[Federal Register Volume 71, Number 124 (Wednesday, June 28, 2006)]
[Notices]
[Pages 36800-36811]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-5843]


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FEDERAL RESERVE SYSTEM

[Docket No. OP-1259]


Policy on Payments System Risk

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Policy statement; request for comment.

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SUMMARY: The Board requests comments on proposed changes to Part I of 
its Policy on Payments System Risk (PSR policy) addressing risk 
management in payments and settlement systems. The proposed policy 
changes include (1) incorporating into the PSR policy the 
Recommendations for Central Counterparties (Recommendations for CCP) as 
the Board's minimum standards for central counterparties, (2) 
clarifying the purpose of Part I of the policy and revising its scope 
with regard to central counterparties, and (3) establishing an 
expectation that systemically important systems disclose publicly self-
assessments against the Core Principles for Systemically Important 
Payment Systems (Core Principles), Recommendations for Securities 
Settlement Systems (Recommendations for SSS), or Recommendations for 
CCP, as appropriate, demonstrating the extent to which these systems 
meet the principles or minimum standards. The Board is also making 
other technical changes.

DATES: Comments must be received by September 22, 2006.

ADDRESSES: You may submit comments, identified by Docket No. OP-1259, 
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]. Include the 
docket number in the subject line of the message.
     Fax: (202) 452-3819 or (202) 452-3102.
     Mail: Address to Jennifer J. Johnson, Secretary, Board of 
Governors of the Federal Reserve System, 20th Street and Constitution 
Avenue, NW., Washington, DC 20551.

All public comments will be made available on the Board's Web site at 
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, comments 
will not be edited to remove any identifying or contact information. 
Public comments may also be viewed 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: Jeff Stehm, Assistant Director (202/
452-2217), Division of Reserve Bank Operations and Payment Systems, or 
Jennifer Lucier, Senior Financial Services Analyst (202/872-7581), 
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

    Since the early 1980s, the Board has published and periodically 
revised a series of policies encouraging the reduction and management 
of risks in payments and securities settlement systems.\1\ In 1992, the 
Board issued its ``Policy Statement on Payments System Risk,'' which 
provided a comprehensive statement of its previously adopted policies 
regarding payments system risk reduction, including risk management in 
private large-dollar funds transfer networks, private delivery-against-
payment securities systems, offshore dollar clearing and netting 
systems, and private small-dollar clearing and settlement systems.\2\
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    \1\ See 50 FR 21120, May 22, 1985; 52 FR 29255, August 6, 1987; 
and 54 FR 26104 and 26092, June 21, 1989.
    \2\ 57 FR 40455, September 3, 1992.
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    During this same period, the Federal Reserve also worked with other 
central

[[Page 36801]]

banks and securities regulators to develop standards to strengthen 
payments and securities settlement infrastructures and to promote 
financial stability. These efforts initially produced the Lamfalussy 
Minimum Standards, which were incorporated into the Board's PSR policy 
in 1994.\3\ More recently, this work resulted in the publication of the 
Core Principles and the Recommendations for SSS in 2001, which were 
incorporated into the Board's PSR policy in 2004.4 5 The 
Core Principles extended and replaced the Lamfalussy Minimum Standards, 
while the Recommendations for SSS provided, for the first time, 
explicit standards for securities settlement systems.
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    \3\ 59 FR 67534, December 29, 1994. The Lamfalussy Minimum 
Standards were set out in the ``Report of the Committee on Interbank 
Netting Schemes of the Central Banks of the Group of Ten 
Countries,'' published by the Bank for International Settlements in 
November 1990. See the full report at http://www.bis.org/publ/cpss04.pdf.
    \4\ The Core Principles were developed by the Committee on 
Payment and Settlement Systems (CPSS) of the Central banks of the 
Group of Ten countries, and the Recommendations were developed by 
the CPSS in conjunction with the Technical Committee of the 
International Organization of Securities Commissions (IOSCO). In 
addition to the Federal Reserve, the Securities and Exchange 
Commission and the Commodity Futures Trading Commission participated 
in the development of the Recommendations for SSS. Both the Core 
Principles and the Recommendations for SSS were published by the 
CPSS and IOSCO for public comment before being adopted in their 
final form, and in their final form have been adopted as part of the 
Financial Stability Forum's Compendium of Standards that are widely 
recognized and endorsed by U.S. authorities as integral to 
strengthening global financial stability. The full reports on the 
Core Principles and the Recommendations for SSS are available at 
http://www.bis.org/publ/cpss43.htm and http://www.bis.org/publ/cpss46.htm, respectively.
    \5\ 69 FR 69926, December 1, 2004.
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    In addition to establishing specific principles and standards, the 
Core Principles and Recommendations for SSS call for central banks to 
state clearly their roles and policies regarding payments and 
securities settlement systems, assess compliance with the Core 
Principles and the Recommendations for SSS when overseeing relevant 
systems, and coordinate with other authorities in overseeing systems. 
Moreover, the Core Principles and Recommendations for SSS are intended 
to apply to systems operated by both central banks and the private 
sector.
    Concurrent with the drafting and adoption of the 2004 policy 
revisions, the Federal Reserve was working with the CPSS and IOSCO to 
finalize the Recommendations for CCP.\6\ These recommendations 
establish minimum standards for central counterparty risk management, 
operational reliability, efficiency, governance, transparency, and 
regulation and oversight. The Recommendations for CCP build upon the 
Recommendations for SSS and supersede those recommendations where 
central counterparties are concerned (these two sets of recommendations 
are collectively referred to as the ``CPSS-IOSCO Recommendations''). At 
the time it incorporated the Core Principles and Recommendations for 
SSS into the PSR policy, the Board noted that the CPSS and IOSCO were 
developing the Recommendations for CCP and that it would review the 
Recommendations for CCP at a later time and determine whether it would 
be appropriate to incorporate them into its PSR policy.
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    \6\ Final recommendations were issued in November 2004. In 
addition to the Federal Reserve, the Securities and Exchange 
Commission and the Commodity Futures Trading Commission also 
participated in the development of the Recommendations for CCP. The 
full report on the Recommendations for CCP is available at http://www.bis.org/publ/cpss64.htm.
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II. Discussion of Proposed Policy Changes

    The policy changes proposed by the Board include (1) incorporating 
into the PSR policy the Recommendations for CCP as the Board's minimum 
standards for central counterparties, (2) clarifying the purpose of 
Part I of the policy and revising its scope with regard to central 
counterparties, and (3) establishing an expectation that systemically 
important systems disclose publicly self-assessments against the Core 
Principles, Recommendations for SSS, or Recommendations for CCP 
demonstrating the extent to which these systems meet the principles or 
minimum standards. The Board is also making other technical changes.

A. Incorporation of the Recommendations for CCP

    The Board is proposing to incorporate the Recommendations for CCP 
with no modifications as the Board's minimum standards for central 
counterparties. Central counterparties occupy an important place in the 
financial system, interposing themselves between counterparties to 
financial transactions. Given a central counterparty's position in a 
market, its risk management practices can have implications for the 
stability of the financial system and pose risks to the Federal 
Reserve. The Board believes the Recommendations for CCP are an 
important framework for promoting sound risk management in central 
counterparties and believes that adherence to these recommendations can 
promote financial stability. The Federal Reserve, along with the 
Securities and Exchange Commission and the Commodity Futures Trading 
Commission, were actively involved in developing these recommendations, 
which reflect broad input and a balanced view of acceptable risk 
management practices.
    The incorporation of the Recommendations for CCP into the PSR 
policy continues the Board's long-standing interest in the safety and 
soundness of the nation's payments and settlement systems. The Board 
believes that its incorporation of the Recommendations for CCP 
continues its past efforts to adopt appropriate international standards 
for key payments and settlement systems and to enhance the 
understanding and management of risks by users and other stakeholders 
in these systems. The Board also believes that this change is 
consistent with the spirit and intention of the 2004 PSR policy 
revisions, clarifying the Board's policy objectives and expectations 
for payments and settlement systems subject to its authority, and 
providing further guidance on how it expects systems to manage and 
disclose their risks. Accordingly, the Board is proposing to 
incorporate the Recommendations for CCP into the policy to highlight 
the importance of central counterparties to the financial markets and 
to demonstrate the Board's desire to encourage the use of 
Recommendations for CCP globally in cooperation with other domestic and 
foreign financial system authorities.

B. Purpose and Scope of Part I of the PSR Policy

    In support of incorporating the Recommendations for CCP, the Board 
is proposing to clarify the purpose of Part I of the policy and revise 
its scope with regard to central counterparties. First, the Board is 
proposing to revise the purpose of Part I of the PSR policy to set 
forth the Board's views and related principles and minimum standards 
regarding the management of risks in payments and settlement systems 
generally. A range of payments and settlement systems operate in the 
financial markets and a failure in one or more of them could affect 
financial stability and expose the Federal Reserve to certain risks. 
While the Federal Reserve does not directly oversee all of these 
systems, it does have a fundamental interest in financial stability for 
the financial system as whole. Robust risk management by these systems 
plays an important role in maintaining financial stability. Therefore, 
the Board is proposing to

[[Page 36802]]

revise its policy to broadly state its views on risk management for all 
systems that could affect financial stability.
    In this context, the Board encourages key payments and settlement 
systems and their primary regulators to take the principles and minimum 
standards in the PSR policy into consideration in the design, 
operation, monitoring, and assessment of these systems. Private- and 
public-sector systems subject to the Board's authority, however, are 
expected to meet the Board's expectations as described in the PSR 
policy. The Board's proposed revisions also clarify this latter point.
    Second, the Board is also proposing to revise the scope to include 
central counterparties as key systems that could affect financial 
stability. The Board's current PSR policy applies to public- and 
private-sector ``payments and securities settlement systems,'' that 
meet certain volume thresholds. The term ``securities settlement 
system'' currently includes foreign-exchange settlement systems and 
central counterparties in the securities markets.\7\ The Board is 
proposing to revise the scope to refer to ``settlement systems,'' which 
can include a range of systems, including a settlement system for 
foreign exchange transactions, a securities settlement system, or a 
central counterparty. To affect this change, the Board has deleted the 
exemption for clearance and settlement systems for exchange-traded 
futures and options.
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    \7\ The Board's current PSR policy explicitly does not cover 
central counterparties for exchange-traded futures and options, and 
is silent on the coverage of central counterparties for foreign 
exchange contracts and over-the-counter derivative contracts.
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    The Board recognizes that several of the systems within the revised 
scope of Part I of the policy are supervised, regulated, or overseen by 
other financial system authorities. Where the Board does not have 
authority or does not have exclusive authority over systems covered by 
the policy, it will work with other domestic and foreign financial 
system authorities to promote the Core Principles and CPSS-IOSCO 
Recommendations and the objectives of this policy.\8\ The Board 
believes clarifying the purpose of Part I and revising its scope to 
include the full range of current and future central counterparties for 
contracts in financial markets are warranted for several reasons.
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    \8\ The revised scope will include central counterparties to 
contracts in financial markets, including derivatives and foreign 
exchange markets. The Board acknowledges that the policy's current 
$5 billion threshold and factors for considering a system's systemic 
importance may not be useful benchmarks for central counterparties 
operating in these markets. Therefore, the Board encourages the 
appropriate financial system authorities to apply appropriate 
benchmarks or standards for determining whether central 
counterparties should meet specific risk management expectations, 
such as those included in the policy, or whether they should meet 
the Recommendations for CCP.
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    First, the Board's policy rests on a fundamental interest of the 
Federal Reserve as the central bank in financial stability and the role 
that payments and settlement systems play in promoting and maintaining 
resilience in the financial system. Therefore, the Board believes that 
its policy should reflect the Board's views on risk management for the 
full range of systems that clear and settle payments and other 
financial instruments that could affect financial stability, including 
central counterparties.
    Second, revising the scope will enable the policy to conform to 
changes in the payments and settlement landscape as it continues to 
evolve. The benefits of central counterparty clearing have been 
considered and implemented in multiple markets, including the 
securities, options, and futures markets. In addition, the financial 
services industry has proposed or implemented central counterparties 
for foreign exchange transactions in the past, such as Multinet and 
ECHO,\9\ and continues to debate the efficacy of central counterparties 
for over-the-counter derivatives products. Should the industry pursue 
the implementation of central counterparty clearing models in these 
markets, introduce new systems, or redesign existing ones, the 
designers and owners of these systems will have clear ex ante knowledge 
of the Board's views and expectations regarding risk management for 
central counterparties as they design and develop their systems.
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    \9\ In 1996, Multinet was authorized as a limited-purpose bank 
under New York Law to provide multilateral netting services; 
Multinet, however, never became operational. ECHO, Exchange Clearing 
House Limited, was a London-based clearing house that, from 1995 to 
1997, provided multilateral netting and settlement of spot and 
forward foreign exchange obligations for its users. In 1997, 
Multinet and ECHO merged forming the basis for the Continuous Linked 
Settlement (CLS) Bank which currently provides payment-versus-
payment services to its users trading in the 15 currencies eligible 
for settlement at CLS.
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    Finally, in their role as providers of payments and settlement 
services, the Reserve Banks provide settlement services to a variety of 
private-sector payments and settlement arrangements. In providing such 
services, the Reserve Banks need to consider the risks that they might 
incur should a system fail to settle. One reason the Board developed 
its PSR policy was to address the risks that systems present not only 
to the financial system, but also to the Federal Reserve Banks. 
Revising the scope to cover the full range of potential payments and 
settlement systems, therefore, would provide a defined set of 
principles and standards that the Reserve Banks could look to for 
assessing the risks of systems seeking settlement services, if needed.

C. Self-Assessments by Systemically Important Systems

    The Board believes that the effective implementation of the risk 
management concepts embodied in the Core Principles and CPSS-IOSCO 
Recommendations will further strengthen the financial system. The Core 
Principles and CPSS-IOSCO Recommendations establish an expectation that 
a system will disclose sufficient information to allow users and other 
stakeholders to identify, understand, and evaluate accurately the risks 
and costs of using the system's services. Central banks as well as 
systems have pursued a variety of disclosure practices, resulting in 
varying levels of information being disseminated to users and the 
public generally. Given these varying practices, users and others may 
find it difficult to obtain access to sufficient information in order 
to assess a particular system against internationally accepted 
principles or minimum standards. The Board believes that broadening the 
availability of information concerning a system's risk management 
controls, governance, and legal framework, for example, can assist 
users and other interested persons in evaluating and managing their 
risk exposures while furthering global financial stability.
    The Board acknowledges that disclosure can be achieved in several 
ways, including through public disclosure of assessments by the central 
bank. Certain central banks in other countries functioning as overseers 
publish oversight reports that have included summarized and, in some 
cases, detailed assessments of systemically important systems against 
the same principles and minimum standards in the Board's policy. The 
Board, however, supervises as well as oversees certain systemically 
important systems. In order to produce robust assessments, it is 
important for the Board to draw upon all relevant and available 
information, including supervisory information that traditionally has 
been treated confidentially. This constrains the ability of the Board 
to issue a public assessment that relies, at least in part, on 
confidential information. In this context, and in order to promote

[[Page 36803]]

appropriate disclosure, the Board believes the individual system 
operators are well positioned to make informed, accurate disclosures to 
meet both the information needs of users and other persons and the 
stated policy objectives.
    Therefore, in furtherance of its objectives, the Board is proposing 
to revise its policy to establish an expectation that systemically 
important systems subject to the Board's authority will complete self-
assessments against the principles or minimum standards, as applicable, 
in the policy and publicly disclose those assessments. The Board is 
proposing several guidelines to assist the system operator in 
developing a self-assessment consistent with the Board's expectations.
    The Board expects the content of a self-assessment to be 
comprehensive and objective. The Board is proposing that a system 
determine its level of implementation and state whether each principle 
or minimum standard is observed, broadly observed, partly observed, or 
non-observed; all conclusions should be fully supported in the self-
assessment. In documenting the basis for the self-assessment, however, 
the Board does not expect the system to disclose sensitive information 
that may expose system vulnerabilities, such as specific business 
continuity plans. For further guidance in developing a self-assessment 
and understanding the relevant principles or minimum standards, the 
Board would encourage a system operator to consult the interpretation 
discussion in the Core Principles or the assessment methodology for the 
relevant CPSS-IOSCO Recommendations as further guidance. A system may 
also consult the Board for assistance with respect to the individual 
principles and minimum standards and the completion of its self-
assessment.
    The Board believes that in order for a self-assessment to be useful 
to users and others in understanding and managing their risks the 
content must be accurate and readily available. Therefore, the Board is 
proposing that the system's senior management and board of directors 
review and approve a self-assessment prior to publication to ensure 
system accountability for accuracy and completeness. To achieve broad 
disclosure, the Board is proposing that the system publish its self-
assessment on its public Web site. The Board is also proposing that a 
system complete and publish its first self-assessment within twelve 
months of the effective date of the final policy changes. Lastly, to 
ensure continued accuracy, the Board is proposing that the system 
update statements in its assessment following material changes to the 
system or its environment, and, at a minimum, review annually its self-
assessment.
    As part of its ongoing oversight of systemically important payments 
and settlement systems over which it exercises authority, the Federal 
Reserve will review published self-assessments and, if the Federal 
Reserve materially disagrees with the content of a self-assessment of a 
system, it will communicate its concerns to the system's senior 
management or the board of directors, as appropriate. The Federal 
Reserve may also discuss its concerns with other relevant financial 
system authorities, as appropriate. The Board would evaluate the 
effectiveness of this self-assessment framework after a few years to 
determine if the self-assessment process is meeting its policy 
objectives.

III. Request for Comment

    The Board requests comment on the proposed revisions to its PSR 
policy. In particular, the Board requests comment on whether the 
revisions to the scope and application of the policy are sufficiently 
clear and provide the appropriate coverage to achieve the policy's 
intended objectives. The Board will carefully consider comments 
submitted to ensure the final self-assessment framework is appropriate 
for all systems subject to this policy and subject to the Board's 
authority. The Board also requests comment on the following specific 
questions:
    1. Are the proposed policy objectives clear?
    2. Is the incorporation of the Recommendations for CCP reasonable 
and appropriate?
    3. Are the clarifications to the purpose and revisions to the scope 
with regard to central counterparties reasonable and appropriate?
    4. Do you believe that self-assessments are an effective method to 
facilitate the availability of information for users and other 
interested parties to identify, understand, and evaluate the risks of a 
systemically important system?
    5. Are the proposed guidelines regarding self-assessments clear and 
do they provide sufficient guidance to system operators?
    6. Do the implementation measures included in the Core Principles 
and the assessment methodologies for the CPSS-IOSCO Recommendations 
provide sufficiently clear and useful frameworks to complete 
comprehensive and objective self-assessments? If not, please explain. 
Are there alternatives to these frameworks that can provide equally 
robust and objective self-assessments?
    7. Will the inclusion of ratings (observed, broadly observed, 
partly observed, and non-observed) be helpful to persons evaluating a 
particular systemically important system against the principles and 
minimum standards? What are the pros and cons of including self-ratings 
as part of self-assessments?
    8. Are there any drawbacks to the public disclosure of self-
assessments? If so, what are they? Given the stated policy objectives, 
are there valid reasons to consider a more limited distribution of 
self-assessments and/or self-ratings (e.g., only to a system's users)?
    9. Is the proposed twelve month time frame for a system to complete 
and publish its first self-assessment appropriate?
    10. Are the proposed triggers for reviewing and updating a self-
assessment appropriate? If not, what other triggers would ensure 
published self-assessments remain accurate?

IV. Regulatory Flexibility Act Analysis

    The Board has determined that this proposed policy statement would 
not have a significant economic impact on a substantial number of small 
entities. The proposal would require payments and securities settlement 
systems to address material risks in their systems. The proposal is 
designed to minimize regulatory burden on smaller systems that do not 
raise material risks.

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.\10\ 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 anticipated benefits are significant enough 
to proceed with the change despite the adverse effects. The proposed 
policy revisions provide that Reserve Bank systems will be treated 
similarly to private-sector systems and thus will have no material 
adverse effect on the ability of other service providers

[[Page 36804]]

to compete effectively with the Federal Reserve Banks in providing 
payments and securities settlement services.
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    \10\ These procedures are described in the Board's policy 
statement ``The Federal Reserve in the Payments System,'' as revised 
in March 1990 (55 FR 11648, March 29, 1990).
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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 reviewed the policy 
statement under the authority delegated to the Board by the Office of 
Management and Budget. The Federal Reserve may not conduct or sponsor, 
and an organization is not required to respond to, this information 
collection unless it displays a currently valid OMB control number. An 
OMB control number will be assigned upon approval of the new 
information collection.
    The collection of information that is proposed to be implemented by 
this notice is found in Part I of the Board's Policy on Payments System 
Risk (PSR policy). This information is required to evidence compliance 
with the requirements of the PSR policy. The respondents are 
systemically important systems, as defined in the PSR policy.
    The Board proposes that systemically important systems, subject to 
the Board's authority, complete initial comprehensive self-assessments 
and thereafter, review and update self-assessments annually or as 
otherwise provided in the PSR policy. The Board also proposes that 
these self-assessments be reviewed and approved by the system's senior 
management and board of directors. Upon approval and in order to 
achieve broad disclosure, the systems should publish self-assessments 
on their public Websites. In order to help minimize burden the Board is 
proposing guidelines to assist system operators in developing self-
assessments consistent with the Board's expectations.
    The proposed burden for the initial reporting and disclosure 
requirements associated with this policy statement is estimated to be 
on average 310 hours per system (ranging from 200 to 400 hours). The 
burden includes: 215 hours for staff to review the requirements and 
complete the self-assessment; 30 hours for senior management to review 
that each principle was fully assessed; 50 hours for the board of 
directors to review and approve the self-assessment; and 15 hours for 
type-setting and technical editing of the document and preparing the 
website. The Board estimates that currently about three private-sector 
systems are systemically important and subject to the Board's 
authority; therefore, the total burden for systems under the Board's 
authority is estimated to 930 hours to complete the initial self-
assessments.
    Following the initial assessment, the Board estimates that the 
burden will decrease for a system to conduct an annual review and 
report and disclose updates to its self-assessment. The proposed burden 
for annual reviews and updates associated with this policy is estimated 
to be on average 70 hours per system (ranging from 50-100 hours). The 
burden includes: 25 hours for staff to review the self-assessment and 
update relevant sections; 15 hours for senior management to review the 
self-assessment; 25 hours for the board of directors to review and 
approve the self-assessment; and 5 hours for technical editing and 
Website activities. The total burden for the approximately three 
private-sector systems under the Board's authority would be an 
estimated 210 hours. These initial estimates will be adjusted in the 
future, as appropriate.
    Comments are invited on a. Whether the proposed collection of 
information is necessary for the proper performance of the Federal 
Reserve's functions, including whether the information has practical 
utility; b. The accuracy of the Federal Reserve's estimate of the 
burden of the proposed information collection, including the cost of 
compliance; c. Ways to enhance the quality, utility, and clarity of the 
information to be collected; and d. Ways to minimize the burden of 
information collection on respondents, including through the use of 
automated collection techniques or other forms of information 
technology. Comments on the collections of information should be sent 
to Secretary, Board of Governors of the Federal Reserve System, 
Washington, DC 20551, with copies of such comments to be sent to the 
Office of Management and Budget, Paperwork Reduction Project (7100-PSR 
Policy), Washington, DC 20503.

VII. Federal Reserve Policy on Payments System Risk

Introduction [Revised]
Risks in Payments and Settlement Systems [Revised]
I. Risk Management in Payments and Settlement Systems [Revised]
    A. Scope
    B. General Policy Expectations
    C. Systemically Important Systems
    1. Principles for Systemically Important Payments Systems
    2. Minimum Standards for Systemically Important Securities 
Settlement Systems and Central Counterparties
II. Federal Reserve Daylight Credit Policies [No Change]
    A. Daylight Overdraft Definition and Measurement
    B. Pricing
    C. Net Debit Caps
    D. Collateral
    E. Special Situations
    F. Monitoring
    G. Transfer-size Limit on Book-Entry Securities
III. Other Policies [No Change]
    A. Rollovers and Continuing Contracts

Introduction

    Payments and settlement systems are critical components of the 
nation's financial system. The smooth functioning of these systems is 
vital to the financial stability of the U.S. economy. Given the 
importance of these systems, the Board has developed this policy to 
address the risks that payments and settlement activity present to the 
financial system and to the Federal Reserve Banks (Reserve Banks).
    In adopting this policy, the Board's objectives are to foster the 
safety and efficiency of payments and settlement systems. These policy 
objectives are consistent with (1) the Board's long-standing objectives 
to promote the integrity, efficiency, and accessibility of the payments 
mechanism; (2) industry and supervisory methods for risk management; 
and (3) internationally accepted risk management principles and minimum 
standards for systemically important payments and settlement 
systems.\1\
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    \1\ For the Board's long-standing objectives in the payments 
system, see ``The Federal Reserve in the Payments System,'' 
September 2001, FRRS 9-1550, available at http://www.federalreserve.gov/paymentssystems/pricing/frpaysys.htm.
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    Part I of this policy sets out the Board's views, and related 
principles and minimum standards, regarding the management of risks in 
payments and settlement systems, including those operated by the 
Reserve Banks. In setting out its views, the Board seeks to encourage 
payments and settlement systems, and their primary regulators, to take 
the principles and minimum standards in this policy into consideration 
in the design, operation, monitoring, and assessing of these systems. 
The Board also will be guided by this part, in conjunction with 
relevant laws and other Federal Reserve policies, when exercising its 
authority over certain systems or their participants, when providing 
payment and settlement services to systems, or when providing intraday 
credit to Federal Reserve account holders.
    Part II of this policy governs the provision of intraday or 
``daylight'' overdrafts in accounts at the Reserve Banks and sets out 
the general methods used by the Reserve Banks to control their intraday 
credit exposures.\2\ Under

[[Page 36805]]

this part, the Board expects depository institutions to manage their 
Federal Reserve accounts effectively and minimize their use of Federal 
Reserve daylight credit.\3\ Although some intraday credit may be 
necessary, the Board expects that, as a result of this policy, 
relatively few institutions will consistently rely on intraday credit 
supplied by the Federal Reserve to conduct their business.
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    \2\ To assist depository institutions in implementing this part 
of the Board's payments system risk policy, the Federal Reserve has 
prepared two documents, the ``Overview of the Federal Reserve's 
Payments System Risk Policy'' and the ``Guide to the Federal 
Reserve's Payments System Risk Policy,'' which are available online 
at http://www.federalreserve.gov/paymentssystems/PSR paymentssystems/PSR or from any 
Reserve Bank. The ``Overview of the Federal Reserve's Payments 
System Risk Policy'' summarizes the Board's policy on the provision 
of daylight credit, including net debit caps and daylight overdraft 
fees. The overview is intended for use by institutions that incur 
only small and infrequent daylight overdrafts. The ``Guide to the 
Federal Reserve's Payments System Risk Policy'' explains in detail 
how these policies apply to different institutions and includes 
procedures for completing a self-assessment and filing a cap 
resolution as well as information on other aspects of the policy.
    \3\ The term ``depository institution,'' as used in this policy, 
refers not only to institutions defined as depository institutions'' 
in 12 U.S.C. 461(b)(1)(A), but also to U.S. branches and agencies of 
foreign banking organizations, Edge and agreement corporations, 
trust companies, and bankers' banks, unless the context indicates a 
different reading.
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    Through this policy, the Board expects financial system 
participants, including the Reserve Banks, to reduce and control 
settlement and systemic risks arising in payments and settlement 
systems, consistent with the smooth operation of the financial system. 
This policy is designed to fulfill that aim by (1) making financial 
system participants and system operators aware of the types of basic 
risks that arise in the settlement process and the Board's expectations 
with regard to risk management, (2) setting explicit risk management 
expectations for systemically important systems, and (3) establishing 
the policy conditions governing the provision of Federal Reserve 
intraday credit to account holders. The Board's adoption of this policy 
in no way diminishes the primary responsibilities of financial system 
participants generally and settlement system operators, participants, 
and Federal Reserve account holders more specifically, to address the 
risks that may arise through their operation of, or participation in, 
payments and settlement systems.

Risks in Payments and Settlement Systems

    The basic risks in payments and settlement systems are credit risk, 
liquidity risk, operational risk, and legal risk. In the context of 
this policy, these risks are defined as follows.\4\
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    \4\ These definitions of credit risk, liquidity risk, and legal 
risk are based upon those presented in the Core Principles for 
Systemically Important Payment Systems (Core Principles) and the 
Recommendations for Securities Settlement Systems (Recommendations 
for SSS). The definition of operational risk is based on the Basel 
Committee on Banking Supervision's ``Sound Practices for the 
Management and Supervision of Operational Risk,'' available at 
http://www.bis.org/pub/bcbs96.htm. Each of these definitions is 
largely consistent with those included in the Recommendations for 
Central Counterparties (Recommendations for CCP).
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    Credit Risk. The risk that a counterparty will not settle an 
obligation for full value either when due, or anytime thereafter.
    Liquidity Risk. The risk that a counterparty will not settle an 
obligation for full value when due.
    Operational Risk. The risk of loss resulting from inadequate or 
failed internal processes, people, and systems, or from external 
events. This type of risk includes various physical and information 
security risks.
    Legal Risk. The risk of loss because of the unexpected application 
of a law or regulation or because a contract cannot be enforced.
    These risks arise between financial institutions as they settle 
payments and other financial transactions and must be managed by 
institutions, both individually and collectively.\5 6\ Multilateral 
payments and settlement systems, in particular, may increase, shift, 
concentrate, or otherwise transform risks in unanticipated ways. These 
systems also may pose systemic risk to the financial system where the 
inability of a system participant to meet its obligations when due may 
cause other participants to be unable to meet their obligations when 
due. The failure of one or more participants to settle their payments 
or other financial transactions, in turn, could create credit or 
liquidity problems for other participants, the system operator, or 
depository institutions. Systemic risk might lead ultimately to a 
disruption in the financial system more broadly or undermine public 
confidence in the nation's financial infrastructure.
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    \5\ The term ``financial institution,'' as used in this policy, 
includes a broad array of types of organizations that engage in 
financial activity, including depository institutions and securities 
dealers.
    \6\ Several existing regulatory and bank supervision guidelines 
and polices also are directed at institutions' management of the 
risks posed by interbank payments and settlement activity. For 
example, Federal Reserve Regulation F (12 CFR 206) directs insured 
depository institutions to establish policies and procedures to 
avoid excessive exposures to any other depository institutions, 
including exposures that may be generated through the clearing and 
settlement of payments.
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    These risks stem, in part, from the multilateral and time-sensitive 
credit and liquidity interdependencies among financial institutions. 
These interdependencies often create complex transaction flows that, in 
combination with a system's design, can lead to significant demands for 
intraday credit, either on a regular or extraordinary basis. Some level 
of intraday credit is appropriate to ensure the smooth functioning of 
payments and settlement systems. To the extent that financial 
institutions or the Reserve Banks are the direct or indirect source of 
such intraday credit, they may face a direct risk of loss if daylight 
credit is not extinguished as planned. In addition, measures taken by 
Reserve Banks to limit their intraday credit exposures may shift some 
or all of the associated risks to private-sector systems.
    The smooth functioning of payments and settlement systems is also 
critical to certain public policy objectives in the areas of monetary 
policy and banking supervision. The effective implementation of 
monetary policy, for example, depends on both the orderly settlement of 
open market operations and the efficient distribution of reserve 
balances throughout the banking system via the money market and 
payments system. Likewise, supervisory objectives regarding the safety 
and soundness of depository institutions must take into account the 
risks payments and settlement systems pose to depository institutions 
that participate directly or indirectly in, or provide settlement, 
custody, or credit services to, such systems.

Part I: Risk Management in Payments and Settlement Systems

    This part sets out the Board's views regarding the management of 
risk in payments and settlement systems, including those operated by 
the Reserve Banks. The Board will be guided by this part, in 
conjunction with relevant laws and other Federal Reserve policies, when 
exercising its authority in (1) supervising state member banks, Edge 
and agreement corporations, bank holding companies, and clearinghouse 
arrangements, including the exercise of authority under the Bank 
Service Company Act, where applicable,\7\ (2) setting or reviewing the 
terms and conditions for the use of Federal Reserve payments and 
settlement services by system operators and participants, (3) 
developing and applying policies for the provision of intraday 
liquidity to Reserve Bank account holders, and (4) interacting with 
other domestic and foreign

[[Page 36806]]

financial system authorities on payments and settlement risk management 
issues. The Board's adoption of this policy is not intended to exert or 
create new supervisory or regulatory authority over any particular 
class of institutions or arrangements where the Board does not 
currently have such authority.
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    \7\ 12 U.S.C. 1861 et seq.
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    Where the Board does not have exclusive authority over systems 
covered by this policy, it will work with other domestic and foreign 
financial system authorities to promote effective risk management in 
payments and settlement systems, as appropriate. The Board encourages 
other relevant authorities to consider the principles and minimum 
standards embodied in this policy when evaluating the risks posed by 
and to payments and settlement systems and individual system 
participants that they oversee, supervise, or regulate. In working with 
other financial system authorities, the Board will be guided, as 
appropriate, by Responsibility D of the Core Principles, Recommendation 
18 of the Recommendations for SSS, Recommendation 15 of the 
Recommendations for CCP, the ``Principles for Cooperative Central Bank 
Oversight of Cross-border and Multi-currency Netting and Settlement 
Schemes,'' and the Principles for International Cooperative Oversight 
(Part B) of the Committee on Payment and Settlement Systems (CPSS) 
report, ``Central Bank Oversight of Payment and Settlement Systems.'' 
\8\ The Board believes these international principles provide an 
appropriate framework for cooperating and coordinating with other 
authorities to address risks in domestic, cross-border, multi-currency, 
and, where appropriate, offshore payments and settlement systems.
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    \8\ Payments and settlement systems within the scope of this 
policy may be subject to oversight or supervision by multiple public 
authorities, as a result of the legal framework or the system's 
operating structure (e.g., multi-currency or cross-border systems). 
As such, the Federal Reserve, other central banks, securities 
regulators, or other financial system authorities may need to find 
practical ways to cooperate in order to discharge fully their own 
responsibilities. In some cases, multiple authorities may have 
responsibility for a multi-currency, cross-border, or other 
arrangement. In these situations, financial authorities need to be 
sensitive to the potential for duplicative or conflicting 
requirements, oversight gaps, or unnecessary costs and burdens 
imposed on the system. The ``Principles for Cooperative Central Bank 
Oversight and Multi-currency Netting and Settlement Schemes'' are 
set out in the ``Report of the Committee on Interbank Netting 
Schemes of the Central Banks of the Group of Ten Countries'' 
(Lamafalussy Minimum Standards). The CPSS report, ``Central Bank 
Oversight of Payment and Settlement Systems'' (Oversight Report), 
Part B, ``Principles for international cooperative oversight,'' 
provides further information on the practical application of the 
Lamfalussy Cooperative Oversight Principles. The Lamfalussy Minimum 
Standards and the Oversight Report are available at http://www.bis.org/cpss/cpsspub.htm.
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A. Scope

    This policy applies to public- and private-sector payments and 
settlement systems that expect to settle a daily aggregate gross value 
of U.S. dollar-denominated transactions exceeding $5 billion on any day 
during the next 12 months.9 \10\ For purposes of this 
policy, a payments or settlement system is considered to be a 
multilateral arrangement (three or more participants) among financial 
institutions for the purposes of clearing, netting, and/or settling 
payments, securities, or other financial transactions among themselves 
or between each of them and a central party, such as a system operator 
or central counterparty.11 12 13 A system generally embodies 
one or more of the following characteristics: (1) A set of rules and 
procedures, common to all participants, that govern the clearing 
(comparison and/or netting) and settlement of payments, securities, or 
other financial transactions, (2) a common technical infrastructure for 
conducting the clearing or settlement process, and (3) a risk 
management or capital structure where any credit losses are ultimately 
borne by system participants rather than the system operator, a central 
counterparty or guarantor, or the system's shareholders.
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    \9\ The $5 billion threshold was designed to apply to cash 
markets and may not be a useful benchmark for central counterparties 
operating in derivatives markets. The appropriate financial system 
authorities in derivatives markets may therefore have different 
benchmarks and standards relevant to such central counterparties.
    \10\ The `next' twelve-month period is determined by reference 
to the date a determination is being made as to whether the policy 
applies to a particular system. Aggregate gross value of U.S. 
dollar-denominated transactions refers to the total dollar value of 
individual U.S. dollar transactions settled in the system which also 
represents the sum of total U.S. dollar debits (or credits) to all 
participants prior to or in absence of any netting of transactions.
    \11\ A system includes all of the governance, management, legal, 
and operational arrangements used to effect settlement as well as 
the relevant parties to such arrangements, such as the system 
operator, system participants, and system owners.
    \12\ The types of systems that may fall within the scope of this 
policy include, but are not limited to, large-value funds transfer 
systems, automated clearinghouse (ACH) systems, check 
clearinghouses, and credit and debit card settlement systems, as 
well as central counterparties, clearing corporations, and central 
securities depositories. For purposes of this policy, the system 
operator is the entity that manages and oversees the operations of 
the system.
    \13\ For the purposes of this policy, a ``settlement system'' 
includes a payment-versus-payment settlement system for foreign 
exchange transactions, a securities settlement system, and a system 
operating as central counterparty. The CPSS defines ``payment-
versus-payment'' as ``* * * a foreign exchange settlement system 
which ensures that a final transfer of one currency occurs if and 
only if a final transfer of the other currency or currencies takes 
place.'' The CPSS and the Technical Committee of the International 
Organization of Securities Commission (IOSCO) define a ``securities 
settlement system'' as the full set of institutional arrangements 
for confirmation, clearance, and settlement of securities trades and 
safekeeping of securities and a ``central counterparty'' is an 
entity that interposes itself between counterparties to contracts 
traded in one or more financial markets, becoming the buyer to every 
seller and the seller to every buyer. A central counterparty can 
include a derivatives clearing organization, such as a 
clearinghouse, clearing association, clearing corporation, or 
similar entity, facility, system, or organization that, with respect 
to an agreement, contract, or transaction, acts as a central 
counterparty to each party to an agreement, contract, or 
transaction; arranges or provides for multilateral netting; or 
provide clearing services or arrangements that mutualize or transfer 
credit risk among participants in the organization.
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    These systems may be organized, located, or operated within the 
United States (domestic systems), outside the United States (offshore 
systems), or both (cross-border systems) and may involve other 
currencies in addition to the U.S. dollar (multi-currency systems). The 
policy also applies to any system based or operated in the United 
States that engages in the settlement of non-U.S. dollar transactions 
if that system would be otherwise subject to the policy.\14\
    This policy does not apply to bilateral relationships between 
financial institutions and their customers, such as traditional 
correspondent banking, including traditional government securities 
clearing services. The Board believes that these relationships do not 
constitute ``a system'' for purposes of this policy and that relevant 
safety and soundness issues associated with these relationships are 
more appropriately addressed through the bank supervisory process.
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    \14\ The daily gross value threshold will be calculated on a 
U.S. dollar equivalent basis.
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B. General Policy Expectations

    The Board encourages payments and settlement systems within the 
scope of this policy and expects systems subject to its authority to 
implement a risk management framework appropriate for the risks the 
system poses to the system operator, system participants, and other 
relevant parties as well as the financial

[[Page 36807]]

system more broadly. A risk management framework is the set of 
objectives, policies, arrangements, procedures, and resources that a 
system employs to limit and manage risk. While there are a number of 
ways to structure a sound risk management framework, all frameworks 
should
     Clearly identify risks and set sound risk management 
objectives;
     Establish sound governance arrangements;
     Establish clear and appropriate rules and procedures; and,
     Employ the resources necessary to achieve the system's 
risk management objectives and implement effectively its rules and 
procedures.
    In addition to establishing a risk management framework that 
includes these key elements, the Board expects systems subject to its 
authority that it determines are systemically important to meet the 
policy expectations set out in Section C (Core Principles, 
Recommendations for SSS, or Recommendations for CCP, as applicable).
    Identify Risks and Set Sound Risk Management Objectives. The first 
element of a sound risk management framework is the clear 
identification of all risks that have the potential to arise in or 
result from the system's settlement process and the development of 
clear and transparent objectives regarding the system's tolerance for 
and management of such risks.
    System operators should identify the forms of risk present in their 
system's settlement process as well as the parties posing and bearing 
each risk. In particular, system operators should identify the risks 
posed to and borne by themselves, the system participants, and other 
key parties such as a system's settlement banks, custody banks, and 
third-party service providers. System operators should also analyze 
whether risks might be imposed on other external parties and the 
financial system more broadly.
    In addition, system operators should analyze how risk is 
transformed or concentrated by the settlement process. System operators 
should also consider the possibility that attempts to limit one type of 
risk could lead to an increase in another type of risk. Moreover, 
system operators should be aware of risks that might be unique to 
certain instruments, participants, or market practices. System 
operators should also analyze how risks are correlated among 
instruments or participants.\15\
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    \15\ Where systems have inter-relationships with or dependencies 
on other systems (e.g., cross-guarantees, cross-collaterization, 
cross-margining, common operating platforms), system operators 
should also analyze whether and to what extent any cross-system 
risks exist and who bears them.
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    Based upon its clear identification of risks, a system should 
establish its risk tolerance, including the levels of risk exposure 
that are acceptable to the system operator, system participants, and 
other relevant parties. The system operator should then set risk 
management objectives that clearly allocate acceptable risks among the 
relevant parties and set out strategies to manage this risk. Risk 
management objectives should be consistent with the objectives of this 
policy, the system's business purposes, and the type of instruments and 
markets for which the system clears and settles. Risk management 
objectives should also be communicated to and understood by both the 
system operator's staff and system participants.
    System operators should reevaluate their risks in conjunction with 
any major changes in the settlement process or operations, the 
instruments or transactions settled, a system's rules or procedures, or 
the relevant legal and market environments. Systems should revisit 
their risk management objectives regularly to ensure that they are 
appropriate for the risks posed by the system, continue to be aligned 
with the system's purposes, remain consistent with this policy, and are 
being effectively adhered to by the system operator and participants.
    Sound Governance Arrangements. Systems should have sound governance 
arrangements to implement and oversee their risk management frameworks. 
The responsibility for sound governance rests with a system operator's 
board of directors or similar body and with the system operator's 
senior management. Governance structures and processes should be 
transparent; enable the establishment of clear risk management 
objectives; set and enforce clear lines of responsibility and 
accountability for achieving these objectives; ensure that there is 
appropriate oversight of the risk management process; and enable the 
effective use of information reported by the system operator's 
management, internal auditors, and external auditors to monitor the 
performance of the risk management process.\16\ Individuals responsible 
for governance should be qualified for their positions, understand 
their responsibilities, and understand their system's risk management 
framework. Governance arrangements should also ensure that risk 
management information is shared in forms, and at times, that allow 
individuals responsible for governance to fulfill their duties 
effectively.
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    \16\ The risk management and internal audit functions should 
also be independent of those responsible for day-do-day functions.
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    Clear and Appropriate Rules and Procedures. Systems should 
implement rules and procedures that are appropriate and sufficient to 
carry out the system's risk management objectives and that have a well-
founded legal basis. Such rules and procedures should specify the 
respective responsibilities of the system operator, system 
participants, and other relevant parties. Rules and procedures should 
establish the key features of a system's settlement and risk management 
design and specify clear and transparent crisis management procedures 
and settlement failure procedures, if applicable.\17\
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    \17\ Examples of key features that might be specified in a 
system's rules and procedures are controls to limit participant-
based risks, such as membership criteria based on participant's 
financial and operational health, limits on settlement exposures, 
and the procedures and resources to hedge, margin, or collateralize 
settlement exposures. Other examples of key features might be 
business continuity requirements and loss allocation procedures.
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    Employ Necessary Resources. Systems should ensure that the 
appropriate resources and processes are in place to allow them to 
achieve their risk management objectives and effectively implement 
their rules and procedures. In particular, the system operator's staff 
should have the appropriate skills,

[[Page 36808]]

information, and tools to apply the system's rules and procedures and 
achieve the system's risk management objectives. System operators 
should also ensure that their facilities and contingency arrangements, 
including any information system resources, are sufficient to meet 
their risk management objectives.
    The Board recognizes that payments and settlement systems differ 
widely in terms of form, function, scale, and scope of activities and 
that these characteristics result in differing combinations and levels 
of risks. Thus, the exact features of a system's risk management 
framework should be tailored to the risks of that system. The Board 
also recognizes that the specific features of a risk management 
framework may entail trade-offs between efficiency and risk reduction 
and that payments and settlement systems will need to consider these 
trade-offs when designing appropriate rules and procedures. In 
considering such trade-offs, however, it is critically important that 
systems take into account the costs and risks that may be imposed on 
all relevant parties, including parties with no direct role in the 
system. Furthermore, in light of rapidly evolving technologies and risk 
management practices, the Board encourages all systems to consider 
periodically making cost-effective risk-management improvements.
    To determine whether a system's current or proposed risk management 
framework is consistent with this policy, the Board will seek to 
understand how a system achieves the four elements of a sound risk 
management framework set out above. In this context, it may be 
necessary for the Board to obtain information from system operators 
regarding their risk management framework, risk management objectives, 
rules and procedures, significant legal analyses, general risk 
analyses, analyses of the credit and liquidity effects of settlement 
disruptions, business continuity plans, crisis management procedures, 
and other relevant documentation.\18\ It may also be necessary for the 
Board to obtain data or statistics on system activity on an ad-hoc or 
ongoing basis. All information provided to the Federal Reserve for the 
purposes of this policy will be handled in accordance with all 
applicable Federal Reserve policies on information security, 
confidentiality, and conflicts of interest.
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    \18\ To facilitate analysis of settlement disruptions, systems 
may need to develop the capability to simulate credit and liquidity 
effects on participants and on the system resulting from one or more 
participant defaults, or other possible sources of settlement 
disruptions. Such simulations may need to include, if appropriate, 
the effects of changes in market prices, volatilities, or other 
factors.
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C. Systemically Important Systems

    Financial stability depends, in part, on a robust and well-managed 
financial infrastructure. If risks are not effectively managed by 
systemically important systems, these systems have the potential to be 
a major channel for the transmission of financial shocks across systems 
and markets. Financial system authorities, including central banks, 
have promoted sound risk management practices by developing 
internationally accepted guidelines to encourage the safe design and 
operation of payments and settlement systems, especially those 
considered systemically important.
    In particular, the Core Principles, Recommendations for SSS, and 
Recommendations for CCP (the latter two collectively referred to as the 
CPSS-IOSCO Recommendations) set forth risk management practices for 
payments systems, securities settlement systems, and central 
counterparties, respectively.\19 20\ The Federal Reserve collaborated 
with participating financial system authorities in developing these 
principles and minimum standards. In addition, the Securities and 
Exchange Commission and Commodity Futures Trading Commission 
participated in the development of the CPSS-IOSCO Recommendations. The 
principles and minimum standards reflect broad input and provide a 
balanced view of acceptable risk management practices. The Core 
Principles and Recommendations for SSS are also part of the Financial 
Stability Forum's Compendium of Standards that have been widely 
recognized, supported, and endorsed by U.S. authorities as integral to 
strengthening the stability of the financial system. The Board believes 
that the implementation of the individual principles and minimum 
standards by systemically important systems can help promote safety and 
efficiency in the financial system and foster greater financial 
stability in domestic and global economies.
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    \19\ The Core Principles were developed by the CPSS; reference 
to ``principles'' in this policy are to the Core Principles. The 
Core Principles draw exclusively on the previous work of the CPSS, 
most importantly the Lamfalussy Minimum Standards. The Core 
Principles extend the Lamfalussy Minimum Standards by adding several 
principles and broadening the coverage to include systematically 
important payments systems for all types, including gross settlement 
systems, net settlement systems, and hybrid systems, operated by 
either the public or private sector. The Core Principles also 
address the responsibilities of central banks in applying the Core 
Principles.
    \20\ The CPSS and IOSCO developed the CPSS-IOSCO Recommendations 
as ``minimum standards'' and are referred to as such in this policy. 
The full reports on the Core Principles and the CPSS-IOSCO 
Recommendations are available at http://www.bis.org/pucl/cpss43.htm, 
http://www.bis.org/pucl/cpss46.htm, and http://www.bis.org/publ/cpss64.htm.
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    Systemically important systems that are subject to the Board's 
authority are expected to meet the specific risk management principles 
and minimum standards in this section, as appropriate, and the general 
expectations of Section B because of their potential to cause major 
disruptions in the financial system.\21\ To determine whether a system 
is systemically important for purposes of this policy, the Board may 
consider, but will not be limited to, one or more of the following 
factors: \22\
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    \21\ Systematically important payments systems are expected to 
meet the principles listed in Section C.1. Securities settlement 
systems of systemic importance are expected to meet the minimum 
standards listed in Section C.2.a., and systematically important 
central counterparties are expected to meet the minimum standards 
listed in C.2.b. For a system not subject to its authority, the 
Board encourages the system and its appropriate financial system 
authority to consider these principles and minimum standards when 
designing, operating, monitoring, and assessing the system, as 
appropriate and applicable.
    \22\ The Board will inform a system subject to its authority if 
it considers it systemically important and therefore expected to 
meet the principles or minimum standards in this policy. The Board 
will also inform such system if they are expected to exceed any of 
the principles or minimum standards. The appropriate financial 
system authorities responsible for supervising or regulating central 
counterparties are encouraged to inform the central counterparties 
as to whether they are expected to meet the Recommendations for CCP.
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     Whether the system has the potential to create significant 
liquidity disruptions or dislocations should it fail to perform or 
settle as expected;
     Whether the system has the potential to create large 
credit or liquidity exposures relative to participants' financial 
capacity;
     Whether the system settles a high proportion of large-
value or interbank transactions;
     Whether the system settles transactions for important 
financial markets; \23\
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    \23\ Important financial markets include, but are not limited 
to, critical markets as defined in the ``Interagency Paper on Sound 
Practices to Strengthen the Resilience of the U.S. Financial 
System'' as the markets for federal funds, foreign exchange, and 
commercial paper; U.S. government and agency securities; and 
corporate debt and security securities. See 68 FR 17809, April 11, 
2003.
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     Whether the system provides settlement for other systems; 
and,
     Whether the system is the only system or one of a very few 
systems for settlement of a given financial instrument.
    Some systemically important systems, however, may present an 
especially high degree of systemic risk, by virtue

[[Page 36809]]

of their high volume of large-value transactions or central role in the 
financial markets. Because all systems are expected to employ a risk 
management framework that is appropriate for their risks, the Board may 
expect these systems to exceed the principles and minimum standards set 
out below. Finally, the Board expects systemically important systems to 
demonstrate the extent to which they meet the applicable principles or 
minimum standards by completing self-assessments and disclosing 
publicly the results of their analyses in a manner consistent with the 
guidelines set forth in Section C.3.
1. Principles for Systemically Important Payments Systems
    1. The system should have a well-founded legal basis under all 
relevant jurisdictions.
    2. The system's rules and procedures should enable participants to 
have a clear understanding of the system's impact on each of the 
financial risks they incur through participation in it.
    3. The system should have clearly defined procedures for the 
management of credit risks and liquidity risks, which specify the 
respective responsibilities of the system operator and the participants 
and which provide appropriate incentives to manage and contain those 
risks.
    4. The system should provide prompt final settlement on the day of 
value, preferably during the day and at a minimum at the end of the 
day.
    5. A system in which multilateral netting takes place should, at a 
minimum, be capable of ensuring the timely completion of daily 
settlements in the event of an inability to settle by the participant 
with the largest single settlement obligation.
    6. Assets used for settlement should preferably be a claim on the 
central bank; where other assets are used, they should carry little or 
no credit risk and little or no liquidity risk.
    7. The system should ensure a high degree of security and 
operational reliability and should have contingency arrangements for 
timely completion of daily processing.
    8. The system should provide a means of making payments which is 
practical for its users and efficient for the economy.
    9. The system should have objective and publicly disclosed criteria 
for participation, which permit fair and open access.
    10. The system's governance arrangements should be effective, 
accountable and transparent.
2. Minimum Standards for Systemically Important Securities Settlement 
Systems and Central Counterparties
    The CPSS-IOSCO Recommendations apply to the full set of 
institutional arrangements for confirmation, clearance, and settlement 
of securities transactions, including those related to market 
convention and pre-settlement activities. As such, not all of these 
standards apply to all systems. Moreover, the standards applicable to a 
particular system also will vary based on the structure of the market 
and the system's design.
    While the Board endorses the CPSS-IOSCO Recommendations in their 
entirety, its primary interest for purposes of this policy is in those 
recommendations related to the settlement aspects of financial 
transactions, including the delivery of securities or other financial 
instruments against payment, and related risks. The Board expects that 
systems engaged in the management or conduct of clearing and settling 
financial transactions to meet the expectations set forth in the 
applicable set of CPSS-IOSCO Recommendations.
a. Recommendations for Securities Settlement Systems
    1. Securities settlement systems should have a well-founded, clear, 
and transparent legal basis in the relevant jurisdictions.
    2. Confirmation of trades between direct market participants should 
occur as soon as possible after the trade execution, but no later than 
the trade date (T+0). Where confirmation of trades by indirect market 
participants (such as institutional investors) is required, it should 
occur as soon as possible after the trade execution, preferably on T+0, 
but no later than T+1.
    3. Rolling settlement should be adopted in all securities markets. 
Final settlement should occur no later than T+3. The benefits and costs 
of a settlement cycle shorter than T+3 should be evaluated.
    4. The benefits and costs of a central counterparty should be 
evaluated. Where such a mechanism is introduced, the central 
counterparty should rigorously control the risks it assumes.
    5. Securities lending and borrowing (or repurchase agreements and 
other economically equivalent transactions) should be encouraged as a 
method for expediting the settlement of securities transactions. 
Barriers that inhibit the practice of lending securities for this 
purpose should be removed.
    6. Securities should be immobilized or dematerialized and 
transferred by book entry in central securities depository to the 
greatest extent possible.
    7. Central securities depositories should eliminate principal risk 
linking securities transfers to funds transfers in a way that achieves 
delivery versus payment.
    8. Final settlement should occur no later than the end of the 
settlement day. Intraday or real time finality should be provided where 
necessary to reduce risks.
    9. Central securities depositories that extend intraday credit to 
participants, including central securities depositories that operate 
net settlement systems, should institute risk controls that, at a 
minimum, ensure timely settlement in the event that the participant 
with the largest payment obligation is unable to settle. The most 
reliable set of controls is a combination of collateral requirements 
and limits.
    10. Assets used to settle the ultimate payment obligations arising 
from securities transaction should carry little or no credit or 
liquidity risk. If central bank money is not used, steps must be taken 
to protect central securities depository members from potential losses 
and liquidity pressures arising from the failure of the cash settlement 
agent whose assets are used for that purpose.
    11. Sources of operational risk arising in the clearing and 
settlement process should be identified and minimized through the 
development of appropriate systems, controls and procedures. Systems 
should be reliable and secure, and have adequate, scalable capacity. 
Contingency plans and backup facilities should be established to allow 
for the timely recovery of operations and completion of the settlement 
process.
    12. Entities holding securities in custody should employ accounting 
practices and safekeeping procedures that fully protect customers' 
securities. It is essential that customers' securities be protected 
against the claims of a custodian's creditors.
    13. Governance arrangements for central securities depositories and 
central counterparties should be designed to fulfill public interest 
requirement and to promote the objectives of owners and users.
    14. Central securities depositories and central counterparties 
should have objective and publicly disclosed criteria for participation 
that permit fair and open access.
    15. While maintaining safe and secure operations, securities 
settlement systems should be cost-effective in meeting the requirements 
of users.

[[Page 36810]]

    16. Securities settlement systems should use or accommodate the 
relevant international communication procedures and standards in order 
to facilitate efficient settlement of cross-border transactions.
    17. Central securities depositories and central counterparties 
should provide market participants with sufficient information for them 
to identify and evaluate accurately the risks and costs associated with 
using the central securities depository or central counterparty 
services.
    18. Securities settlement systems should be subject to transparent 
and effective regulation and oversight. Central banks and securities 
regulators should cooperate with each other and with other relevant 
authorities.
    19. Central securities depositories that establish links to settle 
cross-border trades should design and operate such links to reduce 
effectively the risks associated with cross-border settlement.
b. Recommendations for Central Counterparties
    1. A central counterparty should have a well founded, transparent, 
and enforceable legal framework for each aspect of its activities in 
all relevant jurisdictions.
    2. A central counterparty should require participants to have 
sufficient financial resources and robust operational capacity to meet 
obligations arising from participation in the central counterparty. A 
central counterparty should have procedures in place to monitor that 
participation requirements are met on an ongoing basis. A central 
counterparty's participation requirements should be objective, publicly 
disclosed, and permit fair and open access.
    3. A central counterparty should measure its credit exposures to 
its participants at least once a day. Through margin requirements, 
other risk control mechanisms, or a combination of both, a central 
counterparty should limit its exposures to potential losses from 
defaults by its participants in normal market conditions so that the 
operations of the central counterparty would not be disrupted and non-
defaulting participants would not be exposed to losses that they cannot 
anticipate or control.
    4. If a central counterparty relies on margin requirements to limit 
its credit exposures to participants, those requirements should be 
sufficient to cover potential exposures in normal market conditions. 
The models and parameters used in setting margin requirements should be 
risk-based and reviewed regularly.
    5. A central counterparty should maintain sufficient financial 
resources to withstand, at a minimum, a default by the participant to 
which it has the largest exposure in extreme but plausible market 
conditions.
    6. A central counterparty's default procedures should be clearly 
stated, and they should ensure that the central counterparty can take 
timely action to contain losses and liquidity pressures and to continue 
meeting its obligations. Key aspects of the default procedures should 
be publicly available.
    7. A central counterparty should hold assets in a manner whereby 
risk of loss or of delay in its access to them is minimized. Assets 
invested by a central counterparty should be held in instruments with 
minimal credit, market, and liquidity risks.
    8. A central counterparty should identify sources of operational 
risk and minimize them through the development of appropriate systems, 
controls, and procedures. Systems should be reliable and secure, and 
have adequate, scalable capacity. Business continuity plans should 
allow for timely recovery of operations and fulfillment of a central 
counterparty's obligations.
    9. A central counterparty should employ money settlement 
arrangements that eliminate or strictly limit its settlement bank 
risks, that is, its credit and liquidity risks from the use of banks to 
effect money settlements with its participants. Funds transfers to a 
central counterparty should be final when effected.
    10. A central counterparty should clearly state its obligations 
with respect to physical deliveries. The risks from these obligations 
should be identified and managed.
    11. Central counterparties that establish links either cross-border 
or domestically to clear trades should evaluate the potential sources 
of risks that can arise, and ensure that the risks are managed 
prudently on an ongoing basis. There should be a framework for 
cooperation and coordination between the relevant regulators and 
overseers.
    12. While maintaining safe and secure operations, central 
counterparties should be cost-effective in meeting the requirements of 
participants.
    13. Governance arrangements for a central counterparty should be 
clear and transparent to fulfill public interest requirements and to 
support the objectives of owners and participants. In particular, they 
should promote the effectiveness of a central counterparty's risk 
management procedures.
    14. A central counterparty should provide market participants with 
sufficient information for them to identify and evaluate accurately the 
risks and costs associated with using its services.
    15. A central counterparty should be subject to transparent and 
effective regulation and oversight. In both a domestic and an 
international context, central banks and securities regulators should 
cooperate with each other and with other relevant authorities.
3. Self-Assessments by Systemically Important Systems
    The Board believes that the implementation of these principles and 
minimum standards by systemically important systems can foster greater 
financial stability in payments and settlement systems. Users and 
others commonly are interested in understanding how these systems 
function in order to manage their risks. At this time, different 
disclosure practices and requirements for payments and settlement 
systems have resulted in varying levels of information being 
disseminated to users and others. Users and others outside the user 
community (such as prospective users or other public authorities) may 
find it difficult to obtain access to sufficient information to 
understand and assess a particular system's approach to risk management 
against internationally accepted principles and minimum standards. 
Broadening the availability of information concerning a system's risk 
management controls, governance, and legal framework, for example, can 
assist those interested in a system in evaluating and managing their 
risk exposures. The Board believes that operators of systemically 
important systems are well positioned to assess and demonstrate the 
extent to which they have implemented the principles or minimum 
standards in this policy. Therefore, in furtherance of its policy 
objectives, the Board expects systemically important systems subject to 
its authority to complete comprehensive, objective self-assessments 
against the applicable principles or minimum standards in this policy 
and disclose publicly the results of these efforts. Adopting this self-
assessment framework, however, does not preclude the Federal Reserve 
from independently assessing compliance of systemically important 
systems with relevant rules, regulations, and Federal Reserve policies.
    The Board expects systemically important systems subject to its 
authority to complete self-assessments based on the following 
guidelines. First, systemically important systems are expected to 
document the basis for their self-assessment and support any

[[Page 36811]]

conclusions regarding the extent to which they meet a particular 
principle or minimum standard.\24\ The Board notes that the CPSS and 
CPSS-IOSCO have developed implementation measures and assessment 
methodologies that can assist system operators in structuring their 
self-assessments.\25\ Accordingly, payment system operators are 
encouraged to consult Section 7 of the Core Principles for guidance 
when developing their self-assessments and in measuring the extent to 
which the system meets each principle. Likewise system operators for 
securities settlement systems and central counterparties are encouraged 
to consult the assessment methodology for the relevant minimum 
standards for further guidance on each minimum standard and are 
encouraged to respond to the key questions included therein.\26\ A 
system may consult the Board for assistance with respect to the 
principles and minimum standards and the completion of its assessment. 
Second, to further ensure system accountability for accuracy and 
completeness, the Board expects the system's senior management and 
board of directors to review and approve self-assessments upon 
completion. Third, to achieve broad disclosure, the system is expected 
to make its self-assessments readily available to the public, such as 
by posting the self-assessment on the system's public Web site. 
Finally, in order for self-assessments to reflect correctly the 
system's current rules, procedures, and operations, the Board expects a 
systemically important system to update the relevant parts of the self-
assessment following material changes to the system or its environment. 
At a minimum, a systemically important system would be expected to 
review its self-assessment annually to ensure continued accuracy.
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    \24\ System operators should use one of the following assessment 
categories to describe the extent to which the system meets a 
particular principle or minimum standard: Observed, broadly 
observed, partly observed, or non-observed. The assessment should 
contain information robust enough to enable users and other 
interested persons to assess the risks associated with the system. 
The Board, however, does not expect payments and settlement systems 
to disclose publicly sensitive information that would expose system 
vulnerabilities or otherwise put the system at risk (e.g., specific 
business continuity plans).
    \25\ The Core Principles include an implementation summary for 
each principle. The CPSS, however, has not developed an assessment 
methodology for the Core Principles. In November 2002, CPSS-IOSCO 
published an Assessment Methodology for the Recommendations for SSS 
available at http://www.bis.org/publ/cpss51.htm. In November 2004, 
CPSS-IOSCO published the CCP Recommendations and an Assessment 
Methodology available at http://www.bis.org/publ/cpss64.htm.
    \26\ The assessment methodologies for the CPSS-IOSCO 
Recommendations include key questions to assist an assessor in 
determining to what extent a system meets a particular minimum 
standard.
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    As part of its ongoing oversight of systemically important payments 
and settlement systems, the Federal Reserve will review published self-
assessments by systems subject to the Board's authority to ensure the 
Board's policy objectives and expectations are being met.\27\ Where 
necessary, the Federal Reserve will provide feedback to these systems 
regarding the content of their self-assessments and their effectiveness 
in achieving the policy objectives discussed above.\28\ The Board 
acknowledges that payments and settlement systems vary in terms of the 
scope of instruments they settle and markets they serve. It also 
recognizes that systems may operate under different legal and 
regulatory constraints and within particular market infrastructures or 
institutional frameworks. The Board will consider these factors when 
reviewing self-assessments and in evaluating how a systemically 
important system addresses a particular principle or minimum standard 
and complies with the policy generally. Where the Board does not have 
exclusive authority over a systemically important system, it will 
encourage appropriate domestic or foreign financial system authorities 
to promote self-assessments by systemically important systems as a 
means to achieve greater safety and efficiency in the financial system.
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    \27\ Any review of an assessment by the Federal Reserve should 
not be viewed as an approval or guaranty of the accuracy of a 
system's self-assessment.
    \28\ If the Federal Reserve materially disagrees with the 
content of a system's self-assessment, it will communicate its 
concerns to the system's senior management and possibly to its board 
of directors, as appropriate. The Federal Reserve may also discuss 
its concerns with other relevant financial system authorities, as 
appropriate.

    By order of the Board of Governors of the Federal Reserve 
System, June 22, 2006.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 06-5843 Filed 6-27-06; 8:45 am]
BILLING CODE 6210-01-P