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FEDERAL RESERVE BANK
OF NEW YORK
[
Circular No. 10694
February 25, 1994
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EXPANSION OF O PERATING H O URS FOR
T H E FE D W IR E O N -L IN E FU N D S T R A N SF E R SERVICE
To All Depository Institutions in the Second
Federal Reserve District, and Others Concerned:
F o llo w in g is th e te x t o f a s ta te m e n t is s u e d b y th e B o a r d o f G o v e r n o r s o f th e F e d e r a l R e s e r v e
S y s te m a n n o u n c in g th e a p p r o v a l o f th e e x p a n s io n o f F e d w ir e o n - lin e f u n d s t r a n s f e r s e r v ic e o p e r a tin g
h o u r s to 18 h o u r s a d ay , f iv e d a y s a w e e k , b e g in n in g in 1 9 9 7 :
The Federal Reserve Board has announced approval of the expansion of Fedwire on-line funds
transfer service operating hours to 18 hours a day, from 12:30 a.m. to 6:30 p.m. Eastern Time (ET),
five days a week, beginning in early 1997. A specific implementation date will be announced
approximately one year in advance of the effective date.
Intraday credit from the Federal Reserve will be available during expanded hours on the same terms
that it would be provided from 8:30 a.m. ET to 6:30 p.m. ET. Further expansion of the funds transfer
operating day could be considered following several years of experience with the new schedule.
Additionally, the Board announced that current Fedwire securities transfer service operating hours
will not be expanded until after the implementation of new service capabilities that permit receivers of
securities to control the use of securities-related intraday Federal Reserve credit.
Public comment will be sought later this year on new service capabilities that permit users the option
to participate in expanded securities transfer service operating hours and to control the receipt of
securities that are delivered to them during expanded hours.
P r i n t e d o n th e f o llo w in g p a g e s is th e te x t o f th e B o a r d ’s n o tic e in th is m a tte r, w h ic h h a s b e e n
s u b m itte d f o r p u b lic a tio n in th e
Federal Register.
I n c lu d e d in th is m a ilin g a r e t h o s e in d iv id u a ls o n
o u r m a ilin g lis ts w h o h a v e r e q u e s te d c ir c u la r s is s u e d b y th is B a n k c o n c e r n i n g e le c tr o n ic f u n d s
t r a n s f e r m a tte r s . A d d itio n a l c o p ie s o f th is n o tic e m a y b e o b ta in e d a t th is B a n k (3 3 L i b e r t y S tr e e t)
f r o m th e I s s u e s D iv is io n o n th e f ir s t f lo o r o f th is b u ild in g .
Q u e s tio n s r e g a r d in g th is m a tte r m a y b e d ir e c te d to H e n r y F. W ie n e r, V ic e P r e s i d e n t , E le c tr o n ic
P a y m e n ts F u n c tio n (T e l. N o. 2 1 2 - 7 2 0 - 5 0 7 9 ) .
W il l ia m J . M c D o n o u g h ,
President.
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FEDERAL RESERVE SYSTEM
[Docket No. R-0778]
Federal Reserve Bank Services
AGENCY:
Board of Governors of the Federal Reserve System.
ACTION:
Notice.
SUMMARY:
The Board has approved an expansion of Fedwire funds transfer
operating hours for the public policy benefits that will result through the
use, over the long term, of the service by banks individually and through
clearing groups. The Board believes that the potential, long run benefits
from offering final payment capabilities that will strengthen interbank
settlements outweigh the costs to the Federal Reserve of expanding the Fedwire
funds transfer service operating hours. Over time, longer Fedwire funds
transfer hours can contribute to reductions in Herstatt risk through
innovations in payment and settlement practices. As well, the Fedwire funds
transfer service will become a tested tool for managing settlement risk early
in the day during times of financial stress.
Specifically, the Board is announcing that the hours of operation
of the Fedwire on-line funds transfer service will be expanded to 18 hours per
day, opening at 12:30 a.m. ET and closing at 6:30 p.m. ET, five days per week
(Monday through Friday) to become effective in early 1997. A specific
implementation date will be announced approximately one year in advance of the
effective date. Intraday credit from the Federal Reserve will be available
during expanded hours on the same terms that it would be provided from 8:30
a.m. ET to 6:30 p.m. ET. Further expansion of the funds transfer operating
day could be considered following several years of experience with the new
schedule.
In addition, the Board is announcing that current Fedwire
securities transfer operating hours will not be expanded until after the
implementation of new service capabilities that permit receivers of securities
to control the use of securities-related intraday Federal Reserve credit.
Public comment will be sought in 1994 on new service capabilities that permit
users the option to participate in expanded securities transfer service
operating hours and to control the receipt of securities that are delivered to
them during expanded hours. This request for public comment could be combined
with a request for views on the use of similar service features during regular
securities transfer operating hours. In the case of expanded or regular
hours, but especially in the latter case, a key issue concerns the effects of
such changes on the liquidity and efficiency of the U.S. government securities
market.
FOR FURTHER INFORMATION CONTACT:
John H. Parrish, Assistant Director
(202/452-2224), Gayle Brett, Manager (202/452-2934), or Lisa Hoskins, Senior
Financial Services Analyst (202/452-3437), Division of Reserve Bank Operations
and Payment Systems, Board of Governors of the Federal Reserve System. For
the hearing impaired only, Telecommunication Device for the Deaf (TDD),
Dorothea Thompson (202/452-3544), Board of Governors of the Federal Reserve
System, 20th and C Streets, NW., Washington, DC 20551.
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SUPPLEMENTARY INFORMATION: The growth in financial market activity worldwide,
and in foreign exchange market activity in particular, has heightened
attention and sensitivity to settlement and systemic risks. Market
participants, as well as regulators, are particularly concerned about current
methods for settling multi-currency, cross-border transactions. Data
published by the Bank for International Settlements (BIS) indicate that the
daily average value of global foreign exchange market activity was
approximately $880 billion in April 1992.1 The interbank payments generated
by foreign exchange transactions account for a substantial portion of the
total value of payments settled in many of the industrialized countries.
The most significant settlement risks presented by foreign
exchange or other multi-currency contracts involve the risk that a
counterparty to such contracts will pay one currency and not receive payment
in the contra-currency. Concerns about such risks have been prominent since
the failure of Bankhaus Herstatt in 1974, when foreign exchange counterparties
of Herstatt made Deutsche mark payments to Herstatt to settle foreign exchange
contracts, but did not receive contra-payments in U.S. dollars before the
closure of the bank, which occurred at the end of the German banking day. The
settlement risk associated with the sequential payment of currencies, and
involving the potential loss of the full principal amount of foreign exchange
contracts, has come to be known as Herstatt risk.
Despite the rapid growth of the foreign exchange markets since
1974, foreign exchange contracts are currently settled much as they were at
the time of the Herstatt episode. For example, in the case of yen-U.S. dollar
foreign exchange contracts, the yen amounts due on a particular banking day
would be paid and settled in Tokyo before the start of that banking day in New
York. U.S. dollar contra-payments would likely be initiated early in the U.S.
banking day and settled with finality at the end of the U.S. banking day, some
18 hours after the close of business in Tokyo. Similarly, payments in most
European currencies would be made and settled hours before U.S. dollar
payments are either initiated or settled with finality. The overall magnitude
of Herstatt risks associated with these settlement delays has grown
commensurately with the rapid growth in foreign exchange and other multicurrency transactions.
Over the past few years, there has been a series of central bank
studies aimed at heightening the understanding and awareness of risks in
various international payment and settlement processes. These studies have
also provided a common framework for evaluating both new and enhanced
interbank settlement arrangements, as well as changes in central bank
services, that might be designed to reduce and manage better Herstatt risk.
Working groups from the G-10 central banks have published reports, under the
aegis of the BIS, on such topics as minimum standards for interbank netting
systems, delivery-versus-payment (DVP) in securities settlement systems, and
options for enhanced central bank payment and settlement services with respect
1
See "Central Bank Survey of Foreign Exchange Market Activity in April
1992" published by the Bank for International Settlements, Basle, March 1993.
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to multi-currency and cross-border transactions.2
The recent report on central bank services, for example, pointed
to the significant expansion of the operating hours for large-value payment
systems as an important central bank option that could contribute to
reductions in risk in settlement practices. Longer hours for central bank
large-value payment systems would provide the banking sector3 with additional
flexibility in developing innovative methods to reduce time delays between the
settlement of the different legs of foreign exchange contracts. Such
innovations might include the development of delivery-versus-payment
techniques, in which one currency is paid (settled) when and only when the
contra-currency is also paid (settled), either by individual correspondent
banks or by groups of banks that are members of clearing arrangements. Over
the long run, such arrangements could substantially reduce Herstatt risks in
the settlement of multi-currency contracts. Even without the development of
delivery-versus-payment techniques, the possibility of greater harmonization
of the timing of currency settlements based on longer operating hours of
central bank large-value payment systems could help reduce time delays and
risks in settlements.
Significant advances in information technology have been
introduced to banking and financial markets in recent years. The level of
automation and sophistication of banking systems has increased rapidly and
likely will continue to do so for some time to come. In this environment, and
particularly during a time of increasing volumes, values, and sophistication
of financial transactions, advanced technology needs to be applied to payment
systems so that these systems can provide for both high efficiency and low
risk in the settlement of all kinds of economic transactions. The adoption
and implementation of this kind of technology, however, requires significant
lead times and careful, advanced planning.
Against this background, and following public comment on the
Board's October 1992 proposal to open the Fedwire funds transfer service two
hours earlier in the morning, the Board directed a staff task force (Fedwire
Study Group, see Appendix A of this notice) to discuss the issues involving
longer Fedwire hours with representatives of commercial banks and other
interested members of the public and to analyze the associated public policy
concerns. These discussions helped clarify the issues relating to the
2 Report on Netting Schemes, February 1989; Report of the Committee on
Interbank Netting Schemes of the Central Banks of the Group of Ten Countries,
November 1990; Delivery Versus Payment in Securities Settlement Systems,
September 1992; Central Bank Payment and Settlement Services With Respect to
Cross-Border and Multi-Currency Transactions, September 1993. These reports
are available through the Bank for International Settlements.
3 For discussion purposes only, references to bank include all
depository institutions, such as commercial banks, savings institutions, and
credit unions. As used in this docket, the term private-sector bank means any
bank (including a Federal Home Loan Bank) other than a Federal Reserve Bank.
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4
expansion of Fedwire hours and the difficulties in devising new techniques to
reduce settlement risks.
Consideration of the appropriate operating hours for the Fedwire
funds and securities transfer services must, in the first instance, take
account of the Federal Reserve's responsibilities as a central bank to support
final interbank settlement. The Federal Reserve Banks provide final interbank
payment and settlement services to the banking system through the transfer of
banks' balances (reserves and clearing balances) on deposit with Reserve
Banks. These balances--also called central bank money--are free of default
risk and are an integral part of monetary arrangements for the U.S. dollar.
"Instantaneous" intraday final payment in risk-free, central bank money is
delivered operationally to banks through the Fedwire funds and securities
transfer services. The benefits of such instantaneous intraday final payment
in central bank money are, in turn, available to the public through the
payment services provided by banks to their customers. To achieve this level
of finality, Fedwire and similar sophisticated central bank payment services
rely on a processing technique known as real-time gross settlement. In fact,
most G-10 central banks currently provide, or are in the process of
introducing, real-time gross settlement payment services, along the lines of
the Fedwire funds transfer service.4 (See Appendix B of this notice for a
discussion of the structure of large-value interbank payment arrangements.)
The following two public policy objectives can be stated for the
Fedwire funds and securities transfer services. These public policy
objectives are useful as a guide to analysis of expanded operating hours and
were used by the Fedwire Study Group to set the stage for discussions held
with the public. Fedwire should:
(1)
Provide a means that can be used to enhance the safety and
efficiency of U.S. dollar settlement arrangements, including
arrangements that rely on interbank settlement of netted
positions, particularly during periods of financial stress.
(2)
Respond to the needs of both existing and emerging financial
markets, including overseas markets, which depend on the U.S.
dollar and are increasingly reliant on state-of-the-art
technology.
Members of the Fedwire Study Group met with representatives of
various commercial banks, broker-dealers, and clearing organizations, and with
a group of corporate treasurers to discuss current problems in payment and
settlement arrangements. The Fedwire Study Group encountered a diversity of
4
The central banks of the European Union have recommended that every
central bank in the European Union install a real-time gross settlement
system. See Report to the Committee of Governors of the central banks of the
member states of the European Economic Community by the Working Group on EC
Payment Systems, "Minimum Common Features for Domestic Payment Systems"
(November 1993).
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5
views within the financial industry, and even within individual organizations,
regarding approaches to managing settlement risk and the use of Fedwire to
obtain real-time gross settlement in central bank money outside of current
operating hours.
The diversity of views is, in part, related to the functional
responsibilities of the individuals interviewed. For example, a number of
persons with credit management responsibilities in banks and other financial
firms tended to favor expanded Fedwire hours based on the potential benefits
associated with access to final, that is, irrevocable and unconditional,
settlement using central bank money--notably, potential reductions in
counterparty and systemic risk. In contrast, individuals with
responsibilities for transaction processing services and information
technology within banking organizations tended not to favor an expansion of
Fedwire operating hours because, for example, (1) they could not identify
customer demand for longer Fedwire hours, (2) there would be costs and
operational challenges associated with "off hour" services, and (3)
competitive responses by rival banking organizations would compel them to
undertake product and operational changes. In addition, many of those
interviewed also pointed to the charging of fees for Federal Reserve intraday
credit as creating a disincentive to the use of Fedwire funds and securities
transfer services during both regular and expanded hours of operation.
A main concern raised during the meetings held by the Fedwire
Study Group, particularly by executives and senior credit managers, was that
of settlement risk in foreign exchange dealings, or Herstatt risk. Those
expressing concern noted, however, that while expanded Fedwire funds transfer
operating hours might be useful as a component part of some new approaches to
controlling Herstatt risk, without changes in overall settlement practices,
longer hours would not be able to make a major contribution to risk reduction.
Further, changes in risk management techniques and settlement practices would
need to take account of a variety of operational and financial factors for
different currencies. Some of these issues are discussed further in Appendix
C of this notice.
Given that there is a reduced tolerance for temporal risk in
settlements, especially--but not solely--settlement of multi-currency
transactions, the Board anticipates that efforts to control settlement risk
will continue, with or without the support of central banks. The Board
believes, however, that final, real-time gross settlement through Fedwire
should play an important part in market efforts to control risk more
effectively. As discussed earlier, final settlements in central bank money
are free of default risk and, as a result, settlement in central bank money
provides the highest possible degree of certainty and liquidity in interbank
settlements.
The routine availability of Fedwire on an expanded schedule will
add final interbank payment capabilities that the markets, the Federal
Reserve, and other federal regulatory agencies recognize as being particularly
important during periods of financial stress. Only by becoming familiar with
the use of expanded Fedwire will banks be prepared operationally and
procedurally to use expanded final payment capabilities effectively. Over
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6
time, as the availability and use of expanded Fedwire capabilities becomes
more routine, operating procedures for using Fedwire earlier in the day will
become well tested and integrated into banks' operations and contingency
planning.
In addition, expanding Fedwire operating hours will eliminate an
operational barrier that stifles potentially important innovation in
privately-provided payment and settlement services. Expansion of Fedwire
operating hours will provide opportunities for market participants to
experiment with the use of real-time gross settlement to meet a variety of
market needs. New bank services and settlement arrangements based on real
time gross settlement will have the potential to reduce significantly banks'
own and their customers' settlement risks in the foreign exchange and other
markets.5 A particular application could be the development of deliveryversus-payment settlement techniques either for individual foreign exchange
transactions or for obligations arising from netting arrangements.
A Federal Reserve initiative to expand Fedwire funds transfer
operating hours also demonstrates a long-term commitment to increasing the
availability of real-time gross settlement services in the international
financial system. The Federal Reserve is taking a leadership role in the
international financial community in seeking to stimulate new or enhanced
central bank services to facilitate cross-border, multi-currency payments and
settlements. By expanding the operating hours of Fedwire, the Federal Reserve
will make it possible for banks to settle the U.S. dollar, with finality using
central bank money, during the banking and trading days of major international
financial centers in Europe and the Far East.6 Such a Federal Reserve
initiative looks to private sector banking organizations to develop improved
multi-currency services and settlement arrangements, in some cases relying on
Fedwire.
Finally, a clearly stated Federal Reserve policy regarding Fedwire
operating hours provides the certainty and stability banks have indicated that
they need to develop their own business and technology plans. This approach
to communicating Federal Reserve policy was requested both in public comments
on the Board's October 1992 proposal and in meetings with representatives of
the industry held by the Fedwire Study Group. As noted here, expanded Fedwire
funds transfer operating hours are announced three years in advance of
5
Examples of private sector initiatives currently underway
the development of multilateral netting systems for foreign exchange
transactions, such as Exchange Clearing House Organization (ECHO) and
Multinet.
include
Staff notes that the Bank of Japan recently expanded the operating
hours for its large-value funds transfer system to later in the Tokyo banking
day. Also, as noted earlier, the European Union central banks have recently
endorsed the establishment of real-time gross settlement systems in all EU
countries as well as closer coordination of operating hours for settlement
services.
7
implementation. Banks will have a clear understanding of the Federal
Reserve's intentions with respect to its operating hours and could use the
lead time to incorporate the expanded hours into their strategic plans for
payment services and supporting technical systems.
Fedwire on-line funds transfer operating hours will be expanded to
open at 12:30 a.m. ET (5:30 a.m. GMT and 2:30 p.m. Tokyo time) to support
strengthened, interbank settlement for domestic and cross-border markets.
This precedes the opening of the current European banking day by about three
hours and overlaps with current payment system and money market hours in Tokyo
by about two and one-half hours. This overlap of payment system hours could
increase further if, in the future, the operating hours of other national
payment systems were expanded.
The closing time for the Fedwire funds transfer service will
remain at 6:30 p.m. ET (11:30 p.m. GMT and 8:30 a.m. Tokyo time), in order not
to delay inordinately the calculation of U.S. dollar positions by U.S. banks
providing dollar clearing services to clients operating in the Asian markets,
or to disrupt domestic money management. Further, keeping the closing time at
6:30 p.m. ET will not disturb the reserve management operations of the large
number of smaller U.S. banks that are not active internationally and that are
unlikely to participate in an expanded Fedwire operating day.
The Federal Reserve's estimated incremental costs to operate the
funds transfer service from 12:30 a.m. ET to 6:30 p.m. ET will be roughly $2.5
to $4.0 million per year, or about 3 to 5 percent of the total cost of
providing the service in 1993. While the operational costs incurred by banks
using Fedwire during the expanded operating period are difficult to estimate,
such costs would be incurred entirely voluntarily. Banks could choose to
remain closed during the expanded operating period and thus forego any
additional operating costs.
Further, an 18-hour day (beginning at 12:30 a.m. ET and closing at
6:30 p.m. ET) provides an adequate six-hour quiet period within which banks
can perform end-of-day processing and provides for contingency situations. It
also provides for a definite period for measuring reserve positions, a
requirement for the conduct of monetary policy. There are some other minor
issues posed by an 18-hour Fedwire funds transfer day that are discussed in
Appendix C of this notice.
With respect to Fedwire securities transfer operating hours, under
current DVP arrangements, banks do not have the capability to control the
timing of deliveries of securities and associated debits to their funds
accounts. Accordingly, banks have limited control over the effect of
securities-related debits on their funds positions and their use of Federal
Reserve securities-related intraday credit. These control limitations could
lead to either increased operating costs or increased use of intraday credit,
with accompanying charges, during periods of expanded hours.
(See Appendix C
of this notice for further discussion.) In contrast to the Fedwire funds
transfer service, therefore, expanding the operating hours of the securities
transfer service would likely impose unavoidable costs on a large number of
banks. Thus, the Board believes that it is inadvisable at this time to
approve an expansion of the operating hours for the Fedwire securities
transfer service.
COMPETITIVE IMPACT ANALYSIS
During expanded Fedwire funds transfer operating hours, the
Federal Reserve Banks will be providing real-time gross settlement in central
bank money. While this service cannot be duplicated in the private sector,
this situation is no different under expanded operating hours than it is under
the existing Fedwire operating hours. Service providers that provide funds
transfer services under a netting arrangement could expand their operating
hours to coincide with Fedwire operating hours; however, only by setting
earlier settlement time(s) and settling through Fedwire could these
organizations provide risk-free central bank money earlier in the day to their
participants. Service providers that provide real-time gross settlement funds
transfer services across their own books could not solely backstop these
transactions with central bank money and, thus, could be reliant on their own
capital and credit standing to assure participants of final settlement.
Again, this situation is no different under expanded operating hours than it
is under normal Fedwire operating hours.
By order of the Board of Governors of the Federal Reserve System,
February 15, 1994.
William W. Wiles,
Secretary of the Board.
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Appendix A
FEDWIRE STUDY GROUP
Bruce J. Summers, FRB Richmond, Chair
Carol W. Barrett, FRB New York
Gayle Brett, Board staff
Paul Connolly, FRB Boston
Lisa Hoskins, Board staff
Dara Hunt, FRB Chicago
Oliver Ireland, Board staff
Barbara Kavanagh, FRB Chicago
Donald R. Lieb, FRB San Francisco
David E. Lindsey, Board staff
Jeffrey C. Marquardt, Board staff
Christopher J. McCurdy, FRB New York
Gerard J. Nick, FRB Chicago
Patrick M. Parkinson, Board staff
John H. Parrish, Board staff
Israel Sendrovic, FRB New York
A. Patricia White, Board staff
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Appendix B
STRUCTURE OF LARGE-VALUE INTERBANK PAYMENT ARRANGEMENTS
Most large-value, domestic interbank payments are currently made
via the transfer of money balances on the books of the Federal Reserve Banks
through the Fedwire system. Fedwire is the large-value payment system
operated by the Federal Reserve Banks for the transfer of funds and delivery
of book-entry (electronic) securities against payment. Fedwire is a real-time
gross settlement system that settles transfers immediately on a transactionby-transaction basis. The Fedwire funds transfer service is a credit transfer
process. That is, a bank sends a funds transfer to the Federal Reserve
instructing the Federal Reserve to debit its account for a specified amount
and to credit the account of another bank. In 1993, the daily average value
of transfers originated over the Fedwire funds transfer system was about $824
billion.
In contrast, the Fedwire securities transfer service, which is the
principal means for transferring and settling U.S. government securities,7 is
a debit transfer process that permits the seller of the securities to send a
transfer that will result in the Federal Reserve withdrawing funds from the
account of the receiver of the securities transfer. The Fedwire securities
transfer process is based on the delivery-versus-payment (DVP) principle,
whereby the final transfer of securities from the seller to the buyer
(delivery) occurs at the same time as final transfer of funds from the buyer
to the seller (payment). Fedwire achieves such simultaneous settlement by
treating the instruction initiated by the seller as both an instruction to
deliver securities to the buyer and an instruction to debit payment from the
buyer's reserve or clearing account. In 1993, the daily average value of
transfers originated through the Fedwire securities transfer system was
roughly $580 billion.
Banks may also provide settlement services to their customers
through the final transfer of balances across their books. In addition, banks
also use multilateral clearing and settlement arrangements to meet some of
their large-value payment needs. In such arrangements, including the Clearing
House Interbank Payments System (CHIPS) operated by the New York Clearing
House, payment instructions may be entered into a netting system throughout a
pre-determined clearing cycle and each participant's net position vis-a-vis
the other participants is determined on an ongoing basis throughout the cycle.
Settlement for the payment instructions occurs at an agreed upon settlement
time. Participants with net debit obligations may satisfy their obligations
by transferring funds on the books of a "settlement bank." Central banks can
serve as a "settlement bank" for such interbank netting arrangements and, in
7
Netting is performed outside Fedwire through the Government
Securities Clearing Corporation (GSCC) for transactions that settle on a next
day or forward basis, with the netted securities and funds positions settled
on Fedwire.
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11
the case of CHIPS, this role is performed by the Federal Reserve Bank of New
York.
In this arrangement, CHIPS settling participants in a net debit
position send Fedwire funds transfers to a settlement account at the Federal
Reserve Bank of New York, which, when fully funded, is the source for payments
to participants in net credit positions. In 1993, the daily average value of
transfers originated through the CHIPS system was over $1 trillion.
/d & 9 * /
12
Appendix C
ISSUES ASSOCIATED WITH EXPANDED FEDWIRE OPERATING HOURS
This appendix analyzes issues associated with expanded Fedwire
funds and securities transfer operating hours. The appendix is organized in
three parts. First, settlement practices in financial markets are analyzed,
with particular attention to Herstatt risk. Second, the operation of the
Fedwire securities transfer delivery-versus-payment service is analyzed.
Finally, other implementation issues associated with expanded Fedwire hours
are analyzed.
Settlement Practices in Financial Markets. The following
discussion of settlement practices and risks in financial markets takes into
account (1) the integrity of settlement during times of financial stress, (2)
multi-currency, cross-border settlements, (3) domestic corporate and interbank
markets and the needs of the futures markets, and (4) the current availability
of bank payment services on a 24-hour basis.
S e t t l e m e n t du r i n g times o f f i n a n c i a l stress.
Concerns regarding
the ability of counterparties to meet their payment obligations and the
certainty of settlement are heightened during times of financial stress.
Sudden events that disrupt markets can increase the risk associated with
domestic and, in particular, multi-currency transactions, and can contribute
to uncertainty, payment delays, and market liquidity problems. If such
problems are widespread, systemic risk may be increased substantially. It is
during times of stress in the financial markets that the certainty associated
with interbank settlement across the books of the central bank takes on added
importance.
In the past, the Fedwire funds transfer service has been opened
early on an ad hoc basis, at short notice, during times of stress in the
financial markets at the request of market participants and regulatory
authorities. For example, the Federal Reserve opened the Fedwire funds
transfer service early on the days following the October 1987 stock market
break and the beginning of the Gulf War. Experience has shown, however, that
market participants are not prepared operationally to use facilities, such as
Fedwire, when these facilities are made available during "off-hours" on an ad
hoc basis at short notice. These difficulties suggest that to be most helpful
during times of financial stress, Fedwire should be available in the early
morning hours on a more routine basis.
M u l t i - c u r r e n c y s e t t l e m e n t s . With respect to multi-currency
settlements, the settlement of a foreign exchange contract involves the
settlement of both currencies involved in the contract, such as the U.S.
dollar and the Deutsche mark or the U.S. dollar and the yen. In such
settlements, risk management and efficiency considerations must take into
account payment arrangements in the country of issue for each currency,
including the relative intraday timing of payments and the finality of payment
in the respective currencies. Settlement risk is incurred by paying final
funds in one currency before receiving final funds in another currency. As a
/o (o9<f
13
general matter, the magnitude of settlement risk in the foreign exchange
markets has grown substantially, in large part as a result of a vast expansion
of foreign exchange trading. At the same time, there has been continued
reliance on traditional methods of settling trades one currency at a time with
significant delays before related payments and contra-payments become final.
Because the large U.S. cities are in the western-most time zones
of the major financial centers, under current settlement arrangements for
multi-currency transactions, the U.S. dollar is normally the last currency to
be settled. The two charts at the end of this appendix provide information on
global time zone relationships and on the operating hours of selected largevalue interbank transfer systems in different countries.8
On an exception basis today, banks may choose to require final
payment of the U.S. dollar leg of a multi-currency transaction either in
advance of, or in certain cases simultaneously with, final payment of the
contra-currency, as a means to protect against risk of nonpayment.9 Foreign
exchange market participants have indicated that such protective measures are
taken, for example, in special cases where counterparties would exceed their
U.S. dollar credit lines. Banks, however, find these exception procedures to
be very expensive due to the lack of an established mechanism to effect
settlements under these terms (that is, final U.S. dollar payment before, or
simultaneously with, final payment in the other currency). For exception
processing, the parties must negotiate how the related payments are to be made
and closely monitor the settlement process to ensure that the payment sequence
unfolds as expected.
Substantially earlier Fedwire funds transfer service operating
hours as well as later payment system hours for other major currencies will
increase the opportunity to achieve simultaneous or near-simultaneous
settlements of individual deals involving the U.S. dollar and European and
Asian currencies, where needed. Such settlements might involve a variety of
new institutional designs for settlements, including private correspondent
bank DVP services, new clearing organization procedures, or innovative
arrangements that are not readily apparent given current payment system
constraints.
Current initiatives to reduce Herstatt risk in foreign exchange
transactions point to the need for greater future overlap of final interbank
settlement facilities in Asia, Europe, and North America. While in the future
Asian and European systems may well be open later during their local banking
days, the achievement of a significant overlap in payment system hours also
requires earlier opening hours for U.S. payment systems, especially to achieve
overlapping hours with Asian markets. With such earlier hours, opportunities
8 These charts were published in the report on Central Bank Payment and
Settlement Services with Respect to Cross-Border and Multi-Currency
Transactions, Basle, September 1993.
9 In markets for exchange traded derivative instruments, some
settlements are conducted currently using delivery-versus-payment techniques.
J O (o 9 y
14
may increase substantially for more nearly simultaneous settlements of multicurrency transactions, and associated reductions in Herstatt risk. It should
be noted, however, that although simultaneous or near-simultaneous payment for
multi-currency transactions reduces the temporal dimension of settlement risk,
achieving final payment in one currency against a simultaneous, but
provisional, payment in another currency does not eliminate fully Herstatt
risk. Therefore, to address fully the problem of controlling Herstatt risk,
it is important that the overlap in operating hours include overlap in systems
that provide final settlement in central bank money.10
D o m e s t i c markets.
With respect to domestic markets, there are
relatively few types of transactions for which immediate and final payment at
a particular time during the day is an absolute requirement. The demand for
final payment at a particular time during the day for corporate customers is
currently quite small and is limited to such things as payments to settle
mergers and acquisitions and the distribution of funds from underwritings of
securities. In general, because banks often make funds available to corporate
customers before final settlement, corporate customers are largely unaware of
the distinctions between final and provisional payment or when during the day
payments are actually settled. Instead, corporations generally rely on their
banks to make decisions regarding how their large-value payments are
originated and received.
Even in the interbank markets, participants are typically
satisfied with same-day settlement for certain types of transactions. At
present, Federal funds contracts do not generally stipulate that payment must
be made at or before a specific time of day other than before the close of the
Fedwire funds transfer service. Federal funds contracts are generally settled
using the Fedwire funds transfer system.
For some futures exchange settlements, the convention today is to
accept irrevocable commitments to pay from designated settlement banks to
cover clearing members' settlement obligations prior to the start of the
current day's trading, with the settlement banks actually fulfilling the
obligation via Fedwire funds transfers by 10:00 a.m. ET. The futures clearing
organizations and the Commodity Futures Trading Commission (CFTC) have
expressed a desire for settlement to occur in final funds before the
commencement of trading. Such earlier settlement is viewed as reducing risks
to futures exchanges and the financial markets despite some concerns that it
would merely shift risks from the clearing organizations to their settlement
10
Fedwire in the United States and BOJ-NET in Japan, for example,
currently provide real-time gross settlement services in the U.S. dollar and
yen, respectively. Significant projects to establish real-time gross
settlement systems are now underway in France, the United Kingdom, and other
countries, and legal developments are occurring that will help ensure the
availability of payment systems in all or most European countries that provide
for final payments on an intraday basis. Thus, in the next few years,
concerns about the lack of intraday final payment capabilities in major
industrialized countries are likely to be reduced substantially.
/ob9-Y
15
banks. Settlement banks would clearly need to manage carefully their own cash
needs earlier in the day in order to make settlement payments at an earlier
time, which is not necessary under current arrangements.
Within a few years, there may be a demand for later Fedwire funds
transfer hours from banks that provide services to the futures and options
markets. This demand could arise from two sources. First, some clearing
organizations are progressively moving toward same-day settlement of margin
obligations arising from the current day's trading activity. Second, some of
the exchanges are contemplating longer trading hours for certain of their
products. The exchanges are beginning to incorporate automated trade matching
and confirmation systems that will permit timely same-day calculation of all
margin obligations. Indications are that these systems, which will remove a
significant obstacle to same-day settlement, could be widely adopted within
three to five years. Longer trading hours, in combination with the desire for
same-day settlement, would argue for a later Fedwire funds transfer service
closing time.
To date, there has been little evidence of demand for a materially
later closing time for the Fedwire funds and securities transfer services to
meet domestic needs. The most likely source of demand to make later payments
is from the Pacific time zone. Banks with operations in that time zone,
however, have expressed only slight interest in later Fedwire hours in
response to requests for comment made by the Board of Governors in 1989 and in
1992. Moreover, many corporate treasurers generally view later-in-the-day
payments activity as disruptive to their primary goal of determining the
amount of money available for investment. This preference is, of course,
conditioned by current conventions in the U.S. money markets, especially the
times at which decisions must be made to invest or borrow funds.
B a n k payment services.
Currently, a number of large,
internationally active U.S. banks offer their customers real-time account
balance inquiry and payment services on a 24-hour basis. Many of these banks
offer the capability to originate payment instructions in up to 60 currencies.
Payment orders may be processed as book transfers or held in an electronic
queue until the national payment system for the currency to be paid is open
for business. Given current queuing practices, there would appear to be some
scope for earlier settlement of queued payments if international clearing
banks find it advantageous to process customer payments earlier in the day and
national payment systems are open to process and settle such payments.
Fedwire Securities Transfer Service. As mentioned earlier, most
interbank transfers of U.S. government securities are processed through
Fedwire. The DVP capability of the Fedwire securities transfer service
increases the efficiency and integrity of the securities clearance and
settlement process. In fact, the liquidity of the government securities
market is partly a function of the Fedwire securities transfer system design,
whereby the seller is assured of payment at the time the securities are
delivered. While it virtually eliminates settlement risk, the current design
of the Fedwire securities transfer service may, in some cases, result in
significant demands for intraday credit. Once Fedwire opens in the morning,
16
users of the Fedwire securities transfer service have no control over the time
at which they may receive securities on a DVP basis. In particular, since the
sellers of securities initiate the DVP transfers, receivers do not have any
operational control over the time during the day when their securities and
funds accounts are credited and debited, respectively.
Since the inception of the Board's Payment System Risk Reduction
Program, the implications of the cost of intraday credit have taken on greater
significance for participants in the Fedwire DVP securities transfer service.
Receivers of securities, especially those maintaining relatively low intraday
cash balances, are not in a position to manage their use of intraday Federal
Reserve credit resulting from securities deliveries. Because of the inability
to review transfers prior to receipt, this problem may be compounded if the
securities delivery is not known, or the delivery amounts are incorrect.
Although receivers of securities can reverse transfers received in error
virtually immediately after delivery and payment occur, they must very
actively monitor and manage their activity to be in a position to do so.
The charging of fees for Federal Reserve intraday overdrafts has
important implications for expanding the Fedwire securities transfer operating
hours. An expansion of such operating hours could impose significant cost
burdens on a potentially large number of banks that would need to make a
choice between staffing their operations to manage their intraday overdraft
positions, or remaining closed and incurring the costs of intraday overdrafts
that might arise from securities deliveries during "off-hours." In an effort
to provide participants with the tools necessary to manage their operations
and credit costs, the Federal Reserve is designing new Fedwire securities
transfer service features, including receiver controls (such as receiverauthorized deliveries) and a mechanism allowing participants to choose whether
to use the service during non-standard business hours. The Board believes
that public comment on these new service features is required because of the
impact they would have on senders and receivers of securities transfers and on
the operation of the U.S. government securities market.
Analysis of a potential expansion of Fedwire securities transfer
service operating hours must also take into account "free" transfers of
securities, that is, the movement of collateral. The ability to move
collateral during early morning Fedwire operating hours was identified as a
potentially useful measure by several clearing organizations and banks in
their comments on the Board's October 1992 Fedwire operating hours proposal.
The ability to pledge collateral during early morning hours can reduce
settlement uncertainties and enhance participant liquidity, particularly in
times of financial stress.
The discussion above suggests that careful attention must be given
in the near term to features of the Fedwire securities transfer service that
limit the control users of the service have over the receipt of securities,
particularly if the hours of operation for the service were to be lengthened.
The Board anticipates that the implementation of new service capabilities,
such as those discussed earlier, could reduce or even eliminate the
involuntary costs imposed on receivers of securities transfers, especially
during expanded operating hours. Under these conditions, the public benefits
jo
fc o y
u
of expanding these operating hours could be significant and would be derived
in part from the opportunities to use securities as collateral, or as a near
cash equivalent, for purposes of meeting obligations that arise overnight. At
present, however, an expansion of hours would not be advisable. The Board
believes that the issues surrounding the development and use of new features
for the Fedwire securities transfer service can be effectively addressed
through the public comment process during 1994.
Implementation Issues. Because of the aforementioned
complications associated with operating characteristics of the current Fedwire
securities transfer system, the following analysis of implementation issues is
limited to an expansion of Fedwire funds transfer service operating hours.
The key implementation issues addressed in this section are technology,
operational costs, monetary control and reserve management, overlapping
business and calendar days, and the Federal Reserve's intraday overdraft
policy.
T e c h n o l o g y issues.
Banks as well as other financial and nonfinancial institutions are installing or planning to install advanced
technology to support their critical business functions. For example, many
major banking organizations employ real-time control procedures to manage
their own and customer payments over major large-value electronic payment
systems. Many financial organizations are also continuing to automate major
dealing functions and integrate these with their clearing and payment systems.
In turn, in order to provide the banking and financial system with
advanced tools with which to design payment and settlement arrangements using
central bank money, the Federal Reserve is installing advanced computing and
communications systems. These systems will support all of the Federal
Reserve's national payment services and accounting functions. Among other
things, this new technology will enable the Federal Reserve to provide real
time gross settlement services in central bank money virtually around-theclock. Other benefits of this technology are expected to include greater
payments processing efficiency, improvements in the reliability and
availability of critical payment systems, and enhanced contingency processing
capabilities.
Most existing accounting and other back office systems require
that banks, including Federal Reserve Banks, accumulate a wide range of
transactions throughout the day in order to calculate and balance customer
account positions. Traditionally, this "end-of-day" processing has been
treated as a batch operation for which large quantities of information are
accumulated from a variety of sources and then processed overnight. For
example, information received from large commercial banks that provide
corporate payment services and U.S. dollar clearing services reveals that
their current systems have been designed to perform end-of-day processing
within an approximate six- to eight-hour window. Most large commercial banks
are either currently changing, or have plans to change, their systems to move
to a two- to four-hour end-of-day processing window, an evolution which should
be completed within about five years.
/a ( o 9 f
18
Contingency processing requirements also need to be considered in
connection with proposals to expand Fedwire funds transfer operating hours, or
bank payment system operations more generally. Specifically, for large
commercial banks, an 18-hour operating day compresses the current end-of-day
processing period, including a "cushion" of time to deal with the failure of
regular systems or other unexpected operational disruptions that must be
resolved before opening for the next day's business.
The Board believes that current efforts by banks and other
financial institutions to use technology to improve the efficiency of end-ofday processing will, over the next several years, reduce the time necessary to
perform these activities. Thus, with a 3-year lead time, an 18-hour Fedwire
day should provide an adequate cushion of time for end-of-day processing under
normal and most contingency conditions.
O p e r a t i o n a l costs.
The Reserve Bank's incremental costs to expand
operating hours can be estimated fairly accurately. The estimated incremental
costs to the Federal Reserve of lengthening the current 10-hour funds transfer
operating day to 18 hours are relatively small compared to the total cost of
providing the service. Specifically, the Board estimates that an 18-hour day
beginning at 12:30 a.m. ET will add roughly $2.5 to $4.0 million to annual
Fedwire funds transfer operating costs, or about 3 to 5 percent of 1993 total
service costs.11 (The Board recently asked staff to study issues related to
Federal Reserve pricing methodology, which is underway.)
The incremental costs that would be incurred by banks in using the
Fedwire funds transfer service during expanded hours are difficult to
estimate. In any event, the incremental operational costs to banks of
participating in expanded hours would be incurred entirely voluntarily. Banks
would make individual business decisions whether to use the Fedwire funds
transfer service during expanded hours.
M o n e t a r y control and re s e r v e m a n a g e m e n t issues.
The Board
believes that an expansion of Fedwire funds transfer operating hours,
involving a 6:30 p.m. ET closing time, does not complicate reserve maintenance
for banks. Also, provided that there is a sufficient break in time during the
operating day for purposes of measuring reserve holdings, monetary measurement
and control problems do not arise for the Federal Reserve. In the event of
full 24-hour operations, both monetary measurement and control issues would
need careful attention.
O v e r l a p p i n g b u s i n e s s a n d c a l e n d a r days.
One complication
associated with a Fedwire funds transfer day that begins earlier than 3:00
a.m. ET concerns asynchronous business and calendar days for domestic payments
and possibly for cross-border payments as well. For example, assuming a 6:30
p.m. ET closing time and an 18-hour Fedwire funds transfer day, the 12:30 a.m.
ET opening time is 9:30 p.m. Pacific Time (PT). This means that today's
11
The Federal Reserve's estimated incremental costs associated with
providing a near 24-hour operation are significantly higher than for an 18hour operation.
/o b 9 y
19
business day, as defined by the opening of Fedwire, begins on the prior
calendar day in continental United States time zones other than the Eastern
time zone. Some clarification or adjustment in accounting practices and
possibly legal conventions may be necessary to address this situation. These
adjustments do not appear to present large issues and they can be readily
addressed through such things as modifications in financial reporting
conventions and business practices.
For example, financial reporting conventions that rely on precise
"as of" reporting dates and times would appear reasonably to address most
reporting issues. Similarly, more precision may be needed in financial
contracts about when completion of a payment or other financial transaction
must occur. This is a problem that exists today and that is addressed in
contracts by specifying the location at which payment is to be made and the
date ("pay to my account in San Francisco on x date"). The new problem posed
by an earlier Fedwire opening time could be addressed readily by specifying
when during the day payment is to be made at a particular location ("pay to my
account in San Francisco by close of Fedwire on x date").
Federal Reserve daylight overdraft policy.
In an expanded Fedwire
funds transfer operating environment, Federal Reserve intraday credit will be
provided to banks on the same basis that it would be provided from 8:30 a.m.
ET to 6:30 p.m. ET. That is, eligible institutions will be able to incur
intraday overdrafts subject to the net debit caps and daylight overdraft fees
in place at the time the overdraft is incurred.
Some adjustments to the intraday overdraft measurement rules will
be required. For example, posting times for non-wire transactions settled on
the books of the Reserve Banks that are currently tied to the opening of
Fedwire, such as ACH and principal and interest payments for securities, need
to be adjusted. Since users will be accustomed to the current schedule, which
generally results in posting these transactions at 8:30 a.m. ET, a clear
option would be for the Board to consider establishing 8:30 a.m. ET as the
"explicit" posting time for these transactions.
20
/6 6 ? * /
Global time zone relationships:
Opening hours of selected large-value interbank transfer systems
For same value day *
GMT+9
Japan - FEYSS
Japan • BOJ-NET
12
GMT+1
15
18
21
24
03
06
09
12
15
18
21
24
03
06
09
12
15
18
21
Belgium - Clearing House
France • SAGITTAIRE
Germany - EAF
Germany • Electronic Transfer
• i t i i l * • I
Italy - SIPS
Ita ly -B IS S
Netherlands - 8007 S.W.I.F.T.
Sweden • RIX
Switzerland • SIC
ECU clearing system
GMT
09
12
15
18
24
21
18
03
21
24
03
06
09
12
15
GMT-5
06
Eastern standard time
09
12
15
18
21
24
03
06
09
12
15
18
21
24
03
06
09
Canada • IIPS
United States - Fedwire
United States • CHIPS
I
I
Opening hours of net settlement system (settlement finality indicated).
Opening hours of gross settlement system (intraday finality indicated).
•
Cut-off time for international correspondents' payment orders where applicable
(in most cases guidelines only, may be later in practice).
▼
Cut-off time for third-party payment orders where applicable.
* The diagram shows the opening hours, as of August 1993, of selected interbank funds transfer systems as they relate to the same value day;
some systems, including SAGITTAIRE and the ECU clearing system, may accept payment orders for a number of value days. As indicated,
some systems open on the day before the value day. For Canada, settlement finality for IIPS occurs on the next business day, with retroactive
value dating. Precise information on opening hours and cut-off times is provided in the table. For FEYSS, Fedwire and CHIPS, the cut-off time for
third-party and international correspondents' payment orders is the same.
21
ii i :
United Kingdom • CHAPS
I
18
12
15
/§L>9<j
21
Operating hours of selected large-value interbank funds transfer systems1
(as of August 1993)
System
Gross
(G) or
net
(N)
Openingdosing time
for same-day
value
(local time)
Settlement
finality (local
time)
Cut-off for
all thirdparty
payment
orders
Cut-off for
international
corres
pondents'
payment
orders
Memo item:
Standard
money market
hours
(local time)
Belgium
C.E.C.2 ...;;..........
Clearing House of
B elgium .............
N
13:46-13:453
16:30
13:30
8:3 d4
N
9:00-16:30
16:30
13:00
8:3 c)4
N7
N
8:00-16:00
18:00-24:00
15:00s
15:00s
14:309
17:00
16:009
(9:00-16:15s)
Canada6
UPS ....................
ACSS...................
(8:30-17:30)
n.a.
France
8:00-13:0010
8:00-17:15
18:30
8:00-17:15
n.a.
G
02)
8 :0 0 "
8 :0 0 "
Express electronic
credit transfer
system .................
G
8:30-14:30
8:30-14:30
03)
8:00"
Express (paperbased) local credit
transfer system ...
G
8:00-12:00
8:00-12:00
(13)
8 :0 0 "
EAF15.................
N
8:00-12:30
14:3016
(13)
8 :0 0 ''
Italy17
BISS ...................
S IP S ....................
ME .....................
G
8:00-17:00
16:30
16:30
17:00
14:00
16:00
9 :0 0 "
9 :0 0 "
9 :0 0 "
(8:30-17:30)
N
8:00-17:00
8:00-14:00
8:00-16:00
Japan
FEY SS...............
BOJ-NET...........
9:00-13:45
9:00-17:00
15:00
9:00-17:00
1 0:30'1
14:00
10:30"
(9:00-17:00)
G 18
Netherlands19
Central Bank
FA System .........
8007 S.W.I.F.T.
G
N
8:00-15:30
8:00-11:3020
8:00-15:30
13:00
12:45
Sweden
RIX..................
G18
8:15-16:302'
G
18:00-16:1523
N
8:30-15:1024
end of day
none
12:00"
(9:00-12:0b15)
Fedwire...............
CHIPS ................
G
N
8:30-18:30
7:00-16:30
8:30-18:30
18:0O27
18:00
16:30
18:00
16:30
(8:30-18:3d26)
ECU clearing
system..................
N
15:45
none
none
(TOM/NEXT29)
SAGITTAIRE.....
TBF (planned)....
N
(8:15-17:00)
Germany
(9:30-13:00'A)
N
N
n.a.
n.a.19
n.a.19
8 :0 0 "
8:15-1 e ^ 1
12:0022
8 :0 0 "
18:00-16:1
15:0c)23
(8:00-15:30)
(9:00-16:00)
Switzerland
• S I C .....................
(9:00-16:00)
United Kingdom
C H A PS...............
United States6
14:01-14:0628
@FedFRASER