Presented by: The Northern Trust Company Dan Carey

1. Windy City Summit CTP Review Chapters 10 Service Expertise Integrity Presented by: The Northern Trust Company Dan Carey

2. Chapter 10 Payment Systems, Collections and Disbursements Dan Carey

3. Overview of Payment Methods • Payment Systems Payment Instrument/Method +Clearing Channel Settlement Mechanism that transfers money Payment System • Cash- coin and currency • Paper- checks, drafts • Electronic- • Business Electronic Payment Systems- wire, ACH • Consumer Electronic Payment Systems- ACH or giros • Payment Card- debit and credit cards, smart cards

4. Payment Systems • Key Participants in the Payments Clearing Process • Paying Bank- payor’s bank • Receiving Bank- payee’s bank • Correspondent Bank- “partner” bank • Central Bank or Monetary/Banking Authority- runs clearing system • Banking Clearinghouse- groups of banks agreeing to exchange paymens • Third-Party Clearing Entity- third-party that handles clearing, but not settlement, process (CHIPS and credit card networks)

5. Overview of Payment Systems • Settlement • Settlement occurs when depository bank account is credited and drawee bank account is debited • Payee’s and payor’s account credited and debited • Provisional credit: credit may be reversed • Real- time settlement: transaction processed when initiated; settlement may be transaction by transaction (gross), intraday, or net • Settlement is final when payment unconditional and irrevocable- returns not accepted • Settlement Methods • Exchange of value between banks • Corresponding bank accounts • Reserve accounts at banking authority (Fed accounts)

6. Common Payment Practices and Issues • Society for Worldwide Interbank Financial Telecommunication (SWIFT) • Interbank network that allows banks to send electronic payment-related information in standard formats • Cash Payments • Security and integrity issues and costly • Paper-Based International Payments • Slow, complicated and expensive • Industry-Based Net Settlement Systems • Airlines, oil and gas, telecommunications and securities • Electronic Payment Security • Encryption, Authentication, Security Tokens

7. Global Banking Systems and Practices • Identification of Bank Accounts • Bank Identification Code (BIC): international standard for identifying banks • International Bank Account Number (IBAN): international standard for identifying bank accounts • European Payment Systems • Economic and Monetary Union (EMU): to integrate the economies of all them members • European Central Bank (ECB): sets policy for EU members that have accepted the euro as their currency (in “euro zone”) • Advantages of euro include elimination of exchange rate risk, lower transaction costs, consolidation of banks and simplification of treasury management techniques

8. Global Banking Systems and Practices • Settlement Mechanisms • TARGET2 • Correspondent Banking • Internal Networks and Local Clearing Channels • Euro Bankers Association (EBA) • Single Euro Payments Area (SEPA) • Straight-thru electronic payment system that allows cashless transactions be made in euro zone using only one bank and one set of instructions

9. Global Banking Systems and Practices • Bank of Canada is the central bank • 5 major banks and 60 other smaller financial institutions • Automated Clearing Settlement System (ACSS) • The Large Value Transfer System (LVTS) • Banco de Mexico (Banxico) is central bank • Two major clearing/settlement channels • Sistema de Pagos Electronicos Interbancarios (SPEI) • Sistema de Camara (SICAM)

10. Global Banking Systems and Practices • Anti-money laundering (AML):legal constraints requiring financial institutions to prevent or report suspected money laundering activities • Financial Action Task Force (FAFT): set policies aimed at combating money laundering and terrorist funding (travel rule) • Office of Foreign Assets and Control (OFAC): U.S. office that administers and enforces economic and trade sanctions (provides list of specially designated individuals) • Continuous Linked Settlement (CLS): a simultaneous exchange of both sides of financial transactions eliminating settlement risk • Straight-Thru Processing (STP): allows for information that is electronically entered in the settlement process to be processed without manual intervention. • International Organization for Standardization (ISO) 20222 Global Standards: global messaging standard related to SEPA and is the next generation of SWIFT messaging

11. Paper-based Payments • Check/IRD Clearing Process

12. Check Clearing Process • Check 21: • Created Image Replacement Document (IRD) allowing banks to exchange images rather than paper documents • Allowed for the introduction of Remote Deposit Capture (RDC) • Return deadlines • Clearing Channels • On-Us vs Transit Check Clearing • Endpoints: location of the paying bank • Deposit Deadlines and Timing • Ledger cut-off: time a check must be received in order for it to be posted for ledger (provisional) credit that day • Deposit deadline: time it must be received to qualify for availability stated in availability schedule

13. Check Settlement and Funds Availability • Availability Schedules • States, by endpoint, when the bank grants available credit for collected items (generally 0-2 days) • Balances and Float • Ledger Balances: reflect all entries, available or not • Available Balances: funds available for withdrawal • Collected Balances: Average ledger – deposit float used to determine earnings credit • Other Factors Influencing Availability • Pre-encoding/RDC/Image Capture • Reject Items • As-of Adjustments

14. Other Paper-Based Instruments • Payable Thru Drafts (PTD) • Pre-Authorized Draft • Remotely Created Check (RCC) • Money Order • Traveler’s Check • Sight and Time Draft • Cashier’s Check/Certified Check • State Warrants

15. U.S. Payment Systems and Instruments • Check Conversion: converts MICR line into electronic debit transaction • Point-of-Purchase (POP) Check Conversion: information captured and check returned to customer at time of purchase • Accounts Receivable Conversion (ARC): Lockbox checks converted, with prior authorization • Back Office Conversion (BOC): conversion after sale if stated on the receipt • Ineligible for Check Conversion • Greater than $25,000 • If Aux on-us field (business checks) • Third-party checks, credit card checks, money orders, traveler’s checks, cashiers checks

16. Electronic Funds Transfers (EFT) • The Automated Clearing House (ACH) • Clearinghouse for high-volume, low-dollar electronic transactions • NACHA establishes and administers rules and standards, UCC Article 4A covers credit transactions and Reg E governs consumer debit entries • Parties involved in ACH entries include: the originator, receiver, originating depository financial institution (ODFI) and the receiving depository financial institution (RDFI) and the operator (Fed or EPN) • ACH credits: instruct the ODFI to move funds from the originators account to the receiver’s account with the RDFI (e.g. direct deposit of payroll, benefit payments, tax and vendor payments) • ACH debits: instruct the ODFI to take funds from the receivers account at the RDFI and deposit them into the originator’s account at the ODFI (e.g. mortgage payments, insurance premiums, check conversions)

17. U.S. Payment Systems and Instruments • ACH Transaction Processing • Batch, store and forward system • Transactions are value dated (settlement dates) • Simultaneous settlement between originator and reciever • Memo posting common • Risk associated with the ODFI’s obligation to settle credits once credit file is released, regardless of originator’s account status • Returns allowed (unauthorized vs. authorized) • Same-day settlement of on-us and possibly other entries • Standard ACH formats (by SEC code) including addenda record formats • Prenotes optional but recommended • Authorization required for certain transactions (usually consumer)

18. U.S. Payment Systems and Instruments

19. U.S. Payment Systems and Instruments

20. U.S. Payment Systems and Instruments • IATs: any transaction that is sent to, or received from, a foreign source and includes domestic transactions funded internationally • Must include mandatory addenda records to comply with OFAC • Fed Global ACH Payments: • Credit payments 35 countries, debits to Canada • Account to account or Account to Receiver • Fixed to variable: U.S. dollar to destination currency • Fixed to fixed: U.S. dollar to U.S. dollar or foreign currency to foreign currencies

21. U.S. Payment Systems and Instruments • Fedwire • Fedwire transfers settle individually and continuously –gross settlement • Large dollar and/or urgent transactions • Federal Reserve guarantees finality of payment • Funds and information transferred together • Expanded Fedwire format aligns with CHIPS, SWIFT and combats money laundering • Relatively expensive • Regulated by Federal Reserve Regulation J and UCC4A

22. U.S. Payment Systems and Instruments • Fedwire Types • Repetitive transfers (pre-defined debit and credit parties) • Semi-Repetitive transfers (adds description) • Non-Repetitive transfers (free-form) • Drawdown (Used for concentration) • Standing (Used for concentration)

23. U.S. Payment Systems and Instruments • Clearing House Interbank Payments System (CHIPS) • Operated by The Clearing House Association • For international transactions, letter of credit and documentary collections payments and third-party transfer • Clears over 95% of international payments made in U.S. dollars • Specific CHIPS format accommodates extensive information • Real-time intraday net settlement system • Settles in U.S. dollars via Fedwire • Alternative Payment Instruments • Money transfer via Check cashing store • On-line • Paypal

24. U.S. Payment Systems and Instruments • Credit Cards • Two primary bank-issued cards are VISA and MasterCard (AMEX main non-bank card) • Three main steps in the credit card transaction: authorization, clearing and settlement • Merchant charged fees from issuing bank (IRF fees) and network either during settlement process or separately which are set by the network • Fees tied to the swiping of a card at POS are cheaper than internet or phoned in (MOTO) transactions

25. U.S. Payment Systems and Instruments • Debit cards - direct access to cardholder account • Signature or PIN based • Purchasing cards • Travel cards • Ghost Card • Departmental (Un-named) cards • Single-Use cards • Stored Value cards (SVC) • Smart cards

26. U.S. Payment Systems and Instruments • Collection Float Components • Mail Float • Processing Float • Availability Float • Measurement • Float is measured in dollar-days • Float is a function of the transaction’s dollar amount and the number of days delay

27. U.S. Payment Systems and Instruments • Company Processing Center • Primary advantages: control of operation, cost savings • Primary disadvantage: increased float • Lockbox • Advantages: reduced float, scalability, efficient processing • Disadvantage: loss of control • Wholesale • Small volume, large dollar corporate to corporate payments with non-standard remittance data • Retail • Large volume, small-dollar consumer-to-corporate payments with standard return document (ICR,OCR,MICR) • Hybrid

28. U.S. Payment Systems and Instruments • Cost Benefit Analysis: Reduced Float vs. Incremental Costs • Net Benefit Calculation: Reduction in Float Opportunity Cost + Reduction in Internal Processing Cost - Lockbox Processing Costs • Float Opportunity Cost is a function of • the dollar amount of collected items • total collection time for the items • company’s current investment or borrowing rate

29. U.S. Payment Systems and Instruments • Electronic Payment Methods – Three Benefits: • Predictability of settlement improves cash forecasting • Direct payments to any account or financial institution • Ease of transmitting customer remittance information • Check 21 • Enhances collection efficiency • Conversion of checks to ACH debits – POS, ARC • Web based – integrated billing and payment • EBPP (Electronic Bill Presentment and Payment) - Consumer • EIPP (Electronic Invoice Presentment and Payment) - Corporate

30. Disbursements • Goals • Disburse funds to payees in timely and accurate manner • Communicate information to cash manager for cash forecasting and position management • Disbursement Products • Controlled disbursement – same-day notification of check clearings • Programs impacting controlled disbursements • Payor Bank Services – electronic notification • High Dollar Group Sort – second presentment to banks with more than $ 10 million in daily presentments • Same Day Presentment – by 8:00 am

31. Disbursement Products • Payable Through Drafts (PTD) • Drawn against payor, not bank • Used by insurance companies • Positive Pay • Payee match • Reverse positive pay • Multiple Drawee Check/Payable-If-Desired (PID) • Imprest or Petty Cash Account • Account reconciliation services • Full or partial reconciliation • Stop payments and high-order prefix • Image-based Services

32. Electronic Disbursement Methods • Direct Deposit • Purchasing/Procurement Cards (P/Cards) • Issued to designated employees • Authorized for pre-specified types of purchases • Cost savings: • Reduce check volumes • Negotiated terms with major suppliers • Rebates from card providers • Electronic Benefit Transfers and Payroll Cards • Tax Payments (TXP) Format

33. Questions for Chapter 10 What is the Automated Clearing House(ACH) system? Discuss the obligations of the originating depository financial institution and the receiving depository financial institution regarding ACH settlement and returns. What is same-day ACH? What are prenotes and why are they used? What is the Fedwire? What Federal Reserve regulation governs Fedwire transfers? How does Fedwire clear and settle funds transfers? What are the three steps(and substeps) in the credit card transaction process? How long do consumers have to dispute a credit card transaction and what can a merchant do to respond to this chargeback? What is a lockbox processing system? What is the primary advantage of an lockbox? What is the major advantage of a traditional check/mail-based lockbox system over a company processing center? Define dollar-days. How are dollar-days relevant when deciding whether to switch from in-house processing to the use of a lockbox system? What is the Society for Worldwide Interbank Financial Telecommunication (SWIFT) and what does it do?