[Federal Register Volume 62, Number 113 (Thursday, June 12, 1997)]
[Notices]
[Pages 32118-32122]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-15435]


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FEDERAL RESERVE SYSTEM

[Docket No. R-0974]


Enhancement of Federal Reserve Net Settlement Payment Services

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice of proposed service enhancement; Request for comment.

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SUMMARY: The Board is requesting comment on a proposal for the Federal 
Reserve Banks to offer an enhanced net settlement service to depository 
institutions. The proposed service would combine and improve selected 
features from the Reserve Banks' existing net settlement services.
    Under the proposal, the Federal Reserve Banks would offer an 
enhanced and fully automated net settlement service that would provide 
participants in clearing arrangements using the service with finality 
of settlement intraday on the settlement date. The service would 
facilitate improvements in the operational efficiency of clearing 
arrangements by providing the settling participants in such 
arrangements with an on-line mechanism to submit an electronic file of 
settlement information to the Federal Reserve. Besides providing 
operational improvements, the enhanced service is intended to 
facilitate a reduction in the duration of settlement risk for private-
sector clearing arrangements.

DATES: Comments must be received on or before August 11, 1997.

ADDRESSES: Comments should refer to Docket No. R-0974 and may be mailed 
to Mr. William W. Wiles, Secretary, Board of Governors of the Federal 
Reserve System, 20th Street and Constitution Avenue, NW., Washington, 
DC 20051. Comments may also be delivered to the Board's mail room 
between 8:45 a.m. and 5:15 p.m. on weekdays, and to the security 
control room at all other times. The mail room and the security control 
room are accessible from the courtyard entrance on 20th Street between 
Constitution Avenue and C Street, NW. Comments will be available for 
inspection and copying by members of the public in the Freedom of 
Information Office, Room MP-500, between 9:00 a.m. and 5:00 p.m. 
weekdays, except as provided in Section 261.8 of the Board's Rules 
Regarding Availability of Information.

FOR FURTHER INFORMATION CONTACT: Jeffrey Marquardt, Assistant Director 
(202/452-2360), Paul Bettge, Manager (202/452-3174), Myriam Payne, 
Senior Analyst (202/452-3219), Division of Reserve Bank Operations and 
Payment Systems, Board of Governors of the Federal Reserve System; for 
the hearing impaired only, Telecommunications Device for the Deaf 
(TDD), Diane Jenkins (202/452-3544).

SUPPLEMENTARY INFORMATION:

I. Background

    The Federal Reserve Banks provide a variety of services to 
depository institutions. Included among these services are the 
distribution of currency and coin, the processing and collection of 
checks, wire transfers of funds, wire transfers of securities against 
payment, and automated clearing house (ACH) payments. In addition, the 
Federal Reserve Banks support a variety of clearinghouses and other 
clearing arrangements by providing net settlement services to 
depository institutions that participate in the arrangements.
    Clearinghouses and similar arrangements for checks and for 
electronic payments, such as ACH, Automated Teller Machine (ATM), and 
Point-of-Sale (POS) networks, have typically been organized as groups 
of three or more participating depository institutions that exchange 
payment instructions, account for the value exchanged, and settle 
balances on a multilateral net basis. These settlements are a critical 
function of the clearing arrangements. Typically, a net amount is 
computed that represents the difference between what is owed by each 
participant to all others from the exchange of payment instructions 
during a netting cycle and what all others owe the participant. For 
some participants, the difference is a net debit. For others, the 
difference is a net credit. These multilateral differences are then 
settled by participants. The Reserve Banks' net settlement services 
facilitate settlements by providing mechanisms for transferring funds 
between the Federal Reserve accounts of

[[Page 32119]]

the settling participants in a clearing arrangement.\1\
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    \1\ A settling participant in a clearinghouse that uses a 
Reserve Bank net settlement service is a depository institution 
whose account at a Reserve Bank is debited or credited in order to 
transfer the funds needed to complete settlements. In contrast, non-
settling participants typically conduct settlements through a 
settling participant.
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    Currently, two types of net settlement services are offered by the 
Reserve Banks. In the first, which is the traditional model of the 
Reserve Banks' net settlement service, a settlement sheet (in either 
paper or electronic form) containing the net position (net debit or 
credit) of each settling participant in a clearing arrangement is 
typically provided by the arrangement, or a settlement agent, to a 
Reserve Bank on the settlement day (day T). Net debits and credits are 
then posted (often manually) by the Reserve Bank to participants' 
Federal Reserve accounts on day T. Posted credits represent available 
funds for the purposes of intraday cash management and overnight 
reserve management.\2\
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    \2\ The posting time for net settlement entries is chosen by 
each clearing arrangement within the requirements of the Board's 
``Daylight Overdraft Transaction Posting Rules'' (FRRS 9-1000).
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    Many Reserve Banks, however, reserve the right to reverse 
settlement debits and credits, if a settlement debit posted to a 
Federal Reserve account is not covered by the morning, or in some 
cases, early afternoon, of day T+1. This methodology creates the 
possibility of a settlement failure for a clearing arrangement on day 
T+1 with respect to the settlement on day T. Further, because these 
dating conventions refer to banking days, day T+1 may occur on the 
third or even fourth calendar day following settlement, after a holiday 
weekend. This policy of providing next-day finality increases the 
duration of settlement risk for private sector clearing arrangements.
    In 1990, the Board approved a second type of net settlement service 
for national, small-dollar clearing and settlement systems. This 
service provides same-day finality (day T) to participants and was 
modeled after the CHIPS (Clearing House Interbank Payments System) 
settlement arrangement, which was established in 1981. The service is 
currently available to private ACH as well as check clearinghouses.
    To accomplish settlement in these arrangements, the clearinghouse 
staff informs participants of their respective net settlement debit or 
credit position on day T. Settling participants with a net debit 
position send Fedwire funds transfers to a special settlement account 
at a designated Reserve Bank by a specified deadline. Once all debits 
have been covered, clearinghouse staff sends Fedwire funds transfers 
from the special settlement account to the Federal Reserve accounts of 
settling participants with a net credit position. This process is 
completed during the banking day on day T, under normal circumstances.

II. Advantages and Disadvantages of Current Services

Traditional Service

    The main advantage of the traditional next-day net settlement 
service is that it is familiar to clearinghouses and inexpensive for 
clearinghouses and participants to use. The main disadvantage of this 
service is that it increases the duration of settlement risk to 
clearinghouse participants and their customers. Another disadvantage is 
that some versions of this service use unsophisticated security methods 
to ensure authenticity, as well as to safeguard the integrity, of the 
settlement information.
    The traditional next-day settlement service evolved from the 
existing Federal Reserve accounting application to maximize operational 
simplicity and minimize operating costs for users. As a result, a 
disadvantage of the traditional service to Reserve Banks is that 
automated risk-management tools for checking balances on day T were not 
part of the design. Instead, to help control credit risk, the Reserve 
Banks rely on the right to reverse net settlement entries on day T+1, 
if a clearinghouse participant cannot cover a settlement debit to its 
account.
    Further, as interstate branch banking increases and the Federal 
Reserve policy of granting one Federal Reserve account per chartered 
bank, including banks with interstate branches, is phased in next year, 
more clearinghouses will need to conduct net settlements on an 
interdistrict basis. Without effective automated mechanisms to monitor 
and control credit risk at the time it is incurred on the settlement 
day, the Reserve Banks could be exposed to heightened risk.

Fedwire-Based Service

    The main advantage to the private sector of the current Fedwire-
based national net settlement service is that it provides intraday 
finality to clearinghouse participants and their customers on the 
settlement day. The main disadvantage is that it is logistically 
complex for certain clearing arrangements. For example, a settlement 
for a clearinghouse with a large number of participants would involve 
hundreds of individual Fedwire funds transfers having to be sent and 
received within narrow time frames, and with limited coordination, in 
order to complete scheduled settlements. In contrast, for the net 
settlement service with next-day finality, Reserve Bank staff posts 
entries to settling participants' Federal Reserve accounts in order to 
simplify the settlement process and help ensure its orderly completion.
    The main advantage to the Federal Reserve of the current Fedwire-
based service is that Reserve Banks have significantly greater control 
over credit risk because of the use of Fedwire and the associated 
(intraday) Account Balance Monitoring System. Fedwire funds transfers 
can be monitored in real time against available account balances.\3\ 
Transfers that would cause overdrafts beyond established parameters can 
be rejected. These capabilities permit Reserve Bank risk managers to 
perform automated intraday risk management on day T, when settlement 
information becomes available and before settlement entries are posted 
to Federal Reserve accounts.
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    \3\ As used throughout this Federal Register notice, the term 
``available account balance'' refers to a depository institution's 
Federal Reserve account balance plus any available intraday credit.
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III. Proposed Net Settlement Service Enhancement

    The Board proposes to enhance the net settlement services offered 
by the Reserve Banks to depository institutions. A net settlement 
service would be offered to depository institutions that would require 
the settling participants in a clearing arrangement, or their agent, to 
submit electronically to a designated Reserve Bank a file containing a 
net debit or credit for each participant. A Fedline terminal or other 
on-line mechanism would be used for submitting settlement files. Each 
settlement file would be identified by a code unique to that clearing 
arrangement and that particular settlement file.\4\ Files could be 
submitted at any time during an 8:30 a.m. to 4:00 p.m. Eastern Time 
(ET) settlement window, although each clearing arrangement would be 
expected to indicate a regular deadline for submitting its settlement 
files.
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    \4\ The service would support clearing arrangements that perform 
one or more settlements per day.
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    The service would include controls to ensure that a file has been 
submitted by a party authorized by the clearing arrangement, that the 
file contains net settlement entries for authorized settling 
participants only, that the sum of the net settlement debits equals the 
sum of the net settlement credits, and other

[[Page 32120]]

edits. Once all initial edits have been completed, the service would 
check the Federal Reserve account balance of each settling participant 
with a net debit position. If it is determined that sufficient balances 
are available to fund a participant's net debit, the Federal Reserve 
account of the participant would be debited and funds would be 
transferred to a settlement account held on the books of the designated 
Reserve Bank on behalf of the settling participants for the clearing 
arrangement. The transfer of funds from the Federal Reserve account of 
a settling participant in a net debit position would be treated as a 
final and irrevocable transaction from the perspective of that settling 
participant. Once the Federal Reserve accounts of all settling 
participants with net debit positions have been debited and the 
settlement account has been fully funded, the service would transfer 
funds out of the settlement account and credit the Federal Reserve 
account of each settling participant having a net credit position.\5\ 
These transfers would also be final and irrevocable.
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    \5\ For purposes of measuring the daylight overdraft positions 
of settling participants, the net debit and net credit entries would 
be posted to participants' Federal Reserve accounts on a flow basis, 
as they are processed. In the net settlement service with next-day 
finality currently offered by the Reserve Banks, all net debit and 
net credit entries are posted at one predefined time chosen by the 
clearinghouse.
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    The service might be designed to offer clearing arrangements 
different options to address potential situations in which a settling 
participant in a net debit position did not have sufficient balances in 
its Federal Reserve account to fund its settlement obligation. Under 
one scenario, the Federal Reserve would notify the designated agent for 
the clearing arrangement that settlement could not be completed and the 
service would automatically return funds from the settlement account to 
the settling participants whose Federal Reserve accounts had been 
debited. If desired, the agent could submit a revised settlement file 
to the Reserve Bank for processing.
    Under a second scenario, the service would offer features that 
provide for one or more attempts to complete settlement without 
requiring the resubmission of settlement data (retry feature). The 
retry feature would allow the service (automatic retry) or the agent 
(optional retry) to attempt to debit the account of a settling 
participant with a net debit position multiple times until the debit is 
either covered or a predefined time interval has expired.
    Under a third scenario, the clearing arrangement would request that 
the service retain the funds in the settlement account for a period of 
time awaiting specific instructions from the clearinghouse agent. 
Depending on the final design of the proposed service, the agent might 
be able to direct the transfer of additional funds to the settlement 
account in order to complete the settlement, for example, by drawing on 
a preestablished line of credit. The settlement agent might also have 
the ability to request that funds in the settlement account be 
transferred to the account of a predetermined depository institution to 
hold overnight for the purpose of attempting to complete settlement the 
next business day.
    In any event, after a predefined period of time, if settlement 
could not be completed, action would be taken to transfer funds out of 
a settlement account either by returning them to participants or by 
transferring funds to a designated depository institution. As noted 
above, the settlement agent would likely be permitted to submit a 
revised settlement file in the event of a settlement failure.
    Extensions of the settlement window might be granted to accommodate 
operational disruptions or temporary funding problems. However, these 
occurrences are expected to be rare and not to extend beyond the 
operating hours of the Fedwire funds transfer service.
    The enhanced service would improve the quality of the current net 
settlement services offered by the Reserve Banks in two important ways. 
First, it would improve operational efficiency and reduce the 
operational risks of conducting settlements with same-day finality by 
offering a settlement service with same-day finality that does not 
require the sending and receipt of individual Fedwire funds transfers. 
Instead, the proposed service would permit a clearinghouse or a 
settlement agent to submit settlement data to a Reserve Bank, as is now 
permitted in the traditional, next-day settlement service. This feature 
would help ensure that settlement debits and credits are addressed 
according to agreed procedures and in a timely and coordinated manner.
    Second, the proposed service would reduce the duration of 
settlement risk to participants in clearing arrangements by providing 
finality for credits virtually immediately after it has been determined 
that sufficient balances to settle are available in the Federal Reserve 
accounts of the settling participants on day T. If widely employed, the 
enhanced service could significantly reduce the duration of settlement 
risk for check and ACH clearinghouses and other clearing arrangements.
    To manage and limit risk to the Reserve Banks, the enhanced service 
would incorporate effective credit risk monitoring procedures and 
controls, which involve the automated checking of Federal Reserve 
account balances, before final intraday settlement debits and credits 
are posted to settling participants' Federal Reserve accounts. As 
currently envisioned, the credit risk monitoring controls would be as 
robust as those used currently in the Fedwire-based net settlement 
model.
    The Board expects that the proposed service would meet a number of 
key requirements. In particular, the proposed service should:
    1. Provide a standardized nationwide net settlement service to 
private-sector clearing arrangements that also supports interdistrict 
net settlements;
    2. Reduce settlement risks to participants in clearing arrangements 
that use the service, and to their customers, by providing final 
settlement on the same day that settlement information is submitted 
(day T);
    3. Control and minimize credit risk to the Reserve Banks and the 
potential for settlement disruptions by using appropriate account 
balance monitoring tools to check balances in depository institution 
Federal Reserve accounts before granting finality to settlement 
entries;
    4. Improve operational efficiency for participants in clearing 
arrangements by offering a service that does not require the sending of 
individual Fedwire funds transfers by participants to achieve 
settlement;
    5. Provide a mechanism that facilitates the timely completion of 
daily settlements and that accommodates well-defined options for 
clearing arrangements to achieve orderly settlements in the event of 
settlement problems;
    6. Enhance data security, including access controls, by including 
appropriate tools and procedures in a uniform, automated system;
    7. Improve analysis of settlement activity and trends over time by 
incorporating statistical reporting capabilities; and
    8. Provide for a clear legal basis and uniform understanding of the 
terms and conditions under which the service is offered by developing a 
standard Federal Reserve operating circular.

Time Frame for Implementation

    The Federal Reserve expects to make the necessary system changes to 
be able to offer the proposed net settlement service by the end of 
1998.

[[Page 32121]]

IV. Request for Comment

    The Board requests comment on all aspects of the proposed service 
enhancement. The Board is also requesting specific comments on the 
following questions:
    1. If the proposed service with same-day finality is offered, 
should the Federal Reserve continue to offer its existing net 
settlement service with next-day finality? What features, if any, of 
the existing service with next-day finality would make it preferable to 
some clearing arrangements over the proposed service with same-day 
finality?
    2. If the proposed service is offered, should the Federal Reserve 
continue to offer the Fedwire-based net settlement service with same-
day finality that is currently offered to national, small-dollar 
clearinghouses for check and ACH transactions?
    3. If the proposed service is offered, files of settlement data 
would be submitted to a Reserve Bank for processing in a well-defined 
period during which the service would be available. If files were 
generally accepted between 8:30 a.m. and 4:00 p.m. ET, would this 
service period be adequate to support current and future needs of 
potential users of the service? Should there be a capability for the 
receipt and storage (also known as ``warehousing'') of settlement files 
prior to the opening of the settlement window? If files can be 
warehoused prior to the opening of the settlement window, what is the 
maximum period during which the service should permit files to be 
warehoused (for example, for a specified number of hours less than one 
business day, or possibly for one or more business days prior to the 
beginning of the settlement window)?
    4. In order to provide high levels of data security, as well as 
operational efficiency, would it be reasonable to require clearing 
arrangements or their settlement agents to use a Fedline device, or 
other on-line electronic mechanism, to submit settlement data?
    5. In the current Fedwire-based net settlement service with same-
day finality, a settlement account is established at a Reserve Bank and 
a settlement agent for a clearing arrangement has the capability of 
monitoring whether individual participants have transferred funds to 
the settlement account to cover their settlement debits. In the 
proposed service, should a similar monitoring capability be provided to 
a settlement agent?
    6. As described in Section III above, the settlement file submitted 
to the net settlement service would contain only net settlement debits 
or credits for settling participants in a clearing arrangement. Should 
value-added services be offered that would provide information to 
settling participants regarding the individual settlement debit or 
credit positions of non-settling participants for which they settle? 
Should value-added services be offered that would provide a non-
settling participant with information regarding its individual net 
debit or credit position?
    7. In the event that a settlement account cannot be fully funded in 
the first automated attempt to debit the Federal Reserve accounts of 
settling participants, should the proposed service offer features that 
provide for one or more additional attempts to complete settlement 
without requiring the resubmission of settlement data (retry feature) 
or should the service automatically return all funds to the settling 
participants that have transferred funds to the settlement account and 
notify the agent that a settlement cannot be completed? Some of the 
retry features being considered are:
    a. An automated retry feature that would attempt to debit the 
account of a settling participant with a net debit position multiple 
times during a predetermined time interval until the debit is either 
covered or a predefined time interval has expired;
    b. A retry feature controlled by a settlement agent for the 
clearing arrangement that would allow the agent to instruct 
electronically the service to retry the debiting of accounts of 
settling participants that have not covered their net debits (the 
number of retries and the time interval between retries would be 
controlled by the agent within a ``retry window'' provided as part of 
the service).
    8. If the service is designed with retry capabilities as described 
in the question above, how long should the retry window be (for 
example, 15 minutes, one hour)? In addition to the retry window, should 
there be a maximum number of retry attempts designated after which, if 
the settlement is not completed, funds in the settlement account would 
be returned to the appropriate settling participants?
    9. In the proposed service, should the debit and credit entries to 
the Federal Reserve accounts of the settling participants be considered 
funds transfers under Regulation J and other laws applicable to funds 
transfers?
    10. In the case of a default by a settling participant, should the 
service provide the capability for another settling participant or 
depository institution to transfer additional funds (for example, from 
a preestablished line of credit or other liquidity facility) into the 
settlement account in order to complete the settlement?
    11. To what types of clearing arrangements should the proposed 
service be offered (for example, check clearinghouses, ACH 
clearinghouses, ATM networks, POS networks, credit card arrangements, 
or clearing arrangements for emerging types of electronic payment 
transactions)? Should the service potentially be available for 
conducting money settlements between depository institutions in 
connection with arrangements for clearing financial contracts in the 
wholesale financial markets or for conducting interbank settlements of 
obligations arising from nonfinancial markets?

Competitive Impact Analysis

    The Board has established procedures for assessing the competitive 
impact of rule or policy changes that have a substantial impact on 
payments system participants.\6\ Under these procedures, the Board will 
assess whether a change would have a direct and material adverse effect 
on the ability of other service providers to compete effectively with 
the Federal Reserve in providing similar services due to differing 
legal powers or constraints, or due to a dominant market position of 
the Federal Reserve deriving from such differences. If no reasonable 
modifications would mitigate adverse competitive effects, the Board 
will determine whether the anticipated benefits are significant enough 
to proceed with the change despite the adverse effects.
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    \6\ These procedures are described in the Board's policy 
statement ``The Federal Reserve in the Payments System,'' as revised 
in March 1990 (55 FR 11648, March 29, 1990).
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    The Board's proposed enhancements to the net settlement service are 
intended to improve the clearance and settlement process for private 
sector clearing arrangements by increasing the efficiency of the 
services currently offered by the Federal Reserve and by reducing the 
duration of settlement risk to private-sector participants in such 
arrangements. The proposed net settlement service could indirectly 
enhance the ability of private-sector depository institutions to 
compete with the Reserve Banks in the provision of payment services 
such as check and ACH clearing.
    The risk management features that would be implemented for the 
enhanced service would help protect the Federal

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Reserve Banks from the risk of loss. Certain features would help 
provide for orderly settlements in case of settlement difficulties. 
Overall, the Board believes that the proposed enhancements to the 
Federal Reserve's net settlement services would increase efficiency and 
reduce risk for private-sector clearing arrangements and their 
participants, while providing for the more efficient management of risk 
by the Reserve Banks.

Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3506; 5 CAR 1320, Appendix A.1), the Board reviewed the request for 
comments under the authority delegated to the Board by the Office of 
Management and Budget. No collection of information pursuant to the 
Paperwork Reduction Act (44 U.S.C. 3501 et seq.) is contained in this 
notice.

    By order of the Board of Governors of the Federal Reserve 
System, June 9, 1997.
William W. Wiles,
Secretary of the Board.
[FR Doc. 97-15435 Filed 6-11-97; 8:45 am]
BILLING CODE 6210-01-P