It’s fair to say that retail banks have truly embraced digital transformation.
Over recent years major regulatory bodies — including the Financial Conduct Authority, Competition & Markets Authority and Bank of England — have strived to improve efficiency and competition for customers, introducing rules for accountability, driving banks to disclose customer satisfaction data and implementing Open Banking.
It's an exciting time for this industry, which has seen a revolution in lower costs, higher speed and greater transparency for its end users. You don’t have to look far to see the breadth of technological disruption and innovation.
However, while the industry’s focus remains largely on modernising retail transactions, wholesale payment systems, which ultimately underpin and enable rapid retail transfers to take place, have not yet benefitted from meaningful transformation. This is especially true in cross-border wholesale payments, where messaging and liquidity are fragmented into disconnected infrastructure, creating a complex and opaque settlement process. The result is that inter-bank international payments can be slow and expensive, with FX settlement risk remaining a concern.
Around 60% of FX payments, equating to approximately $9 trillion on any given day, is exposed to settlement risk. In part, this can be attributed to legacy infrastructure and outdated processes not fit for the modern age. Furthermore, due to the limitations of netting and trade compression, combined with the rising volume of emerging market currency FX, the risks are growing. As a result, the sector is exposed to high costs and inefficiency, with friction at many parts of the payment process.
The Need for Wholesale Upgrades
There is a clear need for a new, more direct, transparent and efficient payments system to facilitate enhanced, safe cross-border settlement mechanisms for high value payments. One that offers greater flexibility and transparency over liquidity and security, while reducing the cost of transactions and making the settlement process much faster.
Financial systems must deliver the speed and efficiency of all the other digital systems we already use, including domestic and international retail payment systems that have benefitted from transformative innovation over the past decade. You wouldn’t settle for a two-day wait time from your preferred search engine; why should finance be any different?
Time for Change
Thankfully, the industry is waking up to the issue. Previous strategies, firstly in 1996 to reduce FX settlement risk, involved actions taken by banks and industry groups to control their exposures and provide services and actions to be taken by central banks. And while such measures initially led to a big reduction in FX settlement risk — including at the height of the financial crisis — FX settlement risk has grown in both relative and absolute terms.
There was a renewed push for the industry to work to enhance cross-border payments in October 2021, with the Financial Stability Board (FSB) publishing its first Consolidated Progress Report on the G20 Roadmap for Enhancing Cross-Border Payments. The paper summarises the progress made on enhancing cross-border payment services to make them faster, cheaper, more transparent and more inclusive, all while upkeeping the highest standards of safety and security. The FSB also published its report on Targets for Addressing the Four Challenges of Cross-Border Payments, cementing goals for addressing its identified issues and challenges.
Take speed. Today, the time period from payment initiation to final crediting and reconciliation is too long for too many transactions. This is a crucial element in cross-border payments. Latency in the transfer of payments and time lags between receipt and reconciliation of funding and defunding status can translate into risk, cost and inefficiency for both senders and receivers. At present, with traditional correspondent bank funding arrangements, wholesale cross-border payment settlements can take up to 48 hours or longer. The FSB wants 75% of cross-border wholesale payments to be credited within one hour of payment initiation or within one hour of the pre-agreed settlement date and time for forward-dated transactions — and for the remainder of the market to be within one business day of payment initiation. This is clearly a big challenge to meet.
Several of the FSB/G20 Roadmap’s ‘building blocks’ also nod toward payment infrastructures and arrangements. These include considering the feasibility of new multilateral platforms and arrangements, aimed at alleviating friction, and facilitating the increased adoption of payment-vs-payment (PvP), a risk-reducing mechanism which is vital to the wholesale financial exchange market, given the vast amounts of currency exchanged each day.
The very simple fact is that today’s cross-border payments mechanisms are fragmented, delivering PvP in a manner that was designed pre-cloud. Any potential for progress, whether via the implementation of central bank digital currencies (CBDCs) or other innovations, is impeded by a core inefficiency and that is the lack of straight through processing for wholesale interbank transactions.
A new innovative approach is needed. To be successful, close collaboration across jurisdictions and between public and private sectors is essential. The involvement of the private sector, and the sharing of insights and practical expertise to help shape policy and deliver change, is crucial to the success or failure of the roadmap.
New Market Infrastructure, Fit for the 21st Century
To tackle today’s challenges in wholesale cross-border payments provision, the way in which currencies are transferred and exchanged around the world must be built on what works today, but also reimagined for the digital age. Market infrastructure needs to be able to provide cost-efficient, streamlined and secure capabilities not only for inter-bank payment-vs-payment, but also cross-border liquidity management, global commercial payments and more.
Certain digital asset classes, such as free-floating cryptocurrencies or stablecoins, could impact the traditional banking system, with the real risk that a bank could have to run solely on deposits. However, in the long term, these currencies can help to reduce inflation and increase security between countries.
As mentioned, it’s imperative that we maintain stability and retain what works well; namely the use of central bank money, simultaneous payment-vs-payment transfers and adherence to the Principles for Financial Market Infrastructures. But, if the FSB’s targets are to be met, a core part of this is the introduction of innovation.
Over recent years RTGS.global has pioneered a new, cloud-based alternative to legacy systems, which will solve both current and future market needs. It has next-gen communications technology embedded within it, enabling funds movements and bi-lateral PvP FX settlement. The network is free from the shackles of today’s legacy-based architecture, it can be shared between central and commercial banks and is capable of processing transactions at scale. A new market infrastructure enables cross-border payments that are fit for purpose, facilitating safe, secure, immediate and simultaneous transfers of liquidity in traded currencies. This technology is accessible and offers the absolute requirement to execute bona fide, and immutable, transactions.
How the RTGS.global Liquidity Settlement System Works
We’ve collaborated with Microsoft to develop a transformative new system which, for the first time, enables banks to gain complete visibility of liquidity between their counterparties.
The global network safeguards existing commercial banking relationships but will improve the way they work — in many cases moving from what today still involves manual processing to one that materially improves efficiency, reduces costs and enables a new level of customer service.
The new network allows atomic settlement in the exchange of two currencies, authenticating the exchange of funds between banks based on the real-time availability of liquidity. Our proprietary technology locks available liquidity at two counterparty banks, before sending a settlement message to complete the transaction. This whole process can take just 80 milliseconds to complete, enabling real-time, bilateral exchange and settlement of funds.
Further, payments messaging and fund movements do not occur separately. Our Liquidity Settlement System ensures that the payment information and liquidity transferal travel together, rather than having banks rely on two separate service providers: one for messaging and a further one for settlement.
The new infrastructure also makes accessibility easy, offering direct connectivity between the Liquidity Settlement System and participating banks’ back-office systems — in part thanks to advanced communication technologies, such as protocol buffers. Central banks get crucial visibility into the status of funds held with them by the Liquidity Settlement System participant banks they supervise. Further, these transfers are made bilaterally point-to-point, without any need for third parties to act as intermediaries in the flow of funds between participants. Once more, this minimises cost, friction and operational and counterparty risks for participants.
Finally, while the Liquidity Settlement System is built for liquidity transfers in fiat currency, the technology is future proof, ready to adapt to new currencies. CBDCs are under assessment and may be quickly integrated into financial systems of the future.
The result is an international system that solves the challenges of legacy correspondent banking and international banking. Settlement and counterparty credit risk become non-existent. There’s no need to pre-fund a commercial bank money nostro account, and 24/7/365 settlement capabilities enhance the end-customer experience, dramatically improving commercial cash flows.
All of this can be resolved today through the implementation of bilateral atomic settlement against validated liquidity, enabling instant settlement.
For this reason, it’s an exciting time for the cross-border payments industry. For the first time, there has been universal approbation for innovation, endorsed by key international standard-setting bodies, extending beyond the Financial Stability Board and G20 to the Bank for International Settlements and Committee on Payments and Market Infrastructures.
We have an unprecedented opportunity to create international financial processes and infrastructure fit for the modern age. Economies have suffered too long because of outdated technology, but change is in the air.
We must take the lessons learned from the revolution in retail banking and seek to adapt them for the problems which hamper wholesale banking. Together, we can build a financial market infrastructure fit not just for today’s digital age, but tomorrow’s too.
RTGS.global, the world’s first cross-border liquidity network, was founded by fintech entrepreneur and founder of Worldpay and ClearBank, Nick Ogden. The company’s mission is to solve financial friction which is currently estimated to cost the global economy close to $15 trillion dollars per year. RTGS.global does this by bringing together banks and their liquidity to form the world’s first liquidity network. The network makes liquidity visible, enabling bi-lateral liquidity transfers that settle instantly. For the first time, Liquidity vs Liquidity (LvL) transfers are possible.