[Federal Register Volume 63, Number 215 (Friday, November 6, 1998)]
[Notices]
[Pages 60000-60006]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-29709]
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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 service enhancement.
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SUMMARY: The Board of Governors has approved enhancements to the net
settlement services that the Federal Reserve Banks offer to financial
institutions with Federal Reserve accounts that participate in
multilateral settlements for private-sector clearing arrangements. The
enhanced service combines and improves selected features from the
Reserve Banks' existing net settlement services and may be used for
either gross or net multilateral settlements. The service is fully
automated and provides finality of settlement intraday on the
settlement day to participants in clearing arrangements using the
service. The service is intended to facilitate improvements in the
operational efficiency of clearinghouses and reduce operational and
settlement risk for participants.
EFFECTIVE DATE: March 29, 1999.
FOR FURTHER INFORMATION CONTACT: Paul W. Bettge, Assistant Director
(202/452-
[[Page 60001]]
3174); Myriam Y. Payne, Senior Financial Services Analyst (202/452-
3219); for the hearing impaired only, Telecommunications Device for the
Deaf (TDD), Diane Jenkins (202/452-3544).
SUPPLEMENTARY INFORMATION:
I. Background
The Reserve Banks offer net settlement services to depository
institutions that participate in clearinghouses and clearing
arrangements for checks, as well as Automated Clearing House (ACH),
automated teller machine (ATM), point-of-sale (POS) networks, and other
transactions. The arrangements are typically organized as groups of
three or more participating depository institutions that exchange
payment instructions, account for the value exchanged, and settle
balances multilaterally. Typically, the agent \1\ for the arrangement
computes the net amounts owed to or by each participant \2\ after
netting all the transactions on a multilateral basis. The calculated
net amounts represent either a net debit or a net credit for each
participant. If the clearinghouse uses the Reserve Banks' net
settlement services, the multilateral differences may be settled by
transferring funds between the accounts of the settling participants on
the books of the Reserve Banks.
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\1\ The agent is the party designated by the participants to act
on behalf of the clearinghouse.
\2\ A settling participant in a clearinghouse that uses a
Reserve Bank net settlement service is a financial institution with
a Federal Reserve account that is debited or credited to transfer
the funds needed to complete the settlement. In contrast, non-
settling participants typically settle through a settling
participant.
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Currently, the Reserve Banks offer two basic types of net
settlement services. In the traditional model, the clearinghouse agent
provides a settlement sheet (in either paper or electronic form) to a
Reserve Bank on the settlement date. The Reserve Bank then posts a net
debit or a net credit to the Federal Reserve account of each settling
participant. Posted credits represent available funds for the purpose
of intraday cash management and overnight reserve management.\3\ The
Reserve Banks, however, do not provide settlement finality until the
business day after the settlement day. They reserve the right to
reverse settlement debits and credits if a participant is unable to
cover its settlement debit. This methodology creates the possibility of
a settlement failure by a clearinghouse on the day following the
settlement day. Because these dating conventions refer to banking days,
reversals may occur on the third or even the fourth calendar day
following settlement.
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\3\ The posting time for net settlement entries is chosen by
each clearinghouse within the requirements of the Board's Daylight
Overdraft Transaction Posting Rules.
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The traditional settlement sheet service offers clearinghouses a
familiar and inexpensive mechanism to achieve settlement. This service,
however, increases the duration of settlement risk to clearinghouse
participants and their customers because settlement entries are
provisional until the banking day after the settlement day. Another
disadvantage is that some versions of the service lack the security
controls needed to ensure the authenticity of settlement information
provided to the Reserve Bank and to safeguard the integrity of the
settlement. In addition, the design of the traditional service does not
include automated risk-management controls for verifying the Federal
Reserve account balances of participants with net debit positions. To
help control credit risk, the Reserve Banks rely on the right to
reverse net settlement entries on the banking day following the
settlement day if a participant is not able to cover its net debit
obligation. As a result, the traditional service does not provide
effective tools for monitoring or controlling risk to the Reserve Banks
at the point the risk is incurred.
In 1990, the Board approved an interdistrict net settlement service
with settlement-day finality for a national ACH clearinghouse. In this
type of service, individual participants with net debit positions send
Fedwire funds transfers to a settlement account at a designated Reserve
Bank. Once funds transfers have been received into the settlement
account to cover all net debits, the clearing arrangement's agent sends
Fedwire funds transfers from the settlement account to the accounts of
participants in net credit positions. Under normal circumstances, this
process is completed on the settlement day. Because the service uses
Fedwire funds transfers, settlement payments are final and irrevocable
on the settlement day.
The Fedwire-based net settlement service provides intraday finality
on the settlement day, thereby reducing the duration of credit risk to
clearinghouse participants. It also offers Reserve Banks significantly
greater control over credit risk because of the use of Fedwire and the
associated real-time verification of Federal Reserve account balances
performed through the Account Balance Monitoring System (ABMS). Fedwire
funds transfers initiated by clearinghouse participants that would
cause overdrafts beyond established parameters can be rejected. These
capabilities permit Reserve Banks to perform automated intraday risk
management on the settlement day, when settlement information becomes
available and before settlement entries are posted to Federal Reserve
accounts.
Relying on the initiation of individual Fedwire funds transfers to
conduct multilateral settlement, however, increases the logistical
complexity of settlement for certain clearing arrangements. For
example, a settlement for a clearinghouse with a large number of
participants could involve coordinating hundreds of individual Fedwire
funds transfers that have to be sent and received within narrow time
frames in order to complete scheduled settlements.
II. The June 1997 Proposal
In June 1997, the Board requested comments on a proposal that
Reserve Banks offer an enhanced net settlement service to depository
institutions that participate in clearinghouse arrangements (62 FR
32118, June 12, 1997). The proposed service would combine and improve
selected features from the Reserve Bank's existing net settlement
services. Under the proposal, the Reserve Banks would offer a fully
automated settlement service with finality of settlement intraday on
the settlement day. The agent for the clearinghouse would submit an
electronic file containing the settlement information for each settling
participant. The enhanced service would accept and process settlement
files during a predefined settlement period. The service would include
edits and controls to ensure the authenticity and validity of the
settlement file. Once all initial edits have been completed, the
service would check the account balance of settling participants that
fall within established risk parameters in the ABMS and that have debit
settlement positions. If the debit participants have available account
balances \4\ sufficient to cover their settlement obligations, their
Federal Reserve accounts would be debited and funds would be
transferred to a settlement account held on the books of a designated
Reserve Bank. The transfer of funds from the account of a participant
with a debit position would be treated as a final and irrevocable
transaction. When all funds have been transferred from the account of
the debit participants to the settlement account, the enhanced service
would transfer final funds out of the settlement account and credit the
Federal Reserve account
[[Page 60002]]
of each participant with a credit position.
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\4\ The available account balance is defined as the
institution's Federal Reserve account balance plus any available
intraday credit.
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If a participant with a debit position did not have an available
account balance sufficient to cover its settlement obligation, the
Federal Reserve would notify the participant and the agent. The agent
would then be expected to take action as determined by the rules of the
clearing organization. For example, the organization could choose to
fund the settlement account to complete the settlement by drawing on a
preestablished line of credit. Alternatively, the agent might request
that the Reserve Bank cancel the settlement and return all funds in the
settlement account to the participants with debit positions. After a
defined period, if the organization had not been able to complete or
cancel the settlement, the Reserve Bank would return all the funds in
the settlement account to the participants with debit positions. The
terms of the enhanced service would permit the agent to submit a
revised settlement file in the event of a settlement failure.
III. Enhanced Settlement Service
The Board is approving an enhanced settlement service that retains
the essential characteristics described in the proposal issued for
comment in 1997. First, by providing settlement-day finality, the
enhanced service will reduce the duration of credit risk to private-
sector clearinghouse participants relative to the Federal Reserve's
traditional net settlement service. Second, the enhanced service will
improve operational efficiency and reduce operational risk for
clearinghouse participants by offering a settlement mechanism that does
not require the origination of individual Fedwire funds transfers to
achieve settlement-day finality. In addition, the enhanced service
enables the Reserve Banks to manage and limit risk by incorporating
risk controls that are as robust as those used currently in the
Fedwire-based net settlement service.
Service Availability and Features--The enhanced service will be
available to financial institutions with Federal Reserve accounts that
participate in multilateral settlements for private-sector clearing
arrangements. The enhanced service will provide clearing arrangements
with the capability to settle the obligations that result from their
payments exchange on either a net or gross basis. In addition, the
service approved by the Board incorporates the following features:
1. The Federal Reserve will provide settlement services during a
business day beginning at 8:30 a.m. Eastern Time (ET) and concluding
before 6:00 p.m. ET (the settlement window). A file-submission deadline
will be established approximately thirty to sixty minutes before the
end of the settlement window (the file-submission window) to ensure
that all files received by the file-submission window can be processed
before the close of the settlement window. The specific hours of
operation of the service, however, will be reviewed periodically and
may be modified to reflect changes in the operating hours of the
Fedwire system or the business needs of settlement participants.
2. Agents will submit settlement files electronically during the
predefined file-submission window. The initial release of the
application software will support file submission using a standard
Fedline terminal or computer interface bulk data connection.
Preformatted Fedline screens will also be provided for clearinghouse
arrangements that wish to key in the settlement information. In
addition, internet browser capability for file submission and access to
the service is being considered for a future release.
3. Agents may transmit any number of settlement files per
settlement day. The service will process the settlement files for a
particular settlement arrangement one at a time in the order they are
received. Files received after the close of the settlement window will
be held in a queue to be processed in the order received at the opening
of the following day's settlement window, as long as the settlement
date on the file corresponds with the following settlement date.
4. Controls and edits in the application will ensure, among other
things, that the file has been transmitted by an agent authorized by
the participants in the clearing arrangement, that the file has been
transmitted from an authorized terminal, that the file contains
settlement entries from authorized participants only, and that the sum
of all the settlement debits equals the sum of all the settlement
credits.
5. Settlement debit entries will be passed to the ABMS for posting
to each settling participant's Federal Reserve account. The ABMS will
check the available account balance of all participants that fall
within established risk parameters to determine if the settlement
debits can be covered. If the available account balance is sufficient
to cover the participant's settlement debit, the participant's account
will be debited and an offsetting credit will be posted immediately to
a settlement account held on the books of a Reserve Bank. The debit to
the Federal Reserve account will be a final and irrevocable
transaction. When all settlement debits have been covered and the
arrangement's settlement account has been fully funded, credit
settlement balances will be passed to the ABMS for posting to the
relevant participants' Federal Reserve accounts. The credit entries
will also be final and irrevocable transactions.
The ABMS account balance report available to institutions via
Fedline will include a new line that will show the net settlement debit
or credit entries that have been posted to the participants' Federal
Reserve accounts. For purposes of measuring the daylight overdraft
positions of participants, the net debit and net credit entries will be
posted to participants' Federal Reserve accounts on a flow basis, as
they are processed.
Exception Processing--If a settlement cannot be completed because a
participant with a debit position is unable to cover its settlement
obligation, the Federal Reserve will notify the participant and the
agent for the clearing arrangement. The participant with the
insufficient balance will be notified immediately. The agent will be
notified on either an immediate or a delayed basis, depending on the
notification option that the settlement arrangement has selected. If
the clearinghouse chooses immediate notification, the Federal Reserve
will automatically transmit a notification of the failed debit to the
agent. If the deferred option is chosen, the Federal Reserve will defer
notifying the agent for a brief interval after the participant's debit
is rejected. This brief interval will be defined by the Federal
Reserve, initially the interval will be approximately thirty to forty-
five minutes long. The interval is intended to allow the participant
some time to provide funding before the agent is notified. The length
of the interval may be reviewed periodically based on perceived
business needs. If the participant is unable to provide sufficient
funds in its account before the end of the deferral interval, the
Federal Reserve will automatically send a notification to the agent.
When notified of the failed debit, the agent may choose to initiate
actions to complete the settlement as determined by the rules of the
clearing arrangement. Pending action by the agent, the settlement will
remain open and the collected funds will remain in the settlement
account. The enhanced service will provide settlement agents with the
capability to:
1. Instruct the Federal Reserve to retry the failed debit. That is,
the agent would notify Reserve Bank staff that the
[[Page 60003]]
participant in question has received the funds needed to fulfill its
settlement obligation. The Federal Reserve would then retry debiting
the participant's account and crediting the settlement account once
more.
2. Fund the settlement account from an alternative source, such as
a preestablished line of credit.
3. Instruct the Federal Reserve to cancel the settlement and allow
the agent to submit a revised or ``recast'' settlement file that
excludes the transactions of the participant in question and provides
recalculated settlement positions for the remaining participants.
4. Instruct the Federal Reserve to cancel the settlement. If the
agent selects this option, the funds in the settlement account will be
returned to the Federal Reserve accounts of the debit participants that
had covered their settlement obligations.
If processing of a settlement file has not been completed by the
close of the settlement window because a participant is unable to cover
its settlement obligation, the settlement will be cancelled by the
Federal Reserve and all funds in the settlement account will be
returned to the relevant participants. Extensions of the settlement
window might be granted to accommodate operational disruptions or
temporary funding problems. These occurrences, however, are expected to
be rare and not to extend beyond the operating hours of the Fedwire
funds transfer service.
Implementation and Conversion Schedule--Early in 1999, the Reserve
Banks will conduct a pre-implementation pilot of the enhanced
settlement service with two or three settlement arrangements. The pilot
will be conducted in a test environment designed to simulate the
production environment. The pilot will provide an opportunity for both
Reserve Banks and participating arrangements to test the enhanced
service and to refine operating procedures prior to implementation. The
Reserve Banks will begin phased implementation of the enhanced
settlement service on March 29, 1999.
The current Fedwire-based net settlement service used by a few
national clearinghouses will continue to be offered in conjunction with
the enhanced settlement service as long as a reasonable level of demand
for the Fedwire-based service exists. The traditional settlement sheet
service, however, will be phased out gradually. Clearinghouses and
settlement arrangements that currently use the traditional net
settlement service will be able to work with the Federal Reserve to
develop a migration plan that is not in conflict with other critical
efforts that the clearinghouses and participants may have under way.
Specifically, because conversion to the enhanced settlement service may
require clearinghouses to implement internal software changes, it may
not be possible or desirable to address the required changes until
after year 2000 system efforts have been completed. The Board expects
that clearinghouses and settlement arrangements that currently use the
traditional service will be able to convert to the enhanced settlement
service by the end of 2001. The Board will consider extending the
conversion deadline on a case-by-case basis for systems that can
demonstrate significant resource demands due to other critical efforts.
Service Pricing--The planned price structure for the enhanced
service has been designed to recognize both the fixed costs of
providing a settlement service and the variable costs associated with
the number of settlement transactions processed. This will be
accomplished by assessing a charge for each settlement file transmitted
by an arrangement and a charge for each settlement entry in the file.
The actual price for the service will be announced in the fourth
quarter of 1998 as part of the Federal Reserve's 1999 fee schedule.
IV. Summary of Comments
The Board received twenty public comment letters on its proposed
enhanced settlement service.\5\ The commenters included nine
clearinghouse organizations and associations, six commercial banking
organizations, four trade associations, and one retail payment network.
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\5\ This total does not include comment letters from Federal
Reserve Banks.
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General Comments--Most commenters supported the proposed
enhancements to the Federal Reserve's net settlement services. Over
half of the commenters that supported the proposed service requested
that the Board provide a pricing structure for the proposed service or
specify the risk management policy to which institutions would be
required to adhere in order to use this service. One commenter proposed
that the Board convene a meeting of clearing arrangement operators to
review these issues. On December 15, 1997, Federal Reserve staff held a
meeting with private-sector organizations in order to answer questions
and provide additional details regarding the enhanced settlement
service. All organizations that submitted comment letters and other
interested organizations were invited to the meeting.
A few commenters expressed concerns regarding the schedule for
implementation of the proposed service. One commenter stated that if
the Federal Reserve were going to require clearing and settlement
arrangements to use the new service, then such a requirement should not
be imposed on participants until after the year 2000. In light of the
resources devoted to year 2000 issues, the Board will not require
clearing and settlement arrangements to use the new service before the
year 2000.
Issues Discussed at the December 15, 1997 Meeting--At the December
meeting, Federal Reserve staff gave an overview of the proposed risk
management policy that would apply to certain multilateral settlement
systems regardless of whether they use Federal Reserve settlement
services. A final policy was adopted by the Board in its Policy
Statement on Privately Operated Multilateral Settlement Systems (63 FR
34888, June 26, 1998) and will become effective on January 4, 1999. In
adopting that policy statement, the Board also emphasized that
compliance with the policy does not require use of the Federal
Reserve's enhanced settlement service. The planned pricing structure
for the enhanced settlement service was also discussed with the
private-sector representatives.
The Federal Reserve staff also briefly described pilot testing and
the likely transition to the enhanced settlement service. As noted
above, a pre-production pilot of the service will be conducted early in
1999. Phased implementation of the service will begin by the end of the
first quarter of 1999.
One private-sector representative expressed concern regarding the
proposed method of posting debits and credits to participants' Federal
Reserve accounts on a flow basis, as they are processed, for purposes
of measuring daylight overdraft positions. The representative felt that
such a procedure would cause inequities among participants because
participants would be debited or credited based on where the entry was
located in the settlement file. The Board believes that, in most
instances, debits and credits will be posted almost simultaneously, as
soon as the settlement entries are processed. Delays in the posting of
all debits and credits in a settlement file may occur if a participant
is unable to cover its settlement obligation. These situations and the
related consequences should be addressed in the clearinghouse rules.
[[Page 60004]]
A few representatives wanted to know whether daylight overdrafts
could be used to support a debit position by a settling participant.
One of these representatives also requested clarification on how these
debits and credits would affect a participant's daylight overdraft
position. In general, a settling participant will normally be able to
use its available account balance, which includes any authorized
intraday credit, to fund its debit position. In addition, settlement
debits and credits will be posted to the account of participants on a
flow basis, as they occur.
Specific Issues on which the Board Sought Comment--The Board also
sought comment on a number of other issues discussed below:
A. Continuation of Traditional Settlement Sheet Service With Next-Day
Finality
Nine of the thirteen respondents to this question believed that the
Federal Reserve should continue to offer its existing net settlement
service with next-day finality. One commenter felt that the time and
equipment investment necessary for the proposed service might prove to
be a financial burden for small-volume clearinghouses. Two commenters
indicated that some clearing arrangements might prefer the simplicity
and low cost of the existing next-day finality service. Three
commenters felt that the Federal Reserve should not continue to offer
its existing net settlement service with next-day finality if the
proposed service were offered. One of the commenters noted that ``there
are no reasons, operational or otherwise, to allow ongoing and
unnecessary temporal risk in the payments system as a result of next-
day finality.''
The Board believes that the benefits to clearinghouse participants
and the Federal Reserve provided by the enhanced service are
significant. The enhanced service not only offers increased efficiency
and security, but also significantly reduces settlement risk. The Board
believes that the benefits of providing a more efficient and secure
service that incorporates better risk controls outweigh the potential
cost increase to the users of the traditional Federal Reserve net
settlement service. In addition, it would not be cost effective to the
Reserve Banks to continue to provide and support the current
traditional settlement sheet service in addition to the enhanced
service. As a result, the Board intends to phase out the traditional
settlement sheet service with next-day finality. To be sensitive to the
commenters' concerns regarding potential costs and resources that may
have to be invested to convert to the enhanced service, the Board is
adopting a flexible migration plan. Clearinghouses and their
participants will have until the end of 2001 to convert to the enhanced
service.
B. Continuation of the Fedwire-based Service
Nine of the fourteen commenters believed that the Federal Reserve
should continue to offer the Fedwire-based net settlement service with
same-day finality. One commenter felt that the Fedwire-based service
provides greater opportunities for the settlement agent to manage the
settlement actively and reduce the risk of a settlement failure.
Two commenters felt that the Federal Reserve should not continue to
offer its Fedwire-based net settlement service because there would be
no demand for this service with the introduction of the enhanced
service. The commenters viewed the reduction in operational complexity
from the Fedwire-based service as the justification for eliminating it.
The Board will continue to offer the Fedwire-based service as long
as a reasonable level of demand for the service exists. The Fedwire-
based service has robust risk management features. Because finality is
granted when the settlement entries are posted via the use of Fedwire
funds transfers, the Fedwire-based service also reduces settlement risk
to private-sector participants.
C. Length of Settlement Window and Provision of a Warehousing Mechanism
There was no consensus among respondents as to whether the period
between 8:30 a.m. and 4:00 p.m. ET would be adequate to support current
and future needs of potential users of the service. Two commenters
expressed a preference for the service to begin processing settlement
files during the very early morning hours, with 12:30 a.m. suggested by
one of the commenters. Two other commenters felt that, at a minimum, a
6:00 p.m. ET closing deadline should be implemented.
The Board recognizes that the Fedwire funds transfer service is the
primary alternative for orderly and efficient settlement of bilateral
obligations in case a settlement arrangement is unable to complete its
multilateral settlement through the enhanced service. As a result, the
Board has determined that settlement file processing should generally
be completed before 6:00 p.m. to allow at least a thirty minute period
before the standard close of the Fedwire funds transfer system. To
ensure that processing of the settlement files is completed by the
close of the settlement window, the Federal Reserve will establish a
cut-off time for submission of settlement files that is approximately
thirty to sixty minutes in advance of the settlement window deadline.
Extensions of the settlement deadlines may be permitted under
extenuating circumstances. Experience gained during the pilot period
will be used to review and, if necessary, redefine settlement
deadlines. At this time, the Board does not believe that a compelling
business need has been expressed to start processing settlement files
before 8:30 a.m. ET. This issue may be reviewed as experience is gained
with the operation of the enhanced service.
With respect to the warehousing option, seven of the eleven
commenters felt that this feature should be offered. One commenter
claimed that settlement files should be received in a ``flow processing
mode'' twenty-four hours a day, seven days a week. Four commenters did
not support a warehousing option because they thought such an option
would not be useful or thought warehousing should be handled by the
clearing association's settlement agent rather than the Federal
Reserve.
The enhanced settlement service will queue settlement files
received after the close of the settlement window for processing at the
opening of the following day's settlement window, provided the
settlement date on the file corresponds with the following business
date. More sophisticated warehousing capabilities will not be offered
in the initial release due to cost and time constraints.
D. Submission of Settlement Data Through an Electronic Mechanism
All but one of the fifteen commenters that responded to this
question felt it would be reasonable to require clearing arrangements
or settlement agents to use an electronic mechanism to submit
settlement data. The commenters felt that such an electronic mechanism
would ensure that data are sent and received by authorized persons and
not tampered with during transmission. One commenter, while agreeing
that electronic devices should be used, recommended that the Federal
Reserve be able to receive valid settlement data and enter the data
manually into the settlement system in emergencies. One commenter did
not believe that it would be reasonable to require the electronic
[[Page 60005]]
submission of data and encouraged the Federal Reserve to offer a manual
procedure for submitting data.
The Board shares the concerns of the commenters and will provide an
electronic mechanism for settlement data transmission to increase the
efficiency and security of the settlement process. Settlement files may
be transmitted via a standard Fedline terminal or a computer interface
bulk data connection. Preformatted Fedline screens for settlement data
input will also be provided.
Clearing and settlement systems are encouraged to have contingency
arrangements to reduce the risk of a failed settlement resulting from
operational problems. The Reserve Banks will be able to accept and
process non-electronic files on behalf of a settlement agent in
situations in which an arrangement is experiencing severe operational
disruptions and is unable to access the enhanced service directly or
through its contingency channels.
E. Providing Monitoring Capabilities to the Agent
All but one of the fourteen commenters that responded to this
question felt it would be appropriate to offer a monitoring capability
that would allow the settlement agent to determine whether settlement
entries for individual participants had been successfully posted. One
commenter felt that this service should be offered to settlement agents
because they represent their member financial institutions as unbiased
facilitators in all aspects of the settlement process. Another
commenter believed that the settlement agent must have access to
information that will allow it to determine whether individual
participants have fulfilled their settlement obligations.
The enhanced service will provide the agent with the capability to
view the settlement account balance by using the ABMS. Automated
inquiries for monitoring the progress and the status of a settlement
file by the agent will be provided in a later release of the
application.
F. Value-added Services That Provide Non-settling Participant
Information
Eight of the ten respondents to this question did not believe that
the Federal Reserve should offer a value-added service that would
provide non-settling participant information. The general consensus was
that such services are more appropriate for the settlement agent to
offer to its participants. One commenter stated that it does not see a
need for the Federal Reserve to provide these services, as the
settlement agent would have this information in order to calculate the
settling participant's aggregate position. The settlement agent should,
therefore, be able to communicate this information to the settling
participants and any non-settling participants. Two commenters felt
that the value-added services should be offered by the Federal Reserve
because such information would be of assistance to settling and non-
settling participants in analyzing their daily obligations.
The Board agrees that, in most cases, the agent can provide the
non-settling participant information more efficiently. As a result, the
enhanced service will not include these value-added features in the
near term.
G. Provision of a Retry Feature
The fourteen respondents that addressed this issue felt that a
retry feature should be included in the proposed net settlement
service. Eight of these respondents believed that the service should
include a retry feature that automatically attempts to debit the
account of a participant following a predefined interval after the
participant fails to cover its debit obligation. The respondents also
requested a retry feature that could be controlled by the agent. Four
respondents felt that only an automatic retry feature should be
available, whereas two others felt that only a retry feature that can
be controlled by the agent should be offered. A proponent of the
controlled retry feature claimed that such a system would provide the
greatest flexibility and maximum operational effectiveness because a
retry would be attempted only when the settlement agent felt that the
settlement was likely to succeed.
A retry feature will be available in the enhanced settlement
service. In cases where an arrangement has selected the deferred
notification option, the Federal Reserve will retry the failed debit
after a predefined interval before the Federal Reserve notifies the
agent that a participant is unable to cover the debit. Once the agent
has been notified, it will be able to instruct the Federal Reserve to
retry a debit entry to a participant's account. Further automation of
the retry function may be included in a future release of the
application software.
H. Length of the Retry Window and Maximum Number of Retries
There was no consensus among the thirteen respondents that
commented on this question as to how long the retry window should be.
Four commenters suggested a period of anywhere from one hour up to
three hours. One commenter felt that the retry capability should have
no time limits other than being restricted to the operating hours of
the net settlement service. Two others believed that the retry window
time limit should be left to the discretion of the clearing
arrangements.
In the event that a settlement account cannot be fully funded
because the initial attempt to post a settlement debit to a
participant's account has failed, the Federal Reserve may retry the
debit after a short predefined interval. The interval is likely to be
approximately thirty to forty-five minutes after the failed debit
occurred. If the debit continues to remain unfunded, the agent will
automatically be notified. A relatively short interval to retry a debit
will give the agent as much time as possible to take alternative action
to avoid unnecessary settlement failures if the retry fails. The length
of the interval will be reviewed periodically based on perceived
business needs. Further, retry instructions from settlement agents will
be honored at any time during which the settlement service is open.
There was no consensus among the respondents as to the maximum
number of retries that should be allowed. Five respondents stated that
there should be a limited number of attempts but did not specify a
number. Two commenters felt that a maximum of two retries should be
made. Two commenters believed that the maximum number of retries
allowed should be decided by the clearing arrangements.
If the clearing arrangement chooses the delayed notification
option, the Federal Reserve will automatically retry the debit once
following a short interval after the initial debit failed. The Federal
Reserve will review periodically after the initial release whether, for
clearing arrangements choosing the delayed notification option, the
service should provide more than one automated retry following an
initial failure to post a settlement debit. The Board has imposed no
formal limit on the number of times that a settlement agent can request
that a failed debit be retried.
I. Legal Status of the Debit and Credit Settlement Entries
Of the eleven commenters that responded to this question, seven
believed that the debit and credit entries to the Federal Reserve
accounts of the settling participants should not be considered funds
transfers under Regulation J (12 CFR part 210) and other laws
applicable to funds transfers. One respondent stated that the proposed
service does not use Fedwire funds transfers and thus cannot rely on
the same legal basis. Many suggested that the Federal Reserve amend
Regulation J
[[Page 60006]]
to address the status of the entries posted by the enhanced settlement
service. One commenter suggested that debit and credit entries to the
reserve accounts of the settling participants be considered funds
transfers under Regulation J and pertinent sections of Article 4A of
the Uniform Commercial Code. Another felt that although Regulation J
did not apply to the debit and credit entries of the proposed service,
Article 4A did apply.
The Board has not amended Regulation J to cover explicitly debit
and credit entries associated with the enhanced settlement service.
Although certain provisions of Article 4A may apply to the debit and
credit entries, the extent to which these entries would be considered
``payment orders'' under Article 4A is not clear. Therefore, the
Reserve Bank operating circulars will establish the rules governing the
debit and credit entries to the Federal Reserve accounts of the
settling participants, including when those debits and credits will
become final.
J. Capability to Transfer Funds Into the Settlement Account
All but one of the twelve commenters that responded to this
question indicated that it would be beneficial for the service to
provide the capability for a participant or another institution to
transfer additional funds into the settlement account in order to
complete the settlement. One commenter stated that such a feature could
facilitate quick resolution of problems and prevent temporary problems
from becoming permanent defaults.
Only one commenter thought that the Federal Reserve should not
offer the capability for another participant or depository institution
to transfer funds into the settlement account to complete the
settlement process. This commenter stated that a failed debit for a
settling participant should be resolved by that participant and that
the settling participants can set up bilateral funding arrangements if
they so choose.
The enhanced settlement service will allow another settling
participant or depository institution to transfer additional funds into
the settlement account in order to complete the settlement. The agent
or another authorized depository institution will be able to transfer
funds into the settlement account to complete settlement in accordance
with the clearinghouse association rules.
K. Clearing Arrangements That Should be Eligible for the Enhanced
Settlement Service
Seven out of the twelve respondents that addressed this issue felt
that the Federal Reserve should offer the proposed service to any type
of clearing arrangement. Three of these commenters wanted to clarify
that direct settlement participants would have to be entities that are
eligible for Federal Reserve accounts. Another commenter stated that
the proposed service should ``accommodate any type of clearing
arrangement'' because of the rapidly changing payment systems
environment and the increasing need for new services in the industry.
Two commenters believed that the proposed service should be
available only to small-dollar clearing arrangements. One of these
respondents felt that large-dollar clearing arrangements, such as
CHIPS, should not have access to the new service because the settlement
agents should have a very active role in managing the settlements for
large-dollar systems, and the Fedwire-based settlement is best suited
for these purposes.
The Board is confident that the enhanced service offers an
efficient and secure settlement service with strong risk management
features. As a result, the Federal Reserve will make the enhanced
settlement service available to financial institutions with Federal
Reserve accounts that participate in multilateral settlements for
private-sector clearing arrangements.
V. 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 the adverse competitive
effects, the Board will determine whether the expected 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
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 payments
by increasing the efficiency of the services currently offered by the
Federal Reserve and by reducing the uncertainty and disruption to
private-sector participants from the potential reversal of settlement
on the following business day. From this standpoint, the enhanced
settlement service should help reduce risk as well as operational
burden for private-sector settlement arrangements. In addition, risk
controls that would be developed in order to provide finality of
settlements to clearinghouse participants on the settlement date would
help protect the Federal Reserve from the risk of loss. As a result,
the Board believes that the proposed enhancements to the Federal
Reserve's net settlement services would enable depository institutions
to continue to take advantage of the benefits of netting, while
increasing operational efficiency and reducing credit risk to the
private sector.
By order of the Board of Governors of the Federal Reserve
System, November 2, 1998.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 98-29709 Filed 11-5-98; 8:45 am]
BILLING CODE 6210-01-P