[Federal Register Volume 59, Number 37 (Thursday, February 24, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-3847]


[[Page Unknown]]

[Federal Register: February 24, 1994]


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FEDERAL RESERVE SYSTEM
[Docket No. R-0778]

 

Federal Reserve Bank Services

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice.

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SUMMARY: The Board has approved an expansion of Fedwire funds transfer 
operating hours for the public policy benefits that will result through 
the use, over the long term, of the service by banks individually and 
through clearing groups. The Board believes that the potential, long 
run benefits from offering final payment capabilities that will 
strengthen interbank settlements outweigh the costs to the Federal 
Reserve of expanding the Fedwire funds transfer service operating 
hours. Over time, longer Fedwire funds transfer hours can contribute to 
reductions in Herstatt risk through innovations in payment and 
settlement practices. As well, the Fedwire funds transfer service will 
become a tested tool for managing settlement risk early in the day 
during times of financial stress.
    Specifically, the Board is announcing that the hours of operation 
of the Fedwire on-line funds transfer service will be expanded to 18 
hours per day, opening at 12:30 a.m. e.t. and closing at 6:30 p.m. 
e.t., five days per week (Monday through Friday) to become effective in 
early 1997. A specific implementation date will be announced 
approximately one year in advance of the effective date. Intraday 
credit from the Federal Reserve will be available during expanded hours 
on the same terms that it would be provided from 8:30 a.m. e.t. to 6:30 
p.m. e.t. Further expansion of the funds transfer operating day could 
be considered following several years of experience with the new 
schedule.
    In addition, the Board is announcing that current Fedwire 
securities transfer operating hours will not be expanded until after 
the implementation of new service capabilities that permit receivers of 
securities to control the use of securities-related intraday Federal 
Reserve credit. Public comment will be sought in 1994 on new service 
capabilities that permit users the option to participate in expanded 
securities transfer service operating hours and to control the receipt 
of securities that are delivered to them during expanded hours. This 
request for public comment could be combined with a request for views 
on the use of similar service features during regular securities 
transfer operating hours. In the case of expanded or regular hours, but 
especially in the latter case, a key issue concerns the effects of such 
changes on the liquidity and efficiency of the U.S. government 
securities market.

FOR FURTHER INFORMATION CONTACT: John H. Parrish, Assistant Director 
(202/452-2224), Gayle Brett, Manager (202/452-2934), or Lisa Hoskins, 
Senior Financial Services Analyst (202/452-3437), Division of Reserve 
Bank Operations and Payment Systems, Board of Governors of the Federal 
Reserve System. For the hearing impaired only, Telecommunication Device 
for the Deaf (TDD), Dorothea Thompson (202/452-3544), Board of 
Governors of the Federal Reserve System, 20th and C Streets NW., 
Washington, DC 20551.

SUPPLEMENTARY INFORMATION: The growth in financial market activity 
worldwide, and in foreign exchange market activity in particular, has 
heightened attention and sensitivity to settlement and systemic risks. 
Market participants, as well as regulators, are particularly concerned 
about current methods for settling multi-currency, cross-border 
transactions. Data published by the Bank for International Settlements 
(BIS) indicate that the daily average value of global foreign exchange 
market activity was approximately $880 billion in April 1992.1 The 
interbank payments generated by foreign exchange transactions account 
for a substantial portion of the total value of payments settled in 
many of the industrialized countries.
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    \1\See ``Central Bank Survey of Foreign Exchange Market Activity 
in April 1992'' published by the Bank for International Settlements, 
Basle, March 1993.
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    The most significant settlement risks presented by foreign exchange 
or other multi-currency contracts involve the risk that a counterparty 
to such contracts will pay one currency and not receive payment in the 
contra-currency. Concerns about such risks have been prominent since 
the failure of Bankhaus Herstatt in 1974, when foreign exchange 
counterparties of Herstatt made Deutsche mark payments to Herstatt to 
settle foreign exchange contracts, but did not receive contra-payments 
in U.S. dollars before the closure of the bank, which occurred at the 
end of the German banking day. The settlement risk associated with the 
sequential payment of currencies, and involving the potential loss of 
the full principal amount of foreign exchange contracts, has come to be 
known as Herstatt risk.
    Despite the rapid growth of the foreign exchange markets since 
1974, foreign exchange contracts are currently settled much as they 
were at the time of the Herstatt episode. For example, in the case of 
yen-U.S. dollar foreign exchange contracts, the yen amounts due on a 
particular banking day would be paid and settled in Tokyo before the 
start of that banking day in New York. U.S. dollar contra-payments 
would likely be initiated early in the U.S. banking day and settled 
with finality at the end of the U.S. banking day, some 18 hours after 
the close of business in Tokyo. Similarly, payments in most European 
currencies would be made and settled hours before U.S. dollar payments 
are either initiated or settled with finality. The overall magnitude of 
Herstatt risks associated with these settlement delays has grown 
commensurately with the rapid growth in foreign exchange and other 
multi-currency transactions.
    Over the past few years, there has been a series of central bank 
studies aimed at heightening the understanding and awareness of risks 
in various international payment and settlement processes. These 
studies have also provided a common framework for evaluating both new 
and enhanced interbank settlement arrangements, as well as changes in 
central bank services, that might be designed to reduce and manage 
better Herstatt risk. Working groups from the G-10 central banks have 
published reports, under the aegis of the BIS, on such topics as 
minimum standards for interbank netting systems, delivery-versus-
payment (DVP) in securities settlement systems, and options for 
enhanced central bank payment and settlement services with respect to 
multi-currency and cross-border transactions.2
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    \2\Report on Netting Schemes, February 1989; Report of the 
Committee on Interbank Netting Schemes of the Central Banks of the 
Group of Ten Countries, November 1990; Delivery Versus Payment in 
Securities Settlement Systems, September 1992; Central Bank Payment 
and Settlement Services With Respect to Cross-Border and Multi-
Currency Transactions, September 1993. These reports are available 
through the Bank for International Settlements.
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    The recent report on central bank services, for example, pointed to 
the significant expansion of the operating hours for large-value 
payment systems as an important central bank option that could 
contribute to reductions in risk in settlement practices. Longer hours 
for central bank large-value payment systems would provide the banking 
sector3 with additional flexibility in developing innovative 
methods to reduce time delays between the settlement of the different 
legs of foreign exchange contracts. Such innovations might include the 
development of delivery-versus-payment techniques, in which one 
currency is paid (settled) when and only when the contra-currency is 
also paid (settled), either by individual correspondent banks or by 
groups of banks that are members of clearing arrangements. Over the 
long run, such arrangements could substantially reduce Herstatt risks 
in the settlement of multi-currency contracts.
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    \3\For discussion purposes only, references to bank include all 
depository institutions, such as commercial banks, savings 
institutions, and credit unions. As used in this docket, the term 
private-sector bank means any bank (including a Federal Home Loan 
Bank) other than a Federal Reserve Bank.
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    Even without the development of delivery-versus-payment techniques, 
the possibility of greater harmonization of the timing of currency 
settlements based on longer operating hours of central bank large-value 
payment systems could help reduce time delays and risks in settlements.
    Significant advances in information technology have been introduced 
to banking and financial markets in recent years. The level of 
automation and sophistication of banking systems has increased rapidly 
and likely will continue to do so for some time to come. In this 
environment, and particularly during a time of increasing volumes, 
values, and sophistication of financial transactions, advanced 
technology needs to be applied to payment systems so that these systems 
can provide for both high efficiency and low risk in the settlement of 
all kinds of economic transactions. The adoption and implementation of 
this kind of technology, however, requires significant lead times and 
careful, advanced planning.
    Against this background, and following public comment on the 
Board's October 1992 proposal to open the Fedwire funds transfer 
service two hours earlier in the morning, the Board directed a staff 
task force (Fedwire Study Group, see Appendix A of this notice) to 
discuss the issues involving longer Fedwire hours with representatives 
of commercial banks and other interested members of the public and to 
analyze the associated public policy concerns. These discussions helped 
clarify the issues relating to the expansion of Fedwire hours and the 
difficulties in devising new techniques to reduce settlement risks.
    Consideration of the appropriate operating hours for the Fedwire 
funds and securities transfer services must, in the first instance, 
take account of the Federal Reserve's responsibilities as a central 
bank to support final interbank settlement. The Federal Reserve Banks 
provide final interbank payment and settlement services to the banking 
system through the transfer of banks' balances (reserves and clearing 
balances) on deposit with Reserve Banks. These balances--also called 
central bank money--are free of default risk and are an integral part 
of monetary arrangements for the U.S. dollar. ``Instantaneous'' 
intraday final payment in risk-free, central bank money is delivered 
operationally to banks through the Fedwire funds and securities 
transfer services. The benefits of such instantaneous intraday final 
payment in central bank money are, in turn, available to the public 
through the payment services provided by banks to their customers. To 
achieve this level of finality, Fedwire and similar sophisticated 
central bank payment services rely on a processing technique known as 
real-time gross settlement. In fact, most G-10 central banks currently 
provide, or are in the process of introducing, real-time gross 
settlement payment services, along the lines of the Fedwire funds 
transfer service.4 (See Appendix B of this notice for a discussion 
of the structure of large-value interbank payment arrangements.)
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    \4\ The central banks of the European Union have recommended 
that every central bank in the European Union install a real-time 
gross settlement system. See Report to the Committee of Governors of 
the central banks of the member states of the European Economic 
Community by the Working Group on EC Payment Systems, ``Minimum 
Common Features for Domestic Payment Systems'' (November 1993).
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    The following two public policy objectives can be stated for the 
Fedwire funds and securities transfer services. These public policy 
objectives are useful as a guide to analysis of expanded operating 
hours and were used by the Fedwire Study Group to set the stage for 
discussions held with the public. Fedwire should:
    (1) Provide a means that can be used to enhance the safety and 
efficiency of U.S. dollar settlement arrangements, including 
arrangements that rely on interbank settlement of netted positions, 
particularly during periods of financial stress.
    (2) Respond to the needs of both existing and emerging financial 
markets, including overseas markets, which depend on the U.S. dollar 
and are increasingly reliant on state-of-the-art technology.
    Members of the Fedwire Study Group met with representatives of 
various commercial banks, broker-dealers, and clearing organizations, 
and with a group of corporate treasurers to discuss current problems in 
payment and settlement arrangements. The Fedwire Study Group 
encountered a diversity of views within the financial industry, and 
even within individual organizations, regarding approaches to managing 
settlement risk and the use of Fedwire to obtain real-time gross 
settlement in central bank money outside of current operating hours.
    The diversity of views is, in part, related to the functional 
responsibilities of the individuals interviewed. For example, a number 
of persons with credit management responsibilities in banks and other 
financial firms tended to favor expanded Fedwire hours based on the 
potential benefits associated with access to final, that is, 
irrevocable and unconditional, settlement using central bank money--
notably, potential reductions in counterparty and systemic risk. In 
contrast, individuals with responsibilities for transaction processing 
services and information technology within banking organizations tended 
not to favor an expansion of Fedwire operating hours because, for 
example, (1) they could not identify customer demand for longer Fedwire 
hours, (2) there would be costs and operational challenges associated 
with ``off hour'' services, and (3) competitive responses by rival 
banking organizations would compel them to undertake product and 
operational changes. In addition, many of those interviewed also 
pointed to the charging of fees for Federal Reserve intraday credit as 
creating a disincentive to the use of Fedwire funds and securities 
transfer services during both regular and expanded hours of operation.
    A main concern raised during the meetings held by the Fedwire Study 
Group, particularly by executives and senior credit managers, was that 
of settlement risk in foreign exchange dealings, or Herstatt risk. 
Those expressing concern noted, however, that while expanded Fedwire 
funds transfer operating hours might be useful as a component part of 
some new approaches to controlling Herstatt risk, without changes in 
overall settlement practices, longer hours would not be able to make a 
major contribution to risk reduction. Further, changes in risk 
management techniques and settlement practices would need to take 
account of a variety of operational and financial factors for different 
currencies. Some of these issues are discussed further in appendix C of 
this notice.
    Given that there is a reduced tolerance for temporal risk in 
settlements, especially--but not solely--settlement of multi-currency 
transactions, the Board anticipates that efforts to control settlement 
risk will continue, with or without the support of central banks. The 
Board believes, however, that final, real-time gross settlement through 
Fedwire should play an important part in market efforts to control risk 
more effectively. As discussed earlier, final settlements in central 
bank money are free of default risk and, as a result, settlement in 
central bank money provides the highest possible degree of certainty 
and liquidity in interbank settlements.
    The routine availability of Fedwire on an expanded schedule will 
add final interbank payment capabilities that the markets, the Federal 
Reserve, and other federal regulatory agencies recognize as being 
particularly important during periods of financial stress. Only by 
becoming familiar with the use of expanded Fedwire will banks be 
prepared operationally and procedurally to use expanded final payment 
capabilities effectively. Over time, as the availability and use of 
expanded Fedwire capabilities becomes more routine, operating 
procedures for using Fedwire earlier in the day will become well tested 
and integrated into banks' operations and contingency planning.
    In addition, expanding Fedwire operating hours will eliminate an 
operational barrier that stifles potentially important innovation in 
privately-provided payment and settlement services. Expansion of 
Fedwire operating hours will provide opportunities for market 
participants to experiment with the use of real-time gross settlement 
to meet a variety of market needs. New bank services and settlement 
arrangements based on real-time gross settlement will have the 
potential to reduce significantly banks' own and their customers' 
settlement risks in the foreign exchange and other markets.5 A 
particular application could be the development of delivery-versus-
payment settlement techniques either for individual foreign exchange 
transactions or for obligations arising from netting arrangements.
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    \5\ Examples of private sector initiatives currently underway 
include the development of multilateral netting systems for foreign 
exchange transactions, such as Exchange Clearing House Organization 
(ECHO) and Multinet.
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    A Federal Reserve initiative to expand Fedwire funds transfer 
operating hours also demonstrates a long-term commitment to increasing 
the availability of real-time gross settlement services in the 
international financial system. The Federal Reserve is taking a 
leadership role in the international financial community in seeking to 
stimulate new or enhanced central bank services to facilitate cross-
border, multi-currency payments and settlements. By expanding the 
operating hours of Fedwire, the Federal Reserve will make it possible 
for banks to settle the U.S. dollar, with finality using central bank 
money, during the banking and trading days of major international 
financial centers in Europe and the Far East.6 Such a Federal 
Reserve initiative looks to private sector banking organizations to 
develop improved multi-currency services and settlement arrangements, 
in some cases relying on Fedwire.
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    \6\ Staff notes that the Bank of Japan recently expanded the 
operating hours for its large-value funds transfer system to later 
in the Tokyo banking day. Also, as noted earlier, the European Union 
central banks have recently endorsed the establishment of real-time 
gross settlement systems in all EU countries as well as closer 
coordination of operating hours for settlement services.
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    Finally, a clearly stated Federal Reserve policy regarding Fedwire 
operating hours provides the certainty and stability banks have 
indicated that they need to develop their own business and technology 
plans. This approach to communicating Federal Reserve policy was 
requested both in public comments on the Board's October 1992 proposal 
and in meetings with representatives of the industry held by the 
Fedwire Study Group. As noted here, expanded Fedwire funds transfer 
operating hours are announced three years in advance of implementation. 
Banks will have a clear understanding of the Federal Reserve's 
intentions with respect to its operating hours and could use the lead 
time to incorporate the expanded hours into their strategic plans for 
payment services and supporting technical systems.
    Fedwire on-line funds transfer operating hours will be expanded to 
open at 12:30 a.m. e.t. (5:30 a.m. G.m.t. and 2:30 p.m. Tokyo time) to 
support strengthened, interbank settlement for domestic and cross-
border markets. This precedes the opening of the current European 
banking day by about three hours and overlaps with current payment 
system and money market hours in Tokyo by about two and one-half hours. 
This overlap of payment system hours could increase further if, in the 
future, the operating hours of other national payment systems were 
expanded.
    The closing time for the Fedwire funds transfer service will remain 
at 6:30 p.m. e.t. (11:30 p.m. G.m.t. and 8:30 a.m. Tokyo time), in 
order not to delay inordinately the calculation of U.S. dollar 
positions by U.S. banks providing dollar clearing services to clients 
operating in the Asian markets, or to disrupt domestic money 
management. Further, keeping the closing time at 6:30 p.m. e.t. will 
not disturb the reserve management operations of the large number of 
smaller U.S. banks that are not active internationally and that are 
unlikely to participate in an expanded Fedwire operating day.
    The Federal Reserve's estimated incremental costs to operate the 
funds transfer service from 12:30 a.m. e.t. to 6:30 p.m. e.t. will be 
roughly $2.5 to $4.0 million per year, or about 3 to 5 percent of the 
total cost of providing the service in 1993. While the operational 
costs incurred by banks using Fedwire during the expanded operating 
period are difficult to estimate, such costs would be incurred entirely 
voluntarily. Banks could choose to remain closed during the expanded 
operating period and thus forego any additional operating costs.
    Further, an 18-hour day (beginning at 12:30 a.m. e.t. and closing 
at 6:30 p.m. e.t.) provides an adequate six-hour quiet period within 
which banks can perform end-of-day processing and provides for 
contingency situations. It also provides for a definite period for 
measuring reserve positions, a requirement for the conduct of monetary 
policy. There are some other minor issues posed by an 18-hour Fedwire 
funds transfer day that are discussed in appendix C of this notice.
    With respect to Fedwire securities transfer operating hours, under 
current DVP arrangements, banks do not have the capability to control 
the timing of deliveries of securities and associated debits to their 
funds accounts. Accordingly, banks have limited control over the effect 
of securities-related debits on their funds positions and their use of 
Federal Reserve securities-related intraday credit. These control 
limitations could lead to either increased operating costs or increased 
use of intraday credit, with accompanying charges, during periods of 
expanded hours. (See appendix C of this notice for further discussion.) 
In contrast to the Fedwire funds transfer service, therefore, expanding 
the operating hours of the securities transfer service would likely 
impose unavoidable costs on a large number of banks. Thus, the Board 
believes that it is inadvisable at this time to approve an expansion of 
the operating hours for the Fedwire securities transfer service.

Competitive Impact Analysis

    During expanded Fedwire funds transfer operating hours, the Federal 
Reserve Banks will be providing real-time gross settlement in central 
bank money. While this service cannot be duplicated in the private 
sector, this situation is no different under expanded operating hours 
than it is under the existing Fedwire operating hours. Service 
providers that provide funds transfer services under a netting 
arrangement could expand their operating hours to coincide with Fedwire 
operating hours; however, only by setting earlier settlement time(s) 
and settling through Fedwire could these organizations provide risk-
free central bank money earlier in the day to their participants. 
Service providers that provide real-time gross settlement funds 
transfer services across their own books could not solely backstop 
these transactions with central bank money and, thus, could be reliant 
on their own capital and credit standing to assure participants of 
final settlement. Again, this situation is no different under expanded 
operating hours than it is under normal Fedwire operating hours.

    By order of the Board of Governors of the Federal Reserve 
System, February 15, 1994.
William W. Wiles,
Secretary of the Board.

Appendix A--Fedwire Study Group

Bruce J. Summers, FRB Richmond, Chair
Carol W. Barrett, FRB New York
Gayle Brett, Board staff
Paul Connolly, FRB Boston
Lisa Hoskins, Board staff
Dara Hunt, FRB Chicago
Oliver Ireland, Board staff
Barbara Kavanagh, FRB Chicago
Donald R. Lieb, FRB San Francisco
David E. Lindsey, Board staff
Jeffrey C. Marquardt, Board staff
Christopher J. McCurdy, FRB New York
Gerard J. Nick, FRB Chicago
Patrick M. Parkinson, Board staff
John H. Parrish, Board staff
Israel Sendrovic, FRB New York
A. Patricia White, Board staff.

Appendix B--Structure of Large-Value Interbank Payment Arrangements

    Most large-value, domestic interbank payments are currently made 
via the transfer of money balances on the books of the Federal 
Reserve Banks through the Fedwire system. Fedwire is the large-value 
payment system operated by the Federal Reserve Banks for the 
transfer of funds and delivery of book-entry (electronic) securities 
against payment. Fedwire is a real-time gross settlement system that 
settles transfers immediately on a transaction-by-transaction basis. 
The Fedwire funds transfer service is a credit transfer process. 
That is, a bank sends a funds transfer to the Federal Reserve 
instructing the Federal Reserve to debit its account for a specified 
amount and to credit the account of another bank. In 1993, the daily 
average value of transfers originated over the Fedwire funds 
transfer system was about $824 billion.
    In contrast, the Fedwire securities transfer service, which is 
the principal means for transferring and settling U.S. government 
securities,\1\ is a debit transfer process that permits the seller 
of the securities to send a transfer that will result in the Federal 
Reserve withdrawing funds from the account of the receiver of the 
securities transfer. The Fedwire securities transfer process is 
based on the delivery-versus-payment (DVP) principle, whereby the 
final transfer of securities from the seller to the buyer (delivery) 
occurs at the same time as final transfer of funds from the buyer to 
the seller (payment). Fedwire achieves such simultaneous settlement 
by treating the instruction initiated by the seller as both an 
instruction to deliver securities to the buyer and an instruction to 
debit payment from the buyer's reserve or clearing account. In 1993, 
the daily average value of transfers originated through the Fedwire 
securities transfer system was roughly $580 billion.
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    \1\Netting is performed outside Fedwire through the Government 
Securities Clearing Corporation (GSCC) for transactions that settle 
on a next day or forward basis, with the netted securities and funds 
positions settled on Fedwire.
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    Banks may also provide settlement services to their customers 
through the final transfer of balances across their books. In 
addition, banks also use multilateral clearing and settlement 
arrangements to meet some of their large-value payment needs. In 
such arrangements, including the Clearing House Interbank Payments 
System (CHIPS) operated by the New York Clearing House, payment 
instructions may be entered into a netting system throughout a pre-
determined clearing cycle and each participant's net position vis-a-
vis the other participants is determined on an ongoing basis 
throughout the cycle. Settlement for the payment instructions occurs 
at an agreed upon settlement time. Participants with net debit 
obligations may satisfy their obligations by transferring funds on 
the books of a ``settlement bank.'' Central banks can serve as a 
``settlement bank'' for such interbank netting arrangements and, in 
the case of CHIPS, this role is performed by the Federal Reserve 
Bank of New York. In this arrangement, CHIPS settling participants 
in a net debit position send Fedwire funds transfers to a settlement 
account at the Federal Reserve Bank of New York, which, when fully 
funded, is the source for payments to participants in net credit 
positions. In 1993, the daily average value of transfers originated 
through the CHIPS system was over $1 trillion.

Appendix C--Issued Associated With Expanded Fedwire Operating Hours

    This appendix analyzes issues associated with expanded Fedwire 
funds and securities transfer operating hours. The appendix is 
organized in three parts. First, settlement practices in financial 
markets are analyzed, with particular attention to Herstatt risk. 
Second, the operation of the Fedwire securities transfer delivery-
versus-payment service is analyzed. Finally, other implementation 
issues associated with expanded Fedwire hours are analyzed.

Settlement Practices in Financial Markets

    The following discussion of settlement practices and risks in 
financial markets takes into account (1) the integrity of settlement 
during times of financial stress, (2) multi-currency, cross-border 
settlements, (3) domestic corporate and interbank markets and the 
needs of the futures markets, and (4) the current availability of 
bank payment services on a 24-hour basis.
    Settlement during times of financial stress. Concerns regarding 
the ability of counterparties to meet their payment obligations and 
the certainty of settlement are heightened during times of financial 
stress. Sudden events that disrupt markets can increase the risk 
associated with domestic and, in particular, multi-currency 
transactions, and can contribute to uncertainty, payment delays, and 
market liquidity problems. If such problems are widespread, systemic 
risk may be increased substantially. It is during times of stress in 
the financial markets that the certainty associated with interbank 
settlement across the books of the central bank takes on added 
importance.
    In the past, the Fedwire funds transfer service has been opened 
early on an ad hoc basis, at short notice, during times of stress in 
the financial markets at the request of market participants and 
regulatory authorities. For example, the Federal Reserve opened the 
Fedwire funds transfer service early on the days following the 
October 1987 stock market break and the beginning of the Gulf War. 
Experience has shown, however, that market participants are not 
prepared operationally to use facilities, such as Fedwire, when 
these facilities are made available during ``off-hours'' on an ad 
hoc basis at short notice. These difficulties suggest that to be 
most helpful during times of financial stress, Fedwire should be 
available in the early morning hours on a more routine basis.
    Multi-currency settlements. With respect to multi-currency 
settlements, the settlement of a foreign exchange contract involves 
the settlement of both currencies involved in the contract, such as 
the U.S. dollar and the Deutsche mark or the U.S. dollar and the 
yen. In such settlements, risk management and efficiency 
considerations must take into account payment arrangements in the 
country of issue for each currency, including the relative intraday 
timing of payments and the finality of payment in the respective 
currencies. Settlement risk is incurred by paying final funds in one 
currency before receiving final funds in another currency. As a 
general matter, the magnitude of settlement risk in the foreign 
exchange markets has grown substantially, in large part as a result 
of a vast expansion of foreign exchange trading. At the same time, 
there has been continued reliance on traditional methods of settling 
trades one currency at a time with significant delays before related 
payments and contra-payments become final.
    Because the large U.S. cities are in the western-most time zones 
of the major financial centers, under current settlement 
arrangements for multi-currency transactions, the U.S. dollar is 
normally the last currency to be settled. The two charts at the end 
of this appendix provide information on global time zone 
relationships and on the operating hours of selected large-value 
interbank transfer systems in different countries.1
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    \1\These charts were published in the report on Central Bank 
Payment and Settlement Services with Respect to Cross-Border and 
Multi-Currency Transactions, Basle, September 1993.
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    On an exception basis today, banks may choose to require final 
payment of the U.S. dollar leg of a multi-currency transaction 
either in advance of, or in certain cases simultaneously with, final 
payment of the contra-currency, as a means to protect against risk 
of nonpayment.2 Foreign exchange market participants have 
indicated that such protective measures are taken, for example, in 
special cases where counterparties would exceed their U.S. dollar 
credit lines. Banks, however, find these exception procedures to be 
very expensive due to the lack of an established mechanism to effect 
settlements under these terms (that is, final U.S. dollar payment 
before, or simultaneously with, final payment in the other 
currency). For exception processing, the parties must negotiate how 
the related payments are to be made and closely monitor the 
settlement process to ensure that the payment sequence unfolds as 
expected.
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    \2\In markets for exchange traded derivative instruments, some 
settlements are conducted currently using delivery-versus-payment 
techniques.
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    Substantially earlier Fedwire funds transfer service operating 
hours as well as later payment system hours for other major 
currencies will increase the opportunity to achieve simultaneous or 
near-simultaneous settlements of individual deals involving the U.S. 
dollar and European and Asian currencies, where needed. Such 
settlements might involve a variety of new institutional designs for 
settlements, including private correspondent bank DVP services, new 
clearing organization procedures, or innovative arrangements that 
are not readily apparent given current payment system constraints.
    Current initiatives to reduce Herstatt risk in foreign exchange 
transactions point to the need for greater future overlap of final 
interbank settlement facilities in Asia, Europe, and North America. 
While in the future Asian and European systems may well be open 
later during their local banking days, the achievement of a 
significant overlap in payment system hours also requires earlier 
opening hours for U.S. payment systems, especially to achieve 
overlapping hours with Asian markets. With such earlier hours, 
opportunities may increase substantially for more nearly 
simultaneous settlements of multi-currency transactions, and 
associated reductions in Herstatt risk. It should be noted, however, 
that although simultaneous or near-simultaneous payment for multi-
currency transactions reduces the temporal dimension of settlement 
risk, achieving final payment in one currency against a 
simultaneous, but provisional, payment in another currency does not 
eliminate fully Herstatt risk. Therefore, to address fully the 
problem of controlling Herstatt risk, it is important that the 
overlap in operating hours include overlap in systems that provide 
final settlement in central bank money.3
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    \3\Fedwire in the United States and BOJ-NET in Japan, for 
example, currently provide real-time gross settlement services in 
the U.S. dollar and yen, respectively. Significant projects to 
establish real-time gross settlement systems are now underway in 
France, the United Kingdom, and other countries, and legal 
developments are occurring that will help ensure the availability of 
payment systems in all or most European countries that provide for 
final payments on an intraday basis. Thus, in the next few years, 
concerns about the lack of intraday final payment capabilities in 
major industrialized countries are likely to be reduced 
substantially.
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    Domestic markets. With respect to domestic markets, there are 
relatively few types of transactions for which immediate and final 
payment at a particular time during the day is an absolute 
requirement. The demand for final payment at a particular time 
during the day for corporate customers is currently quite small and 
is limited to such things as payments to settle mergers and 
acquisitions and the distribution of funds from underwritings of 
securities. In general, because banks often make funds available to 
corporate customers before final settlement, corporate customers are 
largely unaware of the distinctions between final and provisional 
payment or when during the day payments are actually settled. 
Instead, corporations generally rely on their banks to make 
decisions regarding how their large-value payments are originated 
and received.
    Even in the interbank markets, participants are typically 
satisfied with same-day settlement for certain types of 
transactions. At present, Federal funds contracts do not generally 
stipulate that payment must be made at or before a specific time of 
day other than before the close of the Fedwire funds transfer 
service. Federal funds contracts are generally settled using the 
Fedwire funds transfer system.
    For some futures exchange settlements, the convention today is 
to accept irrevocable commitments to pay from designated settlement 
banks to cover clearing members' settlement obligations prior to the 
start of the current day's trading, with the settlement banks 
actually fulfilling the obligation via Fedwire funds transfers by 10 
a.m. e.t. The futures clearing organizations and the Commodity 
Futures Trading Commission (CFTC) have expressed a desire for 
settlement to occur in final funds before the commencement of 
trading. Such earlier settlement is viewed as reducing risks to 
futures exchanges and the financial markets despite some concerns 
that it would merely shift risks from the clearing organizations to 
their settlement banks. Settlement banks would clearly need to 
manage carefully their own cash needs earlier in the day in order to 
make settlement payments at an earlier time, which is not necessary 
under current arrangements.
    Within a few years, there may be a demand for later Fedwire 
funds transfer hours from banks that provide services to the futures 
and options markets. This demand could arise from two sources. 
First, some clearing organizations are progressively moving toward 
same-day settlement of margin obligations arising from the current 
day's trading activity. Second, some of the exchanges are 
contemplating longer trading hours for certain of their products. 
The exchanges are beginning to incorporate automated trade matching 
and confirmation systems that will permit timely same-day 
calculation of all margin obligations. Indications are that these 
systems, which will remove a significant obstacle to same-day 
settlement, could be widely adopted within three to five years. 
Longer trading hours, in combination with the desire for same-day 
settlement, would argue for a later Fedwire funds transfer service 
closing time.
    To date, there has been little evidence of demand for a 
materially later closing time for the Fedwire funds and securities 
transfer services to meet domestic needs. The most likely source of 
demand to make later payments is from the Pacific time zone. Banks 
with operations in that time zone, however, have expressed only 
slight interest in later Fedwire hours in response to requests for 
comment made by the Board of Governors in 1989 and in 1992. 
Moreover, many corporate treasurers generally view later-in-the-day 
payments activity as disruptive to their primary goal of determining 
the amount of money available for investment. This preference is, of 
course, conditioned by current conventions in the U.S. money 
markets, especially the times at which decisions must be made to 
invest or borrow funds.
    Bank payment services. Currently, a number of large, 
internationally active U.S. banks offer their customers real-time 
account balance inquiry and payment services on a 24-hour basis. 
Many of these banks offer the capability to originate payment 
instructions in up to 60 currencies. Payment orders may be processed 
as book transfers or held in an electronic queue until the national 
payment system for the currency to be paid is open for business. 
Given current queuing practices, there would appear to be some scope 
for earlier settlement of queued payments if international clearing 
banks find it advantageous to process customer payments earlier in 
the day and national payment systems are open to process and settle 
such payments.

Fedwire Securities Transfer Service

    As mentioned earlier, most interbank transfers of U.S. 
government securities are processed through Fedwire. The DVP 
capability of the Fedwire securities transfer service increases the 
efficiency and integrity of the securities clearance and settlement 
process. In fact, the liquidity of the government securities market 
is partly a function of the Fedwire securities transfer system 
design, whereby the seller is assured of payment at the time the 
securities are delivered. While it virtually eliminates settlement 
risk, the current design of the Fedwire securities transfer service 
may, in some cases, result in significant demands for intraday 
credit. Once Fedwire opens in the morning, users of the Fedwire 
securities transfer service have no control over the time at which 
they may receive securities on a DVP basis. In particular, since the 
sellers of securities initiate the DVP transfers, receivers do not 
have any operational control over the time during the day when their 
securities and funds accounts are credited and debited, 
respectively.
    Since the inception of the Board's Payment System Risk Reduction 
Program, the implications of the cost of intraday credit have taken 
on greater significance for participants in the Fedwire DVP 
securities transfer service. Receivers of securities, especially 
those maintaining relatively low intraday cash balances, are not in 
a position to manage their use of intraday Federal Reserve credit 
resulting from securities deliveries. Because of the inability to 
review transfers prior to receipt, this problem may be compounded if 
the securities delivery is not known, or the delivery amounts are 
incorrect. Although receivers of securities can reverse transfers 
received in error virtually immediately after delivery and payment 
occur, they must very actively monitor and manage their activity to 
be in a position to do so.
    The charging of fees for Federal Reserve intraday overdrafts has 
important implications for expanding the Fedwire securities transfer 
operating hours. An expansion of such operating hours could impose 
significant cost burdens on a potentially large number of banks that 
would need to make a choice between staffing their operations to 
manage their intraday overdraft positions, or remaining closed and 
incurring the costs of intraday overdrafts that might arise from 
securities deliveries during ``off-hours.'' In an effort to provide 
participants with the tools necessary to manage their operations and 
credit costs, the Federal Reserve is designing new Fedwire 
securities transfer service features, including receiver controls 
(such as receiver-authorized deliveries) and a mechanism allowing 
participants to choose whether to use the service during non-
standard business hours. The Board believes that public comment on 
these new service features is required because of the impact they 
would have on senders and receivers of securities transfers and on 
the operation of the U.S. government securities market.
    Analysis of a potential expansion of Fedwire securities transfer 
service operating hours must also take into account ``free'' 
transfers of securities, that is, the movement of collateral. The 
ability to move collateral during early morning Fedwire operating 
hours was identified as a potentially useful measure by several 
clearing organizations and banks in their comments on the Board's 
October 1992 Fedwire operating hours proposal. The ability to pledge 
collateral during early morning hours can reduce settlement 
uncertainties and enhance participant liquidity, particularly in 
times of financial stress.
    The discussion above suggests that careful attention must be 
given in the near term to features of the Fedwire securities 
transfer service that limit the control users of the service have 
over the receipt of securities, particularly if the hours of 
operation for the service were to be lengthened. The Board 
anticipates that the implementation of new service capabilities, 
such as those discussed earlier, could reduce or even eliminate the 
involuntary costs imposed on receivers of securities transfers, 
especially during expanded operating hours. Under these conditions, 
the public benefits of expanding these operating hours could be 
significant and would be derived in part from the opportunities to 
use securities as collateral, or as a near-cash equivalent, for 
purposes of meeting obligations that arise overnight. At present, 
however, an expansion of hours would not be advisable. The Board 
believes that the issues surrounding the development and use of new 
features for the Fedwire securities transfer service can be 
effectively addressed through the public comment process during 
1994.

Implementation Issues

    Because of the aforementioned complications associated with 
operating characteristics of the current Fedwire securities transfer 
system, the following analysis of implementation issues is limited 
to an expansion of Fedwire funds transfer service operating hours. 
The key implementation issues addressed in this section are 
technology, operational costs, monetary control and reserve 
management, overlapping business and calendar days, and the Federal 
Reserve's intraday overdraft policy.
    Technology issues. Banks as well as other financial and non-
financial institutions are installing or planning to install 
advanced technology to support their critical business functions. 
For example, many major banking organizations employ real-time 
control procedures to manage their own and customer payments over 
major large-value electronic payment systems. Many financial 
organizations are also continuing to automate major dealing 
functions and integrate these with their clearing and payment 
systems.
    In turn, in order to provide the banking and financial system 
with advanced tools with which to design payment and settlement 
arrangements using central bank money, the Federal Reserve is 
installing advanced computing and communications systems. These 
systems will support all of the Federal Reserve's national payment 
services and accounting functions. Among other things, this new 
technology will enable the Federal Reserve to provide real-time 
gross settlement services in central bank money virtually around-
the-clock. Other benefits of this technology are expected to include 
greater payments processing efficiency, improvements in the 
reliability and availability of critical payment systems, and 
enhanced contingency processing capabilities.
    Most existing accounting and other back office systems require 
that banks, including Federal Reserve Banks, accumulate a wide range 
of transactions throughout the day in order to calculate and balance 
customer account positions. Traditionally, this ``end-of-day'' 
processing has been treated as a batch operation for which large 
quantities of information are accumulated from a variety of sources 
and then processed overnight. For example, information received from 
large commercial banks that provide corporate payment services and 
U.S. dollar clearing services reveals that their current systems 
have been designed to perform end-of-day processing within an 
approximate six- to eight-hour window. Most large commercial banks 
are either currently changing, or have plans to change, their 
systems to move to a two- to four-hour end-of-day processing window, 
an evolution which should be completed within about five years.
    Contingency processing requirements also need to be considered 
in connection with proposals to expand Fedwire funds transfer 
operating hours, or bank payment system operations more generally. 
Specifically, for large commercial banks, an 18-hour operating day 
compresses the current end-of-day processing period, including a 
``cushion'' of time to deal with the failure of regular systems or 
other unexpected operational disruptions that must be resolved 
before opening for the next day's business.
    The Board believes that current efforts by banks and other 
financial institutions to use technology to improve the efficiency 
of end-of-day processing will, over the next several years, reduce 
the time necessary to perform these activities. Thus, with a 3-year 
lead time, an 18-hour Fedwire day should provide an adequate cushion 
of time for end-of-day processing under normal and most contingency 
conditions.
    Operational costs. The Reserve Bank's incremental costs to 
expand operating hours can be estimated fairly accurately. The 
estimated incremental costs to the Federal Reserve of lengthening 
the current 10-hour funds transfer operating day to 18 hours are 
relatively small compared to the total cost of providing the 
service. Specifically, the Board estimates that an 18-hour day 
beginning at 12:30 a.m. e.t. will add roughly $2.5 to $4.0 million 
to annual Fedwire funds transfer operating costs, or about 3 to 5 
percent of 1993 total service costs.4 (The Board recently asked 
staff to study issues related to Federal Reserve pricing 
methodology, which is underway.)
---------------------------------------------------------------------------

    \4\The Federal Reserve's estimated incremental costs associated 
with providing a near 24-hour operation are significantly higher 
than for an 18-hour operation.
---------------------------------------------------------------------------

    The incremental costs that would be incurred by banks in using 
the Fedwire funds transfer service during expanded hours are 
difficult to estimate. In any event, the incremental operational 
costs to banks of participating in expanded hours would be incurred 
entirely voluntarily. Banks would make individual business decisions 
whether to use the Fedwire funds transfer service during expanded 
hours.
    Monetary control and reserve management issues. The Board 
believes that an expansion of Fedwire funds transfer operating 
hours, involving a 6:30 p.m. e.t. closing time, does not complicate 
reserve maintenance for banks. Also, provided that there is a 
sufficient break in time during the operating day for purposes of 
measuring reserve holdings, monetary measurement and control 
problems do not arise for the Federal Reserve. In the event of full 
24-hour operations, both monetary measurement and control issues 
would need careful attention.
    Overlapping business and calendar days. One complication 
associated with a Fedwire funds transfer day that begins earlier 
than 3 a.m. e.t. concerns asynchronous business and calendar days 
for domestic payments and possibly for cross-border payments as 
well. For example, assuming a 6:30 p.m. e.t. closing time and an 18-
hour Fedwire funds transfer day, the 12:30 a.m. e.t. opening time is 
9:30 p.m. Pacific Time (p.t.). This means that today's business day, 
as defined by the opening of Fedwire, begins on the prior calendar 
day in continental United States time zones other than the Eastern 
time zone. Some clarification or adjustment in accounting practices 
and possibly legal conventions may be necessary to address this 
situation. These adjustments do not appear to present large issues 
and they can be readily addressed through such things as 
modifications in financial reporting conventions and business 
practices.
    For example, financial reporting conventions that rely on 
precise ``as of'' reporting dates and times would appear reasonably 
to address most reporting issues. Similarly, more precision may be 
needed in financial contracts about when completion of a payment or 
other financial transaction must occur. This is a problem that 
exists today and that is addressed in contracts by specifying the 
location at which payment is to be made and the date (``pay to my 
account in San Francisco on x date''). The new problem posed by an 
earlier Fedwire opening time could be addressed readily by 
specifying when during the day payment is to be made at a particular 
location (``pay to my account in San Francisco by close of Fedwire 
on x date'').
    Federal Reserve daylight overdraft policy. In an expanded 
Fedwire funds transfer operating environment, Federal Reserve 
intraday credit will be provided to banks on the same basis that it 
would be provided from 8:30 a.m. e.t. to 6:30 p.m. e.t. That is, 
eligible institutions will be able to incur intraday overdrafts 
subject to the net debit caps and daylight overdraft fees in place 
at the time the overdraft is incurred.
    Some adjustments to the intraday overdraft measurement rules 
will be required. For example, posting times for non-wire 
transactions settled on the books of the Reserve Banks that are 
currently tied to the opening of Fedwire, such as ACH and principal 
and interest payments for securities, need to be adjusted. Since 
users will be accustomed to the current schedule, which generally 
results in posting these transactions at 8:30 a.m. e.t., a clear 
option would be for the Board to consider establishing 8:30 a.m. 
e.t. as the ``explicit'' posting time for these transactions.

BILLING CODE 6210-01-P

TN24FE94.026


BILLING CODE 6210-01-C

           Operating Hours of Selected Large-Value Interbank Funds Transfer System (as of August 1993)          
----------------------------------------------------------------------------------------------------------------
                                       Opening-                     Cut-off for                                 
                                     closing time     Settlement     all third-    Cut-off for      Memo item:  
        System           Gross (G)   for same-day      finality        party      international   Standard money
                        or net (N)   value (local    (local time)     payment    correspondents'   market hours 
                                         time)                         orders     payment orders   (local time) 
----------------------------------------------------------------------------------------------------------------
Belgium:                                                                                                        
    C.E.C.............  N              13:46-13:45           16:30        13:30           8:30      (9:00-16:15)
    Clearing House of   N               9:00-16:30           16:30        13:00           8:30    ..............
     Belgium.                                                                                                   
Canada:                                                                                                         
    IIPS..............  N               8:00-16:00           15:00        14:30          16:00      (8:30-17:30)
    ACSS..............  N              18:00-24:00           15:00        17:00           n.a.    ..............
France:                                                                                                         
    SAGITTAIRE........  N               8:00-13:00           18:30         n.a.           8:00      (8:15-17:00)
    TBF (planned).....  G               8:00-17:15      8:00-17:15  ...........           8:00    ..............
Germany:                                                                                                        
    Express electronic  G               8:30-14:30      8:30-14:30  ...........           8:00    ..............
     credit transfer                                                                                            
     system.                                                                                                    
    Express (paper      G               8:00-12:00      8:00-12:00  ...........           8:00      (9:30-13:00)
     based) local                                                                                               
     credit transfer                                                                                            
     system.                                                                                                    
    EAF...............  N               8:00-12:30           14:30  ...........           8:00    ..............
Italy:                                                                                                          
    BISS..............  G               8:00-17:00      8:00-17:00        17:00           9:00      (8:30-17:30)
    SIPS..............  N               8:00-14:00           16:30        14:00           9:00    ..............
    ME................  N               8:00-16:00           16:30        16:00           9:00    ..............
Japan:                                                                                                          
    FEYSS.............  N               9:00-13:45           15:00        10:30          10:30      (9:00-17:00)
    BOJ-NET...........  G               9:00-17:00      9:00-17:00        14:00           n.a.    ..............
Netherlands:                                                                                                    
    Central Bank FA     G               8:00-15:30      8:00-15:30        12:45           n.a.      (8:00-15:30)
     System.                                                                                                    
    8007 S.W.I.F.T....  N               8:00-11:30           13:00         n.a.           8:00    ..............
Sweden:                                                                                                         
    RIX...............  G               8:15-16:30      8:15-16:30        12:00           8:00      (9:00-16:00)
Switzerland:                                                                                                    
    SIC...............  G              18:00-16:15     18:00-16:15        15:00           8:00      (9:00-16:00)
United Kingdom:                                                                                                 
    CHAPS.............  N               8:30-15:10      end of day         none          12:00      (9:00-12:00)
United States:                                                                                                  
    Fedwire...........  G               8:30-18:30      8:30-18:30        18:00          18:00      (8:30-18:30)
    CHIPS.............  N               7:00-16:30           18:00        16:30          16:30    ..............
    ECU clearing        N              14:01-14:00           15:45         none           none        (TOM/NEXT)
     system.                                                                                                    
----------------------------------------------------------------------------------------------------------------

[FR Doc. 94-3847 Filed 2-23-94; 8:45 am]
BILLING CODE 6210-01-P