## _cr10127 ## Source details **Canonical URL:** [_cr10127](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10127.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10127.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10127.pdf.json) --- ### Recommendation 1 — Legal basis, enforceability, and finality - Findings on legal basis and accessibility - Laws, regulations, rules, procedures, and contractual provisions governing the Fedwire Securities Service (FSS) are public and readily accessible to system participants. - Documentation is available on request and is accessible on Federal Reserve websites or, in some instances, other publically available websites. - Section 15 of the Federal Reserve Act (FRA) authorizes the Federal Reserve Banks (FRB) to act as fiscal agents for the Treasury. - TRADES regulations govern Treasury bonds, notes, and bills on the FSS and provide that state law governs rights and obligations to the extent consistent with TRADES; Article 8 of the UCC is the primary state law and has been adopted in all 50 states. - Each Reserve Bank publishes identical Operating Circulars (OC); OC 7, OC 1, and OC 5 specify respectively securities account/transfer terms, master account terms, and electronic access terms. - Under the Supremacy Clause (U.S. Constitution, Art. VI, cl. 2) federal regulations promulgated pursuant to statutory delegation carry the “weight of federal law” and pre-empt conflicting state law. - Enforceability, finality, and DVP - Transaction enforceability governed by TRADES, OC 7, and UCC Article 8. - OC7: unless rejected, all debits and credits with respect to a transfer become final at the time posted to participants’ securities accounts and, if against payment, the participants’ master accounts; notice of the transfer by the FSS is conclusive evidence. - OC7 provides a clear and effective legal basis for delivery versus payment (DVP); a DVP transfer is completed under OC7 when debits and credits for both securities and funds are made. - Book-entry, immobilization, and customer asset protection - FSS is an indirect holding system; Reserve Banks also operate a direct holding system (Legacy Treasury Direct). - All Fedwire-eligible securities are issued on a dematerialized basis; U.S. law supports dematerialized issuance. - Generally under U.S. law, fully-paid-for customer securities held in custody by an intermediary would not be deemed assets of the intermediary. - For insured depository institutions, the Federal Deposit Insurance Act (FDIA) governs distribution of customer securities on insolvency; for nonbank broker-dealers, SIPA and the U.S. Bankruptcy Code apply. - Netting and securities lending - U.S. law supports validity of netting arrangements; FSS does not provide netting services. - U.S. law supports securities lending arrangements; FSS does not provide securities lending services. - Cross-border participation and conflicts of law - FSS does not permit participation by foreign banks without a U.S. presence; non-U.S. laws are not directly applicable to FSS disputes. - Participants may settle Fedwire-eligible securities cross-border through intermediaries, custodians, or ICSDs that in turn hold securities in FSS; custodians participating in foreign CSDs need to address potential conflict of laws. - Assessment: Observed. ### Recommendation 2 — Trade confirmation and matching - Confirmation practices - Trades between direct market participants are confirmed immediately after execution through FICC’s Real Time Trade Matching service (RTTM); matching occurs in real-time (T+0). - FICC accommodates matching for direct and indirect participants; direct participant can submit trades for matching on behalf of an indirect participant via FICC’s Executing Firm service (over 900 Executing Firms). - FSS does not receive trade information nor require settlement-instruction matching prior to settlement. - Settlement instruction matching and returns - FSS does not require settlement instructions to be matched prior to settlement. - Securities transfers can be returned by the receiver via a new transfer identified as a return with a reversal code. - In 2008, less than 5 percent of transfers used the reversal code in FSS. - Oversight - SEC is the regulatory authority for FICC’s trade matching service; supervisors of relevant financial institutions check intermediaries’ internal controls. - Assessment: Observed. - Recommendation: The FSS should explore introducing an instructions matching mechanism prior to settlement. ### Recommendation 3 — Settlement cycle and failed trades - Settlement cycles - Standard settlement period for secondary market trades in Treasury and agency securities is T+1. - Market participants may bilaterally agree on earlier (same-day) or later (forward) settlement dates. - Settlement of agency mortgage-backed securities (MBS) occurs primarily on fixed monthly settlement dates administered through SIFMA. - Fails overview and statistics - FICC clears the large majority of trades in the U.S. government securities market and tracks/margins fails. - Fails are typically a very small percentage of overall trades, but extremely variable. - Fails overview (week ended November 18, 2009): aggregate fails ranged from under US$1 billion to just under US$9 billion compared to approximately US$2 trillion in gross trades and over US$750 billion in net obligations. - Fails by primary dealers — week ended November 18, 2009 (Billions of dollars): - U.S. treasury securities: Fails to receive 17.129; Fails to deliver 13.663 - Agency debt securities: Fails to receive 10.974; Fails to deliver 12.293 - MBS: Fails to receive 444.313; Fails to deliver 542.19 - Additional percentage indicators in the source: 0.0005 and 0.005 percent of gross trades and 0.001 and 0.013 percent of net obligations. - Facilities and market responses to fails - FSS rejects transfer instructions if no securities are available in originator’s securities account, resulting in failure to deliver. - FSS does not provide automated securities lending; well-developed securities lending and reverse repo markets allow participants to “borrow” securities. - When certain issues become “special” in the repo market, the U.S. Treasury has provided additional supply by re-opening issues and selling additional supply. - Incentives and regulatory capital treatment for fails - 1988 FR limit: US$50 million on Fedwire securities transfers to encourage splitting large trades. - Under U.S. Basel I-based rules: unsettled transactions in U.S. government or GSE securities without a positive margin typically receive a 20 percent risk weight. - Under U.S. Basel II-based rules: bank's positive current exposure receives a risk weight from 100 percent to 1,250 percent based on days past settlement date; unsettled non-DVP/non-PVP treated as wholesale exposures until the fifth business day, thereafter 50 percent deduction from tier 1 and 50 percent from tier 2 capital of current market value of deliverables owed. - Broker-dealer SEC net capital rules require additional capital for fails outstanding past a certain period. - CCP developments - Industry concluded to establish a CCP for MBS; FICC proposed FICC-MBSD as CCP for agency MBS and has filed a proposed rule change with the SEC. - Assessment: - Settlement cycle for non-MBS Fedwire-eligible securities is generally shorter than T+3 — Observed for non-MBS Fedwire-eligible securities. - For MBS, settlement primarily on fixed monthly dates — Broadly observed; recommendation not fully observed for MBS. For compliance, MBS should be settled no later than T+3. ### DVP technical framework and volumes - DVP processing and finality - FSS processes securities transfers individually in real-time with simultaneous transfer of securities and associated payments; finality upon posting to master accounts. - FSS links to the Fed centralized accounting system for funds (not to Fedwire RTGS). - Intraday funding and caps - DVP transactions may settle with positive cash balances or via intraday credit (daylight overdrafts); account holders are subject to net debit caps assigned/approved by their Reserve Bank. - Volumes (2008) - Average daily value of transfers settled for direct participants and their customers on FSS on a DVP basis: US$1.66 trillion (Approximately 85 percent of total securities transfer volume). - Remaining 15 percent of FSS transactions are free of payment (FOP) transactions, primarily intra-bank transfers. - Settlement finality and intraday finality - FSS provides real-time final settlement throughout the settlement day; OC7 Section 9.1 states debits and credits become final and irrevocable when Reserve Bank posts them. - Links to foreign CSDs - FSS does not have any direct links with other CSDs. ### Intraday credit, net debit caps, and credit risk controls - Part II of the PSR policy and intraday credit - Federal Reserve extends intraday credit (daylight overdrafts) under Part II of the PSR policy with rigorous risk controls, collateral requirements and limits. - Participants expected to extinguish daylight overdrafts by the end of the Fedwire Funds Service operating day (18:30 Eastern Time). - If overdrafts are not extinguished, participant charged for an overnight overdraft at a penalty rate; overnight overdrafts discouraged and may attract supervisory attention. - Net debit cap mechanics and eligibility - Net debit cap formula: Net debit cap = cap multiple x capital measure. - Net debit cap varies with changes in institution’s capital measure and is discretionary by Reserve Banks. - Only participants with routine discount window access are eligible for a positive net debit cap. - Collateral and security interests - PSR policy generally does not require pledged collateral for daylight overdrafts; healthy participants may pledge collateral for capacity in excess of net debit caps subject to Reserve Bank approval. - Collateral pledged is marked-to-market or internally valued and subject to haircuts per Federal Reserve methodology. - Legal agreements grant Reserve Banks a security interest in funds, securities, and other property held at the Reserve Banks as collateral for any overdraft. - A security interest in favor of a Reserve Bank attaches automatically to Fedwire-eligible securities when purchased using the Reserve Bank’s intraday credit; this interest has priority over conflicting security interests. - Fees and transfer limits - Daylight overdraft fee history: initial annual rate 24 basis points in 1994; increased to 36 basis points on April 13, 1995. - Overdraft fee applied to a measure of average daily overdrafts less a deductible amount related to the institution’s capital. - Transfer-size limit on book-entry securities: US$50 million limit imposed in 1988. - Risk monitoring and supervisory coordination - Reserve Banks monitor participant condition, may reduce net debit caps, impose collateralization or balance requirements, reject or delay transactions, take institution off line or prohibit FSS use. - To minimize FRB credit risk, FRBs monitor financial condition and apply controls including eliminating intraday credit access if condition deteriorates. - Assessment comment: - The Fed’s net debit caps limit intraday credit; recommendation to continue monitoring residual DVP funding risks from uncollateralized intraday credit and assess whether additional mitigation such as collateral is needed. - Recommendation excerpt (Recommendation 10): Assets used to settle ultimate payment obligations should carry little or no credit or liquidity risk; if central bank money is not used, steps must be taken to protect CSD members from potential losses and liquidity pressures arising from failure of the cash settlement agent. ### Concentration, settlement agents, and tri-party repo risks - Concentration statistics and role of clearing banks - Approximately 2,600 depository institutions use the FSS. - In 2008 the top 20 participants accounted for 97 percent of the total transfer value. - As of year-end 2008, the two clearing banks (JPMC and BoNY) initiated approximately 71 percent of securities transfers by volume and approximately 80 percent by value on the FSS. - Two clearing banks also provide settlement for Fedwire-eligible securities for primary dealers and major participants, producing high concentration of “on-us” transfers. - Tri-party repo and funding dependence - Tri-party repo facilities are a main source to fund broker-dealer inventory; collateral returned early next morning. - Dealers heavily rely on intraday credit provided by JPMC and BoNY; this intraday credit is uncommitted but collateralized. - Assessment comment: High concentration in JPMC and BoNY and heavy reliance on their intraday credit could be disruptive if a clearing bank encounters problems or refuses to extend credit. - Suggested mitigation measures - Increase liquidity resilience of cash borrowers in the tri-party market. - Reduce the tiering of settlements. - Address the nature and size of intraday credit extensions by the clearing banks. - Industry task force actions - Payment Risk Committee task force exploring: collateral substitution/asset margining/portfolio margining; reducing funding risk of fixed income dealers; liquidation issues (transparency on collateral type/valuation and liquidation procedures to avoid fire-sale conditions); mitigating pro-cyclicality of risk management procedures. - Progress report released; final report expected during 2010. ### Operational risk, contingency planning, capacity, and availability (Recommendations 11–12) - Operational risk management and security - Reserve Banks have defined IT architecture, policies for IT development/operations/security, and comply with FISMA and FRBNY operational risk management. - Dedicated technical and software specialists monitor Fedwire applications daily; robust application and network testing including penetration and stress testing. - Contingency capabilities and testing - Multiple out-of-region backup data centers and redundant out-of-region staffs; real-time logging to primary and secondary backup data centers. - On-site and remote-site recovery tests conducted each year. - Participants can originate securities transfers offline via telephone and must develop their own contingency/recovery plans; most active participants must participate in a minimum number of contingency tests each year. - Post-disruption reconciliation: Reserve Banks issue reports listing transfers to identify sequence gaps; participants resend transfers within gaps flagged as possible duplicates. - Availability and scalability - In 2008, the Fedwire securities application was available for 100 percent of its operating hours. - Availability standard for Fedwire securities: 99.9 percent of operating hours. - Fedwire Securities capacity sized to accommodate up to 2 million transfers a day. - Daily average volumes between 2007 and 2008 were essentially flat. - Lehman crisis volumes: August 2008 daily average 91,000 transfers; Sept 15 and 16, 2008 about 120,000 and 130,000 transfers respectively; other peaks: Sept 22 about 129,000 and Sept 25 about 125,000 transfers; other days in Sept 12–29 ranged from 74,000 to 94,000 transfers a day. - Transaction capacity is now more than two times the highest number processed in one day; in 2008 the highest daily volume processed was 482, 443. - Audits and reviews - Independent external auditors conduct annual risk-based review of IT systems supporting FSS; most recent review completed as of September 30, 2009. - Assessment: Observed. ### Protection of customers' assets, inventory control, custody supervision (Recommendation 12) - Customer asset protection and UCC Article 8 - FSS is an indirect holding system; Reserve Banks maintain records of direct participants; direct participants maintain client holdings records. - UCC Article 8 requires intermediaries to maintain sufficient investment property to satisfy customer claims and generally prohibits use of customer securities in intermediary’s business except as agreed. - Customers of an insolvent intermediary are generally able under U.S. law to obtain fully-paid-for securities and move positions to a solvent intermediary. - Reporting, reconciliation, and supervision - Daily activity reports and account holdings reports provided as often as daily; audit confirmations provided on request. - Custodian activities of the two clearing banks are subject to supervision by the Federal Reserve and other supervisors. - Assessment: Observed. ### Governance, user participation, access, and participation criteria (Recommendations 13–14) - Governance and representation - Reserve Banks operate FSS consolidated through FRBNY’s Wholesale Product Office (WPO); WPO sets strategic direction subject to Financial Services Policy Committee (FSPC) review. - WPO consists of 18 people and reports regularly to the FSPC. - Clear legal separation exists between operators (Reserve Banks) and overseer (Federal Reserve Board). - Assessment: Observed. - Recommendation: WPO should include representatives of smaller and midsize participants. - Access rules and restrictions - Eligible applicants for securities accounts include depository institutions, U.S. agencies, branches of foreign banks, member banks, the Treasury, certain statutorily authorized entities, Edge and agreement corporations, foreign central banks and monetary authorities, and foreign governments. - To send/receive securities against payment, a participant must also maintain a master account per OC 1. - Eligibility rules require applicants (other than official entities) to be resident in the United States; foreign banks without a U.S. presence are not permitted access. - Nonbank broker-dealers are prevented from direct access to Fedwire due to lack of banking license. - Exit: OC1 Section 2.8 requires at least 5 business days’ advance notice to terminate a master account; Reserve Banks can terminate with generally at least 5 business days’ notice. - Assessment: Partly observed. - Recommendation: Federal Reserve should be given legal authority to open accounts and provide services, at a minimum, for payment, clearing, and settlement infrastructures. ### Cost-effectiveness, fees, service review, and operating hours (Recommendation 15) - Cost recovery and pricing - MCA requires Reserve Banks to set fees to recover all direct and indirect costs including imputed costs; fees set nationally and reviewed annually. - Capacity and operating hours - Transaction capacity more than two times highest daily transactions (2008 highest daily volume 482, 443). - Core operating hours: 8:30 a.m. to 3:15 p.m. ET. - Online participants may initiate reversals until 3:30 p.m. ET and move/reposition securities until 4:30 p.m. against payment and until 7:00 p.m. free of payments. - Offline participants may initiate securities transfers from 9:00 a.m. to 1:30 p.m. ET for same-day processing and until 4:00 p.m. ET for future-day processing. - Under special circumstances WPO may extend operating hours. - Comment/recommendation: Operating hours are relatively short compared to other CSDs; Fed should reassess business case to extend operating hours. - Assessment: Observed. ### Communication standards, disclosure, and oversight (Recommendations 16–18) - Communication standards - FSS uses proprietary message format translatable to international standards; WPO participates in standards groups such as SWIFT but has no plans to adopt SWIFT/ISO for FSS; customers have not expressed interest to move to international standards. - Assessment: Observed. - Comment: International standards could become relevant if remote access were allowed. - Disclosure of rules and self-assessment - Laws, rules, and procedures governing FSS are publicly available; key financial and operational risks and participation costs are publicly disclosed. - FSS has published a self-assessment in line with the CPSS/IOSCO assessment methodology; PSR policy expects systemically important systems to complete and publicly disclose the self-assessment. - Assessment: Observed. - Regulation, oversight, and legal basis - Oversight by the Federal Reserve Board; assessments against CPSS-IOSCO reviewed every two years and when significant changes occur; Board conducts on-site inspections and off-site monitoring. - Reserve Banks operating FSS are subject to Treasury principles and requirements; Treasury’s Bureau of the Public Debt and Inspector General may examine certain fiscal agent activities. - Government Accountability Office (GAO) can review certain Reserve Bank activities at direction of Congress. - Statutory basis for oversight is the Federal Reserve Act (U.S. Code Title 12, Sections 248(j) and 485) derived from Board’s authority to supervise Reserve Banks rather than a specific authority to oversee securities settlement systems. - Board resources: about 7 budgeted staff work full time on policy and oversight for FSS, Fedwire Funds Service, and National Settlement Service. - Cross-border cooperative oversight does not exist since FSS has no direct foreign links and settles only in U.S. dollars. - Assessment: Observed. - Recommendation: Fed should be provided legal basis to oversee systemically important payment, clearing, and settlement market infrastructure. ### Links and cross-border settlement (Recommendation 19) - Findings and applicability - FSS does not have any cross-border direct link in place. - Assessment: Not applicable. - Comments/recommendations: - No cross-border link because foreign CSDs without U.S. legal presence and a banking license cannot open securities accounts at the Fed. - Fed should consider monitoring the functioning of indirect links where major custodians are involved in cross-border transfers of FSS eligible securities between FSS and foreign CSDs. - Assessment methodology lacks clear guidance on assessing indirect links. ### Key statistics and exact figures (preserved verbatim) - Average daily DVP transfers (2008): US$1.66 trillion (Approximately 85 percent of total securities transfer volume). - Remaining FOP transactions share: 15 percent. - Aggregate fails (week ended November 18, 2009): under US$1 billion to just under US$9 billion. - Comparison volumes: approximately US$2 trillion in gross trades and over US$750 billion in net obligations. - Fails by primary dealers (week ended November 18, 2009) — Billions of dollars: - U.S. treasury securities: Fails to receive 17.129; Fails to deliver 13.663 - Agency debt securities: Fails to receive 10.974; Fails to deliver 12.293 - MBS: Fails to receive 444.313; Fails to deliver 542.19 - Percentage indicators: 0.0005 and 0.005 percent of gross trades and 0.001 and 0.013 percent of net obligations. - Dematerialization: of approximately US$5.8 trillion (par value) of Treasury securities held in custody by FSS as of year-end 2008, 99.9 percent are dematerialized. - Securities issued prior to 1986 represent less than 0.01 percent of outstanding Treasury securities and may be held in certificated form. - Fedwire securities availability (2008): 100 percent of operating hours; availability standard 99.9 percent of operating hours. - Fedwire Securities capacity: up to 2 million transfers a day. - Lehman crisis volumes: August 2008 daily average 91,000 transfers; Sept 15 and 16, 2008 about 120,000 and 130,000 transfers respectively; highest daily volume processed in 2008 was 482, 443. - Number of depository institutions using FSS: approximately 2,600. - 2008 concentration: top 20 participants accounted for 97 percent of total transfer value. - Two clearing banks (JPMC and BoNY) initiated approximately 71 percent of securities transfers by volume and approximately 80 percent by value on the FSS as of year-end 2008. - Net debit cap formula: Net debit cap = cap multiple x capital measure. - Daylight overdraft fee history: initial annual rate 24 basis points in 1994; increased to 36 basis points on April 13, 1995. - Transfer-size limit imposed in 1988: US$50 million. - Board oversight staff: about 7 budgeted staff work full time on policy and oversight for FSS, Fedwire Funds Service, and National Settlement Service. - WPO staffing: 18 people. - FICC Executing Firms: over 900. - Minimum advance notice to terminate a master account per OC1 Section 2.8: not less than 5 business days. - Operating day end time for Fedwire Funds Service: 18:30 Eastern Time. - Core operating hours of FSS: 8:30 a.m. to 3:15 p.m. ET; reversal transactions until 3:30 p.m. ET; repositioning until 4:30 p.m. against payment and until 7:00 p.m. free of payments; offline participant initiation 9:00 a.m. to 1:30 p.m. ET for same day processing and until 4:00 p.m. ET for future day processing. - Assessment status highlights: many recommendations rated Observed; Recommendation 3 for MBS rated Broadly observed/not fully observed; Recommendation 14 (access) rated Partly observed; Recommendation 19 (links) Not applicable. ### Consolidated recommended action plan (selected items) - Recommendation 2: Explore introducing an instructions matching mechanism prior to settlement. - Recommendation 3: MBS should be settled no later than T+3; assess CCP implementation for MBS (FICC-MBSD proposed rule change filed with SEC). - Recommendation 9 / DVP funding risks: Continue monitoring residual risks from uncollateralized intraday credit and assess additional mitigation such as collateral. - Recommendation 13: WPO should include representatives of smaller and midsize participants. - Recommendation 14: Provide Federal Reserve legal authority to open accounts and provide services, at minimum, for payment, clearing and settlement infrastructures. - Recommendation 15: Re-assess the business case for extending FSS operating hours. - Recommendation 16: Consider adoption/compatibility with international communication standards if remote access is allowed. - Recommendation 18: Provide Fed legal basis to oversee systemically important payment, clearing, and settlement infrastructures. - Recommendation 19: Monitor indirect cross-border links involving major custodians. ### Authorities’ response (key points) - U.S. authorities strongly support the FSAP program and welcome the independent review. - Authorities note a high degree of compliance of the Fedwire securities service with CPSS-IOSCO Recommendations and largely agree with comments and recommendations. - Authorities will explore introducing settlement instruction matching in Fedwire securities service, considering costs and benefits. - Authorities will reassess the business case for extending Fedwire securities service operating hours and seek ways to ensure needs of smaller and midsize participants are addressed. - On MBS settlement to T+3, authorities agree in principle but note need for careful study and consultation given instrument characteristics and operational changes; near-term risk reduction efforts should focus on industry proposal to implement a CCP for MBS. - On residual intraday credit risks, authorities state a rigorous program for assessing, monitoring, and mitigating these risks is in place and is being strengthened following a comprehensive policy review from 2006 to 2008 and the planned implementation of an explicit collateralization policy in late 2010 or early 2011. - Authorities are confident residual risks are adequately monitored and controlled and appreciate the assessment’s contribution to stability and supervision. *Source: IMF staff content from the provided PDF chapter/section.* ### 1. Detailed Assessment of Observance of the Fedwire Securities Service’s ### Detailed Assessment of Observance of the Fedwire Securities Service’s of the CPSS-IOSCO Recommendations for Securities Settlement Systems ### Recommendation 1 — Legal basis, enforceability, and finality - Description: Securities settlement systems should have a well-founded, clear and transparent legal basis in the relevant jurisdiction. - Accessibility of the regulatory framework (Q1) - Laws, regulations, rules, procedures, and contractual provisions governing the operations and activities of the Fedwire Securities Service (FSS) are public and readily accessible to system participants. - Documentation is available on request and is accessible on Federal Reserve websites or, in some instances, other publically available websites. - Legal basis (Q2) - Section 15 of the Federal Reserve Act (FRA) authorizes the Federal Reserve Banks (FRB) to act as fiscal agents for the Treasury. - Several Federal statutes empower the FRB to act as agent for other federal and international issuers such as government-sponsored enterprises and multinational and regional development banks or other international organizations. - The Treasury promulgated the TRADES regulations to govern Treasury bonds, notes, and bills on the FSS. TRADES regulations provide that state law governs the rights and the obligations of the various parties with respect to the book-entry securities to the extent such state law is consistent with TRADES. Article 8 of the UCC is the primary state law that applies to book-entry securities and has been adopted in all 50 states. - Each Reserve Bank publishes identical Operating Circulars (OC) for the FRB’s various services that describe the terms agreed upon by participants. Under both UCC art. 8 and the TRADES regulations, these agreements have a special status as clearing corporation agreements and, therefore, govern the rights of FSS participants even if the agreement conflicts with UCC Article 8. (TRADES regulations, however, require the OCs to be consistent with TRADES.) - Under the Supremacy Clause of the U.S. Constitution, federal laws are the “supreme law of the land” in the United States and pre-empt conflicting state law (U.S. Constitution, Art. VI, cl. 2). U.S. federal courts have recognized that a regulation promulgated by a federal agency pursuant to a statutory delegation of authority from Congress carries the “weight of federal law” and also pre-empts conflicting state law. - OC 7 sets forth the terms under which each FRB maintains securities accounts and effects transfers of FSS eligible assets for participants in the system, including the terms under which the FRBs hold book-entry securities in custody for the benefit of a state or local government or unit thereof to which the securities have been pledged. - OC 1 sets forth the terms for opening, maintaining and terminating a funds account with a Reserve Bank. - OC 5 sets forth the terms under which a participant may access FRB services, including FSS, by means of electronic connections. - Legal Basis for Book-Entry Transfers - Book-entry transfers on FSS are governed by the laws, rules, and agreements described above, which provide certainty about dematerialization and immobilization and set out other rules governing book-entry transfers. - Enforceability of transactions - Transaction enforceability is governed by TRADES (and the equivalent regulations of other issuers), OC 7, and UCC Article 8. - Article 8 of the UCC sets out rules regarding the rights and obligations of entitlement holders, securities intermediaries, and other parties in both direct and indirect systems for holding securities. - TRADES regulations govern the rights and obligations of the U.S. government and the Reserve Banks with respect to the operation of the FSS and the servicing of Treasury securities. - Customers’ assets protection - FSS is an indirect holding system: participants hold accounts with the FRBs, and non participants hold accounts on the books of a participant or some other intermediary. - The Federal Reserve also operates a direct holding system (Legacy Treasury Direct) on behalf of the U.S. Treasury for investors in U.S. Treasury securities. - Generally under U.S. law, fully-paid for customer securities held in custody by an intermediary would not be deemed as assets of the intermediary. - Indirect holders are not entitled to claims against an issuer, but rather against the intermediary on whose records the Fedwire eligible security is reflected. - For insured depository institutions, distribution of customer securities should the insured depository institution become insolvent is governed by the liquidation provisions of the Federal Deposit Insurance Act (FDIA). These provisions generally provide that the beneficial owner of Fedwire eligible securities held by a failed bank normally would be entitled to the security if the customer’s exclusive ownership is sufficiently documented. - The failure of nonbank broker dealers would require application of the Securities Investor Protection Act (SIPA) and the U.S. Bankruptcy Code. Other entities would be governed by the U.S. Bankruptcy Code. - Immobilization or dematerialization of securities - All Fedwire-eligible securities are issued on a dematerialized basis. U.S. law supports the issuance of securities in a dematerialized form. - Netting arrangements - U.S. law supports the validity of netting arrangements related to securities transactions. - FSS does not provide netting services. - Securities lending arrangements - U.S. law supports securities lending arrangements, but FSS does not provide such services. - There are well-developed securities lending and reverse repo markets in Fedwire-eligible securities allowing participants to “borrow” securities to fulfill settlement obligations. - Securities market lending operations, including close-out of securities lending transactions and pledges of collateral underlying securities lending transactions, are explicitly protected in the event of an insolvency of a counterparty. - Finality of settlement - OC7 states that, unless a transfer is rejected by FSS, all debits and credits with respect to a transfer become final at the time that debits and credits are posted to the participants’ securities accounts and, if the transfer is against payment, the participants’ master accounts. - Notice of the transfer by the FSS is conclusive evidence that the debit(s) and credit(s) were made. - Delivery versus payment (DVP) - OC7 provides a clear and effective legal basis for DVP. - A securities transfer may be (1) a securities transfer that does not involve any funds credit or debit to the master account other than a transaction fee (free transfer) or (2) a securities transfer accompanied by a funds credit to a master account of the sender and a funds debit to the master account of the receiver, for the amount of the transfer (transfer against payment). - A DVP transfer is completed under OC7 when the debits and credits associated with both the securities transfer and the funds movements are made. - Challenges by a court - So far, no court in the jurisdiction has failed to uphold the legal basis for these activities/arrangements. - Enforceability of rules and regulations in the event of a bankruptcy (Q3) - Rules and contracts related to the operations of the FSS are enforceable in case of participant insolvency. - U.S. insolvency law does not include a zero-hour rule that allows the unwinding of securities transfers. - Both the Bankruptcy Code and the FDIA generally uphold the enforceability of securities contracts even when the securities are held by a financial intermediary, notwithstanding the insolvency of one of the parties in the contract. - Conflict of law issues (Q4) - FSS does not permit participation by foreign banks without a U.S. presence; laws of non U.S. jurisdictions are not directly applicable to disputes involving FSS participants. - Assessment: Observed. - Comments: - Participants in FSS may settle Fedwire-eligible securities cross-border through intermediaries that are participants in or custodians for other central securities depositories (CSDs) or international CSDs (ICSDs). ICSDs hold U.S. Treasury securities and have executed transfers in U.S. securities through their U.S. correspondent custody banks, which in turn hold the securities in FSS. - Custodian banks that participate in foreign CSDs need to address potential conflict of laws between U.S. law and the laws in the foreign (I) CSD jurisdictions. ### Recommendation 2 — Trade confirmation and matching - Description: Confirmation of trades between direct market participants should occur as soon as possible after trade execution, but no later than trade date (T+0). Where confirmation of trades by indirect market participants is required, it should occur as soon as possible after trade execution, preferably on T+0, but no later than T+1. - Confirmation of trades between direct market participants (Q1) - Trades between direct market participants are confirmed immediately after trade execution through a system provided by the Fixed Income Clearing Corporation (FICC). - Trades submitted to FICC are matched in real-time on FICC’s Real Time Trade Matching service (RTTM). The RTTM service provides an immediate confirmation of the trade match to FICC’s participants. - Confirmation of settlement instructions (prior to settlement) (Q2) - FSS does not require settlement instructions to be matched prior to settlement. - Securities transfers over FSS can be returned by the receiver through the initiation of a new transfer (identified as a return with a reversal code). - In 2008, less than 5 percent of transfers used the reversal code in FSS. Some of those transfers were likely due to reasons other than unmatched settlement instructions. - Confirmation between direct and indirect participants (Q3) - FSS does not receive trade information (settlement instructions are not tied to specific trades, or may not be related to trading activity), and therefore does not provide or require trade confirmations. - FICC provides trade matching that accommodates both direct and indirect participants. - A direct participant can submit trades for matching on behalf of an indirect participant through FICC’s Executing Firm service. Currently, FICC has over 900 Executing Firms using the service. - FICC monitors the use of its trade matching facility by direct members and knows who is submitting trades and for whom, because required data fields include contra-party identification (direct or indirect participants). - FICC matches trades in real-time as they are submitted by participants; thus, matching occurs on T+0 for direct and indirect participants of FICC. - FICC rules require direct members to submit all their trades executed with another member to FICC. - The SEC is the regulatory authority for FICC’s trade matching service; supervisors of relevant financial institutions have responsibility for checking the internal controls of intermediaries related to their securities clearance business. - Assessment: Observed. - Comments: - The FSS should explore the possibility of introducing an instructions matching mechanism prior to settlement. ### Recommendation 3 — Settlement cycle and failed trades - Description: 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 assessed. - Rolling settlement cycle (Q1) - The standard settlement period for trades in the secondary market for Treasury and agency securities is T+1. - Market participants may agree bilaterally to settle a particular trade on an earlier (same-day) or later (forward) date. - Settlement of agency mortgage-backed securities occurs primarily on fixed monthly settlement dates established by the industry and administered through the Securities Industry and Financial Markets Association (SIFMA). - Failed trades (Q2) - Market participants may fail to deliver securities to discharge (settle) a trade for a variety of reasons involving economic incentives as well as securities inventory issues. - For trades cleared by FICC, FICC would track and margin such fails (FICC clears the large majority of trades in the U.S. government securities market, especially high-value trades). - Although the level of fails to deliver in the U.S. government securities market is extremely variable, it is typically a very small percentage of overall trades. - Data provided by FICC, the CCP for the U.S. government securities market, indicates that in the most recent three months (September – November 2009) fails typically run between - [Note: the source text ends here; no further numerical detail provided in the excerpt.] *Detailed Assessment of Observance of the Fedwire Securities Service’s of the CPSS-IOSCO Recommendations for Securities Settlement Systems* ### 0.0005 and 0.005 percent of gross trades and 0.001 and 0.013 percent of net obligations ### 0.0005 and 0.005 percent of gross trades and 0.001 and 0.013 percent of net obligations ### Fails overview (week ended November 18, 2009) - In aggregate value terms, fails ranged from under US$1 billion to just under US$9 billion during the period compared to approximately US$2 trillion in gross trades and over US$750 billion in net obligations. - Fails by primary dealers — week ended November 18, 2009 (Billions of dollars): - U.S. treasury securities: Fails to receive 17.129; Fails to deliver 13.663 - Agency debt securities: Fails to receive 10.974; Fails to deliver 12.293 - MBS: Fails to receive 444.313; Fails to deliver 542.19 - FICC’s internal data largely tracks similar data on fails collected by the Federal Reserve from the primary dealers. - Source of table data: http://www.newyorkfed.org/markets/pridealers_failsdata.xls ### Facilities to smooth settlement process - Securities transfer instructions to the FSS are rejected if no securities are available in the originator’s securities account at the Federal Reserve, resulting in a failure to deliver. - FSS does not provide an automated securities lending facility to reduce settlement failure. - Well-developed securities lending and reverse repo markets in Fedwire-eligible securities allow participants to “borrow” securities to fulfill settlement obligations. - When fails have increased due to low supply of certain issues on “special” in the repo market, the U.S. Treasury has provided additional supply by re-opening certain issues and selling additional supply. ### Monitoring of fails and supervisory actions - Outstanding fails for major dealers are monitored by Federal Reserve Bank of New York (FRBNY); figures are publicly available. - Risks implications of fails are analyzed by FICC, SEC, and FR and actions are taken to reduce rates and mitigate related risks. - FICC has imposed penalties on its participants for fails outstanding for certain periods of time. ### Incentives to settle on time and regulatory capital treatment - In 1988, the FR imposed a US$50 million limit on Fedwire securities transfers to encourage splitting large trades into multiple partial deliveries, reducing daylight overdrafts and improving fails outcomes. - Under U.S. Basel I-based risk-based capital rules: - A standard risk weight, based on counterparty nature or applicable guarantee/collateral, is applied to on-balance sheet amount of a transaction failed to settle outside a grace period (typically 5 days). - Unsettled transactions in securities issued or guaranteed by the U.S. government or GSEs for which a positive margin of collateral is not maintained on a daily basis typically receive a 20 percent risk weight. - Under U.S. Basel II-based risk-based capital rules: - Capital requirement for unsettled DVP and PVP transactions increases as duration of the fail increases. - The bank's positive current exposure receives a risk weight that ranges from 100 percent to 1,250 percent based on the number of days past the settlement date. - Unsettled non-DVP/non-PVP transactions are treated as wholesale exposures until the fifth business day after the counterparty delivery was due, after which the bank must deduct the current market value of the deliverables owed to the bank 50 percent from tier 1 capital and 50 percent from tier 2 capital. - For broker-dealers, SEC net capital rules require additional capital for fails outstanding past a certain period. ### Settlement cycle and central counterparty (CCP) analysis - Settlement of mortgage-backed securities (MBS) occurs primarily on fixed monthly settlement dates. - Industry cost-benefit analysis concluded to establish a CCP for MBS; FICC proposed to establish FICC-MBSD as a CCP for agency MBS and has filed a proposed rule change with the SEC. - Assessment: - Settlement cycle for non-MBS Fedwire-eligible securities is generally shorter than T+3 — Observed for non-MBS Fedwire-eligible securities. - For MBS, settlement primarily on fixed monthly dates — Broadly observed; recommendation not fully observed for MBS. For compliance, MBS should be settled no later than T+3. - FICC-GSD acts as CCP for all FSS eligible securities except agency MBS; proposed FICC-MBSD rule change with SEC to allow CCP for agency MBS. ### Securities lending and repo markets - There are no fiscal impediments to development and functioning of securities lending in the United States; clear and effective legal basis exists. - The U.S. tax regime does not differentiate between repo transactions and securities lending arrangements. - Markets/facilities: - Very liquid and deep securities lending market. - For Fedwire-eligible securities, settlement occurs through FICC, FSS, or on custodian books. - FSS does not provide securities lending services; no centralized automated securities lending facility exists. - Major participants (broker-dealers, large custodian banks) engage in securities lending or reverse repo to meet delivery obligations and increase portfolio returns. - Custodians and two major clearing banks provide custody account management, securities valuation, transfer administration, investment and lending services. - FRBNY operates a securities lending program lending securities from the System Open Market Account (SOMA) to facilitate smooth clearing; FOMC sets terms and provides oversight. - Supervisory policies: - Banking or securities supervisors review market participants’ risk management practices regarding securities lending transactions. - For SOMA securities loans, the Federal Reserve Board and FRBNY’s internal audit conduct annual reviews of internal and financial controls. ### Immobilization, dematerialization, and legal basis for book-entry - Securities settled in FSS are issued on a dematerialized basis. - As of year-end 2008, of approximately US$5.8 trillion (par value) of Treasury securities held in custody by FSS, 99.9 percent are dematerialized. - All securities held in FSS accounts are in book entry form. - A limited number of Treasury securities issued before 1986 and certain REMICs issued by Ginnie Mae are eligible to be converted to certificated form; securities issued prior to 1986 represent less than 0.01 percent of outstanding Treasury securities and may be held in certificated form. - Legal basis: - Under TRADES and corresponding agency regulations, a direct FSS participant obtains an interest in a Fedwire-eligible security when a Reserve Bank credits the book-entry security to the participant’s account. - Reserve Banks operate an indirect account holding system; securities are reflected in accounts of direct FSS participants, which may hold securities as intermediaries for customers. ### Delivery versus Payment (DVP) technical framework and volumes - FSS technical framework ensures DVP; processes securities transfers individually in real-time with simultaneous transfer of securities and associated payments. - FSS links to the Fed centralized accounting system for funds (not to Fedwire RTGS); finality upon credit/debit to master accounts. - DVP transactions may settle with positive cash balances or via intraday credit (daylight overdrafts); account holders are subject to net debit caps assigned/approved by their Reserve Bank. - Amounts: - In 2008, the average daily value of transfers settled for direct participants and their customers on FSS on a DVP basis was US$1.66 trillion (Approximately 85 percent of total securities transfer volume). - The remaining 15 percent of FSS transactions are free of payment (FOP) transactions, primarily intra-bank transfers. ### Settlement finality and intra-day finality - FSS provides for final settlement of securities transfers on a real-time basis throughout the settlement day. - Timing of settlement finality is defined in TRADES, corresponding agency regulations, UCC Article 8 and OC7; OC7 Section 9.1 states debits and credits become final and irrevocable when Reserve Bank posts them. - Intraday finality: - Real-time settlement supports monetary policy, credit extensions, and functioning of Treasury securities market; intraday finality is important for market participants and CCPs. - No unsettled transfer messages exist in FSS that could be revoked; transfers are final in real time once processed. - Links to foreign CSDs: FSS does not have any direct links with other CSDs. ### Intraday credit extension, liquidity and credit risk controls (FSS) - Federal Reserve extends intraday credit (daylight overdrafts) to eligible participants under Part II of the PSR policy; rigorous risk controls (collateral requirements and limits) are imposed. - Liquidity risk: - Participants are expected to extinguish daylight overdrafts by the end of the Fedwire Funds Service operating day (18:30 Eastern Time). - Daylight overdrafts can be extinguished with incoming payments, money market financing, or discount window borrowings (requires executed legal agreements and pledged collateral). - If overdrafts are not extinguished, participant will be charged for an overnight overdraft at a penalty rate; overnight overdrafts are discouraged, incur higher fees than discount window loans, and may attract supervisory attention. - Credit risk: - Provision of intraday credit converts participant liquidity risk into credit risk borne by Reserve Banks. - If a participant fails and closes before extinguishing its daylight overdraft, a Reserve Bank could face a financial loss. - Part II of the PSR policy defines limits, requirements, and fees to control and mitigate these exposures while providing sufficient liquidity. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10127.pdf* ### Part II of the PSR policy requires that all participants incurring daylight overdrafts in ### _cr10127 - Part II of the PSR policy requires that all participants incurring daylight overdrafts in ### Net debit caps and account risk management - Net debit cap formula: Net debit cap = cap multiple x capital measure. - The net debit cap varies over time with changes in the institution’s capital measure. - Net debit caps are based on creditworthiness as determined by participants’ capital adequacy and the most recent supervisory ratings. - All net debit caps are granted at the discretion of the Reserve Banks. - Only participants with routine discount window access are eligible for a positive net debit cap. - Participants with access to the highest levels of intraday credit must annually assess their financial condition and operating environment. - Reserve Banks employ ex-post and, in some cases, real-time monitoring of participants’ daylight overdrafts. - A participant exceeding its net debit cap may be contacted by its Reserve Bank and counseled. - Reserve Banks have extensive internal guidelines to monitor participants’ condition and to identify institutions that present high potential risk and therefore require special controls and monitoring. - Reserve Banks may reduce net debit caps, impose collateralization or balance requirements, reject or delay certain transactions, or take the institution off line or prohibit it from using the FSS. ### Credit risk in execution of DVP settlement - When executing real-time DVP, the cash leg may be funded with uncollateralized intraday credit, creating credit exposure if a participant fails while in overdraft. - Mitigating measures: - Legal agreements grant Reserve Banks a security interest in all funds, securities, and other property held at the Reserve Banks (excluding securities the participant may not encumber under applicable law) as collateral for any overdraft. - U.S. law provides that the Reserve Bank’s security interest automatically attaches to a Fedwire security held in a participant’s account if the purchase of that Fedwire security caused an overdraft. - Reserve Banks monitor participant condition and receive supervisory reports of supervisory rating; they may require extra collateral if concerned. ### Collateral policy and other security interests - The PSR policy generally does not require participants to pledge collateral to secure daylight overdrafts. - Certain healthy participants may pledge collateral to secure daylight overdraft capacity in excess of their net debit caps, subject to Reserve Bank approval; net debit cap plus additional capacity = “maximum daylight overdraft capacity.” - Collateral pledged for Federal Reserve purposes is marked-to-market or internally valued and subject to haircuts per the Federal Reserve’s methodology. - Reserve Banks may require participants in weakened condition or in imminent danger of failure to pledge collateral to secure any daylight overdrafts. - In addition to pledged collateral, Reserve Banks have a security interest in securities and other property maintained by participants that may arise through legal agreements (OC 1) or as a matter of U.S. law, even without an express pledge. - OC 1 grants the Reserve Bank rights to take actions authorized by law to recover overdrafts, including setoff without demand or notice and realization on available collateral. - Under UCC Article 9–206, a security interest in favor of a securities intermediary attaches to “securities entitlements” when securities are purchased on credit and unpaid. - A security interest in favor of a Reserve Bank attaches automatically to Fedwire-eligible securities when purchased using the Reserve Bank’s intraday credit; this interest arises as a matter of law and has priority over conflicting security interests. ### Daylight overdraft fees and transfer-size limits - Daylight overdraft fee history: - Initial annual rate set at 24 basis points in 1994. - Increased to 36 basis points on April 13, 1995. - The overdraft fee is applied to a measure of average daily overdrafts for each institution less a deductible amount related to the institution’s capital. - Transfer-size limit on book-entry securities: - In 1988, a US$50 million limit was imposed on the par value of individual book-entry securities transfers over the FSS to encourage splitting large trades and reduce daylight overdrafts. - Reserve banks do not permit participants to incur debit balances in securities accounts; the system rejects a transfer instruction if the initiating participant does not have the securities in its securities accounts. Neither provisional nor partial delivery of securities is allowed. ### Evaluation of multiple failures and operational resilience - A multiple participant failure would have limited effect, if any, on FSS operations because the cash advance is central bank money and no securities overdraft is allowed. - To minimize FRB credit risk in single or multiple institution failure scenarios, FRBs monitor financial condition and apply risk controls, including eliminating access to intraday credit if an institution’s condition deteriorates. - FRBs consider supervisory and market information; when an institution is close to failure, FRBs work with the appropriate regulator (e.g., Federal Deposit Insurance Corporation or the National Credit Union Association) to facilitate an orderly resolution. ### Settlement agent role, concentration, and tri-party repo risk - Final settlement of DVP transactions is against payment of funds in central bank money through transfer of account balances held at a Reserve Bank. - Only transactions denominated in U.S. dollar are settled in the FSS; only participants with Reserve Bank master accounts may send or receive DVP transactions in the FSS. - Settlement banks in FSS are the Reserve Banks, subject to Board supervision and their own boards of directors. - Concentration statistics: - Approximately 2,600 depository institutions use the FSS. - In 2008 the top 20 participants accounted for 97 percent of the total transfer value. - As of year-end 2008, the two clearing banks (JPMC and BoNY) initiated approximately 71 percent of securities transfers by volume and approximately 80 percent by value on the FSS. - The two clearing banks (JPMC and BoNY) also provide settlement for Fedwire-eligible securities for primary dealers and other major market participants, producing a high concentration of “on-us” transfers. - The financial condition of the two clearing banks is monitored by relevant Federal and state banking supervisors: BoNY is regulated and supervised by the Federal Reserve and NY State Banking Department; as a bank holding company, JPMC is regulated and supervised by the Federal Reserve and its national bank unit by the OCC. - FSS direct participants have immediate access to settlement proceeds credited to their accounts and can use these funds for other payments. - FSS does not use the Fedwire RTGS payment system; it is connected directly to the Federal Reserve’s centralized accounting system. - Assessment comment: High concentration of securities clearing and settlement in JPMC and BoNY, their central role in tri-party repo facilities, and heavy dealer reliance on intraday credit (uncommitted but collateralized) can be disruptive if a clearing bank encounters problems or refuses to extend credit. - Suggested specific measures to mitigate risks of the two clearing banks include: - Increase the liquidity resilience of cash borrowers in the tri-party market; - Reduce the tiering of settlements; - Address the nature and size of intraday credit extensions by the clearing banks. - Authorities and industry actions: - An industry task force sponsored by the Payment Risk Committee is discussing solutions to increase transparency and mitigate risks associated with tri-party repos, exploring: 1. how to reduce and mitigate risk exposures of the clearing banks (introduction of collateral substitution, asset margining and portfolio margining); 2. how to reduce and mitigate the underlying funding risk of their customers, i.e., the fixed income securities dealers; 3. liquidation issues (e.g., more transparency on type of collateral to liquidate and its valuation) as well as procedures for liquidation that do not create fire-sale conditions or severely constrain market liquidity. ### Observed assessment and recommendation excerpts - Assessment Observed. - Comment summary: The recommendation states that the most reliable approach to controlling potential losses and liquidity pressures from participants’ failures to settle is a combination of collateral requirements and credit limits. The Fed’s net debit caps set limits on the amount of intraday credit used by participants, limiting the Fed total exposures to credit risk. To eliminate residual risk when executing DVP whose cash leg is funded by Fed using uncollateralized intraday credit, the Fed should continue to monitor these risks and assess whether additional mitigation tools such as collateral are needed. - Recommendation 10 (excerpt): Assets used to settle the ultimate payment obligations arising from securities transactions should carry little or no credit or liquidity risk. If central bank money is not used, steps must be taken to protect CSD members from potential losses and liquidity pressures arising from the failure of the cash settlement agent whose assets are used for that purpose. *Source: IMF staff content from the provided PDF chapter/section.* ### 4. Reduce and mitigate effects of pro-cyclicality of risk management procedures ### 4. Reduce and mitigate effects of pro-cyclicality of risk management procedures (including effects on valuation of collateral) ### Operational risk identification, controls, contingency planning, and scalability (Recommendation 11) - Findings: - The Reserve Banks have processes for identifying and managing operational risks associated with the FSS. FSS operates within the Federal Reserve's overall information technology environment, which consists of a defined architectural framework and defined policies regarding IT development, IT operations, and IT security. - The Federal Reserve information security program requires each Reserve Bank with management responsibilities for a business function, such as the FSS, to complete information security risk assessments. - FSS complies with Federal Information Security Management Act of 2002 (FISMA) and the Federal Reserve Bank of New York operational risk management program. - A team of dedicated technical and software specialists monitors the Fedwire applications day-to-day. - The Reserve Banks conduct robust application and network testing, including penetration and stress testing. - Contingency and backup capabilities: - Reserve Banks maintain and regularly test contingency plans and back up facilities; maintain multiple out-of-region backup data centers and redundant out-of-region staffs supporting data centers, FSS applications and customer testing facilities and support services. - FSS transmits and logs transactions and critical database changes to both the primary and the secondary backup data centers in real-time throughout the day. - Reserve Banks conduct on-site and remote-site recovery tests at the out-of-region data centers each year. - Participants can originate securities transfers off line by providing transfer instructions via telephone. - Participants are responsible for developing their own contingency and recovery plans; the most active participants must participate in a minimum number of contingency tests each year, including tests from customers' back up sites. - Post-disruption reconciliation: Reserve Banks issue reports listing securities transfers to identify gaps in sequence numbers; participants resend transfers within gaps, flagged as possible duplicate messages; participants exercise reconciliation regularly during contingency tests. - Reserve Banks require participants to implement physical and logical security measures ensuring initiation of a transfer requires action by more than one employee and that messages contain adequate identifying information (OC7). - Availability and scalability: - In 2008, the Fedwire securities application was available for 100 percent of its operating hours. - The availability standard for Fedwire securities is 99.9 percent of operating hours. - Fedwire Securities capacity is currently sized to accommodate up to 2 million transfers a day. - Daily average volumes between 2007 and 2008 were essentially flat. - During the Lehman crisis in Sept. 2008: - August 2008 daily average: 91,000 transfers. - Sept 15 and 16, 2008 volumes increased to about 120,000 and 130,000 transfers, respectively (about 30 to 40 percent increase from the August 2008 daily average). - Other peaks: September 22 of about 129,000 transfers and September 25 of about 125,000 transfers. - On other days in the September 12 to 29 timeframe, volumes ranged from 74,000 to 94,000 transfers a day. - Transaction capacity is now more than two times the highest number of transactions processed in one day. (In 2008, the highest daily volume of securities transfers processed was 482, 443). - Audits and reviews: - Independent external auditors conduct annual risk based review of IT systems supporting FSS; most recent review completed as of September 30, 2009. - Assessment: Observed. ### Protection of customers' assets, inventory control, and supervision of custodians (Recommendation 12) - Findings: - FSS is an indirect holding system; securities (or interest in securities) are held for the sole benefit of direct participants whose account has been credited. - Reserve Banks maintain records of identities and interests of direct participants; direct participants maintain internal records of specific client holdings. - FSS allows direct participants to have multiple securities accounts to segregate customer holdings. - Physical and technical controls and periodic audits are performed to ensure records are accurate and not subject to theft, loss, or misuse. - UCC Article 8 obligations: - Securities intermediaries, including the FRBs, are required to maintain a sufficient quantity of investment property to satisfy all of their customers’ claims. - Securities intermediaries are prohibited from using customer securities in their own business activities except as agreed to by the customer or to the extent UCC Article 8 creates a statutory lien in favor of the securities intermediary. - Interests in a particular security held by an intermediary are held for the benefit of its customer and are not subject to the claims of the creditors of the securities intermediary, unless the intermediary is a clearing corporation or the creditor has control over the financial assets. - Customers of an insolvent intermediary are generally able, under U.S. law, to obtain fully-paid-for securities and move positions to a solvent intermediary. - Inventory control and reconciliation: - Daily activity reports / clearing summaries are available to participants; account holdings reports provided as often as daily. - Reserve Banks will respond to participants’ requests for audit confirmations for verification as of a particular date. - Similar reporting provided to issuers showing total par value of outstanding securities for each CUSIP number. - Supervision: - Participants maintaining securities accounts for customers are subject to prudential supervision and regulation. - Custodian activities of the two clearing banks are subject to supervision by the Federal Reserve, among other supervisors. - Assessment: Observed. ### Governance, user participation, representation, and access (Recommendations 13–14) - Governance and management: - Reserve Banks operate FSS on a consolidated basis through the FRBNY’s Wholesale Product Office (WPO). - The WPO sets strategic direction (subject to review of the Financial Services Policy Committee (FSPC)), coordinates projects, and ensures wholesale operating sites meet service level agreements. - WPO is a national function managed by the FRBNY on behalf of all FRBs and has "outsourced" several critical activities to other Federal Reserve Banks under service level agreements. - The WPO consists of 18 people organized into groups: (a) Fedwire Funds, (b) Fedwire Securities; (c) National Settlement and access channels; (d) data management; (e) finances; and (f) operations. - WPO reports key information regularly to the FSPC, a standing committee of the Conference of Presidents (COP). - There is a clear and legal separation between operators (Federal Reserve Banks) and the overseer (Federal Reserve Board) of FSS. - Assessment: Observed. - Comment/recommendation: WPO should include representatives of smaller and midsize participants, and not just rely on feedback provided through the financial services website. - User participation and advisory input: - Customer Advisory Group (CAG) established 2008; includes Bank of New York-Mellon, JPMorgan Chase, State Street, Northern Trust, Fannie Mae, Freddie Mac, FHLBs, Treasury, and the FICC; meetings held twice per year. - WPO does not maintain an advisory group for smaller and midsize participants; alternative feedback channels include frbservices.org, customer account representatives, customer support centers, and ad hoc industry group engagement. - Market consultations and public comment are sought for major policy issues and service changes; requests for public comment published by WPO on public website or by the Board in the Federal Register. - Access rules, restrictions, and exit procedures: - Applicants eligible to maintain a securities account with a Reserve Bank include: depository institutions, U.S. agencies and branches of foreign banks, member banks of the Federal Reserve, the Treasury, entities specifically authorized by federal statute, entities designed by the Secretary of the Treasury, Edge and agreement corporations, foreign central banks, foreign monetary authorities, and foreign governments. - To receive or send securities against payment, a participant must also maintain a master account at the appropriate Reserve Bank (master account eligibility set forth in OC 1). - Current eligibility rules require applicants, other than official entities, to be resident in the United States. Foreign banks without a U.S. banking presence are not permitted access to FSS. - Nonbank broker-dealers are prevented from direct access to Fedwire on the basis of lack of a banking license; this prevents some key infrastructures (not chartered as banks) from direct access. - Exit: OC1 Section 2.8 requires advance notice of not less than 5 business days to terminate a master account; Reserve Banks can terminate a master account at any time by giving notice but generally will provide at least 5 business day in advance notice. - Assessment: Partly observed. - Comments / policy recommendations: - Certain key market participants such as nonbank broker dealers are not eligible to maintain accounts at the Federal Reserve; this prevents these participants from settling trades in central bank money thereby increasing settlement risk. - The Federal Reserve should be given the legal authority to open accounts and provide services, at a minimum, for payment, clearing, and settlement infrastructures. ### Cost-effectiveness, fees, service review, and operating hours (Recommendation 15) - Cost recovery and pricing: - The Monetary Control Act of 1980 (MCA) requires Federal Reserve Banks to set fees to recover, over the long run, all direct and indirect costs actually incurred in providing these services as well as imputed costs (including taxes and return on equity). - PSAF and NICB are estimated annually and incorporated when setting priced services fees; fees are set on a national basis and do not vary between Reserve Banks. - Reserve Banks have cost controls including annual budget review and internal controls; the Board annually reviews and approves the Reserve Banks budgets. - Fees are reviewed annually. - Service level review mechanisms: - WPO regularly reviews service levels and seeks to improve efficiency and practicality of FSS; engagement with internal and external stakeholders, including the FSS Customers Advisory Group (established 2008). - Capacity: - Transaction capacity is now more than two times the highest number of transactions processed in one day. (In 2008, the highest daily volume of securities transfers processed was 482, 443). - Operating hours: - Core operating hours of FSS: 8:30 a.m. to 3:15 p.m. ET. - On-line participants may initiate reversal transactions until 3:30 p.m. ET and move or reposition their securities among their securities accounts until 4:30 pm against payment and until 7 pm free of payments. - Offline participants may initiate securities transfers or other requests from 9:00 a.m. to 1:30 p.m. ET for same day processing and until 4 pm ET for future day processing. - Under special circumstances participants may ask the WPO to extend the operating hours. - Comment/recommendation: The operating hours of FSS are relatively short when compared to operating hours of other CSDs. The business case to extend operating hours should be re-assessed by the Federal Reserve. - Assessment: Observed. ### International communication standards and cross-border settlement (Recommendation 16) - Findings: - FSS uses a proprietary message format that can be translated to and from international message standards. - WPO participates in relevant securities industry standard groups such as SWIFT to maintain awareness of developments and existing standards. - The Reserve Banks have no plans to use SWIFT or ISO standards for the FSS; they rely on proprietary standards and have not received interest from customers to move toward international standards. - Assessment: Observed. - Comment/recommendation: Since FSS participation requirements prevent direct remote access from foreign participants, the requirement for use of international communication procedures for cross-border transactions is not as relevant. However, international standards could become relevant should remote access of other infrastructure be allowed. ### Disclosure of rules, risk information, and CPSS/IOSCO self-assessment (Recommendation 17) - Findings: - Laws, regulations, rules and procedures governing FSS activities are publicly available on the Federal Reserve, U.S. Treasury's Bureau of Public Debt, and other public websites. - Key financial and operational risks are publicly disclosed. Participation costs are public on the Federal Reserve’s websites. - The FSS has not completed and disclosed responses to the CPSS-IOSCO Disclosure Framework (CPSS-IOSCO 1997) because that framework was superseded by the CPSS-IOSCO RSSS self-assessment; the self assessment in line with the CPSS/IOSCO assessment methodology has been published. - PSR policy expects systemically important systems to complete the self assessment and publicly disclose the result. - Information is made available in English on the Board website. - Federal Reserve reviews and updates this assessment every two years at minimum. - Assessment: Observed. ### Regulation, oversight, cooperation, and legal basis for supervision (Recommendation 18) - Findings: - FSS is subject to oversight by the Federal Reserve Board; the Board monitors the system, regularly assesses FSS against CPSS-IOSCO recommendations (assessment reviewed every two years and when significant changes occur), makes the assessment publicly available, and conducts on-site inspections and off-site monitoring. - Reserve Banks operating FSS are also subject to principles and requirements by the U.S. Treasury; the Treasury’s Bureau of the Public Debt and Inspector General have the right to examine certain aspects of FSS performed as fiscal agent activities. - The Government Accountability Office (GAO) can review certain Reserve Bank activities, including FSS, at the direction of Congress. - Responsibilities, roles, and major policies of oversight entities are clearly defined and publicly available; Board maintains policies such as the PSR policy. - Oversight framework is based on the Federal Reserve Act. The regulatory framework for U.S. government securities market is based on Government Securities Act and the Securities Exchange Act of 1934. Regulation of FICC is based on the Securities Exchange Act and SEC rules and standards. - U.S. law does not explicitly attribute oversight responsibilities over critical payment, clearing, and settlement infrastructure, such as FSS, to the Fed. - The statutory basis for oversight of the FSS is the Federal Reserve Act (U.S. Code Title 12, Sections 248(j) and 485) derived from the Board's authority to exercise general supervision over the Reserve Banks rather than from a specific authority to oversee securities settlement systems. - Board resources: about 7 budgeted staff work full time on policy and oversight with respect to FSS, Fedwire Funds Service, and the National Settlement Service. - Cross-border cooperation: cross-border cooperative oversight does not exist at the moment since the system does not have direct links with foreign systems nor does it settle in currencies other than the U.S. dollar. - Assessment: Observed. - Comment/recommendation: The Fed should be provided the legal basis to oversee systemically important payment, clearing, and settlement market infrastructure. ### Links and cross-border settlement (Recommendation 19) - Findings: - The FSS does not have any cross-border direct link in place. - Assessment: Not applicable. - Comments / policy suggestions: - No cross-border link is in place because foreign CSDs without a legal presence in the U.S. and a banking license are not allowed to open securities accounts at the Fed (see Recommendation 14). - Fed should consider monitoring the smooth functioning of indirect links, where major custodians are involved in cross-border transfers of FSS eligible securities between FSS and foreign CSDs. - The assessment methodology does not provide clear indications on how assessment of indirect links should be conducted. *Source: _cr10127 - 4. Reduce and mitigate effects of pro-cyclicality of risk management procedures* ### 1. Securities settlement systems should have ### 1. Securities settlement systems should have ### Legal basis and cross-border participation - Securities settlement systems should have a well-founded, clear and transparent legal basis in the relevant jurisdiction. - FSS does not allow participation by non-resident foreign banks; participants in FSS may settle Fedwire-eligible securities cross-border through intermediaries that are participants in or custodians for other central securities depositories (CSDs) or international CSDs (ICSDs). - ICSDs hold U.S. Treasury securities and have executed transfers in U.S. securities through their U.S. correspondent custody banks, which in turn hold the securities in FSS. - Custodian banks that participate in foreign CSDs need to address potential conflict of laws between U.S. law and the laws in the foreign (I)CSD jurisdictions. ### Pre-settlement risk and trade confirmation - Confirmation of trades between market participants should occur as soon as possible after trade execution, but no later than the trade date (T+0). - Where confirmation by indirect market participants is required, it should occur as soon as possible after trade execution, preferably on T+0, but no later than T+1. - Recommended action: The FSS should explore the possibility of introducing an instructions matching mechanism prior to settlement. ### Settlement cycles and central counterparty (CCP) - 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 assessed. - Observation: Recommendation not fully observed for MBS, for which settlement occurs primarily on fixed monthly dates. For compliance, MBS should be settled no later than T+3. - The benefits and costs of a central counterparty should be assessed. Where introduced, the CCP should rigorously control the risks it assumes. - Observation: FICC-GSD acts as CCP for all FSS eligible securities except for agency MBS. FICC has filed a proposed rule change with the SEC to allow FICC-MBSD to act as CCP for agency MBS. ### Securities lending, immobilization, and delivery-versus-payment (DVP) - Securities lending and borrowing (or repurchase agreements and other economically equivalent transactions) should be encouraged to expedite settlement; barriers inhibiting lending should be removed. - Securities should be immobilized or dematerialized and transferred by book entry in CSD to the greatest extent possible. - Securities settlement systems should eliminate principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment. - Final settlement on a DVP basis should occur no later than the end of the settlement day. Intra-day or real-time finality should be provided where necessary to reduce risks. ### Intraday credit, risk controls, and concentration risks - CSDs that extend intraday credit should institute risk controls to ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle; the most reliable controls combine collateral requirements and limits. - The Fed’s net debit caps set limits on intraday credit used by participants, limiting the Fed's total exposures to credit risk. - Recommendation: In view of eliminating the residual risk taken by the Fed when executing DVP whose cash leg is funded by Fed using uncollateralized intraday credit, the Fed should continue to monitor these risks and assess whether additional mitigation tools such as collateral is needed. - High concentration: securities clearing and settlement are concentrated in two clearing banks (JPMC and BoNY), which are the two main providers of tri-party repo facilities and serve as the two settlement banks for FICC. - Tri-party repo facilities represent one of the main sources to fund a broker-dealer’s inventory of securities; these transactions are processed at the end of the day and collateral is returned early the next morning. - Dealers heavily rely on intraday credit provided by JPMC and BoNY. This intraday credit is uncommitted but collateralized. - Potential disruption: a problem at one clearing bank or a refusal to extend credit could disrupt tri-party repo market functioning and settlement of securities transactions. - Suggested mitigation measures: increase liquidity resilience of cash borrowers in the tri-party market; reduce tiering of settlements; address nature and size of intraday credit extensions by the clearing banks. - Industry task force (Payment Risk Committee) exploring four issues: collateral substitution/asset margining/portfolio margining; reducing underlying funding risk of fixed income dealers; liquidation issues (transparency on collateral type/valuation and procedures to avoid fire-sale conditions); and mitigating effects of pro-cyclicality of risk management procedures (including effects on valuation of collateral). - A progress report from the task force has been released; a final report is expected during 2010. ### Operational and custody risk - Sources of operational risk in clearing and settlement should be identified and minimized through appropriate systems, controls, and procedures; systems should be reliable, secure, and have adequate, scalable capacity. - Contingency plans and back-up facilities should be established for timely recovery and completion of settlement. - Entities holding securities in custody should employ accounting practices and safekeeping procedures that fully protect customers' securities and protect those securities against the claims of a custodian's creditors. ### Governance, access, and regulatory oversight - Governance arrangements for CSDs and CCPs should be designed to fulfill public interest requirements and to promote objectives of owners and users. - Recommendation: WPO should include representatives of smaller and midsize participants to ensure their needs and interests are taken into account. - CSDs and CCPs should have objectives and publicly disclosed criteria for participation that permit fair and open access. - Observation: Certain key market participants such as nonbank broker dealers are not eligible to maintain accounts at the Federal Reserve, preventing settlement in central bank money and increasing settlement risk; some key infrastructures are not chartered as banks and thus cannot directly use FSS services. - Recommendation: The Federal Reserve should be given the legal authority to open accounts and provide services, at a minimum, for other payment, clearing and settlement infrastructures. - Securities settlement systems should be subject to regulation and oversight with clearly defined responsibilities for securities regulators and the central bank; these roles and major policies should be publicly disclosed and authorities should have the ability and resources to perform responsibilities and cooperate with other relevant authorities. - Observation: A clear legal basis for Board supervision of FSS exists based on the Federal Reserve as operator rather than legal overseer; recommendation that the Fed be provided legal basis to oversee systemically important payment, clearing, and settlement infrastructures. ### Operating hours, communication standards, and information disclosure - While maintaining safe and secure operations, systems should be cost-effective in meeting users' requirements. - FSS core operating hours: 8:30 a.m. to 3:15 p.m. ET. - Online participants may initiate reversal transactions until 3:30 p.m. ET and move or reposition securities among their securities accounts until 4:30 pm against payment and until 7 pm free of payments. - Offline participants may initiate securities transfers or other requests from 9:00 am to 1:30 pm ET for same day processing and until 4 pm ET for future day processing. - Under special circumstances participants may ask the WPO to extend operating hours. - Observation: Operating hours of FSS are relatively short compared to other CSDs; recommendation that the Fed reassess the business case to extend operating hours. - International communication procedures and standards should be used or accommodated to facilitate efficient cross-border settlement. - Observation: Because FSS participation requirements prevent direct remote access from foreign participants, international communication procedures are less immediately relevant but could become relevant should remote access be allowed; global cooperation calls for adoption of or compatibility with common global standards for major infrastructures. - CSDs and CCPs should provide participants with sufficient information to accurately identify risks and costs associated with using their services. ### Cross-border links and monitoring - CSDs that establish links to settle cross-border trades should design and operate such links to effectively reduce risks associated with cross-border settlement. - Observation: No cross-border link is in place because foreign CSDs without a legal presence in the United States and a banking license are not allowed to open accounts at the Fed. - Recommendation: Fed should consider monitoring the functioning of indirect links where major custodians are involved in cross-border transfers of FSS eligible securities between FSS and foreign CSDs; assessment methodology does not provide clear indications on how assessment of indirect links should be conducted. ### Tabled recommended action plan (high-level summary) - Recommendation 2 (Trade confirmation): The FSS should explore the possibility of introducing an instructions matching mechanism prior to settlement. - Recommendation 3 (Settlement cycles): MBS should be settled no later than T+3. - Recommendation 9 (Risk controls): The Fed should continue to monitor residual DVP funding risks from uncollateralized intraday credit and assess whether additional mitigation tools such as collateral are needed. - Recommendation 13 (Governance): WPO should include representatives of smaller and midsize participants. - Recommendation 14 (Assess access): The Federal Reserve should be given the legal authority to open accounts and provide services, at a minimum, for other payment, clearing and settlement infrastructures. - Recommendation 15 (Operating hours): The Fed should re-assess the operating hours of FSS. - Recommendation 16 (Communication): International standards could become relevant should remote access be allowed; global co-operation calls for adoption of compatible global standards. - Recommendation 18 (Regulation and oversight): The Fed should be provided the legal basis to oversee systemically important payment, clearing, and settlement infrastructures. - Recommendation 19 (Cross-border links): Fed should consider monitoring indirect links involving major custodians in cross-border transfers of FSS eligible securities. ### Authorities’ response (key points) - U.S. authorities strongly support the FSAP program and welcome the independent review. - Authorities note high degree of compliance of the Fedwire securities service with CPSS-IOSCO Recommendations and largely agree with comments and recommendations. - Authorities will explore introducing settlement instruction matching in Fedwire securities service, considering costs and benefits. - Authorities will reassess the business case for extending Fedwire securities service operating hours and seek ways to ensure needs of smaller and midsize participants are addressed. - Regarding MBS settlement to T+3, authorities agree in principle but note the need for careful study and consultation given instrument characteristics and operational changes; near-term risk reduction efforts should focus on industry proposal to implement a central counterparty for MBS. - On residual intraday credit risks, authorities state a rigorous program for assessing, monitoring, and mitigating these risks is in place and is being strengthened following a comprehensive policy review from 2006 to 2008 and the planned implementation of an explicit collateralization policy in late 2010 or early 2011; authorities are confident residual risks are adequately monitored and controlled. - Authorities appreciate the assessment and its contribution to stability and effective supervision of systemically-important payment and settlement systems. *Source: _cr10127 - 1. Securities settlement systems should have* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10127.pdf_