[Federal Register Volume 59, Number 136 (Monday, July 18, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-17330]


[[Page Unknown]]

[Federal Register: July 18, 1994]


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FEDERAL RESERVE SYSTEM

[Docket No. R-0842]

 

Proposed Policy Statement on Privately Operated Large-Dollar 
Multilateral Netting Systems

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Request for comment.

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SUMMARY: The Board of Governors is requesting comment on a proposal to 
update its policies on ``Privately Operated Large-Dollar Funds Transfer 
Networks'' and ``Offshore Dollar-Clearing and Netting Systems'' and 
integrate those policies into a single policy statement on ``Privately 
Operated Large-Dollar Multilateral Netting Systems.'' In general, the 
policy statement would apply to such arrangements as domestic, 
privately operated, large-dollar multilateral payment netting systems; 
offshore large-dollar multilateral payment netting systems; 
multilateral foreign exchange clearinghouses involving settlements in 
U.S. dollars; and multicurrency payment netting systems involving 
settlements in U.S. dollars. The Board is proposing to incorporate into 
the new policy statement minimum standards for the design and operation 
of privately operated large-dollar multilateral netting systems. These 
minimum standards are based on those set out in the Report of the 
Committee on Interbank Netting Schemes of the Central Banks of the 
Group of Ten Countries (``Lamfalussy Report''), which was published in 
November 1990 by the Bank for International Settlements. The Board is 
also requesting comment on the need for, and possible specifications 
of, a higher standard with respect to assuring settlement that might be 
applied to large-dollar multilateral netting systems that present a 
high degree of systemic risk.

DATES: Comments must be received on or before October 17, 1994.

ADDRESSES: Comments should refer to Docket No. R-0842, and may be 
mailed to Mr. William W. Wiles, Secretary, Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, NW., 
Washington, DC 20551. Comments may be delivered to Room B-2222 of the 
Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays or to the 
security control room anytime. Both Room B-2222 and the security 
control room are accessible from the courtyard entrance on 20th Street 
between Constitution Avenue and C Street, NW. Comments may be inspected 
in Room MP-500 of the Martin Building between 9:00 a.m. and 5:00 p.m. 
weekdays, except as provided in 12 CFR 261.8 of the Board's rules 
regarding availability of information.

FOR FURTHER INFORMATION CONTACT: Jeffrey C. Marquardt, Assistant 
Director (202/452-2360), Paul Bettge, Manager (202/452-3174), Kelly 
Shaw, Project Leader (202/452-3054), Division of Reserve Bank 
Operations and Payment Systems; or Oliver Ireland, Associate General 
Counsel (202/452-3625), Stephanie Martin, Senior Attorney (202/452-
3198), Legal Division, Board of Governors of the Federal Reserve 
System; for the hearing impaired only, Telecommunications Device for 
the Deaf, Dorothea Thompson (202/452-3544).

SUPPLEMENTARY INFORMATION: The Board's current Policy Statement on 
Payments System Risk incorporates two policies directed specifically at 
large-dollar funds transfer systems: ``Private Large-Dollar Funds 
Transfer Networks'' and ``Offshore Dollar-Clearing and Netting 
Systems.'' Neither of these policies addresses multicurrency clearing 
and settlement arrangements involving settlements in U.S. dollars, such 
as the multilateral foreign exchange clearinghouses that are under 
development in North America and Europe. Further, the Board intended 
its existing policy statement on ``Offshore Dollar-Clearing and Netting 
Systems'' to be an interim measure until an international consensus was 
reached among central banks on the minimum standards for the 
development and operation of multilateral cross-border netting systems.
    That consensus was reached with the 1990 publication of the Report 
of the Committee on Interbank Netting Schemes of the Central Banks of 
the Group of Ten Countries (``Lamfalussy Report''). The Lamfalussy 
Report recognized that multilateral netting arrangements for interbank 
payment orders and forward-value contractual commitments, such as 
foreign exchange contracts, have the potential to improve the 
efficiency and the stability of interbank settlements through the 
reduction of settlement costs, along with credit and liquidity risks, 
provided that certain conditions are met. In this regard, the report 
developed and discussed, in some detail, ``Minimum Standards for 
Netting Schemes'' (``Lamfalussy Minimum Standards'') and ``Principles 
for Co-operative Central Bank Oversight'' of such arrangements.
    Central banks have now had a period of time to analyze the 
practical implications of the Lamfalussy Minimum Standards, and the 
Board believes that it would be appropriate to revise its ``Policy 
Statement on Payments System Risk'' to incorporate the Lamfalussy 
Minimum Standards and to address explicitly privately operated, large-
dollar multicurrency netting arrangements involving settlements in U.S. 
dollars.1 The Board is proposing to integrate its policies on 
``Private Large-Dollar Funds Transfer Networks'' and ``Offshore Dollar-
Clearing and Netting Systems'' into a single comprehensive policy on 
``Privately Operated Large-Dollar Multilateral Netting Systems'' that 
would include the Lamfalussy Minimum Standards. Large-dollar 
multilateral, multicurrency netting systems would be covered by the 
same policy.
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    \1\The Lamfalussy Minimum Standards have been endorsed by the 
European Union central banks as minimum standards for domestic 
large-value netting systems within the European Union.
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Scope and Application of the Policy

    Specifically, the Board's proposed policy statement would apply to 
such arrangements as domestic, privately operated, large-dollar 
multilateral payment netting systems; offshore large-dollar 
multilateral payment netting systems; multilateral foreign exchange 
clearinghouses involving settlements in U.S. dollars; and multicurrency 
payment netting systems involving settlements in U.S. dollars. The 
inclusion of multilateral foreign exchange clearinghouses and 
multicurrency payment netting systems involving a settlement in U.S. 
dollars represents an expansion of existing policy, as neither of these 
arrangements are covered explicitly by the Board's current policy 
statement on payment system risk. The Board is proposing to apply the 
policy statement to such systems if they meet certain size criteria, in 
order to cover more completely the range of multilateral netting 
systems involving settlements in U.S. dollars that have the potential 
to increase systemic risk in the financial markets. These arrangements 
have the potential to generate the same types of risks as single 
currency systems. Moreover, the Lamfalussy Minimum Standards were 
developed explicitly to address, among other things, risks in 
multilateral foreign exchange netting arrangements.
    The Board's proposed policy statement contains criteria that 
delimit the scope and application of the policy. Specifically, the 
policy will apply to systems that: (1) have three or more participants 
that net payments or foreign exchange contracts involving the U.S. 
dollar, whether or not netted amounts are legally binding; and either 
(2) have, or are likely to have, on any day, settlements with a system-
wide aggregate value of net settlement credits (or debits) larger than 
$500 million (in U.S. dollars and any foreign currencies combined); or 
(3) routinely process individual payments or foreign exchange 
contracts, with a stated dollar value larger than $500,000. A 
multilateral netting system that meets the above criteria will be 
subject to the policy if (1) it is a state-chartered member of the 
Federal Reserve System, (2) any of its agent(s) or participants are 
state-chartered members of the Federal Reserve System, (3) its 
participants' net positions are settled through a Federal Reserve 
settlement account, (4) its participants settle their net positions in 
the multilateral netting system through their individual Federal 
Reserve accounts or the Federal Reserve account of the settlement 
agent(s), or (5) one or more bank holding companies have an investment 
in the multilateral netting system. The Board believes that these 
relatively simple criteria will enable the operators of multilateral 
netting systems to determine when they are subject to the policy and 
will provide that only systems which present systemic risk will be 
covered.
    The Board believes that the Lamfalussy Minimum Standards may apply, 
for example, to all large-dollar multilateral payment netting systems 
irrespective of the type of financial instrument or contractual 
obligation netted by the system. However, the Board recognizes that in 
the case of privately operated large-dollar multilateral netting 
systems for the batch processing of paper-based as well as electronic 
payments, including privately operated Automated Clearing House 
(``ACH'') systems, certain electronic controls that would be required 
to implement the Lamfalussy Minimum Standards may not be feasible. 
Further, the rights and responsibilities of parties within such systems 
as well as the characteristics of the instruments to be cleared or 
netted require further analysis. Consequently, the Board intends to 
study further the implications of the Lamfalussy Minimum Standards, and 
the arrangements to implement the Lamfalussy Minimum Standards, for 
privately operated large-dollar multilateral netting systems for the 
batch processing of paper-based as well as electronic payments. The 
Board expects that it may issue, in due course, a proposal for minimum 
standards for the design and operation of such systems.

Implementation of the Lamfalussy Minimum Standards

    The Board believes that large-dollar multilateral netting systems, 
whether on-shore or off-shore, should meet in full the Lamfalussy 
Minimum Standards, as set forth in the proposed policy statement. The 
Board has developed five risk management measures that a large-dollar 
multilateral netting system would be expected to implement in order to 
satisfy Lamfalussy Minimum Standards III and IV, which deal with risk 
management and settlement completion. Risk management devices that lead 
to a substantially equivalent degree of risk management and control 
could also be adopted, as approved by the Board on a case-by-case 
basis. The proposed measures are: (1) a requirement that each 
participant establish bilateral net credit limits vis-a-vis each other 
participant in the system; (2) establish and monitor in real time 
system-specific net debit limits; (3) establish a system to reject or 
hold any payment or foreign exchange contract that would exceed the 
relevant bilateral and net debit limits; (4) establish liquidity 
resources, such as cash, committed lines of credit secured by 
collateral, or a combination thereof, at least equal to the largest 
single net debit position;2 and (5) establish rules and procedures 
for the sharing of credit losses among the participants in a netting 
system.
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    \2\The term ``largest single net debit position'' means the 
largest intraday net debit position of any individual participant at 
any time during the daily operating hours of the netting system.
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    The first two measures are contained in the Board's existing policy 
statement on Private Large-Dollar Funds Transfer Networks. The third 
measure is also contained in the existing policy statement but it 
applies only to bilateral net credit limits. In the proposed policy 
statement, the Board has expanded the third measure to apply also to 
system-specific net debit limits. Requirements (4) and (5) are new and 
would help ensure that the funds needed for settlement are available to 
multilateral clearing organizations at the proper moment and clarify 
how any losses will affect participants.

Timeframe for Implementation of the Lamfalussy Minimum Standards

    The Board recognizes that not all existing large-dollar 
multilateral netting systems may meet the Lamfalussy Minimum Standards, 
and the associated requirements for implementation of those standards, 
contained in the proposed policy statement. The Board also recognizes 
that existing large-dollar multilateral netting systems will need a 
period of time in which to make any needed changes to their 
organization or operations. Consequently, the Board believes that an 
eighteen-month transition period would be appropriate for large-dollar 
multilateral netting systems that are operating on the date of any 
final action by the Board on the proposed policy. Such systems will be 
expected to comply fully with the policy statement within the eighteen-
month transition period. Large-dollar multilateral netting systems 
established subsequent to the date of final adoption of the policy by 
the Board will be expected to comply fully with the policy statement, 
without benefit of a transition period.

Specific Issues on Which the Board Seeks Comment

    The Board seeks comment on all aspects of the proposed policy 
statement. In addition, the Board is seeking comment on the following 
specific issues:
    1. The proposed criteria for identifying large-dollar multilateral 
netting systems subject to the policy statement.
     Are the thresholds for system-wide aggregate daily net 
settlement debits or credits, as well as for the size of individual 
transactions, set at appropriate levels such that the policy will apply 
to those systems that pose systemic risk?
     Are there other criteria the Board should consider in the 
determination of whether to apply the policy to a particular system?
    2. The five risk management measures for implementation of the 
Lamfalussy Minimum Standards.
     Do the requirements provide operators of large-dollar 
multilateral netting systems with appropriate and adequate mechanisms 
to control the credit, liquidity, and settlement risks inherent in such 
systems?
     What additional risk management measures would be useful?
     What alternative mechanisms would provide substantially 
equivalent degrees of risk management and control?
    3. The timeframe for implementation of the Lamfalussy Minimum 
Standards.
     Does the proposed eighteen-month transition period provide 
existing large-dollar multilateral netting systems with sufficient time 
to make any organizational or operational changes needed to meet the 
Lamfalussy Minimum Standards?
    The Board also seeks comment on whether large-dollar multilateral 
netting systems that present a high degree of systemic risk should be 
expected to meet a standard for ensuring settlement that is higher than 
Lamfalussy Minimum Standard IV. Standard IV requires that a netting 
system be capable of ensuring the completion of daily settlement in the 
event that the participant with the largest net debit position is 
unable to settle its obligation to the system. For example, the Board 
could require that certain large-dollar multilateral netting systems 
would be expected to ensure timely completion of daily settlement in 
the event of an inability to settle by the participant with the largest 
net debit position, as well as the participants with the second or 
third largest net debit positions.
    In multilateral netting systems that extend credit among 
participants, the failure of a participant could trigger a chain of 
defaults and liquidity problems at other participants or in the 
financial markets more generally. This concern is the basis for 
Lamfalussy Minimum Standard IV, which ensures that a default by a 
single net debtor, including the largest, will not, by itself, initiate 
a chain of defaults within the netting arrangement. A requirement that 
a netting system be able to ensure daily settlement in the event of 
settlement defaults by participants in addition to the largest net-
debtor would be based on the risk of a simultaneous default by two or 
more participants. Such an event could be precipitated by financial 
market difficulties in the country of origin of the defaulting 
participants, or some other market disturbance that could cause 
financial institutions with similar or interlinked assets and 
liabilities simultaneously to experience liquidity or credit problems. 
Such simultaneous defaults, however, may be much less likely than a 
single default, and the incremental expected costs and benefits of 
requiring multilateral netting systems to meet a higher standard than 
Lamfalussy Minimum Standard IV must be carefully weighed.3
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    \3\For example, costs would presumably include the opportunity 
cost of pledging collateral to ensure settlement and of taking any 
other steps to ensure that funds will be available for settlement, 
while benefits would include avoidance of potential credit losses, 
liquidity effects, or both, through the greater protection afforded 
by a higher standard. The expected benefits, in particular, may be 
difficult to quantify. In addition, there may well be other measures 
of costs and benefits that would be appropriate to apply in the 
analysis of a higher standard.
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    An additional consideration is which multilateral netting systems 
should be expected to meet a higher standard. The Board anticipates 
that any higher standard would be applied only to multilateral netting 
systems that present a high degree of systemic risk. In determining 
this degree of systemic risk, the Board could, as an example, utilize a 
threshold approach in which systems that exceed a particular measure 
would be expected to meet the higher standard. Such measures might 
include: (1) a specific dollar amount of the aggregate system-wide net 
debit positions; (2) the ratio of the net debit positions of selected 
members of a particular multilateral netting system relative to their 
capital; or (3) the ratio of an aggregate measure of net debit 
positions to the capital of a central counterparty (if one is used).
    The Board is seeking specific comments on:
    4. Application of a higher standard for individual large-dollar 
multilateral netting systems that may present a high degree of systemic 
risk.
     What factors should be considered in analyzing the 
incremental expected costs and benefits of requiring multilateral 
netting systems to meet a higher standard than Lamfalussy Minimum 
Standard IV?
     Should a quantitative threshold level be established? What 
indicator or indicators should be employed in setting a threshold?

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.4 Under these procedures, the Board 
will assess whether a change would have a direct and material adverse 
effect on the ability of other service providers to compete effectively 
with the Federal Reserve in providing similar services due to differing 
legal powers or constraints, or due to a dominant market position of 
the Federal Reserve deriving from such differences. If no reasonable 
modifications would mitigate the adverse competitive effects, the Board 
will determine whether the anticipated benefits are significant enough 
to proceed with the change despite the adverse effects.
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    \4\These procedures are described in the Board's policy 
statement ``The Federal Reserve in the Payments System,'' as revised 
in March 1990. (55 FR 11648, March 29, 1990).
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    The Board does not believe that the Lamfalussy Minimum Standards 
will have a direct and material impact on the ability of other service 
providers to compete effectively with the Reserve Banks' payments 
services. The Board notes that in several cases the payment services 
potentially covered by the policy statement are not offered by the 
Federal Reserve Banks. For example, the Federal Reserve Banks do not 
offer services relating to the electronic clearing and settlement of 
payments or contracts in foreign currencies.
    In the case of domestic large-dollar multilateral netting systems, 
a number of the risk control measures proposed to meet the Lamfalussy 
Minimum Standards as well as certain of the standards themselves have 
grown out of the experience of the private sector in developing robust 
netting arrangements and are currently employed in multilateral netting 
systems. To the extent an incremental burden might be imposed on large-
dollar systems, the need to reduce and control the large potential 
systemic risks of such systems would justify the adoption of prudent 
standards and measures to control risk. The Board does not expect at 
this time, however, that the adoption of the Lamfalussy Minimum 
Standards would have a direct and material impact on the ability of 
other service providers to compete with the Federal Reserve Banks.

Federal Reserve System Policy Statement on Payments System Risk

    The Board proposes to amend its ``Federal Reserve System Policy 
Statement on Payments System Risk'' under the heading ``II. Policies 
for Private-Sector Networks'' by replacing in the heading the word 
``Networks'' with the word ``Systems;'' deleting ``A. Private Large-
Dollar Funds Transfer Networks'' in its entirety and replacing that 
part with ``A. Privately Operated Large-Dollar Multilateral Netting 
Systems;'' and deleting ``C. Offshore Dollar Clearing and Settlement 
Systems'' and redesignating ``D. Private Small-Dollar Clearing and 
Settlement Systems'' as ``C. Private Small-Dollar Clearing and 
Settlement Systems.''

II. Policies For Private-Sector Systems

A. Privately Operated Large-Dollar Multilateral Netting Systems

    Large-dollar multilateral netting systems can create a significant 
degree of credit and liquidity risk for their participants and also 
expose the U.S. payments system and financial markets to systemic risk. 
In the context of large-dollar multilateral netting systems, systemic 
risk is the risk that the inability of one institution within such a 
system, including a central counterparty if one exists, to meet its 
obligations when due will lead to the illiquidity or failure of other 
institutions, either within the particular system or in the financial 
markets as a whole.
    Large-dollar multilateral netting systems may produce efficiencies 
in the clearance and settlement of payments and financial contracts. At 
the same time, multilateral netting may obscure, concentrate, and 
redistribute the credit and liquidity risks associated with clearance 
and settlement. As the size of netted positions increases, for example, 
so do the potential liquidity effects on such systems and their 
participants, as well as third parties, in the event of a settlement 
failure. In addition, if the high volumes of interrelated large-value 
financial contracts and payments, which reflect money and capital 
market activity, are not settled in a timely manner, there is a 
significant potential for widespread financial market disruption.
    Certain types of netting system rules may also create sizable 
systemic liquidity risks, if employed by systems that process large-
value payments that are central to the operation of financial markets. 
For example, privately operated payment systems that permit a system 
operator to unwind, recast, or otherwise reverse same-day funds 
transfers made by system participants, whether for reasons of general 
financial market stress or because of the inability of a system 
participant to settle its obligations on time, can obscure and greatly 
increase the level of systemic liquidity risk associated with the 
system. As a general matter, the Board does not view a same-day recast, 
unwind, or reversal of payments as a satisfactory mechanism for 
managing liquidity and settlement risks in large-dollar multilateral 
netting arrangements.
    The Board also recognizes that the development of offshore 
multilateral netting systems for large-dollar payments and foreign 
exchange contracts may raise concerns about systemic risk that extend 
beyond the potential for disturbances to payment and settlement 
systems, or financial markets, in the United States. For example, the 
offshore clearing of U.S. dollar payments, for subsequent net 
settlement in the United States, may create transactional and other 
efficiencies for participants in such offshore systems. At the same 
time, these arrangements have the potential to concentrate settlement 
risks at clearing organizations and their associated settlement agents 
either in the United States or abroad. If the allocation of credit and 
liquidity risks associated with the netting is not clearly defined, 
understood, and managed, offshore dollar-clearing arrangements may also 
obscure, or even increase, the level of systemic risk in U.S. and 
offshore large-dollar payments systems, as well as in the international 
dollar settlement process. Poorly designed and managed systems may, 
therefore, increase risks to the international banking and financial 
system. In addition, offshore arrangements have the potential to 
operate without sufficient official oversight.
    As the Federal Reserve implements fees for daylight overdrafts, 
along with other risk management measures, it also is important that 
risks not simply be shifted from the Federal Reserve's payment services 
to private, inadequately structured multilateral netting arrangements, 
either domestically or in other countries. For example, the Board has 
been concerned that the steps being taken to reduce systemic risk in 
U.S. large-dollar payments systems may themselves induce the further 
development of ``offshore'' large-dollar multilateral netting systems. 
These offshore systems can settle directly through payments on Fedwire 
or indirectly through a private large-dollar clearing system, which in 
turn settles on a net basis using Fedwire.
    In response to potential systemic risks and the possibility that 
efforts to avoid risk controls will lead to inadequately structured and 
managed systems, the Board is adopting minimum standards within which 
privately operated large-dollar multilateral netting systems should 
operate. The minimum standards apply whether or not these systems 
operate domestically or in other countries. These minimum standards are 
identical to those set out in the Report of the Committee on Interbank 
Netting Schemes of the Central Banks of the Group of Ten Countries 
(Lamfalussy Report).5 The Board recognizes that from time to time, 
in specific cases, questions of interpretation of these standards, as 
they apply to large-dollar multilateral netting systems, may have to be 
resolved by the Board.
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    \5\In November 1990, the Committee on Interbank Netting Schemes 
of the Central Banks of the Group of Ten Countries produced a report 
on multilateral netting schemes. The Committee was chaired by Mr. 
Alexandre Lamfalussy, General Manager of the Bank for International 
Settlements. That report recognized that netting arrangements for 
interbank payment orders and forward-value contractual commitments, 
such as foreign exchange contracts, have the potential to improve 
the efficiency and the stability of interbank settlements through 
the reduction of costs along with credit and liquidity risks, 
provided certain conditions are met. In this regard, the Lamfalussy 
Report developed and discussed, in some detail, both ``Minimum 
Standards for Netting Schemes'' and ``Principles for Co-operative 
Central Bank Oversight'' of such arrangements.
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    It is important to note that the Board's adoption of the Lamfalussy 
Minimum Standards in no way diminishes the primary responsibilities of 
participants in, and operators of, large-dollar netting systems for 
ensuring that these systems have adequate credit, liquidity, and 
operational safeguards. It is the Board's intent to heighten awareness 
of the risks associated with multilateral netting arrangements and of 
the need for their prudent management. The Board also seeks to provide 
the financial system with a set of minimum criteria, which have been 
discussed by the G-10 central banks, against which structural and risk 
management features of large-dollar multilateral netting systems can be 
evaluated.

Scope and Application of the Policy

    This policy statement is directed toward any privately operated, 
multilateral netting system that settles, or seeks to settle, U.S. 
dollar obligations through payments affecting one or more accounts at 
Federal Reserve Banks, either directly or indirectly (``multilateral 
netting systems''). Multilateral netting systems include clearing house 
organizations, with or without a central counterparty, for netting 
payments or foreign exchange contracts among financial institutions.
    The scope of the policy statement is limited to multilateral 
netting systems that involve large-dollar settlements or payments. In 
particular, such systems that: (1) have three or more participants that 
net payments or foreign exchange contracts involving the U.S. dollar, 
whether or not netted amounts are legally binding; and either (2) have, 
or are likely to have, on any day, settlements with a system-wide 
aggregate value of net settlement credits (or debits) larger than $500 
million (in U.S. dollars and any foreign currencies combined); or (3) 
routinely process individual payments or foreign exchange contracts, 
with a stated dollar value larger than $500,000.
    A multilateral netting system that meets the above criteria is 
subject to the policy if (1) it is a state-chartered member of the 
Federal Reserve System, (2) any of its agent(s) or participants are 
state-chartered members of the Federal Reserve System, (3) its 
participants' net positions are settled through a Federal Reserve 
settlement account, (4) its participants settle their net positions in 
the multilateral netting system through their individual Federal 
Reserve accounts or the Federal Reserve account of the settlement 
agent(s), or (5) one or more bank holding companies have an investment 
in the multilateral netting system. The Board also reserves the right 
to apply the elements of this policy to any non-dollar system based, or 
operated, in the United States that engages in the multilateral 
clearing or netting of non-dollar payments among financial institutions 
and that would otherwise be subject to this policy. This policy does 
not apply to systems dealing with exchange-traded futures and options. 
Systems in the United States that undertake only the clearance and 
settlement of debt and equity securities are subject to the Board's 
policy statement on ``Private Delivery-Against-Payment Securities 
Systems.''
    In applying the policy, the Board seeks to distinguish between 
routine banking relationships and arrangements that create a 
multilateral ``system'' for clearing and settling U.S. dollar payment 
and other obligations. This policy statement is not intended to apply 
to routine bilateral relationships between financial institutions, such 
as those involved in correspondent banking. In certain borderline 
cases, for example involving netting systems operated by a single 
financial institution and that combine elements of bilateral and 
multilateral netting, a case-by-case determination that an arrangement 
is a large-dollar multilateral netting system may be necessary for the 
purpose of applying this policy statement.
    In general, the participation in, and operation of, a multilateral 
netting system is governed by rules and procedures designed to 
facilitate multilateral clearance and settlement. Settlement risks are 
typically shared by the participants in some fashion, either implicitly 
or through employment of explicit loss-sharing and liquidity 
arrangements. In contrast, correspondent banking relationships 
generally focus on bilateral relationships and risks; the risk of a 
settlement failure typically falls, at least initially and sometimes 
primarily, on the service provider's or settlement agent's liquidity 
and capital.
    The Board believes that the Lamfalussy Minimum Standards may apply, 
for example, to all large-dollar multilateral payment netting systems 
irrespective of the type of financial instrument or contractual 
obligation netted by the system. However, the Board recognizes that in 
the case of privately operated large-dollar multilateral netting 
systems for the batch processing of paper-based as well as electronic 
payments, including privately operated Automated Clearing House (ACH) 
systems, certain electronic controls that would be required to 
implement the Lamfalussy Minimum Standards may not be feasible. 
Further, the rights and responsibilities of parties within such systems 
may require further analysis. Consequently, the Board intends to study 
further the implications of the Lamfalussy Minimum Standards, and the 
arrangements to implement the Lamfalussy Minimum Standards, for 
privately operated large-dollar multilateral netting systems for the 
batch processing of paper-based as well as electronic payments. As 
such, the Board does not intend to apply the Lamfalussy Minimum 
Standards to these systems at this time.
Lamfalussy Minimum Standards for the Design and Operation of Privately 
Operated Large-Dollar Multilateral Netting Systems.
    The Federal Reserve's policy on privately operated large-dollar 
multilateral netting systems is designed to strike an appropriate 
balance between the requirements of market efficiency and payments 
system stability. A direct means of achieving this balance is to ensure 
that large-dollar multilateral netting systems are designed and 
operated so that the participants and service providers have both the 
incentives and the ability to manage the associated credit and 
liquidity risks. The Board's approach to privately operated large-
dollar multilateral netting systems will be guided by the following 
minimum standards for such systems:6
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    \6\These standards are identical to the minimum standards for 
netting systems in the Lamfalussy Report, with the exception that 
the words ``netting system'' have been substituted for ``netting 
scheme'' in minimum standards one, two, and six, and the words 
``particular system'' have been substituted for ``particular 
scheme'' in standard two.
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    1. Netting systems should have a well-founded legal basis under all 
relevant jurisdictions.
    2. Netting system participants should have a clear understanding of 
the impact of the particular system on each of the financial risks 
affected by the netting process.
    3. Multilateral netting systems should have clearly-defined 
procedures for the management of credit risks and liquidity risks which 
specify the respective responsibilities of the netting provider and the 
participants. These procedures should also ensure that all parties have 
both the incentives and the capabilities to manage and contain each of 
the risks they bear and that limits are placed on the maximum level of 
credit exposure that can be produced by each participant.
    4. Multilateral netting systems should, at a minimum, be capable of 
ensuring the timely completion of daily settlements in the event of an 
inability to settle by the participant with the largest single net 
debit position.
    5. Multilateral netting systems should have objective and publicly-
disclosed criteria for admission which permit fair and open access.
    6. All netting systems should ensure the operational reliability of 
technical systems and the availability of backup facilities capable of 
completing daily processing requirements.
    The Federal Reserve reserves the right to prohibit the use of 
Federal Reserve payment services to support funds transfers that are 
used to settle, directly or indirectly, obligations on large-dollar 
multilateral netting systems that do not meet the Lamfalussy Minimum 
Standards. The Federal Reserve will also take appropriate supervisory 
steps, or refer matters to the appropriate supervisory or regulatory 
authority, in cases of systems not in compliance with the 
aforementioned Lamfalussy Minimum Standards, or their equivalent. 
Moreover, in order for Federal Reserve Banks to monitor properly the 
use of intraday credit, no future or existing privately operated large-
dollar multilateral netting system will be permitted to settle on the 
books of a Federal Reserve Bank unless its participants authorize the 
system to provide position data to the Reserve Bank on request.
Implementation of the Lamfalussy Minimum Standards
    The Board believes that large-dollar multilateral netting systems, 
whether onshore or offshore, should meet in full the Lamfalussy Minimum 
Standards, as set forth in this policy statement. In order to satisfy 
the Lamfalussy Minimum Standards, the Board expects that individual 
large-dollar multilateral netting systems will meet the following risk 
management standards, or their equivalent: (1) a requirement that each 
participant establish bilateral net credit limits vis-a-vis each other 
participant in the system; (2) establish and monitor in real-time 
system-specific net debit limits for each participant; (3) establish 
real-time controls to reject or hold any payment or foreign exchange 
contract that would exceed the relevant bilateral and net debit limits; 
(4) establish liquidity resources, such as cash, committed lines of 
credit secured by collateral, or a combination thereof, at least equal 
to the largest single net debit position;7 and (5) establish rules 
and procedures for the sharing of credit losses among the participants 
in the netting system. The Board will consider, on a case-by-case 
basis, alternative risk management measures that provide for risk 
management systems and controls that are equivalent to the five 
measures listed above. The Board notes that the Lamfalussy Minimum 
Standards and the arrangements to implement the Lamfalussy Minimum 
Standards, as discussed above, in no way diminish the responsibilities 
of the participants in, and the operator of, a large-dollar 
multilateral netting system to determine if additional safeguards would 
be appropriate.
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    \7\The term ``largest single net debit position'' means the 
largest intraday net debit position of any individual participant at 
any time during the daily operating hours of the netting system.
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Timeframe for Implementation of the Lamfalussy Minimum Standards

    The Board recognizes that not all existing large-dollar 
multilateral netting systems may meet the Lamfalussy Minimum Standards, 
and the associated requirements for implementation of those standards, 
set forth in this policy statement. The Board also recognizes that 
existing large-dollar multilateral netting systems will need a period 
of time in which to make any needed changes to their organization and 
operations. Consequently, the Board believes that an eighteen-month 
transition period would be appropriate for large-dollar multilateral 
netting systems that are operating on [insert date of final adoption by 
the Board]. Such systems will be expected to comply fully with the 
policy statement by [insert date eighteen months after the date of 
final adoption by the Board]. Large-dollar multilateral netting systems 
established subsequent to [insert date of final adoption by the Board] 
will be expected to comply fully with the policy statement, without 
benefit of a transition period.
    The Board intends to review periodically the scale and nature of 
the credit, liquidity, and settlement risks in privately operated 
large-dollar multilateral netting systems. Operators of such systems 
should ensure that as the scale of risks in their systems increase, 
risk management systems are designed and operated to control the 
increased scale of risk. The Board expects that over time, whenever 
systems are changed or redesigned, significant attention will be given 
to the issue of risk management in order to ensure that high standards 
of risk control are achieved.
    In addition, offshore, large-dollar multilateral netting systems 
and multicurrency netting systems should at a minimum be subject to 
oversight or supervision, as a system, by the Federal Reserve, or by 
another relevant central bank or supervisory authority. The Board 
recognizes that central banks have common policy objectives with 
respect to large-value netting arrangements. Accordingly, the Board 
expects that it will cooperate, as necessary, with other central banks 
and foreign banking supervisors in the application of the 
aforementioned Lamfalussy Minimum Standards to offshore and 
multicurrency systems. In this regard, the Principles for Co-operative 
Central Bank Oversight outlined in the Lamfalussy Report provide an 
important international framework for cooperation.


    By order of the Board of Governors of the Federal Reserve 
System, July 12, 1994.
William W. Wiles,
Secretary of the Board.
[FR Doc. 94-17330 Filed 7-15-94; 8:45 am]
BILLING CODE 6210-01-P