[Federal Register Volume 62, Number 113 (Thursday, June 12, 1997)]
[Notices]
[Pages 32118-32122]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-15435]
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FEDERAL RESERVE SYSTEM
[Docket No. R-0974]
Enhancement of Federal Reserve Net Settlement Payment Services
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice of proposed service enhancement; Request for comment.
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SUMMARY: The Board is requesting comment on a proposal for the Federal
Reserve Banks to offer an enhanced net settlement service to depository
institutions. The proposed service would combine and improve selected
features from the Reserve Banks' existing net settlement services.
Under the proposal, the Federal Reserve Banks would offer an
enhanced and fully automated net settlement service that would provide
participants in clearing arrangements using the service with finality
of settlement intraday on the settlement date. The service would
facilitate improvements in the operational efficiency of clearing
arrangements by providing the settling participants in such
arrangements with an on-line mechanism to submit an electronic file of
settlement information to the Federal Reserve. Besides providing
operational improvements, the enhanced service is intended to
facilitate a reduction in the duration of settlement risk for private-
sector clearing arrangements.
DATES: Comments must be received on or before August 11, 1997.
ADDRESSES: Comments should refer to Docket No. R-0974 and may be mailed
to Mr. William W. Wiles, Secretary, Board of Governors of the Federal
Reserve System, 20th Street and Constitution Avenue, NW., Washington,
DC 20051. Comments may also be delivered to the Board's mail room
between 8:45 a.m. and 5:15 p.m. on weekdays, and to the security
control room at all other times. The mail room and the security control
room are accessible from the courtyard entrance on 20th Street between
Constitution Avenue and C Street, NW. Comments will be available for
inspection and copying by members of the public in the Freedom of
Information Office, Room MP-500, between 9:00 a.m. and 5:00 p.m.
weekdays, except as provided in Section 261.8 of the Board's Rules
Regarding Availability of Information.
FOR FURTHER INFORMATION CONTACT: Jeffrey Marquardt, Assistant Director
(202/452-2360), Paul Bettge, Manager (202/452-3174), Myriam Payne,
Senior Analyst (202/452-3219), Division of Reserve Bank Operations and
Payment Systems, Board of Governors of the Federal Reserve System; for
the hearing impaired only, Telecommunications Device for the Deaf
(TDD), Diane Jenkins (202/452-3544).
SUPPLEMENTARY INFORMATION:
I. Background
The Federal Reserve Banks provide a variety of services to
depository institutions. Included among these services are the
distribution of currency and coin, the processing and collection of
checks, wire transfers of funds, wire transfers of securities against
payment, and automated clearing house (ACH) payments. In addition, the
Federal Reserve Banks support a variety of clearinghouses and other
clearing arrangements by providing net settlement services to
depository institutions that participate in the arrangements.
Clearinghouses and similar arrangements for checks and for
electronic payments, such as ACH, Automated Teller Machine (ATM), and
Point-of-Sale (POS) networks, have typically been organized as groups
of three or more participating depository institutions that exchange
payment instructions, account for the value exchanged, and settle
balances on a multilateral net basis. These settlements are a critical
function of the clearing arrangements. Typically, a net amount is
computed that represents the difference between what is owed by each
participant to all others from the exchange of payment instructions
during a netting cycle and what all others owe the participant. For
some participants, the difference is a net debit. For others, the
difference is a net credit. These multilateral differences are then
settled by participants. The Reserve Banks' net settlement services
facilitate settlements by providing mechanisms for transferring funds
between the Federal Reserve accounts of
[[Page 32119]]
the settling participants in a clearing arrangement.\1\
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\1\ A settling participant in a clearinghouse that uses a
Reserve Bank net settlement service is a depository institution
whose account at a Reserve Bank is debited or credited in order to
transfer the funds needed to complete settlements. In contrast, non-
settling participants typically conduct settlements through a
settling participant.
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Currently, two types of net settlement services are offered by the
Reserve Banks. In the first, which is the traditional model of the
Reserve Banks' net settlement service, a settlement sheet (in either
paper or electronic form) containing the net position (net debit or
credit) of each settling participant in a clearing arrangement is
typically provided by the arrangement, or a settlement agent, to a
Reserve Bank on the settlement day (day T). Net debits and credits are
then posted (often manually) by the Reserve Bank to participants'
Federal Reserve accounts on day T. Posted credits represent available
funds for the purposes of intraday cash management and overnight
reserve management.\2\
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\2\ The posting time for net settlement entries is chosen by
each clearing arrangement within the requirements of the Board's
``Daylight Overdraft Transaction Posting Rules'' (FRRS 9-1000).
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Many Reserve Banks, however, reserve the right to reverse
settlement debits and credits, if a settlement debit posted to a
Federal Reserve account is not covered by the morning, or in some
cases, early afternoon, of day T+1. This methodology creates the
possibility of a settlement failure for a clearing arrangement on day
T+1 with respect to the settlement on day T. Further, because these
dating conventions refer to banking days, day T+1 may occur on the
third or even fourth calendar day following settlement, after a holiday
weekend. This policy of providing next-day finality increases the
duration of settlement risk for private sector clearing arrangements.
In 1990, the Board approved a second type of net settlement service
for national, small-dollar clearing and settlement systems. This
service provides same-day finality (day T) to participants and was
modeled after the CHIPS (Clearing House Interbank Payments System)
settlement arrangement, which was established in 1981. The service is
currently available to private ACH as well as check clearinghouses.
To accomplish settlement in these arrangements, the clearinghouse
staff informs participants of their respective net settlement debit or
credit position on day T. Settling participants with a net debit
position send Fedwire funds transfers to a special settlement account
at a designated Reserve Bank by a specified deadline. Once all debits
have been covered, clearinghouse staff sends Fedwire funds transfers
from the special settlement account to the Federal Reserve accounts of
settling participants with a net credit position. This process is
completed during the banking day on day T, under normal circumstances.
II. Advantages and Disadvantages of Current Services
Traditional Service
The main advantage of the traditional next-day net settlement
service is that it is familiar to clearinghouses and inexpensive for
clearinghouses and participants to use. The main disadvantage of this
service is that it increases the duration of settlement risk to
clearinghouse participants and their customers. Another disadvantage is
that some versions of this service use unsophisticated security methods
to ensure authenticity, as well as to safeguard the integrity, of the
settlement information.
The traditional next-day settlement service evolved from the
existing Federal Reserve accounting application to maximize operational
simplicity and minimize operating costs for users. As a result, a
disadvantage of the traditional service to Reserve Banks is that
automated risk-management tools for checking balances on day T were not
part of the design. Instead, to help control credit risk, the Reserve
Banks rely on the right to reverse net settlement entries on day T+1,
if a clearinghouse participant cannot cover a settlement debit to its
account.
Further, as interstate branch banking increases and the Federal
Reserve policy of granting one Federal Reserve account per chartered
bank, including banks with interstate branches, is phased in next year,
more clearinghouses will need to conduct net settlements on an
interdistrict basis. Without effective automated mechanisms to monitor
and control credit risk at the time it is incurred on the settlement
day, the Reserve Banks could be exposed to heightened risk.
Fedwire-Based Service
The main advantage to the private sector of the current Fedwire-
based national net settlement service is that it provides intraday
finality to clearinghouse participants and their customers on the
settlement day. The main disadvantage is that it is logistically
complex for certain clearing arrangements. For example, a settlement
for a clearinghouse with a large number of participants would involve
hundreds of individual Fedwire funds transfers having to be sent and
received within narrow time frames, and with limited coordination, in
order to complete scheduled settlements. In contrast, for the net
settlement service with next-day finality, Reserve Bank staff posts
entries to settling participants' Federal Reserve accounts in order to
simplify the settlement process and help ensure its orderly completion.
The main advantage to the Federal Reserve of the current Fedwire-
based service is that Reserve Banks have significantly greater control
over credit risk because of the use of Fedwire and the associated
(intraday) Account Balance Monitoring System. Fedwire funds transfers
can be monitored in real time against available account balances.\3\
Transfers that would cause overdrafts beyond established parameters can
be rejected. These capabilities permit Reserve Bank risk managers to
perform automated intraday risk management on day T, when settlement
information becomes available and before settlement entries are posted
to Federal Reserve accounts.
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\3\ As used throughout this Federal Register notice, the term
``available account balance'' refers to a depository institution's
Federal Reserve account balance plus any available intraday credit.
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III. Proposed Net Settlement Service Enhancement
The Board proposes to enhance the net settlement services offered
by the Reserve Banks to depository institutions. A net settlement
service would be offered to depository institutions that would require
the settling participants in a clearing arrangement, or their agent, to
submit electronically to a designated Reserve Bank a file containing a
net debit or credit for each participant. A Fedline terminal or other
on-line mechanism would be used for submitting settlement files. Each
settlement file would be identified by a code unique to that clearing
arrangement and that particular settlement file.\4\ Files could be
submitted at any time during an 8:30 a.m. to 4:00 p.m. Eastern Time
(ET) settlement window, although each clearing arrangement would be
expected to indicate a regular deadline for submitting its settlement
files.
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\4\ The service would support clearing arrangements that perform
one or more settlements per day.
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The service would include controls to ensure that a file has been
submitted by a party authorized by the clearing arrangement, that the
file contains net settlement entries for authorized settling
participants only, that the sum of the net settlement debits equals the
sum of the net settlement credits, and other
[[Page 32120]]
edits. Once all initial edits have been completed, the service would
check the Federal Reserve account balance of each settling participant
with a net debit position. If it is determined that sufficient balances
are available to fund a participant's net debit, the Federal Reserve
account of the participant would be debited and funds would be
transferred to a settlement account held on the books of the designated
Reserve Bank on behalf of the settling participants for the clearing
arrangement. The transfer of funds from the Federal Reserve account of
a settling participant in a net debit position would be treated as a
final and irrevocable transaction from the perspective of that settling
participant. Once the Federal Reserve accounts of all settling
participants with net debit positions have been debited and the
settlement account has been fully funded, the service would transfer
funds out of the settlement account and credit the Federal Reserve
account of each settling participant having a net credit position.\5\
These transfers would also be final and irrevocable.
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\5\ For purposes of measuring the daylight overdraft positions
of settling participants, the net debit and net credit entries would
be posted to participants' Federal Reserve accounts on a flow basis,
as they are processed. In the net settlement service with next-day
finality currently offered by the Reserve Banks, all net debit and
net credit entries are posted at one predefined time chosen by the
clearinghouse.
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The service might be designed to offer clearing arrangements
different options to address potential situations in which a settling
participant in a net debit position did not have sufficient balances in
its Federal Reserve account to fund its settlement obligation. Under
one scenario, the Federal Reserve would notify the designated agent for
the clearing arrangement that settlement could not be completed and the
service would automatically return funds from the settlement account to
the settling participants whose Federal Reserve accounts had been
debited. If desired, the agent could submit a revised settlement file
to the Reserve Bank for processing.
Under a second scenario, the service would offer features that
provide for one or more attempts to complete settlement without
requiring the resubmission of settlement data (retry feature). The
retry feature would allow the service (automatic retry) or the agent
(optional retry) to attempt to debit the account of a settling
participant with a net debit position multiple times until the debit is
either covered or a predefined time interval has expired.
Under a third scenario, the clearing arrangement would request that
the service retain the funds in the settlement account for a period of
time awaiting specific instructions from the clearinghouse agent.
Depending on the final design of the proposed service, the agent might
be able to direct the transfer of additional funds to the settlement
account in order to complete the settlement, for example, by drawing on
a preestablished line of credit. The settlement agent might also have
the ability to request that funds in the settlement account be
transferred to the account of a predetermined depository institution to
hold overnight for the purpose of attempting to complete settlement the
next business day.
In any event, after a predefined period of time, if settlement
could not be completed, action would be taken to transfer funds out of
a settlement account either by returning them to participants or by
transferring funds to a designated depository institution. As noted
above, the settlement agent would likely be permitted to submit a
revised settlement file in the event of a settlement failure.
Extensions of the settlement window might be granted to accommodate
operational disruptions or temporary funding problems. However, these
occurrences are expected to be rare and not to extend beyond the
operating hours of the Fedwire funds transfer service.
The enhanced service would improve the quality of the current net
settlement services offered by the Reserve Banks in two important ways.
First, it would improve operational efficiency and reduce the
operational risks of conducting settlements with same-day finality by
offering a settlement service with same-day finality that does not
require the sending and receipt of individual Fedwire funds transfers.
Instead, the proposed service would permit a clearinghouse or a
settlement agent to submit settlement data to a Reserve Bank, as is now
permitted in the traditional, next-day settlement service. This feature
would help ensure that settlement debits and credits are addressed
according to agreed procedures and in a timely and coordinated manner.
Second, the proposed service would reduce the duration of
settlement risk to participants in clearing arrangements by providing
finality for credits virtually immediately after it has been determined
that sufficient balances to settle are available in the Federal Reserve
accounts of the settling participants on day T. If widely employed, the
enhanced service could significantly reduce the duration of settlement
risk for check and ACH clearinghouses and other clearing arrangements.
To manage and limit risk to the Reserve Banks, the enhanced service
would incorporate effective credit risk monitoring procedures and
controls, which involve the automated checking of Federal Reserve
account balances, before final intraday settlement debits and credits
are posted to settling participants' Federal Reserve accounts. As
currently envisioned, the credit risk monitoring controls would be as
robust as those used currently in the Fedwire-based net settlement
model.
The Board expects that the proposed service would meet a number of
key requirements. In particular, the proposed service should:
1. Provide a standardized nationwide net settlement service to
private-sector clearing arrangements that also supports interdistrict
net settlements;
2. Reduce settlement risks to participants in clearing arrangements
that use the service, and to their customers, by providing final
settlement on the same day that settlement information is submitted
(day T);
3. Control and minimize credit risk to the Reserve Banks and the
potential for settlement disruptions by using appropriate account
balance monitoring tools to check balances in depository institution
Federal Reserve accounts before granting finality to settlement
entries;
4. Improve operational efficiency for participants in clearing
arrangements by offering a service that does not require the sending of
individual Fedwire funds transfers by participants to achieve
settlement;
5. Provide a mechanism that facilitates the timely completion of
daily settlements and that accommodates well-defined options for
clearing arrangements to achieve orderly settlements in the event of
settlement problems;
6. Enhance data security, including access controls, by including
appropriate tools and procedures in a uniform, automated system;
7. Improve analysis of settlement activity and trends over time by
incorporating statistical reporting capabilities; and
8. Provide for a clear legal basis and uniform understanding of the
terms and conditions under which the service is offered by developing a
standard Federal Reserve operating circular.
Time Frame for Implementation
The Federal Reserve expects to make the necessary system changes to
be able to offer the proposed net settlement service by the end of
1998.
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IV. Request for Comment
The Board requests comment on all aspects of the proposed service
enhancement. The Board is also requesting specific comments on the
following questions:
1. If the proposed service with same-day finality is offered,
should the Federal Reserve continue to offer its existing net
settlement service with next-day finality? What features, if any, of
the existing service with next-day finality would make it preferable to
some clearing arrangements over the proposed service with same-day
finality?
2. If the proposed service is offered, should the Federal Reserve
continue to offer the Fedwire-based net settlement service with same-
day finality that is currently offered to national, small-dollar
clearinghouses for check and ACH transactions?
3. If the proposed service is offered, files of settlement data
would be submitted to a Reserve Bank for processing in a well-defined
period during which the service would be available. If files were
generally accepted between 8:30 a.m. and 4:00 p.m. ET, would this
service period be adequate to support current and future needs of
potential users of the service? Should there be a capability for the
receipt and storage (also known as ``warehousing'') of settlement files
prior to the opening of the settlement window? If files can be
warehoused prior to the opening of the settlement window, what is the
maximum period during which the service should permit files to be
warehoused (for example, for a specified number of hours less than one
business day, or possibly for one or more business days prior to the
beginning of the settlement window)?
4. In order to provide high levels of data security, as well as
operational efficiency, would it be reasonable to require clearing
arrangements or their settlement agents to use a Fedline device, or
other on-line electronic mechanism, to submit settlement data?
5. In the current Fedwire-based net settlement service with same-
day finality, a settlement account is established at a Reserve Bank and
a settlement agent for a clearing arrangement has the capability of
monitoring whether individual participants have transferred funds to
the settlement account to cover their settlement debits. In the
proposed service, should a similar monitoring capability be provided to
a settlement agent?
6. As described in Section III above, the settlement file submitted
to the net settlement service would contain only net settlement debits
or credits for settling participants in a clearing arrangement. Should
value-added services be offered that would provide information to
settling participants regarding the individual settlement debit or
credit positions of non-settling participants for which they settle?
Should value-added services be offered that would provide a non-
settling participant with information regarding its individual net
debit or credit position?
7. In the event that a settlement account cannot be fully funded in
the first automated attempt to debit the Federal Reserve accounts of
settling participants, should the proposed service offer features that
provide for one or more additional attempts to complete settlement
without requiring the resubmission of settlement data (retry feature)
or should the service automatically return all funds to the settling
participants that have transferred funds to the settlement account and
notify the agent that a settlement cannot be completed? Some of the
retry features being considered are:
a. An automated retry feature that would attempt to debit the
account of a settling participant with a net debit position multiple
times during a predetermined time interval until the debit is either
covered or a predefined time interval has expired;
b. A retry feature controlled by a settlement agent for the
clearing arrangement that would allow the agent to instruct
electronically the service to retry the debiting of accounts of
settling participants that have not covered their net debits (the
number of retries and the time interval between retries would be
controlled by the agent within a ``retry window'' provided as part of
the service).
8. If the service is designed with retry capabilities as described
in the question above, how long should the retry window be (for
example, 15 minutes, one hour)? In addition to the retry window, should
there be a maximum number of retry attempts designated after which, if
the settlement is not completed, funds in the settlement account would
be returned to the appropriate settling participants?
9. In the proposed service, should the debit and credit entries to
the Federal Reserve accounts of the settling participants be considered
funds transfers under Regulation J and other laws applicable to funds
transfers?
10. In the case of a default by a settling participant, should the
service provide the capability for another settling participant or
depository institution to transfer additional funds (for example, from
a preestablished line of credit or other liquidity facility) into the
settlement account in order to complete the settlement?
11. To what types of clearing arrangements should the proposed
service be offered (for example, check clearinghouses, ACH
clearinghouses, ATM networks, POS networks, credit card arrangements,
or clearing arrangements for emerging types of electronic payment
transactions)? Should the service potentially be available for
conducting money settlements between depository institutions in
connection with arrangements for clearing financial contracts in the
wholesale financial markets or for conducting interbank settlements of
obligations arising from nonfinancial markets?
Competitive Impact Analysis
The Board has established procedures for assessing the competitive
impact of rule or policy changes that have a substantial impact on
payments system participants.\6\ Under these procedures, the Board will
assess whether a change would have a direct and material adverse effect
on the ability of other service providers to compete effectively with
the Federal Reserve in providing similar services due to differing
legal powers or constraints, or due to a dominant market position of
the Federal Reserve deriving from such differences. If no reasonable
modifications would mitigate adverse competitive effects, the Board
will determine whether the anticipated benefits are significant enough
to proceed with the change despite the adverse effects.
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\6\ These procedures are described in the Board's policy
statement ``The Federal Reserve in the Payments System,'' as revised
in March 1990 (55 FR 11648, March 29, 1990).
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The Board's proposed enhancements to the net settlement service are
intended to improve the clearance and settlement process for private
sector clearing arrangements by increasing the efficiency of the
services currently offered by the Federal Reserve and by reducing the
duration of settlement risk to private-sector participants in such
arrangements. The proposed net settlement service could indirectly
enhance the ability of private-sector depository institutions to
compete with the Reserve Banks in the provision of payment services
such as check and ACH clearing.
The risk management features that would be implemented for the
enhanced service would help protect the Federal
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Reserve Banks from the risk of loss. Certain features would help
provide for orderly settlements in case of settlement difficulties.
Overall, the Board believes that the proposed enhancements to the
Federal Reserve's net settlement services would increase efficiency and
reduce risk for private-sector clearing arrangements and their
participants, while providing for the more efficient management of risk
by the Reserve Banks.
Paperwork Reduction Act
In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3506; 5 CAR 1320, Appendix A.1), the Board reviewed the request for
comments under the authority delegated to the Board by the Office of
Management and Budget. No collection of information pursuant to the
Paperwork Reduction Act (44 U.S.C. 3501 et seq.) is contained in this
notice.
By order of the Board of Governors of the Federal Reserve
System, June 9, 1997.
William W. Wiles,
Secretary of the Board.
[FR Doc. 97-15435 Filed 6-11-97; 8:45 am]
BILLING CODE 6210-01-P
