[Federal Register Volume 72, Number 12 (Friday, January 19, 2007)]
[Notices]
[Pages 2518-2527]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-589]


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FEDERAL RESERVE SYSTEM

[Docket No. OP-1259]


Policy on Payments System Risk

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Policy Statement.

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SUMMARY: The Board has adopted several revisions to Part I of its 
Policy on Payments System Risk (PSR policy) addressing risk management 
in payments and settlement systems. Specifically, the Board has (1) 
incorporated into the PSR policy the Recommendations for Central 
Counterparties (Recommendations for CCP) as the Board's minimum 
standards for central counterparties, (2) clarified the purpose of Part 
I of the policy and revised its scope with regard to central 
counterparties, and (3) established an expectation that systemically 
important systems subject to the Board's authority disclose publicly 
self-assessments against the Core Principles for Systemically Important 
Payment Systems (Core Principles), Recommendations for Securities 
Settlement Systems (Recommendations for SSS), or Recommendations for 
CCP, as appropriate, demonstrating the extent to which these systems 
meet the principles or minimum standards.

EFFECTIVE DATE: January 19, 2007. The Board expects each systemically 
important payments and settlement system subject to its authority to 
complete and publish its initial self-assessment by December 31, 2007.

FOR FURTHER INFORMATION CONTACT: Jeff Stehm, Deputy Associate Director 
(202/452-2217), Division of Reserve Bank Operations and Payment 
Systems, or Jennifer Lucier, Financial Services Project Leader (202/
872-7581), Division of Reserve Bank Operations and Payment Systems; for 
the hearing impaired only: Telecommunications Device for the Deaf, 202/
263-4869.

SUPPLEMENTARY INFORMATION:

I. Background

    On June 22, 2006, the Board requested comment on proposed revisions 
to Part I of the PSR policy, which addresses risk management in 
payments and settlement systems.\1\ The key aspects of the proposal 
included the (1) incorporation of the Recommendations for CCP as the 
Board's minimum standards for central counterparties, (2) the 
clarification of the purpose of Part I of the policy and revisions to 
its scope with regard to central counterparties, and (3) the 
establishment of an expectation that systemically important systems 
subject to the Board's authority disclose publicly self-assessments 
against the Core Principles, the Recommendations for SSS, or the 
Recommendations for CCP, as appropriate.\2\ The proposed changes did 
not affect Part II of the PSR policy.
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    \1\ 71 FR 36800 (June 28, 2006).
    \2\ The G-10 central banks' Committee on Payment and Settlement 
Systems (CPSS) published in 2001 the Core Principles to foster 
safety and efficiency in the design and operation of systemically 
important payments systems. The Recommendations for SSS and 
Recommendations for CCP were developed by the CPSS in conjunction 
with the Technical Committee of the International Organization of 
Securities Commissions (IOSCO) in 2001 and 2004, respectively. The 
Recommendations for SSS set forth minimum standards promoting safety 
and efficiency in securities settlement systems, while the minimum 
standards set forth in the Recommendations for CCP focus 
specifically on central counterparty risk management.
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    The Board proposed these revisions to update the policy to 
incorporate new international risk management standards for central 
counterparties. As discussed in more detail in the proposal, at the 
time the Board last revised Part I of the policy, the Federal Reserve 
was working with the CPSS and IOSCO to finalize the Recommendations for 
CCP.\3\ These recommendations established minimum standards for central 
counterparty risk management, operational reliability, efficiency, 
governance, transparency, and regulation and oversight. At the time it 
incorporated the Core Principles and Recommendations for SSS into the 
PSR policy, the Board noted it would review the Recommendations for CCP 
at a later time and determine whether it would be appropriate to 
incorporate them into its PSR policy. The Board has considered the 
comments and is incorporating the Recommendations for CCP into the 
policy to highlight the importance of central counterparties to the 
financial markets and to demonstrate the Board's desire to encourage 
the use of the Recommendations for CCP globally in cooperation with 
other domestic and foreign financial system authorities. In light of 
this change, the Board has clarified the purpose of Part I of the

[[Page 2519]]

policy and revised its scope in order to reflect the important role 
central counterparties play in the stability of the financial system.
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    \3\ Final recommendations were issued in November 2004. In 
addition to the Federal Reserve, the Securities and Exchange 
Commission and the Commodity Futures Trading Commission also 
participated in the development of the Recommendations for CCP. The 
full report on the Recommendations for CCP is available at http://
www.bis.org/publ/cpss64.htm.
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    The Board believes that the implementation of the Core Principles 
and Recommendations for SSS and CCP can help foster global financial 
stability. The Board further believes that broadening the availability 
of information concerning a system's risk management controls, 
governance, and legal framework, for example, can assist users and 
other interested persons in understanding and assessing systems against 
internationally accepted principles and minimum standards and in 
evaluating and managing any risk exposure to a particular system. The 
policy revisions proposed by the Board in June were designed to meet 
these objectives. Therefore, the Board is establishing an expectation 
that systemically important systems subject to its authority disclose 
publicly self-assessments against the Core Principles, Recommendations 
for SSS, or Recommendations for CCP, as appropriate, demonstrating the 
extent to which these systems meet the principles or minimum standards.

II. Summary of Comments and Analysis

    The Board received four comment letters on the June proposal--two 
from private-sector payments system operators, one from a credit union, 
and one from a foreign central bank. Comments generally supported the 
three key policy revisions proposed by the Board, but varied in 
response to some of the Board's specific questions concerning the 
proposed guidelines for completing self-assessments, namely the 
content, scope of disclosure, and frequency of review. One commenter 
requested further clarity on the scope of Part I of the existing 
policy. The final policy retains all substantive elements of the 
proposed revisions, except that it will adopt a two-year review period 
for self-assessments rather than the annual review proposed. In 
addition, the final policy includes one minor change to clarify that 
self-assessments may need to be considered in the context of the 
system's rules, procedures, and other relevant materials, in order for 
the reader to gain a full appreciation of any risks associated with a 
particular system.

Content of Self-Assessments

    The Board requested comment on whether the implementation 
guidelines in the Core Principles and the assessment methodologies 
accompanying the Recommendations for SSS and CCP provide sufficiently 
clear and useful frameworks to complete comprehensive and objective 
self-assessments.\4\ The Board also requested comment on whether self-
ratings should be included in self-assessments. These self-ratings 
would indicate the extent to which a system meets a particular 
principle or minimum standard, and system operators would be expected 
to use one of the following assessment categories: observed, broadly 
observed, partly observed, or non-observed.
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    \4\The assessment methodologies accompanying the Recommendations 
for SSS and CCP developed by CPSS and IOSCO provide some structure, 
referred to as ``assessment criteria,'' for rating a system against 
a particular recommendation. The Core Principles include 
implementation guidelines intended to assist with the interpretation 
of the principles by providing detailed explanations of each 
principle and practical examples of how they have been interpreted 
and implemented.
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    None of the comments addressed the sufficiency of the guidance, but 
three of the four commenters discussed the inclusion of self-ratings. 
One commenter explicitly supported including ratings. Another stated 
that systemically important systems should perform periodic self-
assessments to ensure they are in compliance with the applicable 
principles or minimum standards. The third commenter did not explicitly 
disagree with the inclusion of ratings; however, it did state that in 
order for self-assessments to be useful it is important that they be 
comparable across different systems, and noted that the risk of systems 
assigning subjective ratings ``make[s] comparison across systems 
difficult.'' Two commenters did state that the risk that ratings would 
be overly subjective could be limited by the Federal Reserve's review 
of self-assessments.
    The Board supports the inclusion of ratings in self-assessments. 
Where the content of self-assessments is sufficiently detailed to 
support the rating assigned, we believe the inclusion of ratings can 
add value to the self-assessment by providing the reader with an 
overall indication on how well the system meets particular principles 
or minimum standards and additional information on how the system views 
its risk management controls. As stated in the final policy, as part of 
its ongoing oversight of systemically important payments and settlement 
systems, the Federal Reserve will review self-assessments published by 
systems subject to the Board's authority. The purpose of this review is 
to ensure the Board's policy objectives and expectations are being met, 
including the expectation that self-assessments are both comprehensive 
and objective.\5\
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    \5\As stated in the final policy, any review of an assessment by 
the Federal Reserve should not be viewed as an approval or guarantee 
of the accuracy of a system's self-assessment.
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    The final policy establishes an expectation that a system's senior 
management and board of directors review and approve the self-
assessment upon completion. The Board believes that the accountability 
of the system's senior management and board of directors for the 
accuracy and completeness of the assessment will encourage them to 
publish robust self-assessments with fully supported ratings. The Board 
also believes that the implementation guidelines for the Core 
Principles and the assessment methodologies for the Recommendations for 
SSS and CCP may facilitate greater consistency in the content of self 
assessments.
    The Board is adopting the final policy with language to clarify 
that self-assessments may need to be considered in the context of 
supplementary information, such as the system's rules, procedures, 
organizational documents, or other relevant information, in order for 
the reader to gain a full appreciation of any risk exposure associated 
with a particular system.\6\ Self-assessments, including the ratings, 
are only one resource for financial system participants and other 
interested persons to consider when evaluating and addressing any risks 
associated with a particular system.
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    \6\These materials may be publicly available or may need to be 
requested directly from the system.
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Scope of Disclosure of Self-Assessments

    The Board proposed that a systemically important system make its 
self-assessment readily available to the public, such as by posting it 
on the system's public Web site. All four comment letters expressed 
support for some degree of disclosure. Three commenters support public 
disclosure. One commenter stated that in order for the reader to gain a 
comprehensive understanding of the system to support an evaluation of 
the system against the applicable standards the self-assessment would 
have to be read or interpreted against the system's rules and 
organizational documents. Therefore, this commenter stated that 
disclosure would be limited to those who have access to this 
supplementary documentation.
    The Board agrees with the proponents of broad disclosure. Public 
disclosure of self-assessments will enable the Board to meet its 
objective of improved information availability. If a system has chosen 
to limit the disclosure of its rules or other documentation to members 
only, then the onus will be on

[[Page 2520]]

the system operator to explain pertinent rules or procedures with 
enough detail to support the reader's independent analysis and 
understanding of how the system meets a particular principle or minimum 
standard.

Frequency of Review of Self-Assessments

    The proposed revisions included an expectation that, in order for 
self-assessments to reflect correctly the system's current rules, 
procedures, and operations, a systemically important system should 
update the relevant parts of its self-assessment following material 
changes to the system or its environment and, at a minimum, review its 
self-assessment annually to ensure continued accuracy. One commenter 
recommended that the review period be extended to every three years.
    The Board has reconsidered the time period for reviewing self-
assessments and is adopting a two-year review period rather than the 
annual review proposed. This longer review period reduces the burden 
associated with an annual review while ensuring sufficiently frequent 
reviews to help ensure assessments remain accurate. A three-year review 
period may allow an unacceptable accumulation of individual ``non-
material'' changes that could affect the accuracy and usefulness of the 
assessment. The Board believes that a biennial review addresses the 
commenter's concern while still achieving the objectives of the policy. 
The final policy retains the requirement that a system update the 
relevant parts of its self-assessment if there is a material change to 
the system or its environment.

Scope of Part I of the Policy

    One commenter sought clarification with respect to which systems 
would be required, and which would be encouraged, to comply with the 
changes to the policy. The Board believes the existing policy describes 
sufficiently what types of systems are expected to comply with the 
Board's general policy expectations. Moreover, the Board communicates 
directly with systems that it has determined to be systemically 
important.
    With regard to the scope, one commenter stated that it ``shares the 
view of the Board that central counterparties should be within the 
scope of central bank oversight.'' While the Board is interested in 
central counterparties as part of its oversight function, the policy 
acknowledges that the Board does not have exclusive authority over all 
payments and settlement systems. Systems organized as central 
counterparties are often supervised by other federal agencies pursuant 
to the existing legal framework. In such circumstances, the policy 
states the Board will work with the other domestic and foreign 
financial system authorities to promote effective risk management in 
those systems, as appropriate.

III. Regulatory Flexibility Act Analysis

    The Board has determined that the final policy statement would not 
have a significant economic impact on a substantial number of small 
entities. The policy would require payments and securities settlement 
systems to address material risks in their systems. The policy does not 
apply to smaller systems that do not raise material risks.

IV. 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.\7\ 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 the adverse competitive effects, the Board 
will determine whether the anticipated benefits are significant enough 
to proceed with the change despite the adverse effects. The final 
policy provides that Reserve Bank systems will be treated similarly to 
private-sector systems and thus will have no material adverse effect on 
the ability of other service providers to compete effectively with the 
Federal Reserve Banks in providing payments and securities settlement 
services.
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    \7\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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V. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
Ch. 3506; 5 CFR Part 1320 Appendix A.1), the Board reviewed the policy 
statement under the authority delegated to the Board by the Office of 
Management and Budget. The Federal Reserve may not conduct or sponsor, 
and an organization is not required to respond to, this information 
collection unless it displays a currently valid OMB control number. An 
OMB control number will be assigned upon approval of the new 
information collection.
    The collection of information that will be implemented by this 
notice is found in Part I of the Board's PSR policy. This information 
is required to evidence compliance with the requirements of the PSR 
policy. The respondents are systemically important systems, as defined 
in the PSR policy.
    The Board expects that systemically important systems, subject to 
the Board's authority, to complete initial comprehensive self-
assessments and thereafter, review and update self-assessments 
biennially or as otherwise provided in the PSR policy. The Board also 
expects that these self-assessments be reviewed and approved by the 
system's senior management and board of directors. Upon approval and in 
order to achieve broad disclosure, the systems should publish self-
assessments on their public Web sites. In order to help minimize the 
burden the Board is implementing guidelines to assist system operators 
in developing self-assessments consistent with the Board's 
expectations.
    None of the commenters discussed the burden estimates for the 
initial reporting and disclosure requirements associated with this 
policy statement. The Board continues to believe that the estimated 
burden for the one-time initial assessment to be 310 hours per system 
(ranging from 200 to 400 hours). The Board estimates that currently 
about three private-sector systems are systemically important and 
subject to the Board's authority; therefore, the total burden to 
complete the one-time initial self-assessments for systems under the 
Board's authority is estimated to be 930 hours.
    Following the initial assessment, the Board estimates that the 
burden will decrease for a system to conduct a biennial review and 
report and disclose updates to its self-assessment. The Board continues 
to believe the estimated burden for the biennial reviews and updates 
associated with this policy to be 70 hours per system (ranging from 50 
to 100 hours). The total burden for the approximately three private-
sector systems under the Board's authority would be an estimated 210 
hours (an average of 105 hours per system, per year). The total annual 
burden for this information collection is estimated to be 1,140 hours.
    The Federal Reserve has a continuing interest in the public's 
opinions of our collections of information. At any time, comments 
regarding the burden estimate, or any other aspect of this collection 
of information, including suggestions for reducing the burden,

[[Page 2521]]

may be sent to: Secretary, Board of Governors of the Federal Reserve 
System, 20th and C Streets, NW., Washington, DC 20551; and to the 
Office of Management and Budget, Paperwork Reduction Project, 
Washington, DC 20503.

VI. Federal Reserve Policy on Payments System Risk

Introduction

Risks In Payments and Settlement Sytems

I. Risk Management In Payments and Settlement Systems
    A. Scope
    B. General Policy Expectations
    C. Systemically Important Systems
    1. Principles for Systemically Important Payments Systems
    2. Minimum Standards for Systemically Important Securities 
Settlement Systems and Central Counterparties
    3. Self-Assessments by Systemically Important Systems
II. Federal Reserve Daylight Credit Policies [No Change]
    A. Daylight Overdraft Definition and Measurement
    B. Pricing
    C. Net Debit Caps
    D. Collateral
    E. Special Situations
    F. Monitoring
    G. Transfer-Size Limit on Book-Entry Securities

Introduction

    Payments and settlement systems are critical components of the 
nation's financial system. The smooth functioning of these systems is 
vital to the financial stability of the U.S. economy. Given the 
importance of these systems, the Board has developed this policy to 
address the risks that payments and settlement activity present to the 
financial system and to the Federal Reserve Banks (Reserve Banks).
    In adopting this policy, the Board's objectives are to foster the 
safety and efficiency of payments and settlement systems. These policy 
objectives are consistent with (1) the Board's long-standing objectives 
to promote the integrity, efficiency, and accessibility of the payments 
mechanism; (2) industry and supervisory methods for risk management; 
and (3) internationally accepted risk management principles and minimum 
standards for systemically important payments and settlement 
systems.\1\
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    \1\ 1 For the Board's long-standing objectives in the payments 
system, see ``The Federal Reserve in the Payments System,'' 
September 2001, FRRS 9-1550, available at http://
www.federalreserve.gov/paymentsystems/pricing/frpaysys.htm.
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    Part I of this policy sets out the Board's views, and related 
principles and minimum standards, regarding the management of risks in 
payments and settlement systems, including those operated by the 
Reserve Banks. In setting out its views, the Board seeks to encourage 
payments and settlement systems, and their primary regulators, to take 
the principles and minimum standards in this policy into consideration 
in the design, operation, monitoring, and assessing of these systems. 
The Board also will be guided by this part, in conjunction with 
relevant laws and other Federal Reserve policies, when exercising its 
authority over certain systems or their participants, when providing 
payment and settlement services to systems, or when providing intraday 
credit to Federal Reserve account holders.
    Part II of this policy governs the provision of intraday or 
``daylight'' overdrafts in accounts at the Reserve Banks and sets out 
the general methods used by the Reserve Banks to control their intraday 
credit exposures.\2\ Under this part, the Board expects depository 
institutions to manage their Federal Reserve accounts effectively and 
minimize their use of Federal Reserve daylight credit.\3\ Although some 
intraday credit may be necessary, the Board expects that, as a result 
of this policy, relatively few institutions will consistently rely on 
intraday credit supplied by the Federal Reserve to conduct their 
business.
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    \2\ To assist depository institutions in implementing this part 
of the Board's payments system risk policy, the Federal Reserve has 
prepared two documents, the ``Overview of the Federal Reserve's 
Payments System Risk Policy'' and the ``Guide to the Federal 
Reserve's Payments System Risk Policy,'' which are available on line 
at www.federalreserve.gov/paymentsystems/PSR or from any Reserve 
Bank. The ``Overview of the Federal Reserve's Payments System Risk 
Policy'' summarizes the Board's policy on the provision of daylight 
credit, including net debit caps and daylight overdraft fees. The 
overview is intended for use by institutions that incur only small 
and infrequent daylight overdrafts. The ``Guide to the Federal 
Reserve's Payments System Risk Policy'' explains in detail how these 
policies apply to different institutions and includes procedures for 
completing a self-assessment and filing a cap resolution, as well as 
information on other aspects of the policy.
    \3\ The term ``depository institution,'' as used in this policy, 
refers not only to institutions defined as ``depository 
institutions'' in 12 U.S.C. 461(b)(1)(A), but also to U.S. branches 
and agencies of foreign banking organizations, Edge and agreement 
corporations, trust companies, and bankers' banks, unless the 
context indicates a different reading.
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    Through this policy, the Board expects financial system 
participants, including the Reserve Banks, to reduce and control 
settlement and systemic risks arising in payments and settlement 
systems, consistent with the smooth operation of the financial system. 
This policy is designed to fulfill that aim by (1) making financial 
system participants and system operators aware of the types of basic 
risks that arise in the settlement process and the Board's expectations 
with regard to risk management, (2) setting explicit risk management 
expectations for systemically important systems, and (3) establishing 
the policy conditions governing the provision of Federal Reserve 
intraday credit to account holders. The Board's adoption of this policy 
in no way diminishes the primary responsibilities of financial system 
participants generally and settlement system operators, participants, 
and Federal Reserve account holders more specifically, to address the 
risks that may arise through their operation of, or participation in, 
payments and settlement systems.

Risks in Payments and Settlement Systems

    The basic risks in payments and settlement systems are credit risk, 
liquidity risk, operational risk, and legal risk. In the context of 
this policy, these risks are defined as follows.\4\
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    \4\ These definitions of credit risk, liquidity risk, and legal 
risk are based upon those presented in the Core Principles for 
Systemically Important Payment Systems (Core Principles) and the 
Recommendations for Securities Settlement Systems (Recommendations 
for SSS). The definition of operational risk is based on the Basel 
Committee on Banking Supervision's ``Sound Practices for the 
Management and Supervision of Operational Risk,'' available at 
http://www.bis.org/publ/bcbs96.htm. Each of these definitions is 
largely consistent with those included in the Recommendations for 
Central Counterparties (Recommendations for CCP).
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    Credit Risk. The risk that a counterparty will not settle an 
obligation for full value either when due, or anytime thereafter.
    Liquidity Risk. The risk that a counterparty will not settle an 
obligation for full value when due.
    Operational Risk. The risk of loss resulting from inadequate or 
failed internal processes, people, and systems, or from external 
events. This type of risk includes various physical and information 
security risks.
    Legal Risk. The risk of loss because of the unexpected application 
of a law or regulation or because a contract cannot be enforced.
    These risks arise between financial institutions as they settle 
payments and other financial transactions and must be managed by 
institutions, both

[[Page 2522]]

individually and collectively.\5\ \6\ Multilateral payments and 
settlement systems, in particular, may increase, shift, concentrate, or 
otherwise transform risks in unanticipated ways. These systems also may 
pose systemic risk to the financial system where the inability of a 
system participant to meet its obligations when due may cause other 
participants to be unable to meet their obligations when due. The 
failure of one or more participants to settle their payments or other 
financial transactions, in turn, could create credit or liquidity 
problems for other participants, the system operator, or depository 
institutions. Systemic risk might lead ultimately to a disruption in 
the financial system more broadly or undermine public confidence in the 
nation's financial infrastructure.
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    \5\ The term ``financial institution,'' as used in this policy, 
includes a broad array of types of organizations that engage in 
financial activity, including depository institutions and securities 
dealers.
    \6\ Several existing regulatory and bank supervision guidelines 
and policies also are directed at institutions' management of the 
risks posed by interbank payments and settlement activity. For 
example, Federal Reserve Regulation F (12 CFR 206) directs insured 
depository institutions to establish policies and procedures to 
avoid excessive exposures to any other depository institutions, 
including exposures that may be generated through the clearing and 
settlement of payments.
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    These risks stem, in part, from the multilateral and time-sensitive 
credit and liquidity interdependencies among financial institutions. 
These interdependencies often create complex transaction flows that, in 
combination with a system's design, can lead to significant demands for 
intraday credit, either on a regular or extraordinary basis. Some level 
of intraday credit is appropriate to ensure the smooth functioning of 
payments and settlement systems. To the extent that financial 
institutions or the Reserve Banks are the direct or indirect source of 
such intraday credit, they may face a direct risk of loss if daylight 
credit is not extinguished as planned. In addition, measures taken by 
Reserve Banks to limit their intraday credit exposures may shift some 
or all of the associated risks to private-sector systems.
    The smooth functioning of payments and settlement systems is also 
critical to certain public policy objectives in the areas of monetary 
policy and banking supervision. The effective implementation of 
monetary policy, for example, depends on both the orderly settlement of 
open market operations and the efficient distribution of reserve 
balances throughout the banking system via the money market and 
payments system. Likewise, supervisory objectives regarding the safety 
and soundness of depository institutions must take into account the 
risks payments and settlement systems pose to depository institutions 
that participate directly or indirectly in, or provide settlement, 
custody, or credit services to, such systems.

Part I: Risk Management In Payments and Settlement Systems

    This part sets out the Board's views regarding the management of 
risk in payments and settlement systems, including those operated by 
the Reserve Banks. The Board will be guided by this part, in 
conjunction with relevant laws and other Federal Reserve policies, when 
exercising its authority in (1) supervising state member banks, Edge 
and agreement corporations, bank holding companies, and clearinghouse 
arrangements, including the exercise of authority under the Bank 
Service Company Act, where applicable,\7\ (2) setting or reviewing the 
terms and conditions for the use of Federal Reserve payments and 
settlement services by system operators and participants, (3) 
developing and applying policies for the provision of intraday 
liquidity to Reserve Bank account holders, and (4) interacting with 
other domestic and foreign financial system authorities on payments and 
settlement risk management issues. The Board's adoption of this policy 
is not intended to exert or create new supervisory or regulatory 
authority over any particular class of institutions or arrangements 
where the Board does not currently have such authority.
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    \7\ 12 U.S.C. 1861 et seq.
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    Where the Board does not have exclusive authority over systems 
covered by this policy, it will work with other domestic and foreign 
financial system authorities to promote effective risk management in 
payments and settlement systems, as appropriate. The Board encourages 
other relevant authorities to consider the principles and minimum 
standards embodied in this policy when evaluating the risks posed by 
and to payments and settlement systems and individual system 
participants that they oversee, supervise, or regulate. In working with 
other financial system authorities, the Board will be guided, as 
appropriate, by Responsibility D of the Core Principles, Recommendation 
18 of the Recommendations for SSS, Recommendation 15 of the 
Recommendations for CCP, the ``Principles for Cooperative Central Bank 
Oversight of Cross-border and Multi-currency Netting and Settlement 
Schemes,'' and the Principles for International Cooperative Oversight 
(Part B) of the Committee on Payment and Settlement Systems (CPSS) 
report, ``Central Bank Oversight of Payment and Settlement Systems.'' 
\8\ The Board believes these international principles provide an 
appropriate framework for cooperating and coordinating with other 
authorities to address risks in domestic, cross-border, multi-currency, 
and, where appropriate, offshore payments and settlement systems.
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    \8\ Payments and settlement systems within the scope of this 
policy may be subject to oversight or supervision by multiple public 
authorities, as a result of the legal framework or the system's 
operating structure (e.g., multi-currency or cross-border systems). 
As such, the Federal Reserve, other central banks, securities 
regulators, or other financial system authorities may need to find 
practical ways to cooperate in order to discharge fully their own 
responsibilities. In some cases, multiple authorities may have 
responsibility for a multi-currency, cross-border, or other 
arrangement. In these situations, financial authorities need to be 
sensitive to the potential for duplicative or conflicting 
requirements, oversight gaps, or unnecessary costs and burdens 
imposed on the system. The ``Principles for Cooperative Central Bank 
Oversight and Multi-currency Netting and Settlement Schemes,'' 
published in 1990, are set out in the ``Report of the Committee on 
Interbank Netting Schemes of the Central Banks of the Group of Ten 
Countries'' (Lamfalussy Minimum Standards). The CPSS report, 
``Central Bank Oversight of Payment and Settlement Systems'' 
(Oversight Report), Part B, ``Principles for international 
cooperative oversight,'' published in 2005, provides further 
information on the practical application of the Lamfalussy 
Cooperative Oversight Principles. The Lamfalussy Minimum Standards 
and the Oversight Report are available at http://www.bis.org/cpss/
cpsspubl.htm.
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A. Scope

    This policy applies to public- and private-sector payments and 
settlement systems that expect to settle a daily aggregate gross value 
of U.S. dollar-denominated transactions exceeding $5 billion on any day 
during the next 12 months.9 10 For purposes of this policy, 
a payments or settlement system is considered to be a multilateral 
arrangement (three or more participants) among financial institutions 
for the purposes of clearing, netting, and/or

[[Page 2523]]

settling payments, securities, or other financial transactions among 
themselves or between each of them and a central party, such as a 
system operator or central counterparty.\11\ \12\ \13\ A system 
generally embodies one or more of the following characteristics: (1) A 
set of rules and procedures, common to all participants, that govern 
the clearing (comparison and/or netting) and settlement of payments, 
securities, or other financial transactions, (2) a common technical 
infrastructure for conducting the clearing or settlement process, and 
(3) a risk management or capital structure where any credit losses are 
ultimately borne by system participants rather than the system 
operator, a central counterparty or guarantor, or the system's 
shareholders.
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    \9\ The $5 billion threshold was designed to apply to cash 
markets and may not be a useful benchmark for settlement systems, 
such as central counterparties, operating in derivatives markets. 
The appropriate financial system authorities in derivatives markets 
may therefore have different benchmarks and standards relevant to 
such systems.
    \10\ The `next' twelve-month period is determined by reference 
to the date a determination is being made as to whether the policy 
applies to a particular system. Aggregate gross value of U.S dollar-
denominated transactions refers to the total dollar value of 
individual U.S. dollar transactions settled in the system, which 
also represents the sum of total U.S. dollar debits (or credits) to 
all participants prior to or in absence of any netting of 
transactions.
    \11\ A system includes all of the governance, management, legal, 
and operational arrangements used to effect settlement as well as 
the relevant parties to such arrangements, such as the system 
operator, system participants, and system owners.
    \12\ The types of systems that may fall within the scope of this 
policy include, but are not limited to, large-value funds transfer 
systems, automated clearinghouse (ACH) systems, check 
clearinghouses, and credit and debit card settlement systems, as 
well as central counterparties, clearing corporations, and central 
securities depositories. For purposes of this policy, the system 
operator manages or directs the operations of the system.
    \13\ For the purposes of this policy, a ``settlement system'' 
includes a payment-versus-payment settlement system for foreign 
exchange transactions, a securities settlement system, and a system 
operating as a central counterparty. The CPSS defines ``payment-
versus-payment'' as ``* * *a foreign exchange settlement system 
which ensures that a final transfer of one currency occurs if and 
only if a final transfer of the other currency or currencies takes 
place.'' The CPSS and the Technical Committee of the International 
Organization of Securities Commissions (IOSCO) define a ``securities 
settlement system'' as the full set of institutional arrangements 
for confirmation, clearance, and settlement of securities trades and 
safekeeping of securities and a ``central counterparty'' as an 
entity that interposes itself between counterparties to contracts 
traded in one or more financial markets, becoming the buyer to every 
seller and the seller to every buyer.
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    These systems may be organized, located, or operated within the 
United States (domestic systems), outside the United States (offshore 
systems), or both (cross-border systems) and may involve other 
currencies in addition to the U.S. dollar (multi-currency systems). The 
policy also applies to any system based or operated in the United 
States that engages in the settlement of non-U.S. dollar transactions 
if that system would be otherwise subject to the policy.\14\
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    \14\ The daily gross value threshold will be calculated on a 
U.S. dollar equivalent basis.
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    This policy does not apply to bilateral relationships between 
financial institutions and their customers, such as traditional 
correspondent banking, including traditional government securities 
clearing services. The Board believes that these relationships do not 
constitute ``a system'' for purposes of this policy and that relevant 
safety and soundness issues associated with these relationships are 
more appropriately addressed through the bank supervisory process.

B. General Policy Expectations

    The Board encourages payments and settlement systems within the 
scope of this policy and expects systems subject to its authority to 
implement a risk management framework appropriate for the risks the 
system poses to the system operator, system participants, and other 
relevant parties as well as the financial system more broadly. A risk 
management framework is the set of objectives, policies, arrangements, 
procedures, and resources that a system employs to limit and manage 
risk. While there are a number of ways to structure a sound risk 
management framework, all frameworks should
     Clearly identify risks and set sound risk management 
objectives;
     Establish sound governance arrangements;
     Establish clear and appropriate rules and procedures; and,
     Employ the resources necessary to achieve the system's 
risk management objectives and implement effectively its rules and 
procedures.
    In addition to establishing a risk management framework that 
includes these key elements, the Board expects systems subject to its 
authority that it determines are systemically important to meet the 
policy expectations set out in Section C (Core Principles, 
Recommendations for SSS, or Recommendations for CCP, as applicable).
    Identify Risks and Set Sound Risk Management Objectives. The first 
element of a sound risk management framework is the clear 
identification of all risks that have the potential to arise in or 
result from the system's settlement process and the development of 
clear and transparent objectives regarding the system's tolerance for 
and management of such risks.
    System operators should identify the forms of risk present in their 
system's settlement process as well as the parties posing and bearing 
each risk. In particular, system operators should identify the risks 
posed to and borne by themselves, the system participants, and other 
key parties such as a system's settlement banks, custody banks, and 
third-party service providers. System operators should also analyze 
whether risks might be imposed on other external parties and the 
financial system more broadly.
    In addition, system operators should analyze how risk is 
transformed or concentrated by the settlement process. System operators 
should also consider the possibility that attempts to limit one type of 
risk could lead to an increase in another type of risk. Moreover, 
system operators should be aware of risks that might be unique to 
certain instruments, participants, or market practices. System 
operators should also analyze how risks are correlated among 
instruments or participants.\15\
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    \15\ Where systems have inter-relationships with or dependencies 
on other systems (e.g., cross-guarantees, cross-collateralization, 
cross-margining, common operating platforms), system operators 
should also analyze whether and to what extent any cross-system 
risks exist and who bears them.
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    Based upon its clear identification of risks, a system should 
establish its risk tolerance, including the levels of risk exposure 
that are acceptable to the system operator, system participants, and 
other relevant parties. The system operator should then set risk 
management objectives that clearly allocate acceptable risks among the 
relevant parties and set out strategies to manage this risk. Risk 
management objectives should be consistent with the objectives of this 
policy, the system's business purposes, and the type of instruments and 
markets for which the system clears and settles. Risk management 
objectives should also be communicated to and understood by both the 
system operator's staff and system participants.
    System operators should reevaluate their risks in conjunction with 
any major changes in the settlement process or operations, the 
instruments or transactions settled, a system's rules or procedures, or 
the relevant legal and market environments. Systems should revisit 
their risk management objectives regularly to ensure that they are 
appropriate for the risks posed by the system, continue to be aligned 
with the system's purposes, remain consistent with this policy, and are 
being effectively adhered to by the system operator and participants.
    Sound Governance Arrangements. Systems should have sound governance 
arrangements to implement and oversee their risk management frameworks. 
The responsibility for sound governance rests with a system operator's 
board of directors or similar body and with the system operator's 
senior management. Governance structures and processes should be 
transparent; enable the establishment of clear risk management 
objectives; set and enforce clear lines of responsibility and 
accountability for achieving these objectives; ensure that there is 
appropriate oversight of the risk

[[Page 2524]]

management process; and enable the effective use of information 
reported by the system operator's management, internal auditors, and 
external auditors to monitor the performance of the risk management 
process.\16\ Individuals responsible for governance should be qualified 
for their positions, understand their responsibilities, and understand 
their system's risk management framework. Governance arrangements 
should also ensure that risk management information is shared in forms, 
and at times, that allow individuals responsible for governance to 
fulfill their duties effectively.
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    \16\ The risk management and internal audit functions should 
also be independent of those responsible for day-to-day functions.
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    Clear and Appropriate Rules and Procedures. Systems should 
implement rules and procedures that are appropriate and sufficient to 
carry out the system's risk management objectives and that have a well-
founded legal basis. Such rules and procedures should specify the 
respective responsibilities of the system operator, system 
participants, and other relevant parties. Rules and procedures should 
establish the key features of a system's settlement and risk management 
design and specify clear and transparent crisis management procedures 
and settlement failure procedures, if applicable.\17\
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    \17\ Examples of key features that might be specified in a 
system's rules and procedures are controls to limit participant-
based risks, such as membership criteria based on participants' 
financial and operational health, limits on settlement exposures, 
and the procedures and resources to hedge, margin, or collateralize 
settlement exposures. Other examples of key features might be 
business continuity requirements and loss allocation procedures.
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    Employ Necessary Resources. Systems should ensure that the 
appropriate resources and processes are in place to allow them to 
achieve their risk management objectives and effectively implement 
their rules and procedures. In particular, the system operator's staff 
should have the appropriate skills, information, and tools to apply the 
system's rules and procedures and achieve the system's risk management 
objectives. System operators should also ensure that their facilities 
and contingency arrangements, including any information system 
resources, are sufficient to meet their risk management objectives.
    The Board recognizes that payments and settlement systems differ 
widely in terms of form, function, scale, and scope of activities and 
that these characteristics result in differing combinations and levels 
of risks. Thus, the exact features of a system's risk management 
framework should be tailored to the risks of that system. The Board 
also recognizes that the specific features of a risk management 
framework may entail trade-offs between efficiency and risk reduction 
and that payments and settlement systems will need to consider these 
trade-offs when designing appropriate rules and procedures. In 
considering such trade-offs, however, it is critically important that 
systems take into account the costs and risks that may be imposed on 
all relevant parties, including parties with no direct role in the 
system. Furthermore, in light of rapidly evolving technologies and risk 
management practices, the Board encourages all systems to consider 
periodically making cost-effective risk-management improvements.
    To determine whether a system's current or proposed risk management 
framework is consistent with this policy, the Board will seek to 
understand how a system achieves the four elements of a sound risk 
management framework set out above. In this context, it may be 
necessary for the Board to obtain information from system operators 
regarding their risk management framework, risk management objectives, 
rules and procedures, significant legal analyses, general risk 
analyses, analyses of the credit and liquidity effects of settlement 
disruptions, business continuity plans, crisis management procedures, 
and other relevant documentation.\18\ It may also be necessary for the 
Board to obtain data or statistics on system activity on an ad-hoc or 
ongoing basis. All information provided to the Federal Reserve for the 
purposes of this policy will be handled in accordance with all 
applicable Federal Reserve policies on information security, 
confidentiality, and conflicts of interest.
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    \18\ To facilitate analysis of settlement disruptions, systems 
may need to develop the capability to simulate credit and liquidity 
effects on participants and on the system resulting from one or more 
participant defaults, or other possible sources of settlement 
disruption. Such simulations may need to include, if appropriate, 
the effects of changes in market prices, volatilities, or other 
factors.
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C. Systemically Important Systems

    Financial stability depends, in part, on a robust and well-managed 
financial infrastructure. If risks are not effectively managed by 
systemically important systems, these systems have the potential to be 
a major channel for the transmission of financial shocks across systems 
and markets. Financial system authorities, including central banks, 
have promoted sound risk management practices by developing 
internationally accepted guidelines to encourage the safe design and 
operation of payments and settlement systems, especially those 
considered systemically important.
    In particular, the Core Principles, Recommendations for SSS, and 
Recommendations for CCP (the latter two collectively referred to as the 
CPSS-IOSCO Recommendations) set forth risk management practices for 
payments systems, securities settlement systems, and central 
counterparties, respectively.19 20 The Federal Reserve 
collaborated with participating financial system authorities in 
developing these principles and minimum standards. In addition, the 
Securities and Exchange Commission and Commodity Futures Trading 
Commission participated in the development of the CPSS-IOSCO 
Recommendations. The principles and minimum standards reflect broad 
input and provide a balanced view of acceptable risk management 
practices. The Core Principles and Recommendations for SSS are also 
part of the Financial Stability Forum's Compendium of Standards that 
have been widely recognized, supported, and endorsed by U.S. 
authorities as integral to strengthening the stability of the financial 
system. The Board believes that the implementation of the individual 
principles and minimum standards by systemically important systems can 
help promote safety and efficiency in the financial system and foster 
greater financial stability in domestic and global economies.
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    \19\ The Core Principles were developed by the CPSS; references 
to ``principles'' in this policy are to the Core Principles. The 
Core Principles draw extensively on the previous work of the CPSS, 
most importantly the Lamfalussy Minimum Standards. The Core 
Principles extend the Lamfalussy Minimum Standards by adding several 
principles and broadening the coverage to include systemically 
important payments systems of all types, including gross settlement 
systems, net settlement systems, and hybrid systems, operated by 
either the public or private sector. The Core Principles also 
address the responsibilities of central banks in applying the Core 
Principles.
    \20\ The CPSS and IOSCO developed the CPSS-IOSCO Recommendations 
as minimum standards and are referred to as such in this policy. The 
full reports on the Core Principles and the CPSS-IOSCO 
Recommendations are available at http://www.bis.org/publ/cpss43.htm, 
http://www.bis.org/publ/cpss46.htm, and http://www.bis.org/publ/
cpss64.htm.
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    Systemically important systems that are subject to the Board's 
authority are expected to meet the specific risk management principles 
and minimum standards in this section, as appropriate, and the general 
expectations of Section B because of their potential to cause major 
disruptions in the financial system.\21\ To determine whether a

[[Page 2525]]

system is systemically important for purposes of this policy, the Board 
may consider, but will not be limited to, one or more of the following 
factors: \22\
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    \21\ Systemically important payments systems are expected to 
meet the principles listed in Section C.1. Securities settlement 
systems of systemic importance are expected to meet the minimum 
standards listed in Section C.2.a., and systemically important 
central counterparties are expected to meet the minimum standards 
listed in C.2.b. For a system not subject to its authority, the 
Board encourages the system and its appropriate financial system 
authority to consider these principles and minimum standards when 
designing, operating, monitoring, and assessing the system, as 
appropriate and applicable.
    \22\ The Board will inform a system subject to its authority if 
it considers it systemically important and therefore expected to 
meet the principles or minimum standards in this policy. The Board 
will also inform such systems if they are expected to exceed any of 
the principles or minimum standards. The appropriate financial 
system authorities responsible for supervising or regulating central 
counterparties are encouraged to inform the central counterparties 
as to whether they are expected to meet the Recommendations for CCP.
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     Whether the system has the potential to create significant 
liquidity disruptions or dislocations should it fail to perform or 
settle as expected;
     Whether the system has the potential to create large 
credit or liquidity exposures relative to participants' financial 
capacity;
     Whether the system settles a high proportion of large-
value or interbank transactions;
     Whether the system settles transactions for important 
financial markets; \23\
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    \23\ Important financial markets include, but are not limited 
to, critical markets as defined in the ``Interagency Paper on Sound 
Practices to Strengthen the Resilience of the U.S. Financial 
System'' as the markets for federal funds, foreign exchange, and 
commercial paper; U.S. Government and agency securities; and 
corporate debt and equity securities. 68 FR 17809 (April 11, 2003).
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     Whether the system provides settlement for other systems; 
and,
     Whether the system is the only system or one of a very few 
systems for settlement of a given financial instrument.
    Some systemically important systems, however, may present an 
especially high degree of systemic risk, by virtue of their high volume 
of large-value transactions or central role in the financial markets. 
Because all systems are expected to employ a risk management framework 
that is appropriate for their risks, the Board may expect these systems 
to exceed the principles and minimum standards set out below. Finally, 
the Board expects systemically important systems to demonstrate the 
extent to which they meet the applicable principles or minimum 
standards by completing self-assessments and disclosing publicly the 
results of their analyses in a manner consistent with the guidelines 
set forth in Section C.3.
1. Principles for Systemically Important Payments Systems
    1. The system should have a well-founded legal basis under all 
relevant jurisdictions.
    2. The system's rules and procedures should enable participants to 
have a clear understanding of the system's impact on each of the 
financial risks they incur through participation in it.
    3. The system should have clearly defined procedures for the 
management of credit risks and liquidity risks, which specify the 
respective responsibilities of the system operator and the participants 
and which provide appropriate incentives to manage and contain those 
risks.
    4. The system should provide prompt final settlement on the day of 
value, preferably during the day and at a minimum at the end of the 
day.
    5. A system in which multilateral netting takes place should, at a 
minimum, be capable of ensuring the timely completion of daily 
settlements in the event of an inability to settle by the participant 
with the largest single settlement obligation.
    6. Assets used for settlement should preferably be a claim on the 
central bank; where other assets are used, they should carry little or 
no credit risk and little or no liquidity risk.
    7. The system should ensure a high degree of security and 
operational reliability and should have contingency arrangements for 
timely completion of daily processing.
    8. The system should provide a means of making payments which is 
practical for its users and efficient for the economy.
    9. The system should have objective and publicly disclosed criteria 
for participation, which permit fair and open access.
    10. The system's governance arrangements should be effective, 
accountable and transparent.
2. Minimum Standards for Systemically Important Securities Settlement 
Systems and Central Counterparties
    The CPSS-IOSCO Recommendations apply to the full set of 
institutional arrangements for confirmation, clearance, and settlement 
of securities transactions, including those related to market 
convention and pre-settlement activities. As such, not all of these 
standards apply to all systems. Moreover, the standards applicable to a 
particular system also will vary based on the structure of the market 
and the system's design.
    While the Board endorses the CPSS-IOSCO Recommendations in their 
entirety, its primary interest for purposes of this policy is in those 
recommendations related to the settlement aspects of financial 
transactions, including the delivery of securities or other financial 
instruments against payment, and related risks. The Board expects that 
systems engaged in the management or conduct of clearing and settling 
financial transactions to meet the expectations set forth in the 
applicable set of CPSS-IOSCO Recommendations.
    a. Recommendations for Securities Settlement Systems
    1. Securities settlement systems should have a well-founded, clear, 
and transparent legal basis in the relevant jurisdictions.
    2. Confirmation of trades between direct market participants should 
occur as soon as possible after the trade execution, but no later than 
the trade date (T+0). Where confirmation of trades by indirect market 
participants (such as institutional investors) is required, it should 
occur as soon as possible after the trade execution, preferably on T+0, 
but no later than T+1.
    3. Rolling settlement should be adopted in all securities markets. 
Final settlement should occur no later than T+3. The benefits and costs 
of a settlement cycle shorter than T+3 should be evaluated.
    4. The benefits and costs of a central counterparty should be 
evaluated. Where such a mechanism is introduced, the central 
counterparty should rigorously control the risks it assumes.
    5. Securities lending and borrowing (or repurchase agreements and 
other economically equivalent transactions) should be encouraged as a 
method for expediting the settlement of securities transactions. 
Barriers that inhibit the practice of lending securities for this 
purpose should be removed.
    6. Securities should be immobilized or dematerialized and 
transferred by book entry in central securities depository to the 
greatest extent possible.
    7. Central securities depositories should eliminate principal risk 
linking securities transfers to funds transfers in a way that achieves 
delivery versus payment.
    8. Final settlement should occur no later than the end of the 
settlement day. Intraday or real time finality should be provided where 
necessary to reduce risks.
    9. Central securities depositories that extend intraday credit to 
participants, including central securities depositories that operate 
net settlement systems, should institute risk controls that, at a

[[Page 2526]]

minimum, ensure timely settlement in the event that the participant 
with the largest payment obligation is unable to settle. The most 
reliable set of controls is a combination of collateral requirements 
and limits.
    10. Assets used to settle the ultimate payment obligations arising 
from securities transaction should carry little or no credit or 
liquidity risk. If central bank money is not used, steps must be taken 
to protect central securities depository members from potential losses 
and liquidity pressures arising from the failure of the cash settlement 
agent whose assets are used for that purpose.
    11. Sources of operational risk arising in the clearing and 
settlement process should be identified and minimized through the 
development of appropriate systems, controls and procedures. Systems 
should be reliable and secure, and have adequate, scalable capacity. 
Contingency plans and backup facilities should be established to allow 
for the timely recovery of operations and completion of the settlement 
process.
    12. Entities holding securities in custody should employ accounting 
practices and safekeeping procedures that fully protect customers' 
securities. It is essential that customers' securities be protected 
against the claims of a custodian's creditors.
    13. Governance arrangements for central securities depositories and 
central counterparties should be designed to fulfill public interest 
requirement and to promote the objectives of owners and users.
    14. Central securities depositories and central counterparties 
should have objective and publicly disclosed criteria for participation 
that permit fair and open access.
    15. While maintaining safe and secure operations, securities 
settlement systems should be cost-effective in meeting the requirements 
of users.
    16. Securities settlement systems should use or accommodate the 
relevant international communication procedures and standards in order 
to facilitate efficient settlement of cross-border transactions.
    17. Central securities depositories and central counterparties 
should provide market participants with sufficient information for them 
to identify and evaluate accurately the risks and costs associated with 
using the central securities depository or central counterparty 
services.
    18. Securities settlement systems should be subject to transparent 
and effective regulation and oversight. Central banks and securities 
regulators should cooperate with each other and with other relevant 
authorities.
    19. Central securities depositories that establish links to settle 
cross-border trades should design and operate such links to reduce 
effectively the risks associated with cross-border settlement.
    b. Recommendations for Central Counterparties
    1. A central counterparty should have a well founded, transparent, 
and enforceable legal framework for each aspect of its activities in 
all relevant jurisdictions.
    2. A central counterparty should require participants to have 
sufficient financial resources and robust operational capacity to meet 
obligations arising from participation in the central counterparty. A 
central counterparty should have procedures in place to monitor that 
participation requirements are met on an ongoing basis. A central 
counterparty's participation requirements should be objective, publicly 
disclosed, and permit fair and open access.
    3. A central counterparty should measure its credit exposures to 
its participants at least once a day. Through margin requirements, 
other risk control mechanisms, or a combination of both, a central 
counterparty should limit its exposures to potential losses from 
defaults by its participants in normal market conditions so that the 
operations of the central counterparty would not be disrupted and non-
defaulting participants would not be exposed to losses that they cannot 
anticipate or control.
    4. If a central counterparty relies on margin requirements to limit 
its credit exposures to participants, those requirements should be 
sufficient to cover potential exposures in normal market conditions. 
The models and parameters used in setting margin requirements should be 
risk-based and reviewed regularly.
    5. A central counterparty should maintain sufficient financial 
resources to withstand, at a minimum, a default by the participant to 
which it has the largest exposure in extreme but plausible market 
conditions.
    6. A central counterparty's default procedures should be clearly 
stated, and they should ensure that the central counterparty can take 
timely action to contain losses and liquidity pressures and to continue 
meeting its obligations. Key aspects of the default procedures should 
be publicly available.
    7. A central counterparty should hold assets in a manner whereby 
risk of loss or of delay in its access to them is minimized. Assets 
invested by a central counterparty should be held in instruments with 
minimal credit, market, and liquidity risks.
    8. A central counterparty should identify sources of operational 
risk and minimize them through the development of appropriate systems, 
controls, and procedures. Systems should be reliable and secure, and 
have adequate, scalable capacity. Business continuity plans should 
allow for timely recovery of operations and fulfillment of a central 
counterparty's obligations.
    9. A central counterparty should employ money settlement 
arrangements that eliminate or strictly limit its settlement bank 
risks, that is, its credit and liquidity risks from the use of banks to 
effect money settlements with its participants. Funds transfers to a 
central counterparty should be final when effected.
    10. A central counterparty should clearly state its obligations 
with respect to physical deliveries. The risks from these obligations 
should be identified and managed.
    11. Central counterparties that establish links either cross-border 
or domestically to clear trades should evaluate the potential sources 
of risks that can arise, and ensure that the risks are managed 
prudently on an ongoing basis. There should be a framework for 
cooperation and coordination between the relevant regulators and 
overseers.
    12. While maintaining safe and secure operations, central 
counterparties should be cost-effective in meeting the requirements of 
participants.
    13. Governance arrangements for a central counterparty should be 
clear and transparent to fulfill public interest requirements and to 
support the objectives of owners and participants. In particular, they 
should promote the effectiveness of a central counterparty's risk 
management procedures.
    14. A central counterparty should provide market participants with 
sufficient information for them to identify and evaluate accurately the 
risks and costs associated with using its services.
    15. A central counterparty should be subject to transparent and 
effective regulation and oversight. In both a domestic and an 
international context, central banks and securities regulators should 
cooperate with each other and with other relevant authorities.
3. Self-Assessments by Systemically Important Systems
    Users and others outside the user community (such as prospective 
users or other public authorities) commonly are interested in 
understanding how systemically important payments and settlement 
systems function in order to

[[Page 2527]]

manage their risks. At this time, different disclosure practices and 
requirements for payments and settlement systems have resulted in 
varying levels of information being disseminated to users and others. 
Users and other persons may find it difficult to obtain access to 
sufficient information to understand and assess a particular system's 
approach to risk management against internationally accepted principles 
and minimum standards. Broadening the availability of information 
concerning a system's risk management controls, governance, and legal 
framework, for example, can facilitate this understanding and analysis 
and also assist those interested in a system in evaluating and managing 
any risk exposure.\24\
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    \24\ The Board considers self-assessments as only one resource 
for users and other persons to consider when evaluating any risks 
associated with a particular system. In order to effectively 
identify and manage risks, a user or other interested person may 
need to consider other relevant documentation such as the system's 
rules, operating procedures, or organizational documents. These 
materials may be publicly available or may need to be requested from 
the system directly.
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    The Board believes that the implementation of the applicable 
principles and minimum standards by systemically important systems can 
foster greater financial stability in payments and settlement systems. 
The Board further believes that operators of systemically important 
systems are well positioned to assess and demonstrate the extent to 
which they have implemented the principles or minimum standards in this 
policy. Therefore, in furtherance of its policy objectives, the Board 
expects systemically important systems subject to its authority to 
complete comprehensive, objective self-assessments against the 
applicable principles or minimum standards in this policy and disclose 
publicly the results of these efforts. Adopting this self-assessment 
framework, however, does not preclude the Federal Reserve from 
independently assessing compliance of systemically important systems 
with relevant rules, regulations, and Federal Reserve policies.
    The Board expects systemically important systems subject to its 
authority to complete self-assessments based on the following 
guidelines. First, systemically important systems are expected to 
document the basis for their self-assessment and support any 
conclusions regarding the extent to which they meet a particular 
principle or minimum standard.\25\ System operators should use one of 
the following assessment categories to describe the extent to which the 
system meets a particular principle or minimum standard: Observed, 
broadly observed, partly observed, or non-observed. The CPSS and CPSS-
IOSCO have developed implementation guidelines and assessment 
methodologies that can assist system operators in structuring their 
self-assessments and assigning an assessment category. Accordingly, 
payment system operators are encouraged to consult Section 7 of the 
Core Principles for guidance when developing their self-assessments and 
in measuring the extent to which the system meets each principle.\26\ 
Likewise system operators for securities settlement systems and central 
counterparties are encouraged to consult the assessment methodology for 
the relevant minimum standards for further guidance on each minimum 
standard and are encouraged to respond to the key questions included 
therein.\27\ A system may consult the Board for assistance with respect 
to the principles and minimum standards and the completion of its 
assessment. Second, to further ensure system accountability for 
accuracy and completeness, the Board expects the system's senior 
management and board of directors to review and approve self-
assessments upon completion. Third, to achieve broad disclosure, the 
system is expected to make its self-assessments readily available to 
the public, such as by posting the self-assessment on the system's 
public Web site. Finally, in order for self-assessments to reflect 
correctly the system's current rules, procedures, and operations, the 
Board expects a systemically important system to update the relevant 
parts of its self-assessment following material changes to the system 
or its environment. At a minimum, a systemically important system would 
be expected to review its self-assessment every two years to ensure 
continued accuracy.
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    \25\ While the Board expects self-assessments to be robust, it 
does not expect payments and settlement systems to disclose publicly 
sensitive information that would expose system vulnerabilities or 
otherwise put the system at risk (e.g., specific business continuity 
plans).
    \26\ The Core Principles include implementation guidelines and 
an implementation summary for each principle. The guidelines provide 
both detailed explanations of each principle and general examples of 
ways to interpret and implement them.
    \27\ In November 2002, CPSS-IOSCO published an Assessment 
Methodology for the Recommendations for SSS, which is available at 
http://www.bis.org/publ/cpss51.htm. In November 2004, CPSS-IOSCO 
published the CCP Recommendations and an Assessment Methodology, 
which are available at http://www.bis.org/publ/cpss64.htm. These 
assessment methodologies for the CPSS-IOSCO Recommendations include 
key questions to assist an assessor in determining to what extent a 
system meets a particular minimum standard.
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    As part of its ongoing oversight of systemically important payments 
and settlement systems, the Federal Reserve will review published self-
assessments by systems subject to the Board's authority to ensure the 
Board's policy objectives and expectations are being met.\28\ Where 
necessary, the Federal Reserve will provide feedback to these systems 
regarding the content of their self-assessments and their effectiveness 
in achieving the policy objectives discussed above.\29\ The Board 
acknowledges that payments and settlement systems vary in terms of the 
scope of instruments they settle and markets they serve. It also 
recognizes that systems may operate under different legal and 
regulatory constraints and within particular market infrastructures or 
institutional frameworks. The Board will consider these factors when 
reviewing self-assessments and in evaluating how a systemically 
important system addresses a particular principle or minimum standard 
and complies with the policy generally. Where the Board does not have 
exclusive authority over a systemically important system, it will 
encourage appropriate domestic or foreign financial system authorities 
to promote self-assessments by systemically important systems as a 
means to achieve greater safety and efficiency in the financial system.
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    \28\ Any review of an assessment by the Federal Reserve should 
not be viewed as an approval or guarantee of the accuracy of a 
system's self-assessment. Furthermore, the contents of a review of a 
self-assessment would be subject to the Board's rules regarding 
disclosure of confidential supervisory information. Therefore, 
without the express approval of the Board, a system would not be 
allowed to state publicly that its self-assessment has been 
reviewed, endorsed, approved, or otherwise not objected to by the 
Federal Reserve.
    \29\ If the Federal Reserve materially disagrees with the 
content of a system's self-assessment, it will communicate its 
concerns to the system's senior management and possibly to its board 
of directors, as appropriate. The Federal Reserve may also discuss 
its concerns with other relevant financial system authorities, as 
appropriate.

    By order of the Board of Governors of the Federal Reserve 
System, January 11, 2007.
Robert deV. Frierson,
Deputy Secretary of the Board.
 [FR Doc. E7-589 Filed 1-18-07; 8:45 am]
BILLING CODE 6210-01-P