N.Y. Clearing House in Final Leg of Overhaul

The New York Clearing House is nearing completion of a makeover that is turning a staid old association into much more of a commercial enterprise.

Formed in 1853 to simplify interbank check exchanges-still a core business-the nation's oldest bank clearing house went high-tech years ago with Chips, the electronic funds transfer system that became a linchpin of international banking and finance. It also does automated clearing house processing for hundreds of banks in the Second Federal Reserve District.

But those had been run as association functions. Under the new corporate framework, hatched over the last two years, they became part of new enterprises owned by banks and driven by the profit motive to seek growth opportunities.

The clearing house has formed two of these limited liability corporations-one for Chips, one to provide payment system technology and support to banks. A third is still in formation for smaller-value payments.

"The world is changing and the clearing house has to change with it," said Jill Considine, president of what is now called New York Clearing House LLC.

"By far this is the most dramatic change in the structure of the New York Clearing House in its 145-year existence."

Chips, the Clearing House Interbank Payments System, has become part of ChipCo LLC. Ninety-four participants in 27 countries share ownership of ChipCo. The clearing house has retained 1% and will operate the system for banks through the second spinoff, ServiceCo LLC, which will also provide technology and operational support for the small-value payments company.

ChipCo's 10-member board consists of representatives from the six largest clearing house members and Swiss Bank Corp. (which is merging with Union Bank of Switzerland), Bank of Tokyo Mitsubishi, Deutsche Bank, and BankAmerica Corp.

The structure is designed to give Chips participants more of a say in policy alongside New York Clearing House banks, officials said.

Thomas G. Labrecque, president of Chase Manhattan Corp., has been named chairman of ChipCo.

Chips is already responsible for a staggering $1.4 trillion of large- value funds transfers on an average day. But its world is changing amid a growing concern about risk management.

CLS Services Ltd., New York, formed last year to address foreign exchange risk through the continuous linked settlement approach, is expected to eventually garner much of the $300 trillion-plus forex market. It has the backing of the committee of investment and commercial banks known as the Group of 20.

Meanwhile, there are "significant opportunities" for Chips in the domestic U.S. payments market, "especially large-dollar business-to- business payments," said George Thomas, senior vice president at the New York Clearing House.

"We are trying to prepare Chips for that electronic commerce initiative- once it gets under way," Mr. Thomas said.

The number of Chips participants has declined slightly in recent years, but transaction volume and dollar value are still growing at roughly 10% annually, he said. The system set its last daily record Nov. 28, 1997, with 457,000 payments, valued at $2.2 trillion.

Chips has worked to become more bank- and customer-friendly by eliminating rules that required members to maintain New York City offices.

Further initiatives could enhance the system's appeal, Mr. Thomas said. One such effort includes adding an electronic data interchange capability by April 2000.

"Corporations want to be able to deliver the payment information with the payment," Mr. Thomas said.

Another initiative involves immediate finality of payments, an attribute that was previously unique to the Federal Reserve's Fed Wire system. However, unlike Fed Wire, the proposed Chips system would not technically be a "real-time gross settlement system."

Chips would be a continuously matching, multilateral netting system that would eliminate whatever slim settlement risk still exists in the current design.

"We are very excited about that," Ms. Considine said. "It delivers the efficiency of a netting system and the finality that one gets in a real- time gross settlement system. It is a hybrid that combines the best of both worlds."

The new clearing system, which requires Fed approval, has been in development for two years.

It would let banks initiate transactions using a prefunded Chips account balance-typically about 10% of the net debit limit on the payment amount that any one participant can make to others at any given time.

Chips would receive a payment request and the system's algorithms would then continuously look for other payments in the system to add to the prefunded amount, effecting the settlement.

In several tests that simulated Chips' peak day, prefunded balances of about $3.3 billion were able to release about $2.18 trillion of payments, almost 98% of the day's volume.

The final funding phase at the end would have required about $18 billion to cover about $65 billion of transactions.

Mr. Thomas said the prefunding system would not only achieve finality, but would prompt larger transactions early in the morning, a rare phenomenon in both Chips and Fed Wire despite their moves last year to a longer operating day that overlapped with overseas payment systems.

Chips banks typically send out smaller payments first to avoid running up against their net debit caps. A fifth of Chips payments, accounting for only 2% of average total dollar value, are processed by 7 a.m., Mr. Thomas said.

He said banks also avoid making large Fed Wire payments early to dodge intraday overdraft fees.

"We believe we can get those (early) payments out at a very minimal cost to the banking industry," Mr. Thomas said.

The New York Clearing House will soon send its system proposals to the Fed for approval and hopes to implement it by April 2000.

A spokesman at the Federal Reserve Bank of New York indicated he was aware of the new Chips effort and noted that several Fed officials have expressed interest in it. The spokesman declined to comment further.

Sources said the Federal Reserve will likely raise the concern that banks could use central bank credit to prefund their Chips accounts, in which case the Fed would be indirectly underwriting Chips.

But others said the Fed should look at the system from a risk perspective and not as a threat to Fed Wire.

"It's the right thing at the right time," said Mr. Labrecque, who said it follows other private- and public-sector collaborative efforts to drive down payments risk, such as that which occurs when a failing bank cannot cover its open positions.

"I think they have absolutely encouraged us over 20 years to get to this point," Mr. Labrecque said.

New York Clearing House officials say they have the overall payment system's best interests at heart. They like to point out that Chips was ahead on compliance with an influential Bank for International Settlements policy statement on risk, the 1990 Lamfalussy Report, even before it was issued.

"Safety and soundness and risk elimination are just as important to us I think as it is to the Fed," said Ms. Considine.

Mr. Labrecque said the clearing house has been working hand-in-hand with the central banking system to "make Chips a model clearing system for the world" and it expects to be supported through the application process.

"We have taken tremendous amounts of risk out of the system already," the Chase executive said. "We will certainly be the first private-sector system to get to finality."

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