[Federal Register Volume 69, Number 201 (Tuesday, October 19, 2004)]
[Notices]
[Pages 61496-61499]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-23378]


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FEDERAL RESERVE SYSTEM

[Docket No. OP-1214]


Proposal to Withdraw from Noncash Collection Service

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice; request for comment.

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SUMMARY: The Board requests comment on a proposal that the Federal 
Reserve Banks withdraw from the noncash collection service at year-end 
2005. The noncash collection service involves the collection and 
processing of definitive municipal bonds and coupons issued by state 
and local governments. The proposal to exit this service is prompted by 
the declining volume of definitive municipal securities, the expected 
underrecovery of costs in future years, and the availability of 
alternate service providers and substitutable services.

DATES: Comments must be received by December 20, 2004.

ADDRESSES: You may submit comments, identified by Docket No. OP-1214, 
by any of the following methods:
     Agency Web site: http://www.federalreserve.gov. Follow the 
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     E-mail: [email protected]
     FAX: 202/452-3819 or 202/452-3102.
     Mail: Jennifer J. Johnson, Secretary, Board of Governors 
of the Federal Reserve System, 20th Street and Constitution Avenue, 
NW., Washington, DC 20551.
    All public comments are available from the Board's Web site at 
www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted, 
except as necessary for technical reasons. Accordingly, your comments 
will not be edited to remove any identifying or contact information. 
Public comments may also be viewed

[[Page 61497]]

electronically or in paper in Room MP-500 of the Board's Martin 
Building (20th and C Streets, NW.,) between 9 a.m. and 5 p.m. on 
weekdays.

FOR FURTHER INFORMATION CONTACT: Kent Owens, Manager (202/728-5848), or 
Lyndsay Huot, Financial Services Analyst (202/452-5238), Division of 
Reserve Bank Operations and Payment Systems; for the hearing impaired 
only: Telecommunications Device for the Deaf, 202/263-4869.

SUPPLEMENTARY INFORMATION:

I. Background

    The Federal Reserve Banks provide a service to depository 
institutions for the collection of definitive municipal securities. 
Definitive municipal securities are registered or bearer bonds that 
have been issued with interest coupons in certificated, or physical, 
form by local governments, as well as by states and their political 
subdivisions and agencies.\1\ The Reserve Banks accept deposits of 
coupons or bonds from depository institutions, identify the appropriate 
paying agent, and present the items to the paying agent for collection. 
These services are collectively referred to as the ``noncash collection 
service.''
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    \1\ Such securities are ``noncash'' items under Regulation J (12 
CFR 210.2(k)).
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    Over the years, the number of outstanding definitive municipal 
securities has declined as a result of legal and market changes. 
Municipalities stopped issuing bearer municipal securities in 1983, 
when the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982 
removed the tax advantages of bearer municipal securities for 
investors. Further, the securities industry began issuing and trading 
municipal securities in book-entry form and began immobilizing existing 
securities. These changes also had implications for the noncash 
collection service, because the volume of bonds and coupons presented 
for collection declines as the number of outstanding definitive 
municipal securities declines.
    In response to these market trends, in the early 1990s the Reserve 
Banks reviewed their role in the definitive securities business, in 
both the areas of safekeeping and collection. In 1993, the Reserve 
Banks withdrew from the priced definitive securities safekeeping 
service but decided to continue providing the priced noncash collection 
service.\2\ Given the volume declines, the Reserve Banks aggressively 
pursued cost savings through consolidation and improvements in 
processing efficiencies. Between 1992 and 1997, the existing twenty-two 
noncash collection operations sites were consolidated into one site.
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    \2\ The Reserve Banks continue to provide safekeeping for 
collateral pledged to the discount window, the Treasury Department, 
or federal government agencies.
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II. Discussion

Volume, Customers, and Paying Agents

    Since 1995, the Reserve Banks' noncash collection volume has 
decreased 85 percent. Over the past five years, volume has decreased an 
average of 20 percent annually and is expected to decline by one-third 
in 2005. Over the last few years, as interest rates have fallen, 
issuers have called high-interest-rate bonds, including those in 
definitive form, and issued bonds in book-entry form with lower rates, 
thereby accelerating the volume decline. The last bearer municipal bond 
is expected to mature in 2030.
    In addition to declining volume, the Reserve Banks' noncash 
collection service has also experienced a decline in the number of 
customers that use the service. In 2003, approximately 1,000 depository 
institutions used the noncash collection service, 10 percent fewer than 
in 2002. In addition, use of the service is highly concentrated, as the 
top twenty-five depository institution customers accounted for 70 
percent of total revenue in 2003.
    Moreover, the Reserve Banks have been presenting noncash collection 
items to a declining number of paying agents over the past several 
years due to the consolidation of paying agents through mergers and 
acquisitions. Currently, the Reserve Banks present to around 100 paying 
agents, whereas in the past this number had been as high as 3,500. In 
addition to the decline in the number of paying agents, there is also a 
significant degree of concentration in the business, with almost 95 
percent of coupon envelope volume being presented to ten paying agents 
in 2003.

Costs and Revenue

    Between 1994 and 2003, the noncash collection service has recovered 
109.5 percent of its costs, including imputed expenses and return on 
equity. In 2004, the Reserve Banks expect the service's cost recovery 
rate to be 110.4 percent. Given the significant decline in volume and 
the fixed-cost nature of the service, the Reserve Banks expect a 
significant underrecovery of costs, beginning in 2005. The Reserve 
Banks have considered price increases to target full cost recovery, but 
analysis suggests that price increases may accelerate volume loss and 
reduce revenue.
    In addition, more than one-third of total noncash collection 
service revenue in 2003 came from return-item fees. A return-item fee 
is charged to depository institutions for submitting coupons that are 
returned from the paying agent, primarily due to the deposit and return 
of coupons from called bonds. In these cases, the institution pays not 
only the $35 return-item fee, but also the cash-letter and coupon-
envelope fee; and it does not receive payment for the returned item. 
\3\ Of the approximately 1,000 customers that used the noncash 
collection service in 2003, 56 percent were charged a return-item fee 
at least once. Because the Reserve Banks no longer provide a 
safekeeping service for municipal securities, there is no readily 
available way for the noncash collection service to track called bonds.
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    \3\ Once a bond is called, it must be presented for redemption 
with all unpaid coupons dated after the call date for early 
redemption, as these coupons are no longer payable. Coupons with 
interest dates payable prior to the call date may still be presented 
separately for redemption.
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Alternatives to Using the Reserve Banks' Noncash Collection Service

    DTC provides both a securities safekeeping service and an over-the-
counter collection service for its participants. The over-the-counter 
coupon collection service, implemented in 1995 in response to 
participants' requests, is comparable to the noncash collection 
service, in that DTC acts as a ``pass-through'' by collecting 
securities and then sending them to the appropriate paying agent. In 
2003, DTC processed 12,800 coupon envelopes through its over-the-
counter coupon collection service. The Reserve Banks charge $4.50 per 
coupon envelope plus $13.00 for the cash letter that must accompany any 
deposit of coupon envelopes. DTC charges $21.00 to $23.00 per coupon 
envelope and does not require an accompanying cash letter. \4\ For 
return items, the Reserve Banks charge $35.00 per envelope, while DTC 
charges $15.00. In addition, it is likely that customers would be 
charged significantly fewer return-item fees if they used DTC. Because 
DTC provides a safekeeping service for securities, it maintains 
information on partially and fully called bonds and notifies its 
customers if they deposit

[[Page 61498]]

items associated with a called bond before presenting these items to 
the paying agents, thereby eliminating returns due to called bonds. In 
addition to the benefits for depositors, paying agents would also 
benefit from the reduction in return items because they incur costs to 
handle items received that must be returned to the depositor. DTC's 
provision of safekeeping services also presents an opportunity to work 
with depository institutions that use DTC as their alternative to 
immobilize additional securities.
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    \4\ DTC charges $21.00 per envelope if the CUSIP is noted on the 
envelope and $23.00 if a customer-assigned identifier is used 
instead. All Reserve Bank and DTC fees are from the 2004 fee 
schedules. The Reserve Banks' fee schedule can be found at http://www.frbservices.org/FeeSchedules/CollectionMunicipal2004.html. DTC's 
fee schedule can be found at http://www.dtc.org/dtcpublic/pdf/rulesandfees/aboutfees.pdf.
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    Correspondent banks also provide services to their customers for 
the processing of definitive municipal securities. Many of the Reserve 
Banks' largest noncash collection customers indicated that a 
significant portion of their transactions are on behalf of other 
depository institutions. This suggests that many market participants 
are already using correspondent banks as alternative service providers. 
Interviews with several of these large banks suggest that they would be 
able to use DTC or present directly to paying agents if the Reserve 
Banks were to withdraw from the service. Thus, it appears that these 
correspondent banks offer a reasonable alternative service to noncash 
collection customers that are not DTC participants.
    Finally, market participants can present directly to the paying 
agent as a substitute to using the noncash collection service or 
similar ``pass-through'' services. Depository institutions that present 
directly would avoid explicit fees, as paying agents do not charge 
presenters for the redemption of definitive municipal coupons and 
bonds; however, they may incur additional internal resource costs to 
present items directly rather than use a fee-based service provider. To 
facilitate the identification of paying agents, the Reserve Banks are 
considering making their paying agent database, current as of the last 
day of the service, available on the Internet. This database includes 
securities descriptions and associated paying agents, including phone 
numbers and addresses. With this and other tools, depository 
institutions would have a number of ways to identify the paying agents 
for direct presentment. First, a depository institution would probably 
start with the paying agent identified in the Reserve Banks' database 
or with the paying agent information printed on the original bond. 
Because paying agents sometimes change, a depository institution would 
next check with the identified paying agent to confirm the information. 
As an alternative, a depository institution could use an on-line 
service such as the Bond Buyer or Bloomberg, or it could contact the 
issuing municipality to determine the current paying agent. 
Furthermore, it has become easier for depository institutions to 
identify paying agents as the number of paying agents has declined and 
the concentration of the business among the top few paying agents has 
increased. Discussions with several major paying agents indicate that 
these trends are expected to continue.

III. Analysis of Request To Withdraw

    The Board has analyzed the proposal in the context of the factors 
for evaluating Reserve Banks requests to withdraw from a priced service 
line. \5\ The evaluation against each factor is detailed below.
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    \5\ The factors, adopted in 1992, are described in the Board's 
policy statement ``Factors for Evaluating Reserve Bank Requests to 
Withdraw from a Priced Service Line,'' Federal Reserve Regulatory 
Service 9-1575, 57 FR 53113, Nov. 6, 1992.
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    1. It is likely that other service providers would supply an 
adequate level of the same service (i.e. access, price, and quality) in 
the relevant market(s) if the Federal Reserve withdraws from the 
service.
    The Board's analysis suggests that depository institutions have a 
number of options available for the processing of definitive municipal 
securities. DTC and some correspondent banks provide services similar 
to the Reserve Banks' noncash collection service. Noncash collection 
customers that are also participants in DTC would be able to use DTC's 
coupon collection service as an alternative. If a customer is not 
already a participant in DTC, the benefits of using DTC for its 
municipal securities processing may not outweigh the cost of becoming a 
participant. \6\ These customers could use a correspondent bank to 
obtain noncash collection services. These correspondent institutions 
may, in turn, use DTC services, if they are participants, or they may 
present directly to the paying agents. These options should supply an 
adequate level of the same, or similar, service to customers that want 
to continue to use a service provider for a fee.
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    \6\ The fee for a DTC participant account is $760 per account 
per month for the first five accounts.
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    2. If other service providers are not likely to provide an adequate 
level of the same service in the relevant market(s), it is likely that 
users of the service could obtain other substitutable services that 
could reasonably meet their needs.
    In addition to the alternate service providers available, 
depository institutions have the option of presenting directly to the 
paying agent for the redemption of their definitive municipal 
securities. While depository institutions may incur additional internal 
resource costs to present directly, paying agents do not charge 
presenters for the redemption of their coupons or bonds. This option 
should reasonably meet the needs of customers that want to use their 
own resources to process definitive municipal securities, rather than 
use a fee-based service provider.
    3. Withdrawal from the service would not have a material, adverse 
effect on the Federal Reserve's ability to provide an adequate level of 
other services.
    Withdrawal from the noncash collection service should have no 
material, adverse effect on the Federal Reserve's ability to provide an 
adequate level of any other service. The noncash collection service is 
a standalone business and is the smallest Reserve Bank priced service, 
representing less than 0.2 percent of the total budgeted priced 
financial services costs in 2004. In addition, the proposed withdrawal 
by the Reserve Banks from the municipal coupon and bond collection 
process does not include nor have any impact upon the redemption of 
Treasury coupons, currently handled by the Reserve Banks.
    4. Withdrawal from the service would not have a material, adverse 
effect on the Federal Reserve's ability to discharge other 
responsibilities.
    Withdrawal from the noncash collection service should have no 
material, adverse effect on the Federal Reserve's ability to discharge 
any other responsibilities. There are no material linkages between this 
service and any other Federal Reserve responsibilities, with the 
exception of a small amount of definitive municipal securities being 
held in safekeeping for the Treasury Tax and Loan and Discount 
collateral programs. This linkage is minimal and only occurs with 
coupons that are deposited and collected by the Reserve Banks on behalf 
of the depository institutions holding collateral for these programs. 
For example, Reserve Banks deposited only 4 of the 23,787 coupon 
envelopes processed by the noncash collection service in January 2004, 
which is historically one of the highest-volume months.
    5. The public benefits of continued Federal Reserve provision of 
the service do not outweigh the benefits of withdrawing from the 
service. [The Board would consider whether there was any other public 
benefit, not addressed under the previous factors, that could be 
achieved through continued provision of the service.]

[[Page 61499]]

    As discussed in detail in this notice, the Reserve Banks expect 
that the substantial decline in volume and customers for the noncash 
collection service will make it difficult for the Reserve Banks to 
recover the costs of the service in the coming years. The availability 
of other reasonable options for depository institutions to collect 
definitive municipal securities and coupons is addressed under the 
previous factors. In addition, the public benefit that the Reserve 
Banks provide in identifying for customers the appropriate paying agent 
has diminished commensurate with the decline in the number of paying 
agents (from 3,500 to 100). The Board has not identified any other 
public benefits that could be achieved through continued provision of 
the service that would outweigh the benefits of withdrawing from the 
service.

IV. Request for Comment

    The Board requests comment on the Reserve Banks' proposal to 
withdraw from the noncash collection service at the end of 2005 and the 
Board's analysis of the proposal. In addition, the Board requests 
specific comments in the following areas:
    (1) Are there alternative service providers or substitutable 
services, in addition to DTC, correspondent banks, and direct 
presentment, that have not been identified in this notice?
    (2) If presenting directly to paying agents, would customers find 
it useful to have access to the Reserve Banks' paying agent database, 
which would be current as of the last day of the service? This database 
includes securities descriptions and associated paying agents, 
including phone number and address.
    (3) Are there other tools that customers would find useful to 
facilitate the transition?
    (4) Are there any public benefits of continued provision of the 
service by the Reserve Banks that have not been identified in this 
notice?

V. Competitive Impact Analysis

    The Board has established procedures for assessing the competitive 
impact of changes that 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. \7\ The proposed 
withdrawal by the Reserve Banks from the noncash collection service 
will leave the provision of this service to private-sector providers; 
therefore, it will have no material, adverse effect on the ability of 
other service providers to compete effectively with the Federal Reserve 
Banks in providing similar services.
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    \7\ These procedures are described in the Board's policy 
statement ``The Federal Reserve in the Payments System,'' Federal 
Reserve Regulatory Service 9-1558.
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VI. 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 proposal 
under the authority delegated to the Board by the Office of Management 
and Budget. No collections of information pursuant to the Paperwork 
Reduction Act are contained in the proposal.

    By order of the Board of Governors of the Federal Reserve 
System, October 14, 2004.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 04-23378 Filed 10-18-04; 8:45 am]
BILLING CODE 6210-01-P