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D0946B-2009

May 2009

Cover Payments: Background Information and Implications of the new SWIFT Message Format (due to go live on November 21, 2009)
It is important that participants in payment systems are aware of the new SWIFT Message Format, due to go live on November 21, 2009. This statement sets forth relevant background to the initiative that has led to the new message format for cover payments and considers some of the consequences of the use of the new message format for participants in payment systems. These consequences may be substantial. Background to the Cover Payments Initiative Due to the design of the payments infrastructure, when cover payments are used, not all payment information available to the originators bank is currently communicated to the intermediary bank(s) involved in making payments. More specifically, the payment message format used for cover payments, the MT 202 (and the MT 205), which is sent to intermediary banks, does not currently require the inclusion of originator and beneficiary information that is contained in the underlying MT 103 (which is sent to the beneficiarys bank, but not to the intermediary banks when the cover payment is used). As a result, the intermediary banks receiving the MT 202 do not currently receive originator and beneficiary information. Reflecting a consensus to facilitate greater transparency and to assist financial institutions in their anti-money laundering and sanctions compliance efforts, SWIFT created a variant of the MT 202 (and the MT 205). This variant, the MT 202 COV (and the MT 205 COV), provides for replication of all information contained in certain fields (i.e. fields containing originator and beneficiary information) of the MT 103 and is to be used for cover payments. Please see the presentation referenced at the end of this statement, which provides a basic explanation of various terms used above and further information regarding cover payments and the nature and use of the MT 202 COV. The proposed message format was subject to approval by SWIFTs membership. The related "country vote" commenced in early December 2007 and concluded with a vote substantially in favor of the proposal. Subsequently issued SWIFT message scope states: [The new message format, the MT 202 COV] must only be used to order the movement of funds related to an underlying customer credit transfer that was sent with the cover method. The MT 202 COV must not be used for any other interbank transfer. For these transfers the MT 202 must be used, and "[MT 202] must not be used to order the movement of funds related to an underlying customer credit transfer that was sent with the cover method. For these payments the MT 202 COV . . . must be used." Reaction to the development of the new message format has been positive and welcomed by regulators. In October 2007, the Basel Committee on Banking Supervision issued a statement saying it supported greater transparency in this area, and, after going through a consultative process, the Committee has just issued its paper, Due diligence and transparency regarding cover payment messages related to cross-border wire transfers, available at www.bis.org. The Committee noted that this paper is consistent with the private sector initiatives supported by the Basel Committee to enhance transparency in payment messages. In this paper, the Committee describes supervisory expectations with regard to originators, cover intermediary, and beneficiary banks, noting that, with reference to cover payment messages, the originators bank must ensure that the messages it sends to the cover intermediary bank contain originator and beneficiary information, (paragraph 21) and highlighting the role of supervisors with regard to originators banks (included in paragraph 38). It is understood that that responsibility for ensuring the correct use of the MT 202 and MT 202 COV and the inclusion of relevant originator and beneficiary information must rest with the originators bank and its home country regulatory authorities. The Basel Committee considers this guidance relevant for all supervisors worldwide. This letter reaffirms the industry commitment to ensuring integrity and transparency of the international payment system but that can only be achieved if each country ensures that originating banks comply with the new message format and adhere to these principles.

Consequences of Use of the New Message Format Many of the organizations contributing to this statement have vast memberships and specialist groups working on the question of cover payments and seek to apprise others in the industry of the forthcoming changes to the payments system and its implications. In so doing, we have collectively observed that it is appropriate to enhance awareness and understanding of the implications that the introduction of the new SWIFT message format onto the SWIFT network will have for all financial institutions, particularly in terms of the following: their usage of message formats and systems modifications the ability to ensure straight-through processing of their payments how their payments are screened an increase in new information that will be available, giving rise to more hits and corresponding false positives generated by automated monitoring systems the appropriate level and training of their staff to handle those hits

Attached is a presentation designed to provide a basic explanation of this initiative, what cover payments are, and possible consequences of use of the new message format. Because these consequences have substantial compliance and operational implications, you should consult about these matters with relevant compliance and operations personnel. To the extent that the organizations making this joint statement can be of assistance to the rest of the industry, or indeed to the financial intelligence community, in providing clarity around the initiative, and its implications, you should feel free to contact the representatives listed below.

Donna K. Alexander Managing Director Bankers Association for Finance & Trade dalexander@aba.com

Thierry Snchal Policy Manager, Banking & Financial Services Commissions Secretary, Corporate Economists Advisory Group (CEAG) International Chamber of Commerce (ICC) thierry.senechal@iccwbo.org Marilyn Skiles Secretary General International Council of Securities Associations mskiles@sifma.org Dan Taylor President and Chief Executive Officer International Financial Services Association dan.taylor@intlbanking.org Gottfried Leibbrandt Head of Markets SWIFT gottfried.leibbrandt@swift.com Tracy Paradise Executive Secretary The Wolfsberg Group tracy.paradise@ubs.com

Joseph R. Alexander Senior Counsel The Clearing House Association L.L.C. joe.alexander@theclearinghouse.org Sbastien de Brouwer Head of Department, Retail FS, Legal & Social Affairs European Banking Federation S.deBrouwer@ebf-fbe.eu Sally Scutt Managing Director International Banking Federation sally.scutt@bba.org.uk

The Introduction of the MT 202 COV in the International Payment Systems

Issues for Consideration

This presentation considers a new payment message format, the MT 202 COV*. It is important that participants in the payment systems are aware of the new SWIFT Message Format, due to go live on November 21, 2009. This presentation sets forth relevant background to the initiative leading to the new message format and considers some of the consequences of the use of the new message format for participants in the payment systems, which may be substantial. For those people who are already familiar with what cover payments are and why they are used, please turn directly to Slide 11. * The MT 205 COV will be introduced at the same time and will basically follow the same rules as the MT 202 COV.

Why this initiative?

All financial institutions involved in the proposal have risk-based programs that apply systems and controls to both the front and back end of wires processed to comply with local regulations and economic sanctions requirements. This presentation considers how transparency in the global payments system may be further enhanced, focusing on Cover Payments. The method of using cover payments is fundamental to the effectiveness of the payments system. However, due to the design of the payments infrastructure, when cover payments are used, not all payment information available to the originators bank is communicated to the intermediary bank that is paying the beneficiarys bank. The messaging practices for cover payments have possible implications for anti-money laundering, anti-terrorist financing efforts, and sanctions compliance. To implement a method to make all payment information available to the originators bank also available to the other banks in the payment process in a reliable, systematic way is a substantial undertaking.
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The Global Payments System

Over the last 30 years, the worlds banks have developed an international payment system that has been instrumental in fostering global economic prosperity, allowing financial transactions to be processed with confidence, speed, and efficiency. The smooth functioning of this system is vital to global financial stability. The system is large and complex. As Timothy F. Geithner (ex-President and CEO of the Federal Reserve Bank of New York, now US Treasury Secretary) remarked in a speech at the 2004 SWIFT Conference: The payments infrastructure of the global financial system is a complex patchwork of national and cross-border systems, not seamless, not uniform, but closely connected. Global Correspondent Banking Network. At the heart of this international payment system is the global correspondent banking network, whereby banks around the world can make payments to and through each other. Within this network, banks communicate and transfer funds to one another. Domestic and Supranational Systems Most countries have domestic payment systems and there are other supra-national systems (e.g., TARGET). Role of SWIFT. SWIFT is the infrastructure supporting both global correspondent banking and most domestic payment systems and Real-Time Gross Settlement ("RTGS") networks and involves nearly 8,000 financial institutions (banks, broker-dealers and investment managers) in over 200 countries and territories. In 2007, SWIFT handled more than 3 billion messages globally (averaging more than 14 million messages per day). Role of Central Banks and Regulators. Central Banks and numerous regulators oversee the system. The global payments system has evolved in a way that, first and foremost, promotes efficiency and effectiveness, i.e., the system concentrates on information essential for processing a payment transaction and on including all countries and financial institutions within the system to allow 4 payments to pass readily across international borders.

Role of the Bank maintaining the Customer Relationship

The role of the bank that maintains the customer relationship is key to an effective AML/ATF/sanctions program The financial institution at which an account is opened has the greatest opportunity adequately to assess its potential customer (the Originator, in the case of the Originators Bank, and the Beneficiary, in the case of the Beneficiarys Bank). The primary due diligence responsibility must remain with each involved institution to know its own customer and fulfill its own AML, ATF and sanctions obligations, and the banking industry and regulatory community should continue to promote robust safeguards at the point of entry. It is the Originators Bank that controls the initiation of the payment messaging process.

What is a Cover Payment?

A typical funds transfer involves the Originator instructing its bank (the Originators Bank) to make payment to the account of a payee (the Beneficiary) with the Beneficiarys Bank. In the context of international funds transfers, the Originators Bank and the Beneficiarys Bank often do not have a relationship that allows them to settle the payment directly. Intermediary accounts at Intermediary Banks must be employed to settle the payment. Accordingly, a typical funds transfer may involve multiple banks in multiple jurisdictions. The messages (payment orders) used to execute funds transfers are carried over a system such as SWIFT, CHIPS or other RTGS systems. SWIFT message protocols allow for the use of the cover payment method to pay the Beneficiarys Bank. A cover payment involves two distinct message streams (MT 103 & MT 202). MT 103 - Direct payment order to the Beneficiarys Bank, and MT 202 Bank-to-bank order(s) to Intermediary Bank(s) to cover the Originators Banks obligation to pay the Beneficiarys Bank. In a cover payment, the Intermediary Bank(s) receiving the MT 202 does not receive the MT 103. As a result, the Intermediary Bank(s) have no ability to monitor or filter the payment details involved in the MT 103. MT 202s are used for primarily two purposes, namely, cover payments and bank-to-bank payments (i.e., settlement of FX trades, payment of interest, reimbursements under documentary credits, etc.), and the Intermediary Bank(s) cannot distinguish in straight through processing between these two uses.

Consequences of Cover Payments

The current cover payment process does not require the inclusion of Originator and Beneficiary information in the MT 202 from the Originators Bank and therefore is not presented to other Financial Institutions in the payment process. The MT 202 COV will contain such information, see the next two slides.

A Cover Payment

*The ordering customer may be a customer of Bank A but there may be other banks between Bank A and the ordering customer. Similarly, there may be one or more banks between Bank B 8 and the beneficiary customer.

A Cover Payment - continued

*The ordering customer may be a customer of Bank A but there may be other banks between Bank A and the ordering customer. Similarly, there may be one or more banks between Bank B 9 and the beneficiary customer.

Transparency in Payment Messages Basel Committee Newsletter No. 12 - October 2007

The Basel Committee welcomes the dialogue between the public and private sector over the issue of enhanced transparency for cover payments initiated by the industry through the Wolfsberg Group and the Clearing House Association as well as the proposals under discussion in the SWIFT community to increase the transparency of transfers. A solution improving transparency in international payments should aid anti-crime efforts worldwide. Cover payments are used in correspondent banking in particular to execute transfers ordered by customers in foreign currencies. This technique of cover payments has advantages for banks, but the current messaging standards do not ensure full transparency for the intermediary banks on the transfers they are helping to execute. This has in some cases raised concerns about the risk that such a type of message could be chosen on purpose to conceal the names of parties to a transaction and about the ability of the intermediary banks to comply with their obligations. The Committee encourages the industry, which is best placed to design the technical solutions to meet this challenge, to proceed with all the necessary changes in order to implement as soon as feasible these solutions for all relevant standards of messages. The Committee encourages the effective and genuine use of such solutions.

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The Basel Committee on Banking Supervision Document on Due diligence and transparency regarding cover payment messages related to cross-border wire transfers

In July 2008, the Basel Committee published its preliminary views on supervisory expectations relating to transparency in payment messages, particularly in anticipation of changes to technical standards for cross-border wire transfers. In May 2009, after a consultative process, the Committee issued its final document. In the final paper, the Committee describes supervisory expectations with regard to originators' banks, cover intermediary banks and beneficiary banks, noting that, with reference to cover payment messages, the originators' bank "must ensure that the messages it sends to the cover intermediary bank contain originator and beneficiary information," (paragraph 21) and highlighting the role of supervisors with regard to originators' banks (included in paragraph 38).

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Issues to consider in preparing for the SWIFT Release of Nov. 21st 2009
From an operational perspective Need for banks (and vendors) to address use of message formats and make systems changes The ability to ensure straight-through processing Increase in hits and consequently in "false positives" and blocked/rejected payments due the increase in quantity of information contained in the payment message Need to have appropriate level and training of relevant personnel ready for November 21st, 2009 Consideration of a process to handle the MT 103 if a corresponding MT 202 COV gives rise to a true hit, and the cover is not forthcoming

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Issues to consider in preparing for the SWIFT Release of Nov. 21st 2009 (continued)
From a general awareness perspective There needs to be more awareness of the appropriate use of the new message format, the MT 202 COV, which will go "live" in only a matter of months. In this regard, it should be noted that SWIFT characterizes the relevant message scope of the MT 202 COV and the MT 202, as they are contemplated to be used starting November 21, 2009, as follows: [The MT 202 COV] must only be used to order the movement of funds related to an underlying customer credit transfer that was sent with the cover method. The MT 202 COV must not be used for any other interbank transfer. For these transfers the MT 202 must be used, and "[The MT 202] must not be used to order the movement of funds related to an underlying customer credit transfer that was sent with the cover method. For these payments the MT 202 COV . . . must be used." The characterization of the relevant message scope does not distinguish on the basis of the currency or jurisdiction involved, but, rather, is general in its application. The SWIFT User Handbook provides that if a message type exists for a particular class of transactions, then customers must use that message type. The availability of the MT 202COV will not preclude the use of the MT 103 on a serial basis. Financial Institutions need to ensure that they have adequate resources allocated to hithandling Law enforcement needs to ensure that their community is aware that this message change will be implemented before year-end, and of the implications it may have for them 13

Additional Resources
Basel Committee on Banking Supervision Due Diligence and Transparency regarding cover payment messages related to cross border wire transfers http://www.bis.org/publ/bcbs154.pdf SWIFT Handbook http://www.swift.com/about_swift/press_room/swift_news_archive/ home_page_stories_archive_2009/SWIFTlimitsStandardsMTRelease200 9tominimisecustomerimpactinfinancialcrisis.page SWIFT MT 202 COV Training http://www.swift.com/training/training_topics/payments_and_cash _management/MT202COV-standards_release_seminar.page Payment Market Practice Group Guidelines for the use of the MT 202 COV www.pmpg.info Wolfsberg/Clearing House Message Payment Standards http://www.wolfsberg-principles.com/pdf/WGNYCH_Statement_on_Payment_Message_Standards_April-19-2007.pdf

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Contact Details
Donna K. Alexander Managing Director Banker's Association for Finance & Trade dalexander@aba.com Joe Alexander Senior Counsel The Clearing House Association L.L.C. Joe.Alexander@theclearinghouse.org Sbastien de Brouwer Head of Department, Retail Financial Services, Legal & Social Affairs European Banking Federation S.deBrouwer@ebf-fbe.eu Sally Scutt Managing Director International Banking Federation sally.scutt@bba.org.uk Thierry Snchal Policy Manager, Banking & Financial Services Commissions Secretary, Corporate Economists Advisory Group (CEAG) International Chamber of Commerce (ICC) thierry.senechal@iccwbo.org Marilyn Skiles Secretary General International Council of Securities Associations mskiles@sifma.org Dan Taylor President and Chief Executive Officer International Financial Services Association dan.taylor@intlbanking.org Gottfried Leibbrandt Head of Markets SWIFT gottfried.leibbrandt@swift.com

Tracy Paradise Executive Secretary The Wolfsberg Group tracy.paradise@ubs.com

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