[Federal Register Volume 66, Number 108 (Tuesday, June 5, 2001)]
[Notices]
[Pages 30193-30195]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-13981]


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FEDERAL RESERVE SYSTEM

[Docket No. R-1110]


Policy Statement on Payments System Risk; $50 Million Fedwire 
Securities Transfer Limit

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Request for comment on policy.

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SUMMARY: The Board is requesting comment on the desirability of 
retaining the current $50 million limit on the transaction size of 
book-entry securities transfers on Fedwire.

EFFECTIVE DATE: Comments must be received by August 6, 2001.

ADDRESSES: Comments, which should refer to Docket No. R-1110, may be 
mailed to Ms. Jennifer J. Johnson, Secretary, Board of Governors of the 
Federal Reserve System, 20th and C Streets, NW, Washington, DC 20551 or 
mailed electronically to [email protected]. Comments 
addressed to Ms. Johnson also may be delivered to the Board's mailroom 
between 8:45 a.m. and 5:15 p.m. and to the security control room 
outside of those hours. Both the mailroom and the security control room 
are accessible from the courtyard entrance on 20th Street between 
Constitution Avenue and C Street, NW. Comments may be inspected in Room 
MP-500 between 9:00 a.m. and 5:00 p.m. weekdays, pursuant to 
Sec. 261.12, except as provided in Sec. 261.14, of the Board's Rules 
Regarding Availability of Information, 12 CFR 261.12 and 261.14.

FOR FURTHER INFORMATION CONTACT: Paul Bettge, Associate Director (202/
452-3174), Stacy Coleman, Manager (202/452-2934), or Doug Conover, 
Financial Services Analyst (202/452-2887), Division of Reserve Bank 
Operations and Payment Systems.

SUPPLEMENTARY INFORMATION: This is one of five notices regarding 
payments system risk that the Board is issuing for public comment 
today. Two near-term proposals concern the net debit cap calculation 
for U.S. branches and agencies of foreign banks (Docket No. R-1108) and 
modifications to the procedures for posting electronic check 
presentments to depository institutions' Federal Reserve accounts for 
purposes of measuring daylight overdrafts (Docket No. R-1109). In 
addition, the Board is requesting comment on the benefits and drawbacks 
to several potential longer-term changes to the Board's payments system 
risk (PSR) policy, including lowering self-assessed net debit caps, 
eliminating the two-week average caps, implementing a two-tiered 
pricing system for collateralized and uncollateralized daylight 
overdrafts, and rejecting payments with settlement-day finality that 
would cause an institution to exceed its daylight overdraft capacity 
level (Docket No. R-1111). The Board is also issuing today an interim 
policy statement and requesting comment on the broader use of 
collateral for daylight overdraft purposes (Docket No. R-1107). 
Furthermore, to reduce burden associated with the PSR policy, the Board 
recently rescinded the interaffiliate transfer (Docket No. R-

[[Page 30194]]

1106) and third-party access policies (Docket No. R-1100).
    The Board requests that in filing comments on these proposals, 
commenters prepare separate letters for each proposal, identifying the 
appropriate docket number on each. This will facilitate the Board's 
analysis of all comments received.

I. Background

    Beginning in 1985, the Board adopted and subsequently modified a 
policy to reduce the risks that payment systems present to the Federal 
Reserve Banks, to the banking system, and to other sectors of the 
economy. An integral component of the PSR policy was to control 
depository institutions' use of intraday Federal Reserve credit, 
commonly referred to as ``daylight credit'' or ``daylight overdrafts.'' 
The Board's intention was to address the Federal Reserve's risk as well 
as risks on various types of private-sector networks, primarily large-
dollar payments systems.
    As part of modifications to the PSR policy in 1988, the Board 
imposed a $50 million limit on the par value of individual book-entry 
securities transfers on the Fedwire system (52 FR 29255, August 6, 
1987).\1\ The purpose of the $50 million limit was to encourage 
government securities dealers to split large trades into multiple 
partial deliveries and, thereby, reduce subsequent book-entry 
securities-related daylight overdrafts. The Board anticipated that 
government securities dealers' practice of building securities 
inventories to meet large trade obligations would diminish and book-
entry securities transfer volume would be distributed more evenly 
throughout the day. The Board recognized, however, that the 
effectiveness of the $50 million limit depended on dealers accepting 
multiple deliveries for the completion of a single trade obligation. As 
a result, Federal Reserve staff worked with the Public Securities 
Association (PSA) to develop delivery guidelines that incorporated 
necessary changes related to the $50 million limit.\2\
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    \1\ The $50 million limit does not apply to original issue 
deliveries of book-entry securities from a Reserve Bank to a 
depository institution or transactions sent to or by a Reserve Bank 
in its capacity as fiscal agent for the United States or 
international organizations.
    \2\ The PSA is now known as the Bond Market Association.
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    Prior to the implementation of the $50 million limit, the PSA's 
delivery guidelines required trade obligations to be delivered in full. 
As a result, dealers often had to accumulate securities in the full 
amount of the trade before they could deliver them. Partial deliveries, 
those for less than the full amount of the trade obligation, were 
typically returned to the sending institution. The incentives to 
minimize fail-to-deliver costs and maximize fail-to-receive benefits 
strongly influenced dealers' decisions regarding their settlement of 
government securities trades.\3\ Because fail costs are proportional to 
the size of unfulfilled obligations, dealers typically organized their 
deliveries to fulfill their largest obligations first. In addition, in 
order to maximize fail benefits, a dealer selling and buying the same 
type of security could strategically delay its deliveries of that 
security until the end of the day, hoping that counterparties trying to 
deliver the same securities would be unable to settle their obligations 
before the close of the securities transfer system.\4\ These incentives 
often led dealers to stockpile large amounts of securities until very 
near the end of the day.
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    \3\ Fail costs are the costs dealers incur if they fail to 
deliver securities to a counterparty on the agreed settlement day. 
These costs can be significant because a dealer that fails to 
deliver securities may have to obtain overnight financing as well as 
forego any interest that the security accrues between the agreed and 
actual settlement days. The purchasing counterparty that does not 
receive its securities on the agreed settlement day benefits because 
that party typically receives the accrued interest on those 
securities, yet postpones financing the securities until they are 
actually delivered.
    \4\ Because many government securities dealers take long and 
short positions in the same security among a relatively small group 
of counterparties, a dealer could be expected to deliver a security 
to one counterparty and receive the same security from another 
counterparty.
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    To stockpile large amounts of securities until very near the end of 
the day in a delivery-versus-payment environment, dealers often used 
daylight credit at their clearing banks. The clearing banks, in turn, 
had to hold positive balances in their Federal Reserve accounts or use 
Federal Reserve daylight credit. As a dealer accumulates securities and 
holds them during the day to deliver on its largest obligations first, 
its overdraft becomes larger and lasts longer. In the absence of 
charges for daylight credit, however, the dealers' had no incentive to 
economize on daylight credit but had a strong incentive to avoid the 
substantial costs associated with failing to deliver on large 
obligations. In addition, because securities deliveries were often 
delayed until near the close of the Fedwire book-entry security 
transfer system, the Federal Reserve frequently extended the system's 
operating hours.
    Although the Board intended the $50 million limit to promote the 
acceptance of partial deliveries, dealers had limited incentive to 
change their delivery practices. Under the PSA good delivery 
guidelines, dealers no longer needed to stockpile securities. As soon 
as an inventory of $50 million in a particular security was obtained, 
dealers could immediately deliver that $50 million to a different 
counterparty, receiving funds to cover any overdraft associated with 
the original receipt of that security. In effect, the transfer limit 
and the PSA's modified delivery guidelines allowed dealers to accept 
partial deliveries and effectively reduced the maximum size of any 
required position to $50 million. Nonetheless, without fees on daylight 
overdrafts, dealers could continue to stockpile securities without 
incurring any explicit costs. Most dealers, therefore, did not change 
their behavior significantly, and the limit had very little impact on 
the clearing banks' use of daylight credit.
    When the Board began charging a fee for daylight overdrafts in 
1994, most clearing banks decided to pass on these charges to their 
government securities dealers. Because government securities dealers 
generally relied heavily on intraday credit to conduct their 
transactions, the fee provided a strong incentive for most major 
dealers to send securities earlier in the day while the limit and the 
PSA delivery guidelines allowed dealers to send and required their 
counterparties to accept partial deliveries in $50 million increments. 
As dealers began to send securities earlier in the day, Federal Reserve 
daylight overdrafts decreased substantially.\5\
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    \5\ Because the limit forced receiving dealers to accept 
multiple deliveries for the settlement of one trade, the receiver 
could not force the sender to stockpile securities. For example, if 
a dealer had an obligation to deliver $100 million of a certain 
security, expected to receive $90 million of the same issue, and 
already held $10 million of that security in its account, delivery 
of its obligation would be dependent upon first receiving the 
expected $90 million, if a limit were not present. With the limit in 
place, the dealer could immediately forward $50 million of that 
security as soon as it was received, rather than waiting for the 
entire $90 million. To the extent that a dealer buys securities from 
many counterparties and that deliveries from these counterparties 
are dependent on receipt of their own purchases, the limit allows 
deliveries to occur earlier than otherwise possible, reducing the 
liquidity required to settle the total amount of transactions.
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II. Effectiveness of the $50 Million Limit

    As part of a broad review of the Federal Reserve's daylight credit 
policies, the Board considered the effectiveness of the $50 million 
limit policy, with a focus on whether the limit imposes an undue 
regulatory burden. To understand better the industry's view of the 
limit, Federal Reserve staff met with representatives of primary 
dealers, clearing banks, and industry utilities. Federal Reserve staff

[[Page 30195]]

learned that many government securities dealers and their clearing 
banks support retaining the $50 million limit. These representatives 
believe that removing the limit could increase position building and 
securities-related overdrafts despite the existence of daylight 
overdraft fees. In addition, the representatives stated that removing 
the limit would likely require costly system changes throughout the 
industry. Given that the industry bears a significant portion of the 
costs and benefits of the limit, both in terms of transaction fees and 
reduced overdraft fees, the support of the limit voiced by industry 
representatives reflects their perception that the limit has a positive 
net effect on the government securities settlement system.
    Industry representatives indicated that removal of the limit would 
likely lead the industry to demand that securities trades be settled in 
full and to reject partial deliveries. While current delivery 
guidelines encourage acceptance of partial deliveries, industry 
representatives expressed concern that there would be no technical 
mechanism to enforce these guidelines. The Board believes the $50 
million limit on book-entry securities transfers in combination with 
daylight overdraft fees has been effective in reducing daylight 
overdrafts. Because the limit appears to have a net positive effect, 
the Board is disposed to retaining the limit. The Board, however, would 
like to ensure that it considers the perspectives of all parties before 
making a final determination regarding the retention of this limit.

III. Request for Comment

    The Board is proposing to maintain its current policy limiting the 
size of individual book-entry security transfers on Fedwire to $50 
million in par value. The Board is requesting comment on all aspects of 
the $50 million limit as well as on the following questions:
    1. Should the limit be retained?
    If yes, is $50 million a reasonable level for the limit? Do the 
benefits of the limit support a reduction of the limit to $25 million? 
Or, would a higher limit reduce transaction costs but maintain the 
existing benefits of the limit? Would changing the limit require costly 
system changes?
    If no, what would be the effect of eliminating the $50 million 
limit on delivery fails, daylight overdrafts, and dealer costs? In 
particular, would eliminating the limit require costly system changes?
    2. Does the limit impose any significant costs on dealers or 
clearing banks, net of any benefits from reduced overdrafts?
    3. Does the limit promote specific benefits in the government 
securities market other than reduced overdrafts?

IV. Competitive Impact Analysis

    Under its competitive equity policy, the Board assesses the 
competitive impact of changes that have a substantial effect of 
payments system participants.\6\ The Board believes that retention of 
the $50 million securities transfer limit will have no adverse effect 
on the ability of other service providers to compete effectively with 
the Federal Reserve Banks in providing similar transfer services.
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    \6\ These assessment procedures are described in the Board's 
policy statement entitled ``The Federal Reserve in the Payments 
System'' (55 FR 11648, March 29, 1990).
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V. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
ch. 3506; 5 CFR 1320 appendix A.1), the Board has reviewed the request 
for comments under the authority delegated to the Board by the Office 
of Management and Budget. The collection of information pursuant to the 
Paperwork Reduction Act contained in the policy statement will not 
unduly burden depository institutions.

    By order of the Board of Governors of the Federal Reserve 
System, May 30, 2001.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 01-13981 Filed 6-4-01; 8:45 am]
BILLING CODE 6210-01-P