T his report examines technological innovation in payment systems generally and particular policy issues as a result of retail (i.e., point of sale) payment innovation. The report also discusses wholesale payment, clearing, and settlement systems that send payment messages between banks and transfer funds, including the "real-time payments" service being introduced by the Federal Reserve. This report includes an Appendix that describes interbank payment, clearing, and settlement systems related to U.S. payments. Background on Payments The U.S. financial system processes millions of transactions each day to facilitate purchases and payments. In general terms, a payment system consists of the means for transferring money between suppliers and users of funds through the use of cash substitutes, such as checks, drafts, and electronic funds transfers. The Committee on Payment and Settlement Systems (CPSS), consisting of representatives from several international regulatory authorities, has developed generally accepted definitions of standard payment system terminology. As defined by the CPSS, a payment system is a system that consists of a set of instruments, banking procedures, and, typically, interbank funds transfer systems that ensure the circulation of money. These systems allow for the processing and completion of financial transactions. From the typical consumer's perspective, making a payment is simple. A person swipes a card, clicks a button, or taps a mobile device and the payment is approved within seconds. However, the infrastructure and technology underlying the payment systems are substantial and complex. To simplify, a payment system has three parts (see Figure 1 ). First, the sender (i.e., the person making the payment) initiates the payment through an end-user service , such as an online payment service or mobile app, instructing the payer's bank to make a payment to the recipient. The payer and recipient interact only with end-user services, which comprise the "retail" portion of payments. Second, the payer's bank sends a payment message containing payment details to the recipient's bank through a payment system (sometimes called a clearing service ). Third, the payment is completed (or settled) when the two banks transfer funds through a settlement system. Different systems can perform each of these parts, and systems' developers and operators compete with each other to provide payment and settlement services to consumers, businesses, and banks. These final two inter-bank steps are the "wholesale" portion of payments. End-user services, which are operated by the private sector, facilitate a consumer's ability to purchase goods and services, pay bills, obtain cash through withdrawals and advances, and make person-to-person payments. Retail payments tend to generate a large number of transactions that have relatively small value per transaction. Retail payment services can be accessed through many consumer financial products, including credit and debit cards and checking accounts. The most common methods of payment are debit cards, cash, credit cards, direct debits and credits via an automated clearing house (ACH), checks, and prepaid debit cards (see Figure 2 ). In the United States, the Federal Reserve (Fed) operates some of the key bank-to-bank payment, clearing, and settlement (PCS) systems that process retail or wholesale transactions, and private-sector organizations operate other systems that clear and settle bank-to-bank payment, including those described in the Appendix . Payment Systems and Financial Technology Technological advances in digitization and data processing and storage have greatly increased the availability and convenience of electronic payments. In recent years, the use of electronic payments has risen rapidly, whereas the use of cash and checks has declined (see Figure 2 ). According the Federal Reserve's most recent triennial payment study (released in 2016), the number of transactions of three electronic payment methodsâdebit card, credit card, and ACHâgrew at annual rates of 7.1%, 8.0%, and 4.9%, respectively. Together, they totaled more than 144 billion transactions with a value of almost $178 trillion in 2015. Meanwhile, check payments declined by an annual rate of 4.4% during that period, and totaled 17.3 billion transactions worth almost $27 trillion in 2015. Less data are available on cash usage and the value of cash transaction in part because they are person-to-person and do not involve a digital record, but a Fed survey estimates that between 2012 and 2015, the share of transactions made in cash fell from 40.7% of all transactions to 32.5%. This trend is probably due, at least in part, to various new technological products and services that offer fast, convenient payments for individuals and businesses. Payment apps linked to bank accounts and payment cards can be downloaded onto mobile devices that allow individuals to send payments to each other or to merchants. These services include Venmo (owned by PayPal), Zelle (owned by a consortium of large U.S. banks), and Cash App (owned by Square). Other companies provide hardware and software products that allow individuals and small businesses to accept debit and credit card payments, online or in person. These companies include PayPal, Square, and Stripe. Another advance in payments is allowing consumers to make payments using a mobile device, wherein debit card, credit card, or bank account information is stored in a "digital wallet" and sensitive information is protected by transmitting surrogate data (a process called tokenization ) at the point of sale. This service includes Apple Pay, Google Pay, and Samsung Pay. These services are generally layered on top of traditional electronic payment systems. To use these services, the consumer or business often must link them to a bank account, debit card, or credit card. The payments are still ultimately settled when the money from the payer's account is deposited in the recipient's account. An exception are payments made by cryptocurrencies, discussed in the text box. Faster Retail Payments: Policy Issues Although faster and potentially less costly payment systems benefit consumers and businesses, the use of new technology in existing and new payment systems raise questions about whether existing regulation adequately addresses issues related to cybersecurity and data privacy, industry competition, and consumer access and protection. Regulatory Framework How payments are federally regulated depends, in part, on whether they are being provided by banks. Banks are subject to a variety of prudential regulation, enforcement, and supervision by federal bank regulators. Nonbank payment processors are subject to similar regulation and supervision (but not enforcement) by bank regulators if they are a service provider to a bank, but otherwise are not. Nonbank companies that do not provide services to banks may be regulated as money transmitters at the state level by state agencies and as money service businesses at the federal level by the Department of the Treasury's Financial Crimes Enforcement Network and subject to applicable laws and regulations. These services are subject to federal consumer protection regulation under the Electronic Fund Transfer Act ( P.L. 95-630 ); anti-money laundering requirements under the Bank Secrecy Act (P.L. 91-508); and various state licensing, safety and soundness, anti-money laundering, and consumer protection requirements. A broad issue that permeates many of the specific issues examined in this report is the debate over whether the various companies providing retail payment services are effectively and efficiently regulated. Nonbank money transmission is largely regulated at the state level. Some observers have argued that this state-by-state regulatory regime, designed to protect against risks presented by traditional money transmitters such as Western Union, is overly onerous and ill-suited when applied to new, technology-focused payment companies. State regulators assert they are best positioned to regulate these companies, noting their experience and recent efforts to coordinate and streamline state regulation. A greater federal role in payment regulation could impose more or less stringent standards (with federal preemption of state regulation, in the latter case) than any given state's current standards. One potential solution for concerns that the current system is too fragmented and overly burdensome could be to allow certain nonbank payment companies to enter the bank regulatory regime. Two potential mechanisms are under consideration that could allow a technology-focused payment company to be federally regulatedâthe Office of the Comptroller of the Currency (OCC) special purpose national bank charter and a state-level industrial loan company (ILC) charter with Federal Deposit Insurance Corporation (FDIC) insurance. Both could be particularly desirable for payment firms if they provide an avenue to directly access Fed wholesale payment systems. However, both mechanisms are controversial and subject to contentious debate. The OCC and proponents of the special purpose charter generally view the charter as a way to free companies from what they assert is the unnecessarily onerous regulatory burden of being subject to numerous state regulatory regimes while not overly relaxing regulationsâunder the special purpose charter, the companies would become subject to the OCC's national bank regulatory regime. Opponents generally assert that the OCC does not have the authority to charter these types of companies and that doing so would inappropriately allow fintech firms offering fast payment services to circumvent important state-level consumer protections. State regulators have filed lawsuits to block the granting of such charters. To date, no companies have applied for such a charter, although ongoing legal uncertainty is likely a discouraging factor. ILC charters are controversial because they allow commercial firmsâsuch as retailers, manufacturers, or technology companiesâto own banks. The United States has historically adopted policies to separate commerce and banking, and the FDIC has not approved deposit insurance for a new ILC since 2006. Opponents of ILC charters argue that by creating an avenue for a commercial firm to own a depository institution, they blur the line between commerce and banking, exposing the U.S. economy to related risks such as creating possible incentives for imprudent underwriting, inappropriately exposing taxpayers to losses through federal deposit insurance, and leading to entities that can exercise market power. Proponents of ILC charters assert these concerns are overstated. They cite the potential benefits of mixed arrangement (e.g., economies of scale, risk diversification, information efficiencies, customer convenience and savings) and note that certain other stable developed countries allow more blending of banking and commerce than the United States with, they argue, no or little ill effect. Recently, three fintech companies submitted applications to the FDIC for ILC deposit insurance. Two companies, however, have since withdrawn their applications, and the company with a pending application, Square, is a payment system provider. Cybersecurity All payment methods expose users to some risks, including money theft or fraudulent payments made using their accounts or identities. In general, improving technology reduces one type of risk but may expose users to new risks. For example, if a pickpocket steals a person's cash, the victim has little recourse. If instead, the pickpocket steals a payment card, the victim can cancel the card and generally would not be held liable for fraudulent purchases. However, identity thieves can steal card information using card reader skimmers, allowing thieves to open and use lines of credit in victims' names without their knowledge. Similarly, new payment technologies reduce certain risks but create others. For example, digital wallets on mobile devices can eliminate the need to carry physical cards that can be lost or stolen and can protect sensitive information at the point of sale through tokenization. However, the device itself can be compromised by software designed to gain unauthorized access to devices, called malware, which may lead to fraudulent charges. In addition, storing payment information on multiple websites, apps, and devices creates more opportunities for hackers to steal it than if the information existed only on the card itself. Recent breaches at various financial and nonfinancial companies in which people's sensitive information were compromised illustrate the potential risk and have raised questions over whether policymakers should implement stricter cybersecurity requirements. Some possible policy responses include enacting a federal breach notification law, creating federal cybersecurity standards, or increasing federal authority to penalize companies that fail to adequately protect consumer data. Data Privacy Payment systems necessarily collect detailed consumer information on transactions, including the retail stores a consumer shops at, the businesses and individuals the consumer pays, and the dates, times, and amounts of each transaction. Through analysis, this data have the potential to reveal a lot of information about individual consumers, including where they live and their gender, age, race, ethnicity, and approximate income. Such data are valuable from a business perspective; for example, for targeting product marketing to consumers. In addition, scammers could use this data to facilitate fraud. Electronic payments have resulted in a proliferation in the availability and use of personal information, which has raised policy concerns about how companies use the data, whether consumers understand how their data will be used, and whether consumers should have more control over its use. Payment data has the potential to improve consumer outcomes. For example, personal financial management apps or other digital tools could help consumers more easily track payments, automate saving and budgeting, and more efficiently shop for financial products that meet their personal needs. Consumers could also in the future share this data with financial institutions to apply for loans or other banking products. Given these benefits, as well as possible privacy concerns, the question becomes how much access should companies have to individuals' information. Privacy policy disclosures to consumers is another important element of privacy policy that might be more difficult as payments become faster using new technology. For example, according to the Bureau of Consumer Financial Protection (CFPB), stakeholders suggest that "providing disclosures that are clear and sufficient for consumers to make informed decisions is difficult" in the mobile environment due to small screens, which may make it difficult to read long, technical disclosure documents. These stakeholders indicate that clear privacy policies and more consumer control over the use of consumer data may be important considerations in this new digital environment. Consumer Protection When developing a new or faster retail payment system, consumer protection is an important consideration. Although new technology offers consumers many potential benefits, it raises issues of concern, such as consumer liability for fraudulent payment and consumer error or nonreceipt of goods resolution. The Electronic Fund Transfer Act, currently implemented by the CFPB through Regulation E, is the most relevant consumer protection law applying to financial payments. Regulation E protects individual consumers who engage in electronic fund transfers. It mandates consumer disclosures, limits consumer liability for unauthorized transfers, and maintains procedures for resolving errors. Other regulations may also be relevant to a new faster payment system, depending on its structure. For example, the Expedited Funds Availability Act ( P.L. 100-86 ), currently implemented by the Federal Reserve as Regulation CC, prescribes how quickly banks must make funds available to customers. When developing a new faster payment system, Congress and federal regulators may consider how a new system should comply with relevant regulations, such as Regulation E. Depending on the structure of the new system, regulators might decide to update these regulations to tailor them as appropriate. For example, current consumer protection rules might not cover all aspects of the system, leaving consumers at risk of financial loss, without clear recourse for some payment-related disputes, or other negative impacts. In this spirit, in 2015, the CFPB released nine consumer protection principles for new faster payments systems, including consumer control over payments, fraud and error resolution protections, and disclosed and clear costs. The CFPB has not acted on these principles through rulemaking or other initiatives since their release in 2015. Financial education might be another consumer protection policy option. As new technology is introduced into financial products, consumers may need to learn new skills, sometimes referred to as digital financial literacy , which includes "knowing how to use devices to safely access financial products and services via digital channels in ways that help consumers achieve their financial goals, protect against financial harm and enhance ability to know where to get help." This type of financial education might be particularly important to ensure that lower-income and older consumers are included in a new faster payment system. Financial Access and Underserved Groups Innovations in the payment system may benefit some consumers and fail to reach others. New retail payment options that are linked to bank accounts, internet-based, or require mobile devices could disadvantage consumers who rely on cash payments, do not have easy internet or mobile access, or do not feel comfortable using this new technology. As long as payments remain based on the banking system, the unbanked and underbanked may encounter participation limits to faster payments. In contrast, innovation in technology may help marginalized groups gain access to the financial system. The ability to access digital channels using cash may be particularly important for including underserved consumers, leading to the development of new payment productsâsuch as pre-paid cards and servicesâthat allow cash to be placed in an account that can be used to make online payments. The cost of internet and mobile data plans might limit the ability of underserved consumers to access a faster payment system that is internet- or mobile-based. However, as internet access and mobile devices continue to proliferate and decline in cost, barriers to accessing those technologies may decline. For example, most consumers, including unbanked and underbanked consumers, have access to mobile phones and smartphones, and the use of these technologies is growing. According to a national survey, in 2017, 83% of underbanked and 50% of unbanked consumers had access to a smart phone. The survey noted that underbanked consumers were more likely to use mobile banking services than the rest of the U.S. population. A faster payment system may provide certain other benefits besides access for low-income or liquidity-constrained consumers (colloquially, those living "paycheck to paycheck") who may more often need access to their funds quickly. In particular, many lower-income consumers say that they use alternative financial services, such as check cashing services and payday loans, because they need immediate access to funds. Faster payments may also help some consumers avoid checking account overdraft fees. Note, however, that some payments that households make would also be cleared fasterâdebiting their accounts more quicklyâ than the current system, which could be harmful to some underserved households. Market Concentration Traditional payment systems generally are characterized by strong economies of scale and are subject to network effects , wherein the more widespread a payment method's use and acceptance becomes the more incentive additional consumers and businesses have to adopt it. These economic characteristics may mean payment industries naturally become highly concentrated, because a small number of widely used systems are more efficient than many narrowly used systems. For instance, established payment systems currently have high market concentrations. Debit card payment processing networks are dominated by Visa and Mastercard, and credit card processing networks are mostly operated by Visa, Mastercard, American Express, and Discover. Some observers are concerned that market concentration will also be a feature in new payment systems. Others argue that new payment systems based on the internet may avoid similar concentration observed in traditional systems, because they do not require new entrants to make large initial investments in infrastructure. To date, the entry of multiple new services and companies into the market for end-user payment systems has supported competition and consumer choice. Whether the industry will eventually consolidate remains to be seen. Creating additional concentration concerns is the entrance of some of the largest global technology companies into the payment industry, including U.S. companies such as Google (Google Pay), Apple (Apple Pay), Amazon (Amazon Pay) and Facebook (Facebook Pay and the Libra proposal). Such companies already have large market shares in various technology-related industries and collect huge amounts of consumer data, which could increase as they now seek to expand their scope into the payment industry. Were they to dominate electronic payments, it could pose competition concerns in the payment industry, as well as increase their dominance in their core industries. In addition, these developments raise concerns discussed above (see the " Regulatory Framework " section), relating to the implications of mixing commerce with what has traditionally been a core banking activity. Wholesale Payment Systems and Real-Time Payments Payments between two parties who are both members of the same end-user serviceâa closed loop paymen t âcan occur in real time because the service can instantly communicate between the two parties, verifying that the payer has sufficient funds in the account to make the payment. However, a payment in which one party is outside of a single end-user service typically travels through the banking system, and thus cannot occur in real time unless real-time messaging, clearing, and settlement of the payment is available through wholesale payment systems. For example, a debit or credit card payment to a merchant needs to transfer funds from the sender's bank (in the case of a credit card, the card-issuing bank) and send them to the recipient's bank. Real-time payment can only occur in this scenario if settlement occurs in real-time or if payment occurs before settlement (putting the recipient's bank at risk that the transfer never occurs). Even within an end-user service that would provide real-time payment, if the transfer were made between two members entirely using existing balances within the service, delivery of funds could be delayed if the payer needs to add funds to their account to make payment (via direct debit or credit card transfer, for example) or if the recipient wishes to withdraw funds from the payment service to deposit in its bank account. Thus, the speed of many existing end-user services are ultimately limited by what happens with wholesale payment systems. On August 5, 2019, the Fed announced plans to create a wholesale real-time payment (RTP) system. This section discusses the history of the Fed's role in the payment system; compares recent RTP initiatives by the Fed, the private sector, and abroad; and analyzes policy issues raised by these initiatives. History of the Fed's Role in the Payment System The Fed was originally created as a "banker's bank" to improve the functioning of a national banking system that was dominated at the time by small, local banks. To that end, providing bank-to-bank check-clearing services was one of the Fed's original, primary functions. Problems with private clearinghouses were one of the central issues in the financial panic that led to the Fed's creation. As other payment methods have emerged over time, the Fed has also provided other types of bank-to-bank payment and settlement systems. The Fed provides these services by linking the accounts that all banks maintain at the Fed to comply with reserve requirements. Throughout the Fed's history, the private sector has operated competing payment and settlement systems that the Fed has regulated (see Appendix for more details). For example, the Fed and the private-sector Electronic Payments Network (owned by The Clearing House , an association of large banks ) currently operate competing automated clearinghouse (ACH) systems, which are payment systems that allow banks (and certain other financial institutions) to send direct debit and credit messages that initiate fund transfers. The Fed also operates two wholesale settlement systems for payments, Fedwire Funds Service and the National Settlement Service. The Clearing House Interbank Payment System (CHIPS) is a competing private-sector gross settlement system. (The Fed does not operate any end-user service directly accessed by individuals or nonfinancial businesses.) Real-Time Payments Initiatives A typical bank-to-bank electronic payment is currently settled on the same or next business day. The Fed plans to introduce an RTP system called FedNow in 2023 or 2024. FedNow would be "a new interbank 24x7x365 real-time gross settlement service with integrated clearing functionality to support faster payments in the United States," that "would process individual payments within seconds ... (and) would incorporate clearing functionality with messages containing information required to complete end-to-end payments, such as account information for the sender and receiver, in addition to interbank settlement information." According to the Fed, FedNow will be available to all banks with a reserve account at the Fed. It will require banks using FedNow to make funds transferred over it available to their customers immediately after being notified of settlement. In a November 2018 proposal, the Fed also sought comment on the possibility of the Fed creating "a liquidity management tool that would enable transfers between Federal Reserve accounts on a 24x7x365 basis to support services for real-time interbank settlement of faster payments, whether those services are provided by the private sector or Federal Reserve Banks." The purpose of this tool would be to accommodate the need for banks to move funds between their accounts at the Fed continuously, including outside of business hours in real-time settlement. In the August notice, the Fed stated it was exploring whether this goal could be accomplished by expanding Fedwire Funds Service and the National Settlement Service to permit 24x7x365 real-time gross settlement. Previously, the Fed proposed expanding same-day payment settlements on Fedwire and the National Settlement Service. Several private-sector initiatives are also underway to implement faster payments, some of which would make funds available to the recipient in real time (with deferred settlement) and some of which would provide real-time settlement. Notably, the Clearing House introduced its RTP network (with real-time settlement) in November 2017; according to the Clearing House, it currently "reaches 50% of U.S. transaction accounts, and is on track to reach nearly all U.S. accounts in the next several years." In addition, both the Fed and private-sector companies can set joint standards, rules, and a governance framework to facilitate the adoption of faster payments, whether those systems are operated by the Fed or the private sector, and promote interoperability between systems. The Fed convened the Faster Payments Task Force, composed of more than 300 stakeholders, which has issued a number of recommendations to facilitate the adoption of faster payments. Policy Issues Other countries have already introduced or are in the process of introducing RTP. According to Fed Chair Jerome Powell, "the United States is far behind other countries in terms of having real-time payments available to the general public." Businesses and consumers would benefit from the ability to receive funds more quickly, particularly as a greater share of payments are made online or using mobile technology. Some have argued that RTP would be especially beneficial to low-income, liquidity-constrained individuals as described in the " Financial Access " section above. The main policy issue regarding the Federal Reserve and RTP is whether Fed entry in this market is desirable. The Fed bases decisions on whether to introduce new payment systems or system features on three principles: "The Federal Reserve must expect to achieve full recovery of costs over the long run. The Federal Reserve must expect that its providing the service will yield a clear public benefit, including, for example, promoting the integrity of the payments system, improving the effectiveness of financial markets, reducing the risk associated with payments and securities-transfer services, or improving the efficiency of the payments system. The service should be one that other providers alone cannot be expected to provide with reasonable effectiveness, scope, and equity." Stakeholders are divided over the introduction of FedNow. Some question whether, in light of these principles, the Fed can justify creating a RTP system in the presence of competing private systems. Some fear that FedNow will hold back or crowd out private-sector initiatives already underway and could be a duplicative use of resources. The Treasury Department supports Fed involvement on the grounds that it will help private-sector initiatives at the retail level. Others, including many small banks , fear that aspects of payment and settlement systems exhibit some features of a natural monopoly (because of network effects), and, in the absence of FedNow, private-sector solutions could result in monopoly profits or anticompetitive behavior, to the detriment of financial institutions accessing RTPs and their customers (merchants and consumers). In 2017, the Justice Department sent the Clearing House a letter stating that it did not plan to challenge the Clearing House's RTP system on antitrust grounds, based on the Clearing House's plans at that time. From a societal perspective, it is unclear whether it is optimal to have a single provider or multiple providers in the case of a natural monopoly, particularly when one of those competitors is governmental. Multiple providers could spur competition that might drive down user costs, but more resources are likely to be spent on duplicative infrastructure. RTP competition between the Fed and the private sector also has mixed implications for other policy goals: Innovation. Competition typically fosters innovation, but the Fed's unique cost structure could potentially undermine the private sector's success, limiting the latter's willingness to invest in innovations. Ubiquity. The Fed argues that RTP ubiquity is more likely with its involvement because it has existing relationships with all banks and because no single payment system has ever achieved ubiquity historically. However, the Fed's entry into RTP could delay the achievement of universal RTP in the next few years if banks decide to wait until FedNow is available instead of joining the Clearing House's network. Interoperability. Interoperability (the ability to make payments across different systems) is more difficult to achieve with competing firms, but the Fed argues that if no single RTP system is ubiquitous, the ability of any two given institutions to exchange funds is improved if competing systems increase ubiquity. The ability to make payments across ACH networks is an example of how interoperability has currently been achieved between competing Fed and Clearing House systems. However, the technology involved in RTP may make interoperability more difficult. In its proposal, the Fed did not commit to ensure interoperability, but stated that it was a desirable goal. Equity. The Clearing House has attempted to assuage equity concerns by pledging access to its system on equal terms to all banks, regardless of size, but these terms could change, and small banks have raised concerns that they may since the system is owned by large banks. The Clearing House has pointed to the Fed's volume discounts for existing payment systems as evidence that FedNow may not be equitable, however. Security. Security across competing systems could be difficult to coordinate, but systems might also attempt to compete by providing better security features. The Fed argues that competing RTP systems reduces operational and systemic risks because a system with only one provider has a "single point of failure." Repeated data breaches at large financial institutions also point to the difficulty of monitoring cybersecurity in private systems, although government has also proven to be vulnerable to data breaches as well. The Fed states that "participating banks would continue to serve as a primary line of defense against fraudulent transactions, as they do today ... " under FedNow. The Fed, and by extension the taxpayer, is exposed to default risk because of its provision of intraday and overnight credit (some of which is uncollateralized) when banks use its payment and settlement systems. Currently, when banks use Fed payment and settlement systems, the time lag between payment and settlement can cause mismatches in the amounts due and the amounts available in their accounts. As a result, the Fed extends intraday credit for a fee (if uncollateralized) to avoid settlement failures. Daily overdrafts have been relatively low in recent years, but peaked at $186 billion during the 2007-2009 financial crisis. Introducing real-time payments with deferred settlement could increase the use of intraday credit. The Fed does not state in its final rule whether it expects the level of intraday credit to be affected under FedNow, although it notes that it might need to extend the availability of intraday credit to off-hours. Note that the Fed provides this credit to reduce systemic risk to the banking system, so eliminating intraday credit has the potential to reduce financial stability. Regulation RTPs offered by the private sector could fit into the existing regulatory framework. The Fed already regulates and supervises private payment systems for risk management and transparency, but not pricing. RTP could potentially alleviate some existing risks (e.g., if settlement is in real time, credit risk is reduced for the recipient institution) while posing new risks (e.g., RTP requires more active liquidity management). Any RTP system and regulation would need to account for these changing risks. To address systemic risk concerns, a private RTP system could be designated as a systemically important Financial Market Utility (FMU) under Title VIII of the Dodd-Frank Act ( P.L. 111-203 ). The Dodd-Frank Act allows the Financial Stability Oversight Council , a council of financial regulators led by the Treasury Secretary, to designate a payment, clearing, or settlement system as systemically important on the grounds that "the failure of or a disruption to the functioning of the FMU could create or increase the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the U.S. financial system." FMUs, currently including the Clearing House Interbank Payments System, are subject to heightened regulation, and the Fed has supervisory and enforcement powers to ensure those standards are met. Policymakers could consider whether systemic risk concerns are better addressed through Fed operation of payment and settlement systems or Fed regulation of private systems. Appendix. Selected Interbank Payment, Clearing, and Settlement Systems Involved in U.S. Payments


T his report provides an overview of economic and fiscal conditions in the U.S. Virgin Islands (USVI). The political status of the U.S. Virgin Islands and responses to Hurricanes Irma and Maria are not covered in depth here. Fiscal and economic challenges facing the USVI government raise several issues for Congress. First, Congress may choose to maintain oversight of federal policies that could affect the USVI's long-term fiscal stability. Second, Congress may consider further legislation that would extend or restructure long-range disaster assistance programs to mitigate those challenges and promote greater resiliency of infrastructure and public programs. Federal responses to the USVI's fiscal distress could conceivably affect municipal debt markets more broadly. Geography The U.S. Virgin Islands are located about 45 miles east of Puerto Rico and about 1,000 miles southeast of Miami, Florida. The three larger islandsâSt. Croix, St. Thomas, and St. Johnâare home to nearly all of the roughly 105,000 people living in the U.S. Virgin Islands. The USVI capital, Charlotte Amalie, is located on St. Thomas, which is the primary center for tourism, government, finance, trade, and commerce. The Virgin Islands National Park covers about two-thirds of the island of St. John, which is located to the east of St. Thomas. St. Croixâsituated approximately 40 miles south of St. Thomas and St. Johnâis the agricultural and manufacturing center of the USVI. The U.S. Virgin Islands also includes a fourth smaller islandâWater Islandâas well as many other smaller islands and cays. The British Virgin Islands (BVI) are, by and large, east and slightly north of the U.S. Virgin Islands. The southern shore of Tortola, the largest island in BVI, is less than two miles north of the northern shore of St. John, USVI. Historical Background Second Voyage of Christopher Columbus On his second voyage to the Caribbean in November 1493, Admiral Christopher Columbus and his crew reached the archipelago of the Lesser Antillesâthe string of islands ranging southeast from Puerto Rico. As his ships sailed northwest toward Puerto Rico, they encountered one larger island, which Columbus named Santa Ursula, and saw to the north what they thought were at least 40-odd other islands, which were called "las once mil VÃrgenes." Santa Ursula, now known as St. Croix, was described as "very high ground, most of which was bare, the likes of which no one had seen before or after." Over time those islands became known as the Virgin Islands. In the decades following Columbus's voyages, the Spanish crown had nearly sole control over all trade and navigation in the Caribbean. By the mid-1500s, merchants and privateers from France, England, and Holland moved into the region to trade with colonists who chafed at the high prices and narrow restrictions of Spanish imperial rules. Spanish galleons returning to Spain with goods and gold provided an additional motivation to privateers and pirates. The Spanish shifted much of their settlements and operations to the South American mainland and to the larger Caribbean islands, where resources were easier to exploit and defenses were easier to mount. The smaller islands to the east in the Lesser Antilles were thus largely left to others. Control of many of those islands, including the Virgin Islands, shifted back and forth among European powers, as peace treaties settled in Europe seldom applied in the New World. Danish Colonial Era In 1672, the Royal Danish West Indian Company ( Det Kongelige Octroyerede Danske Vestindiske Compagnie ) took control of St. Thomas and set up plantations. The company expanded to St. John (then St. Jan) in 1718 and then purchased St. Croix from France in 1733. Sugar production and export was the primary economic sector during the period of Danish colonial control, although cotton, tobacco, indigo, and other products were also exported. In 1754, the king of Denmark established a free trading policy, which encouraged commercial activity on St. Thomas, sidestepping restrictions imposed by the main European powers of the time. Economic conditions on those islands, however, slowed in the 1830s, and a slave revolt in 1848 led to the abolition of slavery. After 1848, the Virgin Islands' economy slowed for a combination of reasons. Other Caribbean ports attracted more trade, steam-powered ships traveled more directly between North America and Europe, and the expansion of beet sugar production in Europe, Russia, and North America led to lower prices for the cane sugar industry. U.S. Acquisition and Administration In 1867, Secretary of State William Seward reached an agreement with Denmark to buy the islands. The Senate, however, declined to ratify the treaty. After other unsuccessful attempts in the first decade of the 20 th century, the U.S. government purchased the islands from Denmark in 1917, after a set of negotiations prompted by concerns that Germany might use the islands to attack American shipping. The U.S. government assumed control of the islands on March 31, 1917, just a week before the United States entered World War I. While the United States acquired the islands for strategic reasons, the islands have not generally served a strategic purpose beyond keeping them out of the control of potentially hostile powers. Naval officers administered the islands after the United States took possession and made important improvements in public health, water supply, education, and social services. Efforts to advance economic development were less successful. In 1931, governance responsibilities were transferred to the U.S. Department of the Interior. In the 1930s, civilian administrators soughtâlargely unsuccessfullyâto revive sugar production and convert failing plantations into smallholder homesteads. The diversion of labor to military projects during World War II led to further declines in agricultural production. After the end of Prohibition in 1933, however, rum distilling became a growing source of manufacturing employment, and taxes on rum have been an important revenue source. Post-World War II Economic Development Other types of manufacturing once employed significant numbers, but have declined in recent years. Several watch assembly plants started up in 1959, but the last one closed in 2015. A large bauxite processing plant was built on St. Croix in the early 1960s, but closed in 2000 after several ownership changes. Near that site, Hess Oil partnered with a Venezuelan oil company to build a major oil refinery. That refinery, known as HOVENSA, for a time was one of the largest in the world, but closed in 2012. Early efforts in the 1950s to promote tourism were another success, especially after the closing of Cuba to American tourism after the 1959 Cuban Revolution. Tourism remains the major employer and economic activity in the U.S. Virgin Islands. The Revised Organic Act of 1954 (P.L. 83-517) included a provision to rebate, or "cover over," federal excise taxes on goods produced in the Virgin Islands to the island's government. The cover over of federal taxes on rum has been an especially important revenue source. Current Structure of the Economy Income Trends and Distribution Typical incomes in the USVI are lower than on the U.S. mainland and poverty rates are higher. Household Incomes Median household income in the USVI in 2009, according to the U.S. Census Bureau, was $37,254, about 75% of the mainland estimate of $50,221. Demographic and economic data for U.S. territories are typically less extensive and reported less frequently than for states. Table 1 compares the distribution of household incomes in 2009 for the USVI with the U.S. total. The distribution of household income levels in the USVI is skewed toward lower income brackets compared to U.S. totals. For example, 13.5% of USVI households had incomes below $10,000 in 2009, as compared to 7.8% for the U.S. total. GDP per Capita and Distortions Due to Tax Avoidance Gross domestic product (GDP) per capita provides another measure of economy activity. GDP is defined as the value of goods and services produced in a given area during a year. While income produced in an area that is repatriated elsewhere is included in GDP, it is excluded from gross national product (GNP), which reflects incomes of area residents. For areas where flows of repatriated earnings are large, GDP may be a flawed measure of local incomes. Data on such flows of repatriated earnings, which may result from tax avoidance or minimization strategies, are difficult to obtain. The European Union added the USVI to a list of "non-cooperative tax jurisdictions" in March 2018. The European Council, a body consisting of EU heads of government and senior EU officials, stated that jurisdictions added to the list "failed to make commitments at a high political level in response to all of the EU's concerns." The USVI government called that decision "unjustified." In October 2019, the European Council declined to remove the USVI from the list of noncooperative tax jurisdictions. With those caveats regarding GDP in mind, Figure 1 presents trends in per capita GDP from 2004 through 2015. Florida and Louisiana, which have both been affected by major hurricanes in that time period, are included for comparison. While USVI per capita GDP did not fall during the 2007-2009 Great Recession, it did drop sharply after the demise of the HOVENSA refinery. Tourism In recent years, tourism and related trade has been the predominant component of the economy of the Virgin Islands. In years before Hurricanes Irma and Maria, about 1.2 million cruise passengers and about 400,000 airplane passengers arrived each year. Virgin Islands tourist destinations compete with many other Caribbean destinations. Much of the growth in Caribbean tourism has taken place in all-inclusive resorts that rely on low-wage labor, such as in the Dominican Republic. Many hotels and resorts were seriously damaged or destroyed in the September 2017 hurricanes. Employment and tourist arrival data, discussed below, suggest the tourism sector has started to rebound, although that process could take years to complete. Manufacturing Manufacturing, which had played a major role in the Virgin Islands since the 1960s, now plays a minor economic role aside from two rum distilleries, which enjoy extensive public subsidies. Slightly more than 600 people were employed in manufacturing in 2015, mostly in small firms. Rum The Cruzan distillery, which has a capacity to produce about 9 million proof gallons per year, claims a presence in the Virgin Islands since the mid-18 th century. Cruzan was sold to Fortune Brands in 2008, after several changes in ownership. The Diageo distillery, which can produce some 20 million proof gallons per year, was built as part of a 2008 agreement with the territorial government. Diageo is a British multinational corporation specializing in the marketing of alcoholic beverages, which previously operated a distillery in Puerto Rico. A separate agreement between Cruzan and the USVI government was negotiated in 2009. In 2012, the USVI government agreed to modify the Cruzan agreement to increase subsidies, subject to set sales and marketing expense benchmarks. The agreements with the Virgin Islands Government and Diageo and Fortune Brands included an estimated $3.7 billion in subsidies and tax exemptions over 30 years, provided through proceeds of bonds that securitized "cover-over" excise taxes on rum sales rebated from the U.S. government and local tax abatements. The agreements also committed the USVI government to provide ongoing production and marketing subsidies paid from cover-over revenues. The agreement bars the USVI government from seeking reductions in rum subsidies. As noted above, federal excise taxes on rum imported into the United States from the USVI and Puerto Rico (PR), or from anywhere else, are "covered over" to the PR and the USVI governments. The HOVENSA Refinery and Limetree Bay The HOVENSA oil refinery, mentioned above, had been one of the USVI's largest employers, with about 1,200 workers and nearly 1,000 contractors. Since 1998, the refinery operated as a joint venture between Hess Oil and PetrÃ³leos de Venezuela, a petroleum company owned by the Venezuelan government. The refinery suddenly shut down in 2012 after running large losses. While mainland refineries had shifted to natural gas as an energy source, the HOVENSA facility relied on relatively expensive fuel oil. HOVENSA filed for bankruptcy under chapter 11 of the Bankruptcy Code in September 2015. The USVI government received $220 million as part of the agreement to resolve HOVENSA's assets, which was used to cover the government's budget deficit for 2015. Limetree Bay purchased some HOVENSA facilities to build an oil storage facility that initially employed about 80 people and which later expanded to employ about 650 people. A renovation of the HOVENSA refinery complex was reportedly three-quarters complete in late 2019, potentially allowing fuel deliveries in early 2020. Agriculture Over many decades, agriculture's role in the economy has dwindled to a marginal activity. Most of the island's food supply and essentially all of the molassesâa syrup extracted from sugar caneâused to produce rum is imported. Energy and Water40 The high cost of electricity in the U.S. Virgin Islands is one factor that hinders economic development. Residential customers pay 40 cents per kilowatt/hour (kWh) or about three times the average cost on the mainland. Commercial electricity rates are approximately $0.47/kWh. Island power systems do not benefit from gas pipelines or electric grids that extend over large areas, thus face higher costs than mainland systems. U.S. Virgin Islands Water and Power Authority (VIWAPA) supplies electrical power and water. The bulk of power generation is fueled by oil and diesel, although initiatives to enable use of propane and natural gas have been under way. For instance, VIWAPA modified some electric generating units to allow them the option to use natural gas, propane, or fuel oil. Expanding the efficient use of renewable sources of electricity, such as wind and solar, may require upgrades in transmission and generation systems. In 2015, renewable sources made up 8% of VIWAPA's peak demand generating capacity. Public Finances High Public Debt Levels Raise Concerns Fiscal challenges facing the USVI government have intensified in recent years. Several news reports in 2017 posed pointed questions about the sustainability of the islands' public debts, which total about $2 billion. Those debt levels, on a per capita or on a percentage of GDP basis, are extremely high compared to other subnational governments in the United States. In addition, the most recent actuarial analysis of public pensions found a net pension liability of about $4 billion. In 2017, the Government Accountability Office (GAO) found that "more than a third of USVI's current bonded debt outstanding as of fiscal year 2015 was issued to fund government operating costs." A 2019 GAO report noted that the USVI government had been shut out of capital markets since 2017, which could hobble its ability to roll over maturing debt. The report also summarized concerns with the solvency of the public pension system, growth prospects, effects of 2017 changes in the federal tax law, and the uncertain status of federal Medicaid funding. Concerns about debt levels had led each of the three major credit ratings agencies to downgrade at least part of the islands' public debts. Others suggested that USVI's public debts would have to be restructured. In August 2017, then-Governor Mapp said that communications with credit ratings agencies had been suspended, which prompted those agencies to drop USVI's credit ratings. The U.S. Virgin Islands and other U.S. territories are not covered by the provisions of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA; P.L. 114-187 ). Nonetheless, some credit ratings agencies saw enactment of PROMESA as a sign that Congress and the President could enact future legislation to enable debt adjustments in other territories. USVI Fiscal Responses Like many state governments, USVI public revenues were severely affected by the 2007-2009 Great Recession. Tourism, the mainstay of the USVI economy, was affected. In turn, government revenues, typically closely tied to economic activity, also fell. In addition, rum subsidy payments doubled from 2006 to 2007 and 2008. As noted above, the closure of the HOVENSA refinery in 2012 resulted in hundreds of lost jobs and a significant contraction of the USVI tax base. In recent years, the islands' government has run structural deficits and has used bond proceeds to cover shortfalls. Kenneth Mapp, who was inaugurated as governor in January 2015, had proposed various fiscal measures intended to reduce or eliminate those deficits. In August 2016, the islands' government took steps to issue bonds, which were to be used to cover financing shortfalls for its FY2017 budget. That issue was postponed until January 2017 and then cancelled. The loss of access to capital markets at reasonable rates left the islands' government with a narrow set of liquidity resources. In January 2017, then-Governor Mapp proposed a series of measures intended to strengthen public finances, including certain tax increases, enhanced revenue collection measures, and reductions in public spending. A package of tax measures, including higher taxes on beer, liquor, sodas, and timeshare rentals, which were part of the governor's proposals, was enacted on March 22, 2017. GAO, in an analysis of debts of U.S. territories, expressed doubts that those fiscal measures would restore access to capital markets or address shortfalls in the funding of public pensions and other retirement benefits. Then-Governor Mapp also had announced that a $40 million revenue anticipation note would soon be issued through Banco Popular, which he contended would provide the USVI government with liquidity through September 2017. It appears that issuance was also suspended. The form of USVI's public debt service, in which many funds are routed through escrow accounts before reaching government coffers, also limits options for USVI policymakers. Governor Albert Bryan Jr., who succeeded Mapp in January 2019, claimed to have stabilized government operations and finances in his first year in office, including by taking steps to reestablish relations with credit rating agencies and enhance transparency of public finances. Aftermath of Hurricanes Irma and Maria The USVI was hit by two powerful hurricanes in September 2017, which caused extensive damage from which island residents are continuing to recover. Hurricane Irmaâshown in Figure 2 âwas "one of the strongest and costliest hurricanes on record in the Atlantic basin." Irma passed directly over St. Thomas and St. John on September 6, 2017, causing "widespread catastrophic damage." Two weeks later, on September 20, Hurricane Maria hit St. Croix, before continuing on to devastate Puerto Rico. Figure 3 shows paths and zones of extreme wind speeds for both hurricanes in the vicinity of USVI. In November 2017, the USVI government estimated that uninsured damage from the hurricanes would exceed $7.5 billion. Disaster Responses Disaster declarations following Hurricane Irma and Hurricane Maria enabled the USVI government and its residents to receive federal assistance through various provisions of the Stafford Act ( P.L. 93-288 , as amended). Those declarations authorized the Federal Emergency Management Agency (FEMA) to assist local and territory governments, certain private nonprofit organizations, and individuals through grants, loans, and direct aid. FEMA, the U.S. Corps of Engineers, and the U.S. Coast Guard, among other federal agencies, also directly supported disaster response and recovery efforts. Other forms of federal disaster assistance have included loans and grants to individuals and small businesses, including through the Small Business Administration disaster loan program. The USVI government and two hospital authorities received Community Disaster Loans (CDLs) on January 3, 2018. The USVI government CDL totaled $10 million with a term of 20 years. CDLs were designed to provide liquidity to local governments that have suffered revenue declines due to disasters. Estimates based on USVI fiscal data suggest that public revenues were halved after the two hurricanes. Disaster Funding Funding for disaster relief has been augmented by several supplemental appropriations. The extent of federal disaster assistance received by the USVI will depend, in part, on how funds provided in response to needs resulting from hurricanes and fires in 2017 are allocated among affected areas. In the Bipartisan Budget Act of 2018 ( P.L. 115-123 ; Â§20301), enacted on February 9, 2018, Congress provided the USVI and Puerto Rico with additional Medicaid funding for the period January 1, 2018, through September 30, 2019. For the USVI Medicaid program, an additional $107 million was provided. Another $35.6 million would be available to the USVI subject to certain Medicaid program integrity and statistical reporting requirements. The federal medical assistance percentage (FMAP) was also raised from 55% to 100% for both the USVI and Puerto Rico Medicaid programs during that interval. On February 4, 2020, House Appropriations Chairwoman Nita M. Lowey introduced H.R. 5687 , an emergency supplemental appropriations bill. Title B of the measure includes provisions that would provide additional resources to territories, including the USVI, through support for child tax credits (and certain expansions of eligibility) and other tax credits, as well as a relaxation on limits on rum cover-over revenues directed to Puerto Rico and USVI. The House passed the measure on February 7, 2020, on a 237-161 vote. The Administration warned it would veto the measure. VIWAPA Financial Woes Hinder Recovery from Hurricane Damage Hurricanes Irma and Maria damaged an estimated 80% to 90% of VIWAPA's transmission and distribution lines, although power-generating plants were less affected. The U.S. Department of Energy (DOE) estimated that 93% of total USVI customers had their electric power restored by the end of January 2018. According to the U.S. Virgin Islands action plan submitted to and approved by HUD, the energy sector infrastructure needs as a result of the hurricanes totaled nearly $2.3 billion. The U.S. Department of Housing and Urban Development (HUD) allocated $67.7 million (approximately 3%) to the U.S. Virgin Islands from a $2 billion Community Development Block Grant-Disaster Recovery (CDBG-DR) appropriation included in the Bipartisan Budget Act of 2018 ( P.L. 115-123 ) "to provide enhanced or improved electrical power systems" for Puerto Rico and the USVI. Governor Bryan reportedly asked HUD to "acknowledge that the Virgin Islands needs at least $350 million of these funds to make a meaningful impact in strengthening the grid and lowering the high cost of electricity in the Virgin Islands." On September 16, 2019, $774 million in mitigation funds (CDBG-MIT funds) were allocated to the U.S. Virgin Islands; however, HUD announced that [T]he grantee is prohibited from using CDBG-MIT funds for mitigation activities to reduce the risk of disaster related damage to electric power systems until after HUD publishes the Federal Register notice governing the use of the $2 billion for enhanced or improved electrical power systems. This limitation includes a prohibition on the use of CDBG-MIT funds for mitigation activities carried out to meet the matching requirement, share, or contribution for any Federally-funded project that is providing funds for electrical power systems until HUD publishes the Federal Register notice governing the use of CDBG-DR funds to provide enhanced or improved electrical power systems. The prohibition on the use of CDBG-MIT funds combined with VIWAPA's cash flow challenges limits VIWAPA's ability to improve resiliency. Without sufficient available funds, VIWAPA is unable to meet federal funding matching requirements in order to make use of eligible mitigation funding from FEMA to permanently harden the electrical power systems. The government of the U.S. Virgin IslandsâVIWAPA's largest customerâhas been slow in providing payment for services. The UVSI legislature, however, moved to appropriate $22.2 million for hospitals to pay outstanding obligations to VIWAPA, among other provisions. Throughout 2018 and 2019, USVI policymakers expressed concerns over VIWAPA's financial stability. For instance, Delegate Stacey Plaskett called on Governor Bryan and USVI Senate President Francis to declare a state of emergency in response to the territory's "energy crisis." FY2019 Budget Proposals In his FY2019 budget proposals, Governor Mapp set forth plans to extend the solvency of the USVI public pension systems. According to those proposals, the projected insolvency of those plans would be postponed from 2024 to 2025. Additional measures, to be outlined in the future, were claimed to suffice to postpone insolvency for three additional years. The FY2019 budget proposals also called for a lifting of a hiring freeze. Additional revenues were expected from expanded federal reimbursement for health programs, along with recovery-related investment activity, although decreased tourist traffic is expected to keep accommodation tax and related collections well below prehurricane levels in FY2019. Economic Prospects The USVI economy has relied heavily on tourism and related business activity, which made it more vulnerable to the effects of hurricanes than jurisdictions with more diverse economies. Employment Trends Figure 4 shows employment trends in the tourism-dependent leisure and hospitality sector, the territorial government, the manufacturing sector, and the construction sector. Employment in the leisure and hospitality sector shows a steep decline after Hurricane Marilyn in 1995 and after Hurricanes Irma and Maria in September 2017, after which employment in that sector was halved. Leisure and hospitality employment took about six years to recover to pre-Marilyn levels. Increases in the construction sector offset about half of those losses in 1996 and 1997, presumably due to recovery and reconstruction work. As of December 2019, tourism sector employment has recovered somewhat, but remains well below pre-2017 levels. Construction employment also rose in 2018 and 2019, but that uptick appears much smaller than in the post-Marilyn time period. Moreover, the posthurricane increases in construction-related activity have been small relative to the loss of tourism employment after 2017. Employment in the USVI territorial government declined over the 2010-2014 period, but has remained relatively stable since then. Tourism Trends The severity of damage from Irma and Maria, and the subsequent disruption of the USVI tourism industry, suggest that a full economic recovery could take years. Many hotels have remained closed since the hurricanes, although some reopened in 2019. Cruise ship passenger arrivals fell from 1.8 million in calendar year (CY) 2016 to 1.3 million in 2017, but have rebounded somewhat. Air passenger arrivals fell from nearly 800,000 in 2016 to less than 500,000 in 2018. Air arrivals for the first three quarters of CY2019 ran 44% ahead of the same period in 2018. Unemployment Claims The economic effects of Hurricanes Irma and Maria can also be seen in initial unemployment claims data, shown in Figure 5 . The post-Irma and Maria uptick in late 2017 is more than twice the size of the 2011-2012 upticks near the time of the closure of the HOVENSA refinery. The New York Federal Reserve Bank compared the economic effects of Hurricanes Irma and Maria on the USVI and Puerto Rico, noting that the estimated percentage job loss following those hurricanes (-7.8%) was far greater than the percentage job losses in New York City (-3.3%) during the Great Recession. Researchers report that many young professionals and health care workers have left the USVI for positions on the mainland, which may complicate recovery efforts in the health care sector. Tracking the progress of USVI economic recovery is complicated as many federal statistical programs report fewer data series for U.S. territories than for states. The Virgin Islands Bureau of Economic Research (VIBER), however, reports regularly on economic, tourism, and population trends. Considerations for Congress The fiscal and economic challenges facing the USVI government raise several issues for Congress. First, Congress may consider further legislation that would extend or restructure long-range disaster assistance programs to mitigate those challenges and promote greater resiliency of infrastructure and public programs. Second, if fiscal pressures on the USVI intensify, Congress might consider a framework similar to that established by the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA; P.L. 114-187 ). In the past, however, USVI policymakers opposed making PROMESA provisions available to other territories because of concerns about borrowing costs. At present, the USVI lacks access to the federal Bankruptcy Code or other processes for debt restructuring involving judicial processes. Third, Congress might consider proposals to support initiatives to lower energy costs for the USVI. Mainland electrical power generation, to a large extent, has shifted to using more natural gas as a fuel. Construction of a liquefied natural gas (LNG) import facility and accompanying generation plants could lead to lower energy prices and an enhanced capacity to employ renewable energy sources. Other innovative energy technologies might also be used to that end. While VIWAPA has taken some steps to modernize its generating units, some major investments may be required. For example, construction of a LNG facility and further conversions of generating units could lower electricity rates, but would require financial commitments that would likely challenge the fiscal capacity of the USVI government and VIWAPA. Moreover, LNG supply contracts typically extend over decades due to the scale of required investments, arrangements which could be difficult to negotiate given the USVI's fiscal situation. Fourth, Congress may expand oversight of federal agencies that administer disaster assistance programs, including FEMA and HUD, to ensure the timely receipt of assistance by grantees. Several Members of Congress have expressed concerns that funds for federal disaster recovery efforts have been unduly delayed. Congress could also examine the interplay among federal agencies, federal rules and regulations that apply to disaster responses operations, and local governments and nonprofits in affected areas. Fifth, Congress may revisit the structure of the rum cover-over program to assess whether its current structure is appropriately fitted to public purposes. The contractual bar to USVI advocacy of changes in the cover-over program could require Congress to initiate any such alterations. Sixth, Congress may choose to promote economic and social development through a wide range of tax and social program rules, some of which treat USVI differently than states.


TSA Has Taken Steps to Improve Aviation Security, but Additional Actions Are Needed TSA Has Taken Actions to Strengthen International Aviation Security but Could Take Additional Steps to Ensure the Security of U.S.-bound Flights Civil aviation, including U.S.-bound flights, remains a target of coordinated terrorist activity. In the last 2 years, we issued reports on TSA’s foreign airport and air carrier inspection programs (December 2017), assessments of Cuban aviation security (July 2018), and TSA’s process for reviewing security directives and emergency amendments that apply at last point of departure airports (October 2019). Foreign airport assessments and air carrier inspections. In December 2017, we reported that TSA had taken steps to enhance its foreign airport assessments and air carrier inspections since 2011, including aligning resources based on risk, resolving airport access issues, making evaluations more comprehensive, and creating operational efficiencies. For example, we found that TSA had implemented targeted foreign airport assessments in locations where risk was high and developed a system to strengthen its data analysis capabilities. However, we also found that TSA’s database for tracking the resolution status of security deficiencies did not have comprehensive data on security deficiencies’ root causes and corrective actions. In addition, the database lacked adequate categorization mechanisms such as capturing subcategories that would better explain the root causes of security deficiencies. We recommended, among other things, that TSA fully capture and more specifically categorize data on the root causes of security deficiencies that it identifies and corrective actions. To implement this recommendation, TSA developed a tool to capture airport vulnerability data and provided training to staff in the use of the tool and developed guidance that delineates updated categories for root causes in its data systems. Cuban aviation security. In July 2018, we reported on TSA’s efforts to ensure the security of air carrier operations between the United States and Cuba. We found that TSA’s inspections and assessments in Cuba generally followed standard operating procedures, but TSA did not inspect all air carriers at its own established frequency. We recommended that TSA improve its ability to identify certain air carriers requiring inspection in Cuba and develop and implement a tool that more reliably tracks their operations between the United States and Cuba. In response to our recommendation and as required under the TSA Modernization Act, TSA developed several tools and processes that corroborate and validate flight schedule data. For example, TSA developed a tool to analyze aggregate flight data and validate or identify service to the United States from international locations and began issuing monthly reports on unscheduled operations to its inspectors responsible for Cuba. By taking these steps, TSA is better able to identify operations requiring inspection and corroborate and validate flight schedule data. Security directives and emergency amendments. When threat information or vulnerabilities at foreign airports indicate an immediate need for air carriers to implement additional security measures, TSA may issue new or revise existing security directives (for domestic air carriers) and emergency amendments (for foreign air carriers). The TSA Modernization Act includes a provision for us to review the effectiveness of the TSA process to update, consolidate, or revoke security directives, emergency amendments, and other policies related to international aviation security at last point of departure airports. As of March 2019, there were 46 security directives and emergency amendments (i.e., directives) in effect related to air carrier operations at foreign airports. Earlier this month, we reported that TSA reviews directives, but its process does not fully define how to coordinate with industry representatives and TSA has not determined if it is appropriate to incorporate the security measures of many longstanding directives into air carrier security programs in accordance with TSA policy. Representatives from four domestic air carriers stated that coordination with TSA on directives has improved. However, representatives from six air carriers and two associations indicated that TSA has issued revised directives that are vague or difficult to implement because TSA did not sufficiently involve them in the review process. This contributed to TSA officials offering different interpretations of aircraft cabin search requirements. Further, TSA policy states that directives are not intended to be permanent and are expected to eventually be canceled or incorporated into security programs. Our analysis found that TSA issued more than one half (25) of the directives prior to 2014, meaning they have been in effect for more than 5 years. Several have been in effect for more than 10 years. We recommended, among other things, that TSA better define how to coordinate with air carriers when reviewing directives and when to cancel or incorporate longstanding security directives and emergency amendments into security programs. TSA agreed with our recommendations and plans to develop a process for more formal and consistent coordination with air carrier and industry association stakeholders and consideration of directives for cancellation or incorporation into security programs. TSA Created a Domestic Aviation Security Working Group to Develop and Update Leading Practices with Transportation Security Stakeholders Public area security. In November 2013, an armed individual entered the Los Angeles International Airport, firing multiple shots killing a transportation security officer and injuring two others and a passenger. As a result of this and subsequent airport attacks, TSA co-hosted a series of security summits with stakeholders and published the Public Area Security National Framework in May 2017 outlining a series of best practices and recommendations to secure airport pubic areas. The TSA Modernization Act requires TSA and the DHS Cybersecurity and Infrastructure Security Agency to establish a public area security working group to promote collaboration between TSA and public and private stakeholders to develop non-binding recommendations for enhancing security in public areas of transportation facilities. The Act also requires TSA to periodically share best practices developed by TSA and transportation stakeholders related to protecting public spaces of transportation infrastructure from emerging threats. In March 2019, TSA officials established the public area security working group to engage with stakeholders to validate and update the best practices that were developed in the 2017 Public Area Security National Framework. The working group consisted of security stakeholders from both aviation and surface transportation modes. In October 2019, TSA officials told us that they plan to issue an updated list of best practices in the fall of 2019. Insider threats. Recent incidents involving aviation workers misusing their access privileges have heightened concerns regarding the risk of insider threats at airports. TSA estimated in 2018 that there were approximately 1.8 million people with unescorted access to secured areas of the nation’s airports. We have ongoing work examining the actions TSA, airport operators, and air carriers have taken to mitigate concerns regarding insider threats at airports and the extent to which TSA’s Insider Threat Program is guided by a strategic plan. Additionally, the TSA Modernization Act requires TSA, in consultation with the Aviation Security Advisory Committee to conduct a study examining the cost and feasibility to airports, airlines, and TSA of implementing enhanced employee inspection measures at all access points between non-secured areas and secured areas of certain airports. We will review this study once submitted by TSA. TSA Coordinates Reviews of Passenger Screening Rules, but Could Better Measure Rule Effectiveness Screening rule changes. In 2010, TSA began identifying passengers for enhanced screening who are not known or suspected terrorists, but who fall within the scope of screening rules. Specifically, TSA identifies passengers for enhanced screening through the application of screening rules, which TSA develops by considering current intelligence and other factors. TSA refers to these rules and lists as Silent Partner and Quiet Skies. Silent Partner rules identify passengers for enhanced screening on inbound flights to the United States. Quiet Skies rules—a subset of the Silent Partner rules—identify passengers for enhanced screening on subsequent domestic and outbound flights. The TSA Modernization Act includes a provision for GAO to review the oversight mechanisms and effectiveness of Silent Partner and Quiet Skies. We found that TSA coordinates reviews of Silent Partner and Quiet Skies through quarterly meetings and notifies an expanded set of DHS and TSA stakeholders—including DHS Traveler Redress Inquiry Program and the Federal Air Marshal Service—of rule changes as required under the Act. We also found that TSA has not identified a means to comprehensively measure rule effectiveness. TSA officials explained that they had not yet fully assessed the rules’ effectiveness because it was difficult to measure. TSA has access to data—such as the outcomes of enhanced screening of Silent Partner and Quiet Skies passengers at airport checkpoints—that could be explored to better assess rule effectiveness. Exploring additional data sources could help TSA refine and supplement the agency’s existing efforts to measure program effectiveness. In our draft report, we recommended that TSA explore additional data sources for measuring the effectiveness of Silent Partner and Quiet Skies rules. TSA is currently reviewing the draft report and is scheduled to provide any comments by early November 2019. TSA Should Ensure Aviation Screening Technologies Continue to Meet Detection Requirements after Deployment To protect the U.S. aviation sector, including the roughly 440 airports it regulates, TSA deploys technologies to screen passengers and their carry-on and checked baggage for homemade explosives and other prohibited items that could, among other things, cause catastrophic damage to an aircraft. The ongoing threat of terrorism requires TSA to continually assess the effectiveness of its screening operations and, when necessary, develop and deploy new screening technologies. The TSA Modernization Act includes a provision for us to review whether TSA allocates resources appropriately based on risk at TSA-regulated airports, among other things. Our review of TSA acquisition documents found that TSA considers risk at the beginning of the screening technologies acquisition process. However, TSA officials could not provide an example of when risk information for specific airports had directly influenced decisions about where and in what order to deploy screening technologies to airports in the recent past. Fully disclosing what risk factors are weighed and how decisions are made could better ensure that TSA’s deployment of screening technologies matches potential risks. We recommended that TSA officials document their assessments of risk and the rationale behind decisions to deploy screening technologies. We also found that TSA does not ensure that screening technologies continue to meet detection requirements after they have been deployed to airports, when performance can degrade over time. According to officials, the agency uses certification—a step in the test and evaluation process— to confirm that technologies meet detection requirements before they are deployed to airports, and calibration of the technologies to confirm that technologies are at least minimally operational while in use at airports. They stated that these processes are sufficient to assure TSA that screening technologies are operating as intended. While these processes serve important purposes, they do not ensure that screening technologies continue to meet detection requirements after they have been deployed because performance can degrade over time. Developing and implementing a process to ensure technologies continue to meet detection requirements after deployment would help ensure that TSA screening procedures are effective and enable TSA to take corrective action if needed. In our draft report, we recommended that TSA develop and implement a process to ensure technologies continue to meet detection requirements after deployment. TSA is currently reviewing the draft report and is scheduled to provide any comments by early November 2019. Actions are Needed to Improve Surface Transportation Security TSA Should Improve Coordination for its Surface Transportation Security Training Program The TSA Modernization Act includes a provision that we review resources provided to TSA surface transportation programs and the coordination between relevant entities related to surface transportation security. According to our analysis, TSA Surface Programs received $123 million in fiscal year 2017 and $129 million in fiscal year 2018. The surface program appropriation represented about 1.6 percent of TSA’s total appropriation in both fiscal years, according to DHS data. We also found that in fiscal years 2017 through 2019, TSA reported using surface program resources for non-surface activities. For example, in fiscal year 2018, TSA reprogrammed $5 million from the Surface Programs account to Mission Support activities to address security requirements and increase hiring of transportation security officers. Further, we found that TSA could improve internal coordination roles and responsibilities for planning and implementing its voluntary Intermodal Security Training and Exercise Program (I-STEP)—a program intended to engage with system operators and governmental security partners to enhance surface transportation security. For example, officials from TSA’s office that provides intelligence briefings during program exercises stated that they do not typically participate in planning meetings because they are not consistently invited to attend. In our draft report, we recommended that TSA clarify roles and responsibilities for all offices involved in the coordination of surface transportation exercises, including when these offices are to coordinate. TSA is currently reviewing the draft of this report and is scheduled to provide any comments by early November 2019. Actions Needed to Reflect Pipeline Security Roles in Key Documents and to Address Weaknesses in TSA’s Pipeline Security Program Management More than 2.7 million miles of pipelines transport and distribute the natural gas, oil, and other hazardous liquids that the people and businesses within the United States depend on to operate vehicles and machinery, heat homes, generate electricity, and manufacture products. Responsibility for safeguarding these pipelines is shared by TSA; the Pipeline and Hazardous Materials Safety Administration (PHMSA), within the Department of Transportation (DOT); and pipeline operators. TSA oversees the security of all transportation modes, including pipelines. PHMSA oversees pipeline safety. DHS and DOT signed a memorandum of understanding (MOU) on their roles across all transportation modes in 2004, and an Annex to the MOU in 2006 to further delineate their pipeline security-related responsibilities. The TSA Modernization Act includes a provision for GAO to review DHS and DOT roles and responsibilities for pipeline security. We reported in June 2019 that key pipeline security documents need to better reflect the current operating environment. For example, the MOU Annex has not been reviewed to consider pipeline security developments since 2006. As a result, the MOU Annex may not fully reflect the agencies’ pipeline security and safety-related activities. We reported that by developing and implementing timeframes for reviewing the MOU and updating it, as appropriate, TSA and PHMSA could better ensure any future changes to their respective roles and responsibilities are clearly delineated and updated on a regular basis. In addition, TSA’s Pipeline Security and Incident Recovery Protocol Plan, issued in March 2010, defines the roles and responsibilities of federal agencies and the private sector, among others, related to pipeline security incidents. For example, in response to a pipeline incident, TSA coordinates information sharing between federal and pipeline stakeholders and PHMSA coordinates federal activities with an affected pipeline operator to restore service. However, TSA has not revised the plan to reflect changes in at least three key areas: pipeline security threats (e.g., cybersecurity threats), incident management policies, and DHS’s terrorism alert system. By periodically reviewing and, as appropriate, updating its plan, TSA could better ensure it addresses changes in pipeline security threats and federal law and policy related to cybersecurity, incident management and DHS’s terrorism alert system, among other things. We made five recommendations to address these issues, including for TSA and DOT to develop and implement a timeline for reviewing and updating the 2006 MOU Annex and for TSA to periodically review and update its 2010 pipeline incident recovery plan, as appropriate. TSA and PHMSA have actions under way to address our recommendations. For example, PHMSA officials stated that PHMSA and TSA continue to collaborate on updates to the 2006 MOU Annex. TSA has also developed and provided pipeline operators with voluntary security guidelines, and evaluates the vulnerability of pipeline systems through security assessments. However, in December 2018 we identified some weaknesses and made recommendations to strengthen TSA’s management of key aspects of its pipeline security program. For example, we reported that the number of TSA security reviews of pipeline systems has varied considerably over time. TSA officials stated that staffing limitations— ranging from 1 full-time equivalent in 2014 to 6 from fiscal years 2015 through 2018—within its Pipeline Security Branch have prevented TSA from conducting more reviews. Further, TSA does not have a strategic workforce plan to help ensure it identifies the skills and competencies—such as the required level of cybersecurity expertise— necessary to carry out its pipeline security responsibilities. We recommended that TSA develop a strategic workforce plan. As of October 2019, TSA has not yet fully addressed this recommendation. We will continue to monitor progress. Chairman Correa, Ranking Member Lesko, and Members of the Subcommittee, this concludes my prepared statement. I would be happy to respond to any questions you may have at this time. GAO Contact and Staff Acknowledgments If you or your staff members have any questions about this testimony, please contact me at (202) 512-8777 or russellw@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. Other individuals making key contributions to this work include Kevin Heinz, Assistant Director; Paul Hobart, Analyst-in-Charge; Josh Diosomito; Amber Edwards; Michele Fejfar; Melissa Greenaway; Barbara Guffy; Winchee Lin; Tom Lombardi; Michelle Serfass; and Adam Vogt. Key contributors to the previous work discussed in this statement are listed in each of the cited reports. This is a work of the U.S. government and is not subject to copyright protection in the United States. 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