[Federal Register Volume 63, Number 215 (Friday, November 6, 1998)]
[Notices]
[Pages 60000-60006]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-29709]


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FEDERAL RESERVE SYSTEM

[Docket No. R-0974]


Enhancement of Federal Reserve Net Settlement Payment Services

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice of service enhancement.

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SUMMARY: The Board of Governors has approved enhancements to the net 
settlement services that the Federal Reserve Banks offer to financial 
institutions with Federal Reserve accounts that participate in 
multilateral settlements for private-sector clearing arrangements. The 
enhanced service combines and improves selected features from the 
Reserve Banks' existing net settlement services and may be used for 
either gross or net multilateral settlements. The service is fully 
automated and provides finality of settlement intraday on the 
settlement day to participants in clearing arrangements using the 
service. The service is intended to facilitate improvements in the 
operational efficiency of clearinghouses and reduce operational and 
settlement risk for participants.

EFFECTIVE DATE: March 29, 1999.

FOR FURTHER INFORMATION CONTACT: Paul W. Bettge, Assistant Director 
(202/452-

[[Page 60001]]

3174); Myriam Y. Payne, Senior Financial Services Analyst (202/452-
3219); for the hearing impaired only, Telecommunications Device for the 
Deaf (TDD), Diane Jenkins (202/452-3544).

SUPPLEMENTARY INFORMATION:

I. Background

    The Reserve Banks offer net settlement services to depository 
institutions that participate in clearinghouses and clearing 
arrangements for checks, as well as Automated Clearing House (ACH), 
automated teller machine (ATM), point-of-sale (POS) networks, and other 
transactions. The arrangements are typically organized as groups of 
three or more participating depository institutions that exchange 
payment instructions, account for the value exchanged, and settle 
balances multilaterally. Typically, the agent \1\ for the arrangement 
computes the net amounts owed to or by each participant \2\ after 
netting all the transactions on a multilateral basis. The calculated 
net amounts represent either a net debit or a net credit for each 
participant. If the clearinghouse uses the Reserve Banks' net 
settlement services, the multilateral differences may be settled by 
transferring funds between the accounts of the settling participants on 
the books of the Reserve Banks.
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    \1\ The agent is the party designated by the participants to act 
on behalf of the clearinghouse.
    \2\ A settling participant in a clearinghouse that uses a 
Reserve Bank net settlement service is a financial institution with 
a Federal Reserve account that is debited or credited to transfer 
the funds needed to complete the settlement. In contrast, non-
settling participants typically settle through a settling 
participant.
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    Currently, the Reserve Banks offer two basic types of net 
settlement services. In the traditional model, the clearinghouse agent 
provides a settlement sheet (in either paper or electronic form) to a 
Reserve Bank on the settlement date. The Reserve Bank then posts a net 
debit or a net credit to the Federal Reserve account of each settling 
participant. Posted credits represent available funds for the purpose 
of intraday cash management and overnight reserve management.\3\ The 
Reserve Banks, however, do not provide settlement finality until the 
business day after the settlement day. They reserve the right to 
reverse settlement debits and credits if a participant is unable to 
cover its settlement debit. This methodology creates the possibility of 
a settlement failure by a clearinghouse on the day following the 
settlement day. Because these dating conventions refer to banking days, 
reversals may occur on the third or even the fourth calendar day 
following settlement.
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    \3\ The posting time for net settlement entries is chosen by 
each clearinghouse within the requirements of the Board's Daylight 
Overdraft Transaction Posting Rules.
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    The traditional settlement sheet service offers clearinghouses a 
familiar and inexpensive mechanism to achieve settlement. This service, 
however, increases the duration of settlement risk to clearinghouse 
participants and their customers because settlement entries are 
provisional until the banking day after the settlement day. Another 
disadvantage is that some versions of the service lack the security 
controls needed to ensure the authenticity of settlement information 
provided to the Reserve Bank and to safeguard the integrity of the 
settlement. In addition, the design of the traditional service does not 
include automated risk-management controls for verifying the Federal 
Reserve account balances of participants with net debit positions. To 
help control credit risk, the Reserve Banks rely on the right to 
reverse net settlement entries on the banking day following the 
settlement day if a participant is not able to cover its net debit 
obligation. As a result, the traditional service does not provide 
effective tools for monitoring or controlling risk to the Reserve Banks 
at the point the risk is incurred.
    In 1990, the Board approved an interdistrict net settlement service 
with settlement-day finality for a national ACH clearinghouse. In this 
type of service, individual participants with net debit positions send 
Fedwire funds transfers to a settlement account at a designated Reserve 
Bank. Once funds transfers have been received into the settlement 
account to cover all net debits, the clearing arrangement's agent sends 
Fedwire funds transfers from the settlement account to the accounts of 
participants in net credit positions. Under normal circumstances, this 
process is completed on the settlement day. Because the service uses 
Fedwire funds transfers, settlement payments are final and irrevocable 
on the settlement day.
    The Fedwire-based net settlement service provides intraday finality 
on the settlement day, thereby reducing the duration of credit risk to 
clearinghouse participants. It also offers Reserve Banks significantly 
greater control over credit risk because of the use of Fedwire and the 
associated real-time verification of Federal Reserve account balances 
performed through the Account Balance Monitoring System (ABMS). Fedwire 
funds transfers initiated by clearinghouse participants that would 
cause overdrafts beyond established parameters can be rejected. These 
capabilities permit Reserve Banks to perform automated intraday risk 
management on the settlement day, when settlement information becomes 
available and before settlement entries are posted to Federal Reserve 
accounts.
    Relying on the initiation of individual Fedwire funds transfers to 
conduct multilateral settlement, however, increases the logistical 
complexity of settlement for certain clearing arrangements. For 
example, a settlement for a clearinghouse with a large number of 
participants could involve coordinating hundreds of individual Fedwire 
funds transfers that have to be sent and received within narrow time 
frames in order to complete scheduled settlements.

II. The June 1997 Proposal

    In June 1997, the Board requested comments on a proposal that 
Reserve Banks offer an enhanced net settlement service to depository 
institutions that participate in clearinghouse arrangements (62 FR 
32118, June 12, 1997). The proposed service would combine and improve 
selected features from the Reserve Bank's existing net settlement 
services. Under the proposal, the Reserve Banks would offer a fully 
automated settlement service with finality of settlement intraday on 
the settlement day. The agent for the clearinghouse would submit an 
electronic file containing the settlement information for each settling 
participant. The enhanced service would accept and process settlement 
files during a predefined settlement period. The service would include 
edits and controls to ensure the authenticity and validity of the 
settlement file. Once all initial edits have been completed, the 
service would check the account balance of settling participants that 
fall within established risk parameters in the ABMS and that have debit 
settlement positions. If the debit participants have available account 
balances \4\ sufficient to cover their settlement obligations, their 
Federal Reserve accounts would be debited and funds would be 
transferred to a settlement account held on the books of a designated 
Reserve Bank. The transfer of funds from the account of a participant 
with a debit position would be treated as a final and irrevocable 
transaction. When all funds have been transferred from the account of 
the debit participants to the settlement account, the enhanced service 
would transfer final funds out of the settlement account and credit the 
Federal Reserve account

[[Page 60002]]

of each participant with a credit position.
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    \4\ The available account balance is defined as the 
institution's Federal Reserve account balance plus any available 
intraday credit.
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    If a participant with a debit position did not have an available 
account balance sufficient to cover its settlement obligation, the 
Federal Reserve would notify the participant and the agent. The agent 
would then be expected to take action as determined by the rules of the 
clearing organization. For example, the organization could choose to 
fund the settlement account to complete the settlement by drawing on a 
preestablished line of credit. Alternatively, the agent might request 
that the Reserve Bank cancel the settlement and return all funds in the 
settlement account to the participants with debit positions. After a 
defined period, if the organization had not been able to complete or 
cancel the settlement, the Reserve Bank would return all the funds in 
the settlement account to the participants with debit positions. The 
terms of the enhanced service would permit the agent to submit a 
revised settlement file in the event of a settlement failure.

III. Enhanced Settlement Service

    The Board is approving an enhanced settlement service that retains 
the essential characteristics described in the proposal issued for 
comment in 1997. First, by providing settlement-day finality, the 
enhanced service will reduce the duration of credit risk to private-
sector clearinghouse participants relative to the Federal Reserve's 
traditional net settlement service. Second, the enhanced service will 
improve operational efficiency and reduce operational risk for 
clearinghouse participants by offering a settlement mechanism that does 
not require the origination of individual Fedwire funds transfers to 
achieve settlement-day finality. In addition, the enhanced service 
enables the Reserve Banks to manage and limit risk by incorporating 
risk controls that are as robust as those used currently in the 
Fedwire-based net settlement service.
    Service Availability and Features--The enhanced service will be 
available to financial institutions with Federal Reserve accounts that 
participate in multilateral settlements for private-sector clearing 
arrangements. The enhanced service will provide clearing arrangements 
with the capability to settle the obligations that result from their 
payments exchange on either a net or gross basis. In addition, the 
service approved by the Board incorporates the following features:
    1. The Federal Reserve will provide settlement services during a 
business day beginning at 8:30 a.m. Eastern Time (ET) and concluding 
before 6:00 p.m. ET (the settlement window). A file-submission deadline 
will be established approximately thirty to sixty minutes before the 
end of the settlement window (the file-submission window) to ensure 
that all files received by the file-submission window can be processed 
before the close of the settlement window. The specific hours of 
operation of the service, however, will be reviewed periodically and 
may be modified to reflect changes in the operating hours of the 
Fedwire system or the business needs of settlement participants.
    2. Agents will submit settlement files electronically during the 
predefined file-submission window. The initial release of the 
application software will support file submission using a standard 
Fedline terminal or computer interface bulk data connection. 
Preformatted Fedline screens will also be provided for clearinghouse 
arrangements that wish to key in the settlement information. In 
addition, internet browser capability for file submission and access to 
the service is being considered for a future release.
    3. Agents may transmit any number of settlement files per 
settlement day. The service will process the settlement files for a 
particular settlement arrangement one at a time in the order they are 
received. Files received after the close of the settlement window will 
be held in a queue to be processed in the order received at the opening 
of the following day's settlement window, as long as the settlement 
date on the file corresponds with the following settlement date.
    4. Controls and edits in the application will ensure, among other 
things, that the file has been transmitted by an agent authorized by 
the participants in the clearing arrangement, that the file has been 
transmitted from an authorized terminal, that the file contains 
settlement entries from authorized participants only, and that the sum 
of all the settlement debits equals the sum of all the settlement 
credits.
    5. Settlement debit entries will be passed to the ABMS for posting 
to each settling participant's Federal Reserve account. The ABMS will 
check the available account balance of all participants that fall 
within established risk parameters to determine if the settlement 
debits can be covered. If the available account balance is sufficient 
to cover the participant's settlement debit, the participant's account 
will be debited and an offsetting credit will be posted immediately to 
a settlement account held on the books of a Reserve Bank. The debit to 
the Federal Reserve account will be a final and irrevocable 
transaction. When all settlement debits have been covered and the 
arrangement's settlement account has been fully funded, credit 
settlement balances will be passed to the ABMS for posting to the 
relevant participants' Federal Reserve accounts. The credit entries 
will also be final and irrevocable transactions.
    The ABMS account balance report available to institutions via 
Fedline will include a new line that will show the net settlement debit 
or credit entries that have been posted to the participants' Federal 
Reserve accounts. For purposes of measuring the daylight overdraft 
positions of participants, the net debit and net credit entries will be 
posted to participants' Federal Reserve accounts on a flow basis, as 
they are processed.
    Exception Processing--If a settlement cannot be completed because a 
participant with a debit position is unable to cover its settlement 
obligation, the Federal Reserve will notify the participant and the 
agent for the clearing arrangement. The participant with the 
insufficient balance will be notified immediately. The agent will be 
notified on either an immediate or a delayed basis, depending on the 
notification option that the settlement arrangement has selected. If 
the clearinghouse chooses immediate notification, the Federal Reserve 
will automatically transmit a notification of the failed debit to the 
agent. If the deferred option is chosen, the Federal Reserve will defer 
notifying the agent for a brief interval after the participant's debit 
is rejected. This brief interval will be defined by the Federal 
Reserve, initially the interval will be approximately thirty to forty-
five minutes long. The interval is intended to allow the participant 
some time to provide funding before the agent is notified. The length 
of the interval may be reviewed periodically based on perceived 
business needs. If the participant is unable to provide sufficient 
funds in its account before the end of the deferral interval, the 
Federal Reserve will automatically send a notification to the agent. 
When notified of the failed debit, the agent may choose to initiate 
actions to complete the settlement as determined by the rules of the 
clearing arrangement. Pending action by the agent, the settlement will 
remain open and the collected funds will remain in the settlement 
account. The enhanced service will provide settlement agents with the 
capability to:
    1. Instruct the Federal Reserve to retry the failed debit. That is, 
the agent would notify Reserve Bank staff that the

[[Page 60003]]

participant in question has received the funds needed to fulfill its 
settlement obligation. The Federal Reserve would then retry debiting 
the participant's account and crediting the settlement account once 
more.
    2. Fund the settlement account from an alternative source, such as 
a preestablished line of credit.
    3. Instruct the Federal Reserve to cancel the settlement and allow 
the agent to submit a revised or ``recast'' settlement file that 
excludes the transactions of the participant in question and provides 
recalculated settlement positions for the remaining participants.
    4. Instruct the Federal Reserve to cancel the settlement. If the 
agent selects this option, the funds in the settlement account will be 
returned to the Federal Reserve accounts of the debit participants that 
had covered their settlement obligations.
    If processing of a settlement file has not been completed by the 
close of the settlement window because a participant is unable to cover 
its settlement obligation, the settlement will be cancelled by the 
Federal Reserve and all funds in the settlement account will be 
returned to the relevant participants. Extensions of the settlement 
window might be granted to accommodate operational disruptions or 
temporary funding problems. These occurrences, however, are expected to 
be rare and not to extend beyond the operating hours of the Fedwire 
funds transfer service.
    Implementation and Conversion Schedule--Early in 1999, the Reserve 
Banks will conduct a pre-implementation pilot of the enhanced 
settlement service with two or three settlement arrangements. The pilot 
will be conducted in a test environment designed to simulate the 
production environment. The pilot will provide an opportunity for both 
Reserve Banks and participating arrangements to test the enhanced 
service and to refine operating procedures prior to implementation. The 
Reserve Banks will begin phased implementation of the enhanced 
settlement service on March 29, 1999.
    The current Fedwire-based net settlement service used by a few 
national clearinghouses will continue to be offered in conjunction with 
the enhanced settlement service as long as a reasonable level of demand 
for the Fedwire-based service exists. The traditional settlement sheet 
service, however, will be phased out gradually. Clearinghouses and 
settlement arrangements that currently use the traditional net 
settlement service will be able to work with the Federal Reserve to 
develop a migration plan that is not in conflict with other critical 
efforts that the clearinghouses and participants may have under way. 
Specifically, because conversion to the enhanced settlement service may 
require clearinghouses to implement internal software changes, it may 
not be possible or desirable to address the required changes until 
after year 2000 system efforts have been completed. The Board expects 
that clearinghouses and settlement arrangements that currently use the 
traditional service will be able to convert to the enhanced settlement 
service by the end of 2001. The Board will consider extending the 
conversion deadline on a case-by-case basis for systems that can 
demonstrate significant resource demands due to other critical efforts.
    Service Pricing--The planned price structure for the enhanced 
service has been designed to recognize both the fixed costs of 
providing a settlement service and the variable costs associated with 
the number of settlement transactions processed. This will be 
accomplished by assessing a charge for each settlement file transmitted 
by an arrangement and a charge for each settlement entry in the file. 
The actual price for the service will be announced in the fourth 
quarter of 1998 as part of the Federal Reserve's 1999 fee schedule.

IV. Summary of Comments

    The Board received twenty public comment letters on its proposed 
enhanced settlement service.\5\ The commenters included nine 
clearinghouse organizations and associations, six commercial banking 
organizations, four trade associations, and one retail payment network.
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    \5\ This total does not include comment letters from Federal 
Reserve Banks.
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    General Comments--Most commenters supported the proposed 
enhancements to the Federal Reserve's net settlement services. Over 
half of the commenters that supported the proposed service requested 
that the Board provide a pricing structure for the proposed service or 
specify the risk management policy to which institutions would be 
required to adhere in order to use this service. One commenter proposed 
that the Board convene a meeting of clearing arrangement operators to 
review these issues. On December 15, 1997, Federal Reserve staff held a 
meeting with private-sector organizations in order to answer questions 
and provide additional details regarding the enhanced settlement 
service. All organizations that submitted comment letters and other 
interested organizations were invited to the meeting.
    A few commenters expressed concerns regarding the schedule for 
implementation of the proposed service. One commenter stated that if 
the Federal Reserve were going to require clearing and settlement 
arrangements to use the new service, then such a requirement should not 
be imposed on participants until after the year 2000. In light of the 
resources devoted to year 2000 issues, the Board will not require 
clearing and settlement arrangements to use the new service before the 
year 2000.
    Issues Discussed at the December 15, 1997 Meeting--At the December 
meeting, Federal Reserve staff gave an overview of the proposed risk 
management policy that would apply to certain multilateral settlement 
systems regardless of whether they use Federal Reserve settlement 
services. A final policy was adopted by the Board in its Policy 
Statement on Privately Operated Multilateral Settlement Systems (63 FR 
34888, June 26, 1998) and will become effective on January 4, 1999. In 
adopting that policy statement, the Board also emphasized that 
compliance with the policy does not require use of the Federal 
Reserve's enhanced settlement service. The planned pricing structure 
for the enhanced settlement service was also discussed with the 
private-sector representatives.
    The Federal Reserve staff also briefly described pilot testing and 
the likely transition to the enhanced settlement service. As noted 
above, a pre-production pilot of the service will be conducted early in 
1999. Phased implementation of the service will begin by the end of the 
first quarter of 1999.
    One private-sector representative expressed concern regarding the 
proposed method of posting debits and credits to participants' Federal 
Reserve accounts on a flow basis, as they are processed, for purposes 
of measuring daylight overdraft positions. The representative felt that 
such a procedure would cause inequities among participants because 
participants would be debited or credited based on where the entry was 
located in the settlement file. The Board believes that, in most 
instances, debits and credits will be posted almost simultaneously, as 
soon as the settlement entries are processed. Delays in the posting of 
all debits and credits in a settlement file may occur if a participant 
is unable to cover its settlement obligation. These situations and the 
related consequences should be addressed in the clearinghouse rules.

[[Page 60004]]

    A few representatives wanted to know whether daylight overdrafts 
could be used to support a debit position by a settling participant. 
One of these representatives also requested clarification on how these 
debits and credits would affect a participant's daylight overdraft 
position. In general, a settling participant will normally be able to 
use its available account balance, which includes any authorized 
intraday credit, to fund its debit position. In addition, settlement 
debits and credits will be posted to the account of participants on a 
flow basis, as they occur.
    Specific Issues on which the Board Sought Comment--The Board also 
sought comment on a number of other issues discussed below:

A. Continuation of Traditional Settlement Sheet Service With Next-Day 
Finality

    Nine of the thirteen respondents to this question believed that the 
Federal Reserve should continue to offer its existing net settlement 
service with next-day finality. One commenter felt that the time and 
equipment investment necessary for the proposed service might prove to 
be a financial burden for small-volume clearinghouses. Two commenters 
indicated that some clearing arrangements might prefer the simplicity 
and low cost of the existing next-day finality service. Three 
commenters felt that the Federal Reserve should not continue to offer 
its existing net settlement service with next-day finality if the 
proposed service were offered. One of the commenters noted that ``there 
are no reasons, operational or otherwise, to allow ongoing and 
unnecessary temporal risk in the payments system as a result of next-
day finality.''
    The Board believes that the benefits to clearinghouse participants 
and the Federal Reserve provided by the enhanced service are 
significant. The enhanced service not only offers increased efficiency 
and security, but also significantly reduces settlement risk. The Board 
believes that the benefits of providing a more efficient and secure 
service that incorporates better risk controls outweigh the potential 
cost increase to the users of the traditional Federal Reserve net 
settlement service. In addition, it would not be cost effective to the 
Reserve Banks to continue to provide and support the current 
traditional settlement sheet service in addition to the enhanced 
service. As a result, the Board intends to phase out the traditional 
settlement sheet service with next-day finality. To be sensitive to the 
commenters' concerns regarding potential costs and resources that may 
have to be invested to convert to the enhanced service, the Board is 
adopting a flexible migration plan. Clearinghouses and their 
participants will have until the end of 2001 to convert to the enhanced 
service.

B. Continuation of the Fedwire-based Service

    Nine of the fourteen commenters believed that the Federal Reserve 
should continue to offer the Fedwire-based net settlement service with 
same-day finality. One commenter felt that the Fedwire-based service 
provides greater opportunities for the settlement agent to manage the 
settlement actively and reduce the risk of a settlement failure.
    Two commenters felt that the Federal Reserve should not continue to 
offer its Fedwire-based net settlement service because there would be 
no demand for this service with the introduction of the enhanced 
service. The commenters viewed the reduction in operational complexity 
from the Fedwire-based service as the justification for eliminating it.
    The Board will continue to offer the Fedwire-based service as long 
as a reasonable level of demand for the service exists. The Fedwire-
based service has robust risk management features. Because finality is 
granted when the settlement entries are posted via the use of Fedwire 
funds transfers, the Fedwire-based service also reduces settlement risk 
to private-sector participants.

C. Length of Settlement Window and Provision of a Warehousing Mechanism

    There was no consensus among respondents as to whether the period 
between 8:30 a.m. and 4:00 p.m. ET would be adequate to support current 
and future needs of potential users of the service. Two commenters 
expressed a preference for the service to begin processing settlement 
files during the very early morning hours, with 12:30 a.m. suggested by 
one of the commenters. Two other commenters felt that, at a minimum, a 
6:00 p.m. ET closing deadline should be implemented.
    The Board recognizes that the Fedwire funds transfer service is the 
primary alternative for orderly and efficient settlement of bilateral 
obligations in case a settlement arrangement is unable to complete its 
multilateral settlement through the enhanced service. As a result, the 
Board has determined that settlement file processing should generally 
be completed before 6:00 p.m. to allow at least a thirty minute period 
before the standard close of the Fedwire funds transfer system. To 
ensure that processing of the settlement files is completed by the 
close of the settlement window, the Federal Reserve will establish a 
cut-off time for submission of settlement files that is approximately 
thirty to sixty minutes in advance of the settlement window deadline. 
Extensions of the settlement deadlines may be permitted under 
extenuating circumstances. Experience gained during the pilot period 
will be used to review and, if necessary, redefine settlement 
deadlines. At this time, the Board does not believe that a compelling 
business need has been expressed to start processing settlement files 
before 8:30 a.m. ET. This issue may be reviewed as experience is gained 
with the operation of the enhanced service.
    With respect to the warehousing option, seven of the eleven 
commenters felt that this feature should be offered. One commenter 
claimed that settlement files should be received in a ``flow processing 
mode'' twenty-four hours a day, seven days a week. Four commenters did 
not support a warehousing option because they thought such an option 
would not be useful or thought warehousing should be handled by the 
clearing association's settlement agent rather than the Federal 
Reserve.
    The enhanced settlement service will queue settlement files 
received after the close of the settlement window for processing at the 
opening of the following day's settlement window, provided the 
settlement date on the file corresponds with the following business 
date. More sophisticated warehousing capabilities will not be offered 
in the initial release due to cost and time constraints.

D. Submission of Settlement Data Through an Electronic Mechanism

    All but one of the fifteen commenters that responded to this 
question felt it would be reasonable to require clearing arrangements 
or settlement agents to use an electronic mechanism to submit 
settlement data. The commenters felt that such an electronic mechanism 
would ensure that data are sent and received by authorized persons and 
not tampered with during transmission. One commenter, while agreeing 
that electronic devices should be used, recommended that the Federal 
Reserve be able to receive valid settlement data and enter the data 
manually into the settlement system in emergencies. One commenter did 
not believe that it would be reasonable to require the electronic

[[Page 60005]]

submission of data and encouraged the Federal Reserve to offer a manual 
procedure for submitting data.
    The Board shares the concerns of the commenters and will provide an 
electronic mechanism for settlement data transmission to increase the 
efficiency and security of the settlement process. Settlement files may 
be transmitted via a standard Fedline terminal or a computer interface 
bulk data connection. Preformatted Fedline screens for settlement data 
input will also be provided.
    Clearing and settlement systems are encouraged to have contingency 
arrangements to reduce the risk of a failed settlement resulting from 
operational problems. The Reserve Banks will be able to accept and 
process non-electronic files on behalf of a settlement agent in 
situations in which an arrangement is experiencing severe operational 
disruptions and is unable to access the enhanced service directly or 
through its contingency channels.

E. Providing Monitoring Capabilities to the Agent

    All but one of the fourteen commenters that responded to this 
question felt it would be appropriate to offer a monitoring capability 
that would allow the settlement agent to determine whether settlement 
entries for individual participants had been successfully posted. One 
commenter felt that this service should be offered to settlement agents 
because they represent their member financial institutions as unbiased 
facilitators in all aspects of the settlement process. Another 
commenter believed that the settlement agent must have access to 
information that will allow it to determine whether individual 
participants have fulfilled their settlement obligations.
    The enhanced service will provide the agent with the capability to 
view the settlement account balance by using the ABMS. Automated 
inquiries for monitoring the progress and the status of a settlement 
file by the agent will be provided in a later release of the 
application.

F. Value-added Services That Provide Non-settling Participant 
Information

    Eight of the ten respondents to this question did not believe that 
the Federal Reserve should offer a value-added service that would 
provide non-settling participant information. The general consensus was 
that such services are more appropriate for the settlement agent to 
offer to its participants. One commenter stated that it does not see a 
need for the Federal Reserve to provide these services, as the 
settlement agent would have this information in order to calculate the 
settling participant's aggregate position. The settlement agent should, 
therefore, be able to communicate this information to the settling 
participants and any non-settling participants. Two commenters felt 
that the value-added services should be offered by the Federal Reserve 
because such information would be of assistance to settling and non-
settling participants in analyzing their daily obligations.
    The Board agrees that, in most cases, the agent can provide the 
non-settling participant information more efficiently. As a result, the 
enhanced service will not include these value-added features in the 
near term.

G. Provision of a Retry Feature

    The fourteen respondents that addressed this issue felt that a 
retry feature should be included in the proposed net settlement 
service. Eight of these respondents believed that the service should 
include a retry feature that automatically attempts to debit the 
account of a participant following a predefined interval after the 
participant fails to cover its debit obligation. The respondents also 
requested a retry feature that could be controlled by the agent. Four 
respondents felt that only an automatic retry feature should be 
available, whereas two others felt that only a retry feature that can 
be controlled by the agent should be offered. A proponent of the 
controlled retry feature claimed that such a system would provide the 
greatest flexibility and maximum operational effectiveness because a 
retry would be attempted only when the settlement agent felt that the 
settlement was likely to succeed.
    A retry feature will be available in the enhanced settlement 
service. In cases where an arrangement has selected the deferred 
notification option, the Federal Reserve will retry the failed debit 
after a predefined interval before the Federal Reserve notifies the 
agent that a participant is unable to cover the debit. Once the agent 
has been notified, it will be able to instruct the Federal Reserve to 
retry a debit entry to a participant's account. Further automation of 
the retry function may be included in a future release of the 
application software.

H. Length of the Retry Window and Maximum Number of Retries

    There was no consensus among the thirteen respondents that 
commented on this question as to how long the retry window should be. 
Four commenters suggested a period of anywhere from one hour up to 
three hours. One commenter felt that the retry capability should have 
no time limits other than being restricted to the operating hours of 
the net settlement service. Two others believed that the retry window 
time limit should be left to the discretion of the clearing 
arrangements.
    In the event that a settlement account cannot be fully funded 
because the initial attempt to post a settlement debit to a 
participant's account has failed, the Federal Reserve may retry the 
debit after a short predefined interval. The interval is likely to be 
approximately thirty to forty-five minutes after the failed debit 
occurred. If the debit continues to remain unfunded, the agent will 
automatically be notified. A relatively short interval to retry a debit 
will give the agent as much time as possible to take alternative action 
to avoid unnecessary settlement failures if the retry fails. The length 
of the interval will be reviewed periodically based on perceived 
business needs. Further, retry instructions from settlement agents will 
be honored at any time during which the settlement service is open.
    There was no consensus among the respondents as to the maximum 
number of retries that should be allowed. Five respondents stated that 
there should be a limited number of attempts but did not specify a 
number. Two commenters felt that a maximum of two retries should be 
made. Two commenters believed that the maximum number of retries 
allowed should be decided by the clearing arrangements.
    If the clearing arrangement chooses the delayed notification 
option, the Federal Reserve will automatically retry the debit once 
following a short interval after the initial debit failed. The Federal 
Reserve will review periodically after the initial release whether, for 
clearing arrangements choosing the delayed notification option, the 
service should provide more than one automated retry following an 
initial failure to post a settlement debit. The Board has imposed no 
formal limit on the number of times that a settlement agent can request 
that a failed debit be retried.

I. Legal Status of the Debit and Credit Settlement Entries

    Of the eleven commenters that responded to this question, seven 
believed that the debit and credit entries to the Federal Reserve 
accounts of the settling participants should not be considered funds 
transfers under Regulation J (12 CFR part 210) and other laws 
applicable to funds transfers. One respondent stated that the proposed 
service does not use Fedwire funds transfers and thus cannot rely on 
the same legal basis. Many suggested that the Federal Reserve amend 
Regulation J

[[Page 60006]]

to address the status of the entries posted by the enhanced settlement 
service. One commenter suggested that debit and credit entries to the 
reserve accounts of the settling participants be considered funds 
transfers under Regulation J and pertinent sections of Article 4A of 
the Uniform Commercial Code. Another felt that although Regulation J 
did not apply to the debit and credit entries of the proposed service, 
Article 4A did apply.
    The Board has not amended Regulation J to cover explicitly debit 
and credit entries associated with the enhanced settlement service. 
Although certain provisions of Article 4A may apply to the debit and 
credit entries, the extent to which these entries would be considered 
``payment orders'' under Article 4A is not clear. Therefore, the 
Reserve Bank operating circulars will establish the rules governing the 
debit and credit entries to the Federal Reserve accounts of the 
settling participants, including when those debits and credits will 
become final.

J. Capability to Transfer Funds Into the Settlement Account

    All but one of the twelve commenters that responded to this 
question indicated that it would be beneficial for the service to 
provide the capability for a participant or another institution to 
transfer additional funds into the settlement account in order to 
complete the settlement. One commenter stated that such a feature could 
facilitate quick resolution of problems and prevent temporary problems 
from becoming permanent defaults.
    Only one commenter thought that the Federal Reserve should not 
offer the capability for another participant or depository institution 
to transfer funds into the settlement account to complete the 
settlement process. This commenter stated that a failed debit for a 
settling participant should be resolved by that participant and that 
the settling participants can set up bilateral funding arrangements if 
they so choose.
    The enhanced settlement service will allow another settling 
participant or depository institution to transfer additional funds into 
the settlement account in order to complete the settlement. The agent 
or another authorized depository institution will be able to transfer 
funds into the settlement account to complete settlement in accordance 
with the clearinghouse association rules.

K. Clearing Arrangements That Should be Eligible for the Enhanced 
Settlement Service

    Seven out of the twelve respondents that addressed this issue felt 
that the Federal Reserve should offer the proposed service to any type 
of clearing arrangement. Three of these commenters wanted to clarify 
that direct settlement participants would have to be entities that are 
eligible for Federal Reserve accounts. Another commenter stated that 
the proposed service should ``accommodate any type of clearing 
arrangement'' because of the rapidly changing payment systems 
environment and the increasing need for new services in the industry.
    Two commenters believed that the proposed service should be 
available only to small-dollar clearing arrangements. One of these 
respondents felt that large-dollar clearing arrangements, such as 
CHIPS, should not have access to the new service because the settlement 
agents should have a very active role in managing the settlements for 
large-dollar systems, and the Fedwire-based settlement is best suited 
for these purposes.
    The Board is confident that the enhanced service offers an 
efficient and secure settlement service with strong risk management 
features. As a result, the Federal Reserve will make the enhanced 
settlement service available to financial institutions with Federal 
Reserve accounts that participate in multilateral settlements for 
private-sector clearing arrangements.

V. Competitive Impact Analysis

    The Board has established procedures for assessing the competitive 
impact of rule or policy changes that have a substantial impact on 
payments system participants.6 Under these procedures, the 
Board will assess whether a change would have a direct and material 
adverse effect on the ability of other service providers to compete 
effectively with the Federal Reserve in providing similar services due 
to differing legal powers or constraints or due to a dominant market 
position of the Federal Reserve deriving from such differences. If no 
reasonable modifications would mitigate the adverse competitive 
effects, the Board will determine whether the expected benefits are 
significant enough to proceed with the change despite the adverse 
effects.
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    \6\ These procedures are described in the Board's policy 
statement ``The Federal Reserve in the Payments System,'' as revised 
March 1990. (55 FR 11648, March 29, 1990).
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    The Board's proposed enhancements to the net settlement service are 
intended to improve the clearance and settlement process for payments 
by increasing the efficiency of the services currently offered by the 
Federal Reserve and by reducing the uncertainty and disruption to 
private-sector participants from the potential reversal of settlement 
on the following business day. From this standpoint, the enhanced 
settlement service should help reduce risk as well as operational 
burden for private-sector settlement arrangements. In addition, risk 
controls that would be developed in order to provide finality of 
settlements to clearinghouse participants on the settlement date would 
help protect the Federal Reserve from the risk of loss. As a result, 
the Board believes that the proposed enhancements to the Federal 
Reserve's net settlement services would enable depository institutions 
to continue to take advantage of the benefits of netting, while 
increasing operational efficiency and reducing credit risk to the 
private sector.

    By order of the Board of Governors of the Federal Reserve 
System, November 2, 1998.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 98-29709 Filed 11-5-98; 8:45 am]
BILLING CODE 6210-01-P