[Federal Register Volume 63, Number 243 (Friday, December 18, 1998)]
[Notices]
[Pages 70132-70135]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33575]


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FEDERAL RESERVE SYSTEM

[Docket No. R-1032]


Settlement-day Finality for Automated Clearing House Credit 
Transactions

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice.

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SUMMARY: The Board is requesting comment on the benefits and drawbacks 
of providing settlement finality on the morning of the settlement day 
for ACH credit transactions processed by the Federal Reserve.

DATES: Comments must be submitted on or before March 18, 1999.

ADDRESSES: Comments should refer to Docket No. R-1032 and may be mailed 
to Ms. Jennifer J. Johnson, Secretary, Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, NW, 
Washington, DC 20551. 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 rooms 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: Wesley M. Horn, Manager, ACH Payments 
(202/452-2756); Myriam Y. Payne, Senior Financial Services Analyst, 
Payment Systems Risk and Net Settlement (202/452-3219); Jeffrey S. H. 
Yeganeh, Senior Financial Services Analyst (202/728-5801), Division of 
Reserve Bank Operations and Payment Systems; for the hearing impaired 
only, contact Diane Jenkins, Telecommunication Device for the Deaf 
(TDD) (202/452-3544).

SUPPLEMENTARY INFORMATION:

I. Background

    The Board is considering the merits of providing settlement 
finality on the morning of the settlement day for ACH credit 
transactions processed by the Federal Reserve Banks. The issue of 
settlement finality for ACH transactions processed by the Reserve Banks 
has been a subject of industry discussion since the 1980s. Currently, 
the Reserve Bank's uniform ACH operating circular gives the Reserve 
Banks the right to reverse settlement for either debit or credit 
transactions until 8:30 a.m. eastern time on the morning of the 
business day following the settlement day. A Reserve Bank can reverse 
settlement if it does not receive actually and finally collected funds 
from the depository institution funding the payments (the originating 
depository financial institution (ODFI) in the case of credit 
transactions or the receiving depository financial institution (RDFI) 
in the case of debit transactions) by 8:30 a.m. eastern time on the 
morning of the business day following the settlement day, with 
notification to the ODFIs and RDFIs as soon as possible thereafter. In 
comparison, private-sector ACH operators provide settlement finality 
either on the settlement day or on the business day after the 
settlement day, depending on the type of net settlement arrangement the 
operator uses. The Board expects that all private-sector ACH operators 
will be able to provide settlement-day finality to their customers once 
the Reserve Banks fully implement their enhanced settlement service (63 
FR 60000, November 6, 1998).
    The Board requested comment on proposals to improve settlement 
finality for ACH transactions processed by the Reserve Banks in 1986 
and 1989. The 1986 proposal would have provided settlement finality for 
ACH credit transactions of $5,000 or less at 1:00 p.m. local time on 
the settlement day and for ACH credit transactions of more than $5,000 
and ACH debit transactions when the Reserve Bank received actually and 
finally collected funds (51 FR 45043, December 16, 1986). The 1989 
proposal would have provided settlement finality for ACH credit 
transactions at 6:30 p.m. local time on the settlement day and for ACH 
debit transactions at 10:00 a.m. local time on the business day after 
settlement. Commenters did not support either proposal because neither 
provided finality at the opening of business on the settlement day (54 
FR 8822, March 2, 1989).

[[Page 70133]]

    Over the last several years, there have been renewed calls for the 
Reserve Banks to improve the finality of the ACH mechanism to reduce 
the interbank settlement risk. The Settlement Risk Management Task 
Force, sponsored by the National Automated Clearing House Association 
(NACHA) and the National Organization of Clearing Houses, and NACHA's 
Vision 2000 report called for finality of settlement at opening of 
business on the settlement day for ACH credit transactions. In 
addition, the January 1998 report of the Committee on the Federal 
Reserve in the Payments Mechanism stated that the Federal Reserve would 
explore changes, including changes to ACH finality, that could more 
effectively support the needs of existing and emerging retail payments 
methods.1
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    \1\ Committee on the Federal Reserve in the Payments Mechanism, 
The Federal Reserve in the Payments Mechanism (Board of Governors of 
the Federal Reserve System, January 1998), p. 33. The report can be 
found on the Board's website at http://www.federalreserve.gov/
boarddocs/press/General/1998/19980105.
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    The credit risks associated with ACH debit transactions and ACH 
credit transactions are different and, thus, the Board believes that 
each must be addressed separately. In the case of ACH debit 
transactions, the ODFI is exposed to two kinds of credit risk when it 
makes funds available to the originator. First, the ODFI is exposed to 
the risk that the RDFI may fail and that the settlement for the entries 
would be reversed. Second, the ODFI is exposed to credit risk if the 
RDFI returns the item within its return deadline, or as long as sixty 
days later in the case of an unauthorized transaction. Because the 
RDFI's ability to return items would remain unchanged under any 
proposal to improve settlement finality for debit transactions, 
speeding the settlement finality would not materially reduce the ODFI's 
credit risk. As a result, the Board is not seeking comment on any 
change to the finality for settlement of ACH debit transactions.
    The Board, however, is considering whether there is merit in 
providing settlement finality on the morning of the settlement day for 
ACH credit transactions processed by the Federal Reserve. Specifically, 
the Board is considering making the settlement for ACH credit 
transactions final when posted, which is currently 8:30 a.m. eastern 
time on the day of settlement. In the case of ACH credit transactions, 
NACHA rules require that the RDFI make funds available to its customers 
on the settlement day.2 As a result, the RDFI is at risk if 
(1) the ODFI fails, (2) its customers withdraw funds that have been 
made available before the settlement was final, (3) the Reserve Banks 
later reverse the settlement, and (4) the RDFI is unable to recover the 
funds from its customers.
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    \2\ NACHA Rules Section 4.4.1 requires an RDFI to make funds 
from credit entries available to its customers on the settlement 
day. Further, for credit entries to a consumer's account that are 
made available to the RDFI by 5:00 p.m. local time on the day before 
the settlement day, the RDFI must make the funds available by 
opening of business on the settlement day.
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    The Board believes that if the Federal Reserve were to provide 
settlement-day finality for ACH credit transactions, it should adopt 
risk control measures commensurate with those used in connection with 
other Federal Reserve services with similar finality characteristics. 
Current risk control measures for the ACH service include ex post 
monitoring of daylight overdraft trends, requiring an ODFI at imminent 
risk of failure to prefund the value of the ACH transactions it 
originates, and reversing ACH credit transactions if an ODFI is unable 
to settle for those transactions. Under these risk control measures, 
the Reserve Banks have never reversed a settled ACH credit file due to 
the failure of an ODFI, which has contributed to the public's 
confidence in the ACH system. Because of this success, some commenters 
on the previous proposals have concluded that the current risk control 
measures are sufficient to allow the Reserve Banks to provide finality 
at the opening of business on the settlement day without the adoption 
of more stringent risk controls. The Board, however, does not believe 
that these measures provide Reserve Banks with adequate protection from 
settlement risk if settlement were to become final before the Reserve 
Banks knew whether depository institutions could fund the payments. 
Moreover, if the industry were confident that the Federal Reserve's 
current risk controls were sufficient, it likely would not be 
advocating the adoption of settlement-day finality to reduce RDFI risk.
    The Board believes that the risk control measures needed to provide 
settlement-day finality for ACH credit payments processed through the 
Federal Reserve Banks should be commensurate with those provided in the 
Fedwire funds transfer service and the enhanced settlement service, as 
these services provide final and irrevocable settlement at the time a 
transaction is credited to the depository institution's account. The 
funds transfer and the enhanced settlement services use real-time 
account balance monitoring for depository institutions that fall within 
established risk parameters as a prerequisite for making payments 
final. For institutions monitored in real time, a funds transfer or a 
settlement entry initiated through the enhanced settlement service will 
not be processed unless the institution's available account balance is 
sufficient to cover the debit entry.3 Most depository 
institutions, however, are not monitored in real time. The account 
activity of an institution that is not monitored in real time is 
monitored for compliance with the daylight overdraft transaction 
posting rules on an ex post basis. As a result, Reserve Banks are able 
to control their credit risk exposure by monitoring the account 
balances of a selected group of depository institutions in real time, 
thereby restricting those institutions' access to Federal Reserve 
intraday credit. Providing settlement-day finality for ACH credit 
transactions without applying risk control measures similar to those 
used for Fedwire funds transfers and enhanced settlement entries may 
create incentives for monitored institutions to move payments from 
Fedwire to the ACH to avoid risk management controls.
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    \3\ The available account balance includes the depository 
institution's Federal Reserve account balance plus any available 
intraday credit.
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    The Board also believes that if the Federal Reserve were to provide 
settlement-day finality for the ACH credit transactions it processes, 
it should use risk control measures similar to those used to provide 
settlement-day finality for ACH transactions processed by private-
sector operators. It is anticipated that most private-sector service 
providers will use the enhanced settlement service to provide 
settlement-day finality for ACH transactions. As a result, the Board 
believes that risk control measures used in the Federal Reserve's ACH 
service should be commensurate with those used in the enhanced 
settlement service.

II. Improving Settlement Finality for ACH Credit Transactions 
Processed by the Federal Reserve

    The Board believes that if it were to improve the settlement 
finality for ACH credit transactions processed by the Federal Reserve 
by making settlement final when it is posted, which is currently 8:30 
a.m. eastern time on the day of settlement, it should adopt appropriate 
risk control measures. The Board has considered other alternatives to 
improve settlement finality for ACH

[[Page 70134]]

credit transactions.4 Providing settlement-day finality for 
ACH credit transactions using real-time risk control measures, however, 
is complicated by the use of value-dating in the ACH mechanism. Because 
of value-dating, an ACH credit transaction may be processed up to two 
days prior to the settlement day. The funds to pay for the ACH credit 
transactions, however, are not deducted from the ODFI's account until 
the settlement day. As a result, absent any action to debit funds, a 
balance check of the ODFI's account at the time that a transaction is 
processed would be ineffective in managing risk. In contrast, in the 
funds transfer and enhanced settlement services, a balance check at the 
time that a transaction is processed is an effective risk management 
tool because the actions taken to process and settle for the 
transaction are almost simultaneous. As a result, the Board believes 
that the expanded use of prefunding at the time that transactions are 
processed would be an appropriate risk control mechanism to achieve 
improvements in the finality for the settlement of ACH credit 
transactions. Under prefunding, the Federal Reserve eliminates the 
settlement risk by substituting itself for the ODFI as obligor to 
settle for the ACH credit transactions.
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    \4\ The Board has considered eliminating value-dating in its ACH 
service, which would allow the Reserve Banks to monitor balances and 
settle transactions on the same day. The Board, however, does not 
believe that this alternative is practical because it would 
fundamentally change the nature of the ACH service and disrupt 
established and effective business practices of ODFIs and their 
customers. The Board has also considered processing ACH transactions 
as they are received, monitoring balances on the settlement day, and 
reversing transactions originated by institutions monitored in real 
time early on the settlement day if sufficient funds were 
unavailable to settle the transactions. The Board believes that if 
this alternative were adopted, the risk to an RDFI would not be 
reduced measurably because it might be unable to reverse credits to 
its customers' accounts in a timely fashion after receipt of a 
reversal file. Further, under this alternative, an ODFI would be 
unable to re-initiate transactions for the intended settlement date, 
which may undermine the perceived reliability of the ACH.
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    The Board believes that any ODFI that is being monitored in real 
time, or that would be monitored in real time if it participated in a 
service that uses real-time monitoring, should be required to prefund 
all of the ACH credit transactions it originates. If the ODFI's 
available account balance were sufficient, the transactions would be 
processed and released to the RDFIs and the ODFI's account would be 
debited for the amount of the transactions. On the settlement day, the 
ODFI may receive an as-of adjustment to compensate it for the float 
caused by the prefunding requirement. If the ODFI's available account 
balance were not sufficient, the transactions would not be processed 
until the ODFI funded the account.
    If an ODFI were not being monitored in real time, it would not be 
required to prefund its ACH credit originations and incoming files 
would be processed as they are today. If the ODFI fails, the Reserve 
Banks would reserve the right to reverse the ACH credit originations 
that have not yet settled. Reserve Banks, however, would not reverse 
transactions that had already settled. For example, a depository 
institution that is not required to prefund originates $1,000 worth of 
credit transactions on Monday with $300 to settle on Tuesday and $700 
to settle on Wednesday. If the institution fails on Tuesday, the 
Reserve Banks could bear the loss for the $300 that settled Tuesday 
morning but may reverse the transactions that were intended to settle 
on Wednesday. The reversal entries would be included in the files that 
RDFIs would receive Wednesday morning.
    The Reserve Banks believe that the system changes required to 
implement the risk controls needed for settlement-day finality could be 
available in early 2001. The Banks do not believe that these changes 
would materially increase the cost of the Federal Reserve's ACH 
service.

III. Comment is Requested on the Effect of Settlement-Day Finality 
on the Attractiveness of the Federal Reserve's ACH Service and on 
the ACH System More Generally

    The Board is interested in commenters' views on the benefits and 
drawbacks associated with adopting morning of settlement-day finality 
for ACH credit transactions processed by the Federal Reserve. The Board 
is also interested in whether commenters believe that providing 
settlement-day finality would, on net, increase or reduce the 
attractiveness of the Federal Reserve's ACH service and of the ACH 
system more generally.
    The Board requests comment on the extent to which morning-of-
settlement-day finality would promote ACH volume growth, whether 
certain types of transactions would be more likely to be made by ACH 
credit transactions if the Federal Reserve moved to settlement-day 
finality, and which payment methods are currently used to make these 
payments. The impetus for the industry's recommendation that the 
Federal Reserve adopt morning-of-settlement-day finality is the desire 
to eliminate RDFIs' current risk exposure associated with having to 
make funds from ACH credit transactions available to their customers 
prior to the time that settlement of those funds becomes final. This 
risk, however, has not translated into a loss to any RDFI to date as 
the Federal Reserve has never reversed a settled ACH file due to the 
failure of an ODFI to fund its settlement. Further, it does not appear 
that this risk exposure has discouraged depository institutions' 
participation in the ACH system. The Board also requests comment on 
whether settlement-day finality would facilitate product innovation in 
the ACH service and if so, how.
    The Board is interested in commenters' views on the extent to which 
the differences in finality provided by ACH operators influence 
depository institutions' choice of operator. Currently, one private-
sector ACH operator (Visa) provides settlement-day finality for its ACH 
transactions, but the Federal Reserve and the other private-sector ACH 
operators (the New York Automated Clearing House and the American 
Clearing House) provide next-day settlement finality.
    The Board requests comment on the extent to which the public's 
confidence in the ACH system might be adversely affected if credit 
transactions are not settled on the intended settlement day and 
whether, as a result, the attractiveness of the ACH system might be 
reduced. As discussed above, if the Board were to approve morning-of-
settlement-day finality for ACH credit transactions, the Reserve Banks 
would implement risk control measures commensurate with those used in 
the Fedwire funds transfer service and in the enhanced settlement 
service by requiring all institutions monitored in real time to prefund 
the amount of their ACH credit originations. While these risk control 
measures would reduce the settlement risk to RDFIs, the measures would 
increase the likelihood that the transactions of institutions monitored 
in real time might no longer settle on their intended settlement day 
even though they would likely settle in today's environment. Currently, 
the Federal Reserve settles for ACH credit transactions for these ODFIs 
on the settlement day and has until the next morning, which is when the 
settlement would become final, to ensure that the ODFI has funded the 
transactions. Under the risk control measures discussed above, if the 
ODFI is being monitored in real time and its available account balance 
is not sufficient to fund the payments prior to processing, the 
transactions may not settle on the intended settlement day. Settlement 
may also be delayed if the ODFI were able to arrange for funding later. 
As a

[[Page 70135]]

result, payroll and other direct deposit files could be rejected or 
delayed, which might increase concerns regarding the reliability of the 
ACH mechanism and retard the growth of electronically initiated 
payments.
    In addition, the Board requests comment on the extent to which the 
ACH system would become less attractive to institutions required to 
prefund their credit transactions if those institutions were required 
to modify their internal procedures. The expanded prefunding 
requirement would require ODFIs that are monitored in real time to fund 
ACH transactions earlier than is currently the case and might require 
processing changes at the ODFI or its designated sending point(s). The 
earlier funding would increase the cost of processing ACH transactions 
to those institutions. Further, the ODFI may be required to submit 
separate batches for credit transactions and debit transactions to 
avoid the possibility that debit transactions included in mixed batches 
might be held.
    In the case of an ODFI that settles through the account of a 
correspondent settlement agent, the Board is interested in commenters' 
views on whether the Federal Reserve should base the prefunding 
requirements on the condition of the correspondent or the ODFI. 
Currently, Reserve Banks require prefunding based on the financial 
condition of the ODFI and not that of the correspondent. In either 
case, if transactions could not be processed because the 
correspondent's account had an insufficient account balance to prefund 
ACH credit transactions originated by the ODFI, both the ODFI and the 
correspondent would be notified. Further, if the Reserve Banks based 
their prefunding requirement on the risk profile of the correspondent 
settlement agent, the correspondent would not be permitted to terminate 
a settlement designation for transactions that have been accepted by 
the Federal Reserve for processing.
    Finally, the Board is interested in commenters' suggestions 
regarding alternative risk control approaches, different from that 
described in this notice, that would establish risk controls equivalent 
to those used in the Fedwire funds transfer service and in the enhanced 
settlement service and that may be better suited to the ACH 
environment.

IV. Competitive Impact Analysis

    In assessing the competitive impact of improving the finality for 
the settlement of ACH credit transactions, the Board considers whether 
there will be a direct and material adverse effect on the ability of 
other service providers to compete with the Federal Reserve due to 
differing legal powers or due to the Federal Reserve's dominant market 
position deriving from such legal differences.5
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    \5\ The Federal Reserve in the Payments System, FRRS 7-145.2
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    Although the Federal Reserve's ACH does not derive its dominant 
market position from legal differences, the fact that the Federal 
Reserve maintains accounts directly or indirectly for all depository 
institutions to settle may make it easier from some institutions' 
perspective to use the Federal Reserve's services. The enhanced 
settlement service was designed, in part, to offset that potential 
advantage by making it easier for a private-sector entity to function 
settlement entries to depository institutions nationwide. As was 
mentioned earlier, the enhanced settlement service will check the 
available account balance of all depository institutions that are being 
monitored in real time. If the Reserve Banks were to improve the 
settlement finality for the ACH transactions they process without 
implementing similar risk controls, competitive questions might be 
raised. The Board, however, believes that the expanded use of 
prefunding provides risk controls commensurate with those of the 
enhanced settlement service.
    While private-sector operators that use the Fedwire-based or 
enhanced settlement service will be able to offer settlement-day 
finality for the ACH credit transactions they process, differences 
would remain between the characteristics of their settlement finality 
and those of the Federal Reserve's ACH service, assuming the Board 
adopts settlement-day finality as described in this notice. In 
particular, the need to reverse ACH credit transactions that cannot be 
funded would largely be eliminated in the Federal Reserve's ACH service 
because of the prefunding of those transactions by ODFIs with higher 
risk profiles. In contrast, private operators, to the extent that they 
accept participants with higher risk profiles, would need to reverse 
ACH credit transactions that had been previously processed and 
delivered to RDFIs if the OFDI could not fund its net debit position on 
the settlement day. (Private ACH operators, however, generally do not 
provide services to institutions that do not meet their criteria for 
admission and participation. These criteria are based, in part, on the 
financial condition of the institutions.) From the perspective of the 
RDFIs, avoiding the risk of reversing transactions that had already 
been posted to receivers' accounts may make the risk management 
associated with the Federal Reserve's ACH service more attractive than 
that of the private operators. From the perspective of some ODFIs, 
however, the Federal Reserve's risk management would likely be 
considered more burdensome and therefore less attractive than that of 
the private operators. The Federal Reserve's ACH service would require 
some ODFIs to fund their gross ACH credit originations before 
transactions are processed while private-sector operators require ODFIs 
to fund their net positions at the time of settlement. The provision of 
as-of adjustments for prefunding, however, could mitigate this burden 
somewhat. In general, the Board does not believe that settlement-day 
finality for ACH credit transactions processed by the Federal Reserve 
and conditioned on the expanded use of prefunding would adversely 
affect competition in the provision of interbank ACH services.

    By order of the Board of Governors of the Federal Reserve 
System, December 14, 1998.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 98-33575 Filed 12-17-98; 8:45 am]
BILLING CODE 6210-01-P