The Federal Reserve Board recently issued a final rule for its FedNow instant-payments platform that offers more clarity on how the new service will work while essentially adopting the proposed rule. FedNow will stand alongside private sector initiatives and, like more modern payments systems, will feature credit payments to push funds rather than debit payments to pull funds, offering faster processing.
Highlights of the new rule and FedNow
- Not yet open for business. The Fed continues to target release of FedNow for sometime in 2023. It will implement the 24x7x365 real-time payments service in stages, each with additional features and enhancements.
- Not a consumer or business app or service. Depository institutions that are eligible to hold Reserve Bank accounts will be able to use FedNow, which will be administered by the 12 Reserve Banks. Consumers and businesses may not participate in FedNow directly, and therefore, could not send payment orders to a Reserve Bank through it. They would instead send instant payments through their depository institution accounts.
- Bank v. nonbank direct participation in FedNow. Eligible institutions include banks, savings associations, credit unions, U.S. branches and agencies of non-U.S. banks, Edge or agreement corporations, some systemically important financial market utilities, and government-sponsored entities (including Fannie Mae and Freddie Mac). We use the term “banks” throughout to simplify the discussion.
It is not yet clear whether payments companies and nonbank lenders—whether offering more traditional products and services or more novel applications like crypto and other digital currencies—will be able to use FedNow. Nonbanks have generally not been able to open Federal Reserve accounts, although the Fed earlier this year invited public comment on a proposal that might allow nonbanks to have Federal Reserve accounts, subjecting them to the strictest level of Fed review (see our previous coverage). That would subject nonbanks to much tougher scrutiny—but without a guarantee of direct FedNow participation. Regardless, nonbanks will be able to act as service providers or agents to participating banks.
- Instant payments, except when delayed. Funds may be transferred from a sender’s account to a receiver’s account in near real-time. For instance, a beneficiary’s bank that accepts a payment order through FedNow must pay it “immediately” after acceptance by crediting an account of the order beneficiary as provided under UCC Article 4A. But the Fed has declined to define what “immediately” means. Instead, it generally expects market practice to determine an appropriate timeframe. The Fed has previously stated its intention that customers would be able to send and receive payments within seconds.
A bank will have additional time to decide whether to accept a payment order when it has reasonable cause to believe that the beneficiary is not entitled or permitted to receive payment. Mere suspicion would not appear to suffice as reasonable cause for delay, but payments that could violate U.S. sanctions or, as clarified in the final rule’s commentary, concern fraudulent activity, would.
FedNow also allows a bank to sign off FedNow for limited periods of time—for instance, for system maintenance or following an operational disruption such as a cybersecurity incident.
- Errors, mismatches, and incorrect information. The Fed has declined to direct the Reserve Banks to prevent instances of mismatched information or incorrect information on the grounds that such preventive measures would bog down a real-time system. FedNow instead will include a method to request a return of payment when an error has been identified. Practically speaking, it appears that orders with errors will be processed and corrected afterwards. For instance, if a sender sends a payment order that is not authorized or was erroneously executed under the provisions of UCC Article 4A, the sender will have 60 calendar days after the sender receives notice that the payment order was accepted to notify a Reserve Bank.
- Other laws still apply. The new rule only modifies Regulation J (Collection of Checks and Other Items by Federal Reserve Banks and Funds Transfers through Fedwire). It notably incorporates UCC Article 4A (adding important defined terms), and does not affect other important legal frameworks, such as funds availability.
- Bank protections. By incorporating the provisions of UCC Article 4A, the rule confers important rights on participating banks, including protection from consequential damages liability (unless provided for in an express written agreement), which should help banks offer instant payment services at lower costs and with greater speed.
- Bank obligations. In addition to UCC Article 4A, the rights and obligations with respect to the availability of funds are also independently governed by the Expedited Funds Availability Act and the Fed’s Regulation CC (Availability of Funds and Collection of Checks). The rule incorporates this framework into its funds availability provision.
- Consumer protections. Banks must still comply with requirements under other applicable consumer protection laws. The interplay between these various frameworks may introduce operational and other risks to banks.
- Operating Circulars to further clarify details. The Reserve Banks have authority to issue operating circulars for FedNow that presumably will provide more details and specific terms and conditions. These operating circulars are not guidance and banks must comply with their terms.
- Overdrafts. Because FedNow participants are using accounts at Reserve Banks, overdrafts are not permitted, as is the case today with other Fed services. Banks may need to adjust internal account-monitoring practices, among other controls.
- Separate provisions for FedNow. The FedNow rules now form a new subpart C to Regulation J. Subpart B still covers the Fedwire Funds Service for same-day funds transfers, or wires. FedNow is distinct from Fedwire.
If you have any questions regarding the FedNow rules, please contact an Orrick attorney with whom you have worked in the past.