Ms. Jennifer J. Johnson
Secretary
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue, N.W.
Washington, D.C. 20551

Re: Docket No. R-1032; Settlement-day finality for Automated Clearing House credit transactions

Dear Ms. Johnson:

The Treasury Management Association (TMA) welcomes the opportunity to respond to the Board's request for comment on the benefits and drawbacks of providing settlement finality on the morning of settlement day for ACH credit transactions processed by the Federal Reserve.  The Board also requests comment on the policy and operational implications of associated risk control measures.

TMA represents about 12,000 finance and treasury professionals who, on behalf of over 6,500 corporations and other organizations, are significant participants in the payments system.  Organizations represented by its members are drawn generally from the Fortune 1,000 companies and the largest of the middle market companies.  Many of TMA's members have responsibility for originating and receiving Automated Clearing House (ACH) payments on behalf of their organizations.  They thus have a sizable stake in Federal Reserve policies that impact this electronic payments mechanism.  In developing this letter, TMA held discussions with members of its Government Relations Committee and Payments Advisory Group, and solicited comments from over 60 regional TMA Associations.

The Federal Reserve Board is considering the merits of providing settlement finality on the morning of settlement day for ACH credit transactions processed by the Federal Reserve Banks.  Specifically, settlement for ACH credit transactions would become final when posted at 8:30 a.m. eastern time on settlement day.  Currently, the Reserve Banks have the right to reverse a settlement for ACH credit transactions until 8:30 a.m. eastern time on the morning of the business day following settlement day.  Consequently, receivers and receiving financial institutions are now subject to temporal and credit risk during the period between settlement and finality.  If the originating financial institution fails before finality, the Reserve Bank can reverse the settlement.

If the Board were to accelerate settlement finality by the proposed twenty-four hour period, it would at the same time adopt risk control measures equivalent to those used in the Fedwire funds transfer service and the enhanced settlement service for private-sector ACH operators.  These measures would reduce the risk of accelerated finality to the Reserve Banks by requiring certain "at risk" banks to prefund their ACH credit transactions prior to processing, rather than at settlement.  Under prefunding, the Federal Reserve substitutes itself for the originating financial institution as obligor to settle for the transactions.

TMA recommends that the Board provide settlement-day finality for ACH credit transactions.  TMA recognizes that risk control procedures must be adopted in conjunction with settlement-day finality to reduce risk to the Reserve Banks, although such risk controls should not add a new element of uncertainty to the ACH system.  TMA believes that these measures would offer significant benefits to payments system participants and to the ACH system generally by enhancing the safety of the ACH system and promoting the migration from paper to electronic payments.  Since the Board's request for comment is silent on the issue of pricing, TMA's response is based on the assumption that there would be no resulting Federal Reserve price increase.

TMA believes that settlement-day finality for ACH credit transactions would:

• Reduce risk to the recipient and its receiving depository financial institution.
• Encourage customer scrutiny of bank creditworthiness.
• Enhance the reputation and responsiveness of the ACH system.

Settlement-day Finality Reduces Risk

Settlement-day finality provides guaranteed good funds to the recipient of ACH credits on the morning of the day that the funds are posted to the receiver's account.  It thereby removes the temporal and credit risk to the receiver and its financial institution that would be caused by the failure of the originating financial institution and the reversal of the payment prior to finality.  Uncertainty about the finality of ACH credits has long been a concern of corporations that receive ACH payments.  Although an ACH credit payment has never been reversed, the possibility of its occurrence has clouded corporate perceptions of the ACH system.  If a bank were to fail and an ACH credit file were to be reversed, confidence in the ACH system could be seriously damaged.

Settlement-day Finality Encourages Closer Scrutiny of Bank Creditworthiness

If the Board were to provide morning-of-settlement-day finality for ACH credit transactions, a bank whose account balance is monitored in real-time when it sends wire transfers would be required to fund its ACH credit transactions prior to processing.  TMA believes that these risk control procedures would promote "know your banker" best practices by corporate customers although as noted below, there are other alternatives that might be preferable.  Businesses should attempt to monitor the financial stability of their financial institutions and be on the alert for potential problems. The ACH system should not be designed to accommodate risk from the weakest banks.

Companies that originate ACH credits through financial institutions that the Federal Reserve does not monitor in real-time would not be affected by the risk control measures contemplated by the Board.  Today -- as well as under proposed risk control procedures -- an originating financial institution's Federal Reserve account is debited for ACH credit transactions at 8:30 a.m. on the morning of settlement day.  There would also be no change in the daylight overdraft position of the ACH originating bank.  ACH transactions are already included in the bank's daylight overdraft calculation when they are debited from its account.

Private-sector ACH operators that use the Federal Reserve's enhanced net settlement services will also provide settlement-day finality and implement real-time account balance monitoring for selected banks.  If the Federal Reserve failed to do the same, weaker banks might shift their ACH volume from private operators to the Federal Reserve, or move their payments from Fedwire to the ACH.

TMA understands that banks that use the Fedwire funds transfer system are monitored in real time for a variety of reasons.  They include: banks that are financially precarious; banks that regularly exceed their net debit cap and do not respond to Fed counseling; banks for which the Fed has insufficient supervisory information; and U.S. branches of foreign banks.  Today, their Federal Reserve accounts are debited for ACH credit transactions at settlement time.  Under the proposed risk control procedures, their ACH credits will not be processed unless their Federal Reserve accounts are debited prior to processing, in advance of settlement.  The debit will also be included in their daylight overdraft calculation prior to processing.

Today, about 730 banks are monitored in real time.  It is our understanding that less than half of them may be ACH originators.  An economic downturn might cause their number to rise, with a concomitant potential for increased delays in ACH credit processing.  On balance, however, TMA believes that confidence in the ACH system will be strengthened by the participation of those banks whose financial strength does not call for real-time monitoring by the Federal Reserve, with prefunding required of others.  Banks have put these same risk controls in place for companies deemed to be credit risks, which are also required to prefund their ACH credit originations prior to settlement.

The timely settlement of ACH credits originated by banks that do not have sufficient Federal Reserve account balances (including available intraday credit) may depend, in part, on the processing cycle used by the bank.  If ACH credits are submitted for processing two days in advance of settlement, there may be sufficient time for the bank to obtain funding and resubmit the file.  This may not be true in the case of an ACH credit file that the bank submits to the Federal Reserve for processing at 3:00 a.m. on the morning of settlement day.

It is questionable whether banks that must prefund will, in turn, require their corporate customers to prefund their ACH credits.  A bank might instead draw upon its credit facilities to fund ACH transactions in order to remain competitive in the ACH market.

Alternative Risk Control Approaches

TMA is concerned that companies might not have access to the information that would enable them to accurately evaluate the financial strength of the institutions that originate their ACH credit transactions.  Moreover, bank regulators do not reveal the names of institutions on credit watch, a factor which heightens corporate vulnerability.  As a consequence, a company might learn after the fact that its ACH originating bank has failed to fund its credit transactions and the company's employees were not paid on time.  Or the company's large tax payment might be late, resulting in a substantial penalty.  These occurrences would tarnish the reputation-though not the safety-of the ACH system among consumers and businesses alike.

TMA suggests two alternative risk control measures that could be preferable to prefunding for eliminating risk in the ACH system while avoiding uncertainty of payment:

1. Financial institutions whose account balances are monitored in real time for wire transfers should not be permitted to originate ACH credits.  If deficiencies in financial strength or other reasons cause the Federal Reserve to deny credit to these institutions, they should not contribute to the risk of the ACH system.  The New York Clearing House-a private-sector ACH operator-likewise does not permit the lowest ranked banks to originate ACH credit transactions.
    
2. As an alternative, the Federal Reserve should require financial institutions that it monitors in real time to post collateral for the maximum amount of their ACH credit originations.  This measure would guarantee the availability of funds to cover the Federal Reserve's risk exposure without requiring institutions to raise funds on a daily basis depending on the dollar amount of their ACH entries.

Settlement-day Finality Increases the Attractiveness of the ACH System

TMA believes that settlement-day finality for ACH credits will increase the attractiveness of the ACH system and has the potential to stimulate the growth of business-to-business ACH payments.  Three factors are at work toward this end:

• Increasing back-office automation, the adoption of enterprise-wide resource planning systems, and the upgrading of accounting software in conjunction with Y2K preparedness efforts may encourage corporate migration from checks to electronic payments.  Settlement-day finality will remove the theoretical barrier of uncertainty surrounding ACH credits.
   
• NACHA's ACH Vision 2000 proposes a shortening of ACH Operator processing schedules to provide for more same-day payments.  Settlement-day finality would complement that effort.  It would also promote the conversion of checks to electronic payments.  Over half of respondents to a 1998 TMA survey on the Migration from Check to Electronic Payments said they would increase their use of the ACH system if transactions settled on the same day.
   
• The growth of the Internet to initiate payment instructions will decrease the time and increase the potential volume of ACH transactions.  Settlement-day finality, with appropriate risk controls, can spur innovation and stimulate usage of the ACH for Internet transactions.

TMA Recommendations

TMA recommends that the Federal Reserve Board formulate a proposal to provide settlement-day finality for ACH credit transactions processed by the Federal Reserve Banks, together with appropriate risk control procedures.  An improvement in ACH finality would increase the attractiveness and strengthen the security of the ACH system.

TMA thanks the Federal Reserve for the opportunity to comment on this important issue.  Please call Arlene S. Chapman of TMA at 301-907-2862 if you have further questions on the Association's statement.

Sincerely,

/s/ Nolan L. North, CCM
Vice President and Assistant Treasurer
T. Rowe Price Associates, Inc.
Chair, TMA Government Relations Committee

/s/ David P. Smay, CCM
General Credit Manager and Treasurer
Chevron Products Company
Chair, TMA Payments Advisory Group

/s/ Arlene S. Chapman, CCM
Director, Payments and Standards
Treasury Management Association