Note: The International Money Market (IMM) Chicago trades foreign exchange futures and euro futures options. The London International Financial Futures Exchange (LIFFE) trades foreign exchange futures. The Philadelphia Stock Exchange (PSE) trades foreign currency options.
Source: Federal Reserve Bank of St. Louis, Review, March 1984, p. 9, revised.
The Clearing System.
Technology has standardized and sped up the international transfers of funds, which is at the heart of clearing, or settling, foreign exchange transactions. In the United States, where all foreign exchange transactions involving dollars are cleared, electronic funds transfers take place through the Clearing House Interbank Payments System (CHIPS). CHIPS is a computerized network developed by the New York Clearing House Association for transfer of international dollar payments, currently linking 46 major depository institutions that have offices or affiliates in New York City. Currently, CHIPS handles more than 360,000 interbank transfers daily valued at more than $2 trillion. The transfers represent more than 95% of all interbank transfers relating to international dollar payments.
The New York Fed (Federal Reserve Bank) has established a settlement account for member banks into which debit settlement payments are sent and from which credit settlement payments are disbursed. Transfers between member banks are netted out and settled at the close of each business day by sending or receiving FedWire transfers of fed funds through the settlement account. Fed funds are deposits held by member banks at Federal Reserve branches.
The FedWire system is operated by the Federal Reserve and is used for domestic money transfers. FedWire allows almost instant movement of balances between institutions that have accounts at the Federal Reserve Banks. A transfer takes place when an order to pay is transmitted from an originating office to a Federal Reserve Bank. The account of the paying bank is charged, and the receiving bank’s account is credited with fed funds.
To illustrate the workings of CHIPS, suppose Mizuho Corporate Bank has sold U.S.$15 million to Citibank in return for ¥1.5 billion to be paid in Tokyo. In order for Mizuho to complete its end of the transaction, it must transfer $15 million to Citibank. To do this, Mizuho enters the transaction into its CHIPS terminal, providing the identifying codes for the sending and receiving banks. The message—the equivalent of an electronic check—is then stored in the CHIPS central computer.
As soon as Mizuho approves and releases the “stored” transaction, the message is transmitted from the CHIPS computer to Citibank. The CHIPS computer also makes a permanent record of the transaction and makes appropriate debits and credits in the CHIPS accounts of Mizuho Corporate Bank and Citibank, as both banks are members of CHIPS. Immediately after the closing of the CHIPS network at 4:30 p.m. (eastern time), the CHIPS computer produces a settlement report showing the net debit or credit position of each member bank.
Member banks with debit positions have until 5:45 P.M. (eastern time) to transfer their debit amounts through FedWire to the CHIPS settlement account on the books of the New York Fed. The Clearing House then transfers those fed funds via FedWire out of the settlement account to those member banks with net creditor positions. The process usually is completed by 6:00 P.M. (eastern time).
1 These volume estimates appear in Bank for International Settlements, “Triennial Central Bank Survey: Foreign Exchange and Derivatives Market Activity in 2007,” December 2007, p. 4. About 4% of transactions show up as “gaps in reporting.” These missing transactions are just allocated proportionately to the spot, forward, and swap transactions.