Presented by: The Northern Trust Company Marabeth Milos May 19, 2011

2. Chapter 10 Payment Systems, Collections and Disbursements Marabeth Milos

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

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

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

14. Other Paper-Based Instruments

15. U.S. Payment Systems and Instruments

16. Electronic Funds Transfers (EFT)

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. Chapter 11 Money Markets, Short-Term Investing and Borrowing Marabeth Milos

34. Global Money Markets Money Market Participants Government entities Securities dealers Commercial banks Corporations Individuals Broker-dealer

35. Global Money Markets Types of Money Market Instruments and Investments Commercial Paper (CP)- tradable promissory notes issued by companies at a discounted price (liquid but not secured) Asset-backed commercial paper- CP that is secured against a specific asset Bank Obligations- time deposits such as CDs Government Paper (T-bills)- tradable promissory notes issued by governments Floating rate notes- promises to return face value plus interest Repurchase agreements (repos)- bank or dealer sells securities agreeing to buy them back later at a higher price Money Market Funds- comingled pools of money market instruments Short-Duration Mutual Funds- invest in securities with longer maturities than most money market instruments Sweep Accounts-loan sweeps

36. Short-Term Money Markets in the U.S. Processing and Clearing of Short-Term Investments Commercial Book Entry System(CBES)- Delivery system for the simultaneous transfer of securities against the settlement of funds Depository Trust and Clearing Corporation (DTCC)- Provides clearing, settlement and information services for bonds, money market instruments, securities and derivatives U.S. Money Market Participants U.S. Treasury and federal agencies Commercial banks Thrifts Municipalities Corporations Federal Reserve Securities dealers

37. Short-term Money Markets in the U. S. U. S. Money Market Instruments U.S. Treasury Bills: usually exempt from state income tax, mature in less than one year and are sold through a sealed bid auction Bank Debt Obligations: FDIC insured Commercial Paper: has maturity of less than 270 days, evaluated by rating agencies and is issued by large corporations, and non-bank finance companies U.S. Federal Agency and Government-Sponsored Enterprise (GSE) Securities: carries explicit or implied guarantee by the U.S. government (Ginnie Mae) Municipal Notes, Variable Rate Demand Obligations and Tax-Exempt Commercial Paper: mature in 3 months- one year Money Market Funds: prime, government, treasury and tax-exempt classes, sold in shares by banks, fund providers and investment brokers

38. Managing Short-term Investments Short-Term Investment Policy Focuses on liquidity maintenance and principal preservation, based on risk tolerance In-House Management vs. Outsourced Management In-house expensive for small companies and small investment portfolios Policies and guidelines must be communicated clearly to outside manager when outsourced Investment Strategies Buy-and-hold-to-maturity Actively managed Tax-based Reliable Reporting

39. Managing Short-term Investments Securities Safekeeping and Custody Services Focuses on liquidity maintenance and principal preservation, based on risk tolerance Investment Risk Considerations and Factors Influencing Investment Pricing Credit or Default Risk (higher yields, higher risk) Asset Liquidity Risk Price/Interest Rate Risk Foreign Exchange (FX) Risk

40. Pricing and Yields on Short-Term Investments

41. Managing Short-Term Financing

45. Managing Short-Term Financing