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Breffni McGuire, senior analyst, Global Payments, TowerGroup
Breffni McGuire, senior analyst, Global Payments, TowerGroup
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Resiliency in the Wholesale Payments System

In the wake of September 11th, regulators have grown increasingly concerned about potential points of failure in the payments system-particularly given consolidation among the larger banks, the concentration of banks and payments clearing systems in major cities across the globe, and the interconnectedness of various payments networks.

With the tragic events of September 11th now more than a year in the past, industry regulators have had a chance to assess the resiliency of the high-value payments systems. Both in the United States and abroad, regulators are addressing concerns about potential points of failure in the payments systems. The Bank for International Settlements (BIS) not only is advancing Basel II, which targets disaster and business disruption among its operational risk loss events, but also is strengthening its Core Principles for systemically important payment systems.

U.S. regulators are taking a closer look at how technology and infrastructure vulnerabilities might increase systemic risk in the domestic payments system. The "Draft Interagency White Paper on Sound Practices to Strengthen the Resilience of the US Financial System," ("Sound Practices"), issued in August 2002 by the Federal Reserve, the Office of the Comptroller of the Currency and the Securities and Exchange Commission, recommends specific objectives for the contingency and business resumption programs of core settlement organizations and "significant firms" in critical financial markets. These regulatory initiatives place additional pressure on the payments systems operators (CHIPS and Fedwire) and on the largest banks providing payment clearing and settlement services.

The criticality of high-value payments clearing to major banks, the high-value payments systems and the financial markets cannot be overestimated. Wholesale payments clearing provides substantial revenue to the bottom line for banks and is integrated with a myriad of cash management, credit, foreign exchange and other services that banks provide to their corporate and institutional customers. Clearing must be accomplished safely, securely and reliably -- with continuous processing and systems availability. Each bank must provide a high level of resilience for its own payments processing business including the redundancy, recovery, and resumption capabilities required to prevent, mitigate and manage disasters.

That there are two U.S. high-value payment systems gives the U.S. payments system an added level of resilience. Fedwire and CHIPS each has its own robust recovery and resumption capabilities. Moreover, both systems have established rules and procedures for participant banks to minimize risk and ensure the operational integrity of the payments system. Both require their members to have substantial disaster preparedness and to participate in contingency tests. Contingency and business continuity requirements are also spelled out by the Federal Financial Institutions Examination Council (FFIEC), which sets uniform standards for federal regulators and issues directives to financial institutions. The FFIEC is currently updating its requirements for business continuity planning for the first time since 1996.

September 11th added new dimensions to business continuity planning. Before 9/11, the frequency of hardware and systems failure as the reason for invoking recovery plans fostered the perception that disaster recovery was primarily a technology issue. In the new, post-9/11 world, everyone realizes that disasters may result not only from foreseeable operational failures and natural events but also from terrorist, chemical, electronic and other attacks that may cause serious disruption of unknown duration. September 11th highlighted the interconnectedness of clearing banks and the vulnerabilities of the payments systems and financial markets. This has led directly to new initiatives by payment system operators, the industry and, in particular, US regulators.

Targeted to the top 15 to 20 major banks (and 5 to 10 major securities firms), the Sound Practices white paper introduces a new level of complexity for significant banks clearing high-value payments and proposes rapid recovery and resumption criteria. It addresses people, technology and critical infrastructure issues in the context of out-of-region resource requirements, and raises issues relative to payments processing functions, capacity and connectivity. Diversity of resources is a key criterion: Secondary sites must not rely on the same people, systems or infrastructures as those of the primary site. The white paper also posits that some minimum distance (200 to 300 miles) might be appropriate between primary and secondary sites to mitigate the effects of wide-scale disasters. Although the new rules have direct impact only on the largest banks, other banks processing large volumes of wholesale payments should review their business continuity plans in anticipation of greater supervisory expectations.

Business continuity includes not only recovery from a disaster but also the ability to resume business-as-usual functions quickly. It puts a premium on people and business processes that are essential for maintaining the viability of the bank's payments business. Operational resilience--which depends on proactive initiatives to provide sustained availability and performance of payments processing--is becoming more important. This speaks to the necessity for clearing banks to have a well-defined and documented plan that encompasses people, applications, systems, operations and data center recovery and resumption goals. For payments clearing, the central responsibility for both disaster recovery and business continuity is high availability to customers, continuous (or close to continuous) processing and staff safety.

As payments organizations assess how their disaster recovery and business continuity programs stack up against the regulators' proposals, they must come to grips with critical questions about how operational resiliency and sound practices issues will affect their business, such as:

* What is the impact on the bank's payments processing business and practices? * How do the proposals change existing disaster preparedness models? * How can the requirements be folded into overall business continuity strategies? * What technology is available to help meet regulatory expectations? * What is an appropriate level of investment? * How much is enough?

The largest clearing banks are developing a set of best practices that reflect many of the white paper's sound practices. These best practices start from a clear understanding of risks and critical activities and include dual sites for both payments processing operations and data center facilities, separation of operations sites from data centers, and a high level of redundancy of both systems and people. Best practices combined with a robust wire transfer application help ensure that a bank can meet the four-hour recovery goal proposed in the Sound Practices white paper.

Technology touches all areas of payments processing and clearing -- supporting the high availability and durability requirements of wholesale payments operations and defining the scope and timing of recovery and resumption. Operational resilience begins with robust funds transfer processing software and high-availability hardware and software. Funds transfer processing is already highly automated, but banks continue to look at new technology options to increase day-to-day processing efficiencies as well as to add resilience for business continuity purposes. New technologies offer ways to automate data replication over longer distances and manage recovery and resumption more effectively, while ensuring that business processes are supported at contingency sites as they are at primary locations. Technology alone is not sufficient to ensure the overall resilience of the business, but it is vital for continuity of mission-critical payments clearing operations.

The financial services industry and bank payments forums have engaged in a number of initiatives to tackle different parts of the problem--ranging from payments system risk, to telecommunications and critical infrastructures, to interbank continuity projects. New methods and standards are necessary to determine satisfactory levels of resilience. Regulators and industry organizations can take the lead in developing specific methodologies and guidance that will be acceptable to industry participants. This includes standards, models and benchmarks that will be useful to banks to develop business continuity plans for payments clearing activities.

Although there are outstanding issues, the implications of new regulatory initiatives are clear: Banks will be held to greater levels of disaster preparedness and operational resilience. Initiatives of the BIS and domestic regulators will change how banks handle wholesale payments recovery and resumption. Change will come at a higher cost, where resilience becomes a matter of regulatory expectations not just prudent business decisions. For many payments processing banks, requirements will cause changes to their technology or infrastructure plans and affect how they provide high-value payments clearing.

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