Getting ready for Europe’s new payments architecture

Payments market infrastructures globally are transforming, modernising their systems to align with an increasingly digital financial services environment. The Club talks to Saskia Devolder, Managing Director, Head of Western and Central Europe at SWIFT, about the impact of the changes under way at the EU’s market infrastructures, their migration to ISO 20022 and SWIFT’s strategy.

By Heather McKenzie

The Club: Europe’s payments environment is rapidly transforming. What are the main changes participants are facing?

SD: Many payments market infrastructures (PMIs) have redesigned their systems to be more open, encourage more competition and create new services. Their next step has been to implement a next generation of core payments architecture.

A common element of these renewal projects is ISO 20022. Over the next five years, all major PMIs and their communities will migrate to ISO 20022 messaging. By 2025 it will support around 87% of transaction values worldwide – it will dominate high-value payments. At the same time, SWIFT will adopt ISO 20022 for cross-border payment instructions and reporting.

One of the most ambitious projects is the Eurosystem’s TARGET Consolidation project that will go live in November 2021 in a ‘big bang’ migration over a single weekend. Why do I say ambitious? Well, it will deliver a new real-time gross settlement system, based on ISO 20022 messaging, a central liquidity management system, a harmonised interface and single entry point to TARGET services, called the Eurosystem Single Market Infrastructure Gateway (ESMIG), and a common reference data, data warehouse and billing system.

Also in November 2021 EBA CLEARING will migrate its EURO1 large-value payment system for single same-day euro transactions to ISO 20022.

It’s worth noting that both market infrastructures, in consultation with their communities, have chosen to migrate to “fully fledged” ISO 20022, as opposed to like-for-like, in order for the market to benefit from the much richer data set that can be provided in the ISO 20022 messages.

These changes are taking place in a market that is experiencing increasing demand for fast, frictionless and embedded payments. Instant payments have emerged to meet these needs and in Europe, there are domestic instant payments schemes, which are based on the SEPA Instant Credit Transfer and also pan-European schemes – the Eurosystem’s TARGET Instant Payments Settlement (TIPS) and EBA CLEARING’s RT1.

How do these changes fit in to what is happening globally?

Of course Europe is not alone in experiencing a transformation in the payments landscape. The drivers of change in Europe are seen elsewhere in the world, which is why there is an unprecedented global renewal of payment market infrastructures.

These drivers come from different sources. Customers want faster, friction-free payments, while regulators and central banks want to encourage innovation, open their infrastructures to new participants, enable interoperability and give customers control of their data. In working together to ensure the stability of financial markets since the financial crisis, regulators and central banks have also helped to stimulate greater industry collaboration.

And markets are more interconnected in the new digital economy while new technologies and the acceptance of ISO 20022 enable more efficient processing of transactions. So, when banks are planning for the TARGET Consolidation and EURO1 migration, they need to consider the wider changes affecting the global payments landscape and the interdependencies and opportunities that will result.

What are the biggest impacts and challenges for banks?

The European payments market must be ready for a big bang change to its core payments market infrastructure. At the same time, participants must keep in mind the wider impact for banks and their customers in this interconnected global landscape.

There are quite a few important decisions that will have to be made as Europe’s new payments architecture emerges. For example, in the near future, instant payments will become the norm for consumer, business and cross-border transactions worldwide. This shift presents important strategic, investment and operational challenges to banks. They’ll have to make decisions about which market infrastructure to join and when, but more fundamentally, they’ll have to move away from legacy batch-based processing systems.

As payments become faster and markets more interconnected, regulatory oversight of financial transactions necessarily tightens and fraud prevention measures must be accelerated. A payments environment that is 24x7x365 will present a new challenge for banks’ compliance and fraud prevention operations. When funds clear instantly, the window to halt suspicious payments is very narrow. The technology can deliver instant data, so banks will also have to respond in the same time frame to investigate rejections and respond to customer queries.

There is significant transformation occurring in the international cross-border payments and traditional correspondent banking areas, particularly since the introduction of the global payments innovation (gpi) initiative in 2017. More than 56% of SWIFT cross-border payments – that’s US$30 billion of value each day – use gpi. Half of these payments reach beneficiaries in minutes, many of those in seconds; the vast majority reach the beneficiaries within 24 hours.

Gpi will become the norm for cross-border payments by 2020 and fast payments will become faster. We are all on the road towards global, instant cross-border payments.

The European Central Bank and SWIFT have just completed a pilot programme to enable SWIFT gpi in the TIPS system to  extend the reach of instant cross-border payments in the European market. A group of 20 pilot banks worldwide carried the cross-border legs of the payments, which they then settled through TIPS, allowing for instant crediting of accounts at ultimate beneficiary banks across Europe. The results of this pilot are being announced this week at Sibos.

This continues a gpi instant journey begun with the pilot in Asia Pacific. The next part of the programme is a pilot lined up with UK Faster Payments.

Once real-time back office processing is in place, we can expect cross-border payments to become instant, account-to-account, everywhere. Not only this, participants will also benefit from end-to-end tracking and transparency.

As gpi ramps up, a parallel initiative is under way to migrate MT cross-border payments and cash management messages to ISO 20022. The migration will begin in November 2021, to coincide with the Eurosystem TARGET Consolidation. But the correspondent banking migration will not be a big bang, it will be phased over a four-year period to enable banks to time their migration to suit their individual needs.

In Europe, migrating these messages to ISO 20022 at the same time as the TARGET2 and EURO1 migrations is recommended to help financial institutions reduce the costs and risks of opening internal systems for multiple re-engineering efforts. They’ll also ease compliance tasks as around one third of all cross-border payments have one leg via TARGET2. Regulators will be keen to ensure that intermediary banks carrying cross-border payments in euros pass on additional data received with an incoming ISO 20022 message. And ISO 20022 will deliver many benefits for payment providers and their customers, including end to end visibility on payment flows, easier reconciliation and transmission of more data to the final customer.

Once all these building blocks are in place, interconnected, global digital ecosystems will quickly emerge. Quite soon we might see a scenario where it will be possible to channel instant payments across borders and through domestic systems to beneficiaries’ accounts anytime, anywhere – with complete certainty and richer information contained within the messages.

What are the key milestones for banks to be ready by the November 2021 deadline?

In terms of major projects, November 2021 is not far away, and there’s still a lot to do, so banks have to act now to ensure they can take advantage of the opportunities this transformation and new payment architecture will produce.

By July 2020, financial institutions should have procured and signed a contract with their selected Network Service Provider – SWIFT is one of these. A few months later, in October 2020, participants should have finalised their internal developments to adapt their IT systems and processes to T2 and be ready to start internal testing, which should be completed by December 2020, along with the configuration of network connectivity.

Connectivity testing needs to be complete by March 2021 and user tests completed by September 2021. For those who have selected SWIFT as their NSP, end-to-end testing for TARGET 2 will be possible with SWIFT as of July 2020, more than 6 months before the official Eurosystem user testing phase.

At this point, participants should also be ready to start migration to the production environment and have completed contractual and legal adaptations required. Internal staff should also have been trained and the relevant operational procedures adapted for the new environment.

By 1 October 2021, participants should be ready to start migration activities on the production environment and migration activities should have been completed by 5 November, with the T2 service go-live on 22 November.

What is SWIFT doing to support the industry?

At SWIFT, we have an important role to support banks in their migration to ISO 20022 for TARGET Services, EURO1 and cross-border flows. But it’s more than that. All our assets are aimed at guaranteeing a smooth and future-proof infrastructure, so banks can focus on their core business with their customers across the payments landscape.

The Eurosystem has licensed SWIFT as a network service provider for connectivity via the ESMIG gateway to TARGET Services from November 2021. We will provide high quality, competitively priced ESMIG connectivity for access to T2 for high value payments, TIPS for instant payments, T2S for securities settlement and the future Eurosystem Collateral Management System.

We want to help minimise cost and disruption and maximise the efficiency of participants’ migration projects. We also want to help our customers meet the challenges and manage the complexities of wider banking transformation.

So we will also offer an end-to-end, turn-key solution which will enable SWIFT customers to re-use their SWIFT technology footprint as a single window to connect to ESMIG, to EURO1 and RT1, to the correspondent banking network and to more than 250 market infrastructures worldwide.