47. A bank could eliminate overly restrictive unilateral payment cancellation deadlines (to shorten the duration of Status I) and reduce the time it takes to identify its final and failed receipts of bought currencies (to shorten the duration of Status U). As indicated above, these improvements could require a combination of changes to its own settlement practices and, if relevant, to its correspondent banking arrangements. In October 1994 the New York Foreign Exchange Committee (NYFEC), which is a private sector group sponsored by the Federal Reserve Bank of New York, published a report on Reducing Foreign Exchange Settlement Risk. In its report, the NYFEC defined "best-case" FX settlement practices as those that would give a bank the following capabilities: - To cancel its payment instructions unilaterally up until the opening time on settlement day of the local large-value transfer system (LVTS)
- To identify its final and failed receipts immediately upon finality of the local LVTS
48. While there may be different views as to what constitutes "best practice" in different markets, the NYFEC's definition provides a useful reference point for measuring the effect of changing current settlement practices. In addition, the NYFEC's "best-case" practices are already being followed by at least some market participants, providing concrete evidence that similar practices could be adopted immediately by all participants in the FX market.
49. Table 2a and Figure 2a help to illustrate the potential impact of improving settlement practices. They take as a starting-point the hypothetical portfolio underlying Table 1a and Figure 1a, but instead show the trade status and projected FX settlement exposures from the perspective of a "best-case" bank as defined by the NYFEC. According to the NYFEC's definition, such a bank can cancel its payment instructions up until the opening time of the local LVTS. As a result, as Table 2a shows, it would have only US$ 40 million worth of Status I trades as of 11 a.m. on Friday, compared with US$ 105 million for the "worst-case" bank (in contrast to the "worst-case" bank, a bank following the NYFEC's "best-case" practices could still unilaterally cancel the US$ 65 million of JPY and DEM it is scheduled to pay on Monday). Looked at from another point of view, a "worst-case" bank's minimum exposure would exceed two and a half times the exposure of a bank following the NYFEC's "best-case" practices in settling the same hypothetical set of FX trades.
50. Since, according to the NYFEC's definition, a "best-case" bank identifies its final and failed receipts as soon as they are due, in normal circumstances it would not expect to have any Status U trades - once final receipt is due, such a bank could immediately classify its trade as either Status S or Status F with certainty. Thus, at 11 a.m. on Friday, an NYFEC "best-case" bank will know whether all of the receipts due on Thursday (value US$ 100 million) and all the JPY and DEM receipts due on Friday (value US$ 60 million) were, in fact, received. Table 2a indicates that if all such receipts were verified as paid with finality (i.e. the trades have Status S), the maximum exposure of an NYFEC "best-case" bank would equal only US$ 40 million - the same as its minimum exposure. Furthermore, if it verified the final receipt of the US$ 40 million in USD due on Friday, an NYFEC "best-case" bank could be certain that it had no settlement exposure to its counterparty over most of the weekend, whereas a "worst-case" bank would calculate its maximum exposure at US$ 265 million throughout the weekend. Tables 2b and 2c and Figures 2b and 2c show similar calculations and projections and, hence, potential exposure-reducing benefits from the perspective of Asian and European banks.
