1. Innovation & Globalization In Retail Payments Systems: Legal & Compliance Issues Richard M. Fraher Federal Reserve Bank of Atlanta

2. Technology Drives; Law Reacts Technical innovation drives the new frontiers in payments –Completely new mechanisms—web, M-banking –Transformation of old mechanisms—e-checks Law reacts by balancing competing goals –Promote efficiency, certainty, predictability Allocate risks of loss –Prevent abuses Fraud Money laundering/terrorist financing –Regulate without stifling innovation

3. Online Check Images ACH Cards Emerging –M-banking Electronic Payments

4. Paper to Electronics Number of non-cash electronic payments exceeded checks for first time in 2003; trend is accelerating Source: Federal Reserve, 2004

5. Transformations of Check Processing Paper instruments sorted/posted by hand Electronic processing—1960-1990 –MICR—paper check as “IBM card” –Electronic presentment under UCC 4-110 Attempted escapes from paper –Image exchange agreements; “e-checks” Low adoption rates

6. The Check 21 Act Effective 10/28/2004 Creates Substitute Check to facilitate image exchange Does not define, regulate, or protect image exchange

7. The Substitute Check

8. Paper Check Collection/Return Bank to Bank—UCC 4 Bank of First Deposit CHECK IntermediaryPaying Bank CHECK

9. Bank to Bank Check Collection and Return After C21 CHECKPAPER Intermediary Paying Bank IMAGE PAPER Bank of First Deposit IMAGE or

10. New Deposit Side Services CHECK BOFD backroom process Intermediary or Paying Bank IMAGE Payee Remote Deposit

11. Presentment Side Services PAPER Paying Bank IMAGE cash letter bulk delivery or, by agreement: PAPER Intermediary IMAGE cash letter bulk delivery Drawer

12. Rapid Electronification Explosion of image based check collection, 2004-2007 and beyond…

13. Adoption of Image Exchange

14. Legal Lessons Learned Public lawmaking may be useful to spur adoption of new technologies Adapting old laws to new technology led to unanticipated results –Business outcome: remote deposit capture –New legal issues: duplicates; “rejects” –Evolving technical standards developing in private sector were incorporated in public law

15. Globalization Creating the FedACH international service

16. FedACH International Goal: Make international retail payments faster, cheaper –1990s – “NAFTA ACH” and “WATCH” Discussions –1998 – Rivlin Committee—Fed support for international ACH –2000-2003 Fed discussions with European postal banks Goal: Support U.S. Treasury move away from paper Practice: Building new channels, one border at a time –1999 – Canadian ACH Pilot –2003 – FedACHi Transatlantic to Five Nations –2004 – FedACHi to Mexico –2004 – FedACHi to Panama

17. FedACH International ® Services Guiding Principles –Provide services to banks and to Treasury –Develop safe, efficient, inexpensive solutions for government and commercial payments –Compliance with all laws/regulations –Leverage Fed’s existing ACH network, formats, & application to create a channel for small value cross-border payments –Develop automated, STP solutions –Support bi-directional flows –Offer end-to-end certainty of clearing & settlement times –Offer competitive FX rate –No fees deducted from principal amount of transaction

18. Legal Structure NACHA Cross-Border Rules + FRB OC4 “Gateway Operator” Agreement for: –Settlements—a series of bank to bank steps –Editing, format translation, and forwarding into destination payment system –Establishing exchange/processing timetables to fix date for receipt of funds Payment Rules of Destination Country DI must have adequate compliance program— BSA, AML, USA Patriot Act OFAC compliance regime

19. US BankFedACH Gateway OperatorForeign Bank Originator Receiver FedACH International Process Flow

20. Lessons Learned Efficiencies Produced by FedACHi –Treasury payments moved away from paper –Consumer benefits—safety, reduced costs Compliance can be elusive and expensive Linking payments networks is: –Complex, technically and legally, to begin –Time consuming and expensive to maintain Where are the payments? –US Treasury; remittances; what else?

21. Conclusions In creating a framework of rules for emerging retail payments systems –Public law is difficult to enact quickly enough The more detailed and prescriptive the public law is, the harder it is to keep up with change Should public law state general principles and leave the specifics to the private sector? –Private sector agreements creating new payments mechanisms may or may not adequately protect consumers

22. Conclusions… Compliance has become crucial in retail payments –Concentrations of dirty money are a threat –“Everything changed after 9/11” –As retail payments go global, combating fraud, money laundering, & terrorist financing in retail payments is a global concern –Non banking mechanisms may be hard to police

23. Conclusions… Legal and technical differences from country to country hamper internationalization of bank based retail payments –This sustains a market for non-bank based, non- regulated retail payments mechanisms Regional or global efforts to break down legal and technical barriers may help to create safe, efficient bank based cross border retail payments systems