federal Reserve daylight overdraft policy. In an expanded
Fedwire funds transfer operating environment, Federal Reserve
intraday credit will be provided to banks on the same basis that it
would be provided from 8:30 a.m. e.t. to 6:30 p.m. e.t. That is,
eligible institutions will be able to incur intraday overdrafts
subject to the net debit caps and daylight overdraft fees in place
at the time the overdraft is incurred.
Some adjustments to the intraday overdraft measurement rules
will be required. For example, posting times for non-wire
transactions settled on the books of the Reserve Banks that are
currently tied to the opening of Fedwire, such as ACH and principal
and interest payments for securities, need to be adjusted. Since
users will be accustomed to the current schedule, which generally
results in posting these transactions at 8:30 a.m. e.t., a clear
option would be for the Board to consider establishing 8:30 a.m.
e.t. as the ``explicit'' posting time for these transactions.
BILLING CODE 6210-01-P
TN24FE94.026
BILLING CODE 6210-01-C
Operating Hours of Selected Large-Value Interbank Funds Transfer System (as of August 1993)
----------------------------------------------------------------------------------------------------------------
Opening- Cut-off for
closing time Settlement all third- Cut-off for Memo item:
System Gross (G) for same-day finality party international Standard money
or net (N) value (local (local time) payment correspondents' market hours
time) orders payment orders (local time)
----------------------------------------------------------------------------------------------------------------
Belgium:
C.E.C............. N 13:46-13:45 16:30 13:30 8:30 (9:00-16:15)
Clearing House of N 9:00-16:30 16:30 13:00 8:30 ..............
Belgium.
Canada:
IIPS.............. N 8:00-16:00 15:00 14:30 16:00 (8:30-17:30)
ACSS.............. N 18:00-24:00 15:00 17:00 n.a. ..............
France:
SAGITTAIRE........ N 8:00-13:00 18:30 n.a. 8:00 (8:15-17:00)
TBF (planned)..... G 8:00-17:15 8:00-17:15 ........... 8:00 ..............
Germany:
Express electronic G 8:30-14:30 8:30-14:30 ........... 8:00 ..............
credit transfer
system.
Express (paper G 8:00-12:00 8:00-12:00 ........... 8:00 (9:30-13:00)
based) local
credit transfer
system.
EAF............... N 8:00-12:30 14:30 ........... 8:00 ..............
Italy:
BISS.............. G 8:00-17:00 8:00-17:00 17:00 9:00 (8:30-17:30)
SIPS.............. N 8:00-14:00 16:30 14:00 9:00 ..............
ME................ N 8:00-16:00 16:30 16:00 9:00 ..............
Japan:
FEYSS............. N 9:00-13:45 15:00 10:30 10:30 (9:00-17:00)
BOJ-NET........... G 9:00-17:00 9:00-17:00 14:00 n.a. ..............
Netherlands:
Central Bank FA G 8:00-15:30 8:00-15:30 12:45 n.a. (8:00-15:30)
System.
8007 S.W.I.F.T.... N 8:00-11:30 13:00 n.a. 8:00 ..............
Sweden:
RIX............... G 8:15-16:30 8:15-16:30 12:00 8:00 (9:00-16:00)
Switzerland:
SIC............... G 18:00-16:15 18:00-16:15 15:00 8:00 (9:00-16:00)
United Kingdom:
CHAPS............. N 8:30-15:10 end of day none 12:00 (9:00-12:00)
United States:
Fedwire........... G 8:30-18:30 8:30-18:30 18:00 18:00 (8:30-18:30)
CHIPS............. N 7:00-16:30 18:00 16:30 16:30 ..............
ECU clearing N 14:01-14:00 15:45 none none (TOM/NEXT)
system.
----------------------------------------------------------------------------------------------------------------
[FR Doc. 94-3847 Filed 2-23-94; 8:45 am]
BILLING CODE 6210-01-P
