Failing a student for attendance or grade?

Agreed, this is pretty weird. It sounds so predicated on the (weird) particulars of your university that your guess is as good as and probably better than ours. Anyway:

That's because, for some warped logic, failing to attend classes isn't as bad as failing due to a bad grade: somehow the "system" cleans up attendance failures (but not grade failures) in the future school transcript.

Figuring out exactly what that means is probably the key to treating the situation properly...at least if we assume that "properly" means according to the practices of your university, which sound pretty screwy. Maybe let's take it this way: under what circumstances would it be appropriate to give a student a "failure to attend" grade which is subject to future white-washing? As far as I can see, the most sensible case for this is for a student who neither attended the course nor attempted any of the course work, including homework and exams. If so the registration for the course looks like some kind of mistake.

Does that describe your student? I.e., did he never come to class -- had you seen him before?!? -- or do any of the assignments or exams? If so, then just based on what you have said it sounds to me that this policy could reasonably be applied to him. If he attended a bit at the beginning, turned in an assignment or two and then just stopped entirely then indeed it looks like he was a non-accidental attendee in the course who just did very, very little work and the other kind of failing grade would be appropriate.

Perhaps you should consider talking to someone in your university's administration to get them to explain this screwy policy? If the policy makes sense in the minds of others -- especially, if the students have a consistent understanding that has largely been supported by the policy -- then even if you think it's stupid (and even if you're right!) you could be inviting trouble by calling it as you see it.

Anyway, good luck.

Added: OK, here's another, completely different interpretation. Your university is in the process of adding a new, very formalized (you mention something about implementation coming up in the last two weeks of the semester; is that what you mean, a system for tracking attendance?) mandatory attendance policy. If so, maybe the attendance failure works sort of like an "incomplete" in US university systems: it's a placeholder for future work on the part of the student. Maybe the student makes up the class attendance in the future and they get....I don't know. Either the grade they got the first time around or the grade they got in the new course, in which case indeed failure to attend is an easy loophole to get out of any poor grade. Anyway, there are any number of curious policies that a university might have, and for sure I don't know what's going on in your case.