Earlier this year, the World Trade Organisation predicted that word trade would face “strong headwinds” in 2019 and 2020 after growing more slowly than expected in 2018. Rising trade tensions and economic uncertainty had caused trade volume growth to fall to 2.6% in 2019, down from 3% in 2019. Since the WTO’s announcement, trade tensions have intensified as the US and China exchange blows in the form of tariffs. The WTO believes trade growth may rebound in 2020 to 3% but says this depends on an easing of trade tensions.
Cross-border payments are the foundation of global trade but represent a minor share of the total global payments market. McKinsey’s Global Payments 2018 stated that cross-border payments were at times overlooked but “carry disproportionate weight due to their significant margins and connection to lucrative broader corporate banking relationships”.
The consultancy estimated that cross-border payments revenues exceeded $200 billion during 2017 despite price pressures from increasing competition. “… cross-border payments of all types remain far more economically attractive for providers than their domestic equivalents”, said McKinsey. Revenues were split roughly evenly between transaction fees and foreign exchange. Estimated revenue per transactions was nearly USD45.
However, according to Swift, 2-5% of cross-border payments are subject to an enquiry or investigation, resulting in a time lag in the payment being completed. As more payment infrastructures introduce real-time capabilities, such a lag could become insupportable.
Many of these investigations and enquiries are related to compliance with sanctions, anti-money laundering (AML) and know your customer (KYC) rules. The focus on financial crime and the substitution of diplomacy with the blunt instrument of sanctions has increased financial institutions’ compliance obligations. Financial institutions now operate in a complex environment where failure to comply can result in heavy fines.
“Banks have become more diligent and detailed in assessing AML and sanctions exposures as part of client KYC,” says Anurag Bajaj, global head of banks, transaction banking at Standard Chartered. “Sanctions are becoming less specific and more sectoral in nature, so implementing them is becoming more open to interpretation. There is no standard or single approach towards meeting financial crime prevention requirements – each institution makes decisions on the basis of their own risk appetite – so clients can get very different levels of service for the same banking activity.”
Bahruz Naghiyev, member of the executive board and chief finance officer of Azerbaijan-based Pasha Bank, says financial institutions have improved AML, KYC and other due diligence requirements in response to increased enforcement by regulators and rules imposed by the US Financial Crimes Enforcement Network. “Obviously these rules and enforcements didn’t pass by Azerbaijan and just like all other countries we are also subject to these regulations and rules and all have been adopted by our regulator as well.”
Naghiyev says the bank plays an important role in promoting compliance with these rules, leading among financial institutions in the country and also educating corporate clients and local counterparties about the importance of compliance. “We have a well-established compliance policy and procedures backed with modern systems and we are getting positive feedbacks from our international counterparties. We have to admit that due to these rules we end up losing some businesses which are not in line with requirements, however we believe this is the best way to achieve sustainable growth within ethical norms where all compliance requirements are met.”
Parth Desai, founder and chief executive of software company Pelican, says the fight against financial crime “has never been so important, or so difficult in today’s digital economy”. Criminals are becoming more sophisticated as they operate on a global level, moving increasing amounts of money in and out of financial institutions to commit financial crime. At the same time, technology has advanced exponentially in the past decade, introducing artificial intelligence (AI) and natural language processing into the financial sector. “The traditional rules-based detection models simply cannot defend against attacks that have not been experienced before. This requires a new generation of advanced solutions using machine learning and advanced analytics to lower the risk of financial crime and enhance the customer experience at the same time.”
Battling financial crime and ensuring compliance puts pressure on existing legacy systems, as Desai points up. Nick Armstrong, chief executive of Australian blockchain solutions developer Identitii, agrees. “I don’t really see the ‘real-time’ part as the issue. It’s not the fact that we’re processing payments faster that is the problem. It’s that 8% of payments are still being held up for manual investigation, costing banks and end corporate beneficiaries time and money. We have figures that put the cost of releasing these held up payments at USD43.8billion per year. So how should we overcome the challenge of legacy technology and systems that are still preventing us from moving to fully real-time payments?”
Until financial institutions find a way to stop using email, fax or phone calls to collect and share data and documents and until they start a payment with all the information that is needed to settle it, as opposed to chasing it once funds have arrived, the industry won’t be able to lower that 8% figure, he adds.
“We also need to take into consideration though that as more payments move towards real-time, the surrounding systems and processes also have to hold up. So this process of manual investigations isn’t going to work. We need to automate some of these processes and shift others to payment initiation, as opposed to waiting until the end of the transaction process.”
Desai says what makes the current cross-border payments scenario less advanced than domestic ones is not just the financial crime risk posed, but also the technical platform challenges in connecting institutions in different regulatory environments under one centralised platform to facilitate the payment. “AI is allowing some businesses to already successfully facilitate real-time payments across borders and this is going to increase. It may vary the way we wish to pay or how we want to pay, but it is coming.”
In the past, says Bajaj, a very small proportion of payments required additional due diligence; now that proportion of payments has increased significantly. “This only raises the challenge on institutions, they must ensure that these types of payments are efficiently handled and processed near real time, if not real time.”
Armstrong says as regulators have passed on more requirements to banks, they in turn have passed these on to their corporate clients. “The biggest impact is around data and a key example here is ISO 20022. The mandate to migrate to ISO 20022 is all about regulators wanting more information on transactions. They want more information on who a payment is from, where it’s going and what it’s for to ensure it isn’t breaching AML or CTF rules.” Most of the impact falls on the bank, he adds. There are two considerations: how to handle the change needed for systems to adopt the ISO format (migrate or translate); and how to handle the increased volume of data that new regulations require. “Do banks really want to handle it inside core systems? Probably not. We think it’s going to bring about a sea change in how we look at payments data. Banks are going to start looking at ways to handle data outside the value transfer itself, so you can maintain its integrity even if you translate messages or as it moves internally and externally, otherwise they will be continually upgrading systems to handle every new requirement.”
Desai adds that while advanced technologies are making it easier for financial institutions to “improve the customer journey” by putting the customer experience first, the regulation around payments is constantly changing, making this an “iterative and evolving process”. Rather than referring to ‘frictionless’ payments, Desai says a more appropriate term is ‘seamless payments’. “Frictionless payments are hard to achieve when regulations are on the rise to assure security and compliance with the financial system as a whole.”
Armstrong believes blockchain could provide an answer to the challenges in cross-border payments. “By its nature, blockchain lends itself to compliance because it can help create that auditable and tamper-proof record of every transaction. So whether you’re ensuring your regulatory reporting is complete and accurate or sharing information to enable faster reconciliation, you have more confidence in the underlying data.”
The other element is tokenisation. “The challenge we have with moving to faster payment cycles is that sharing the data we need really isn’t possible using today’s technology and processes. Tokenisation enables that to happen as it lets you treat data separately to the value transfer itself. So instead of trying to fit more and more data into a payment message for example, we can embed tokens into the message that point to the underlying data on the blockchain. So you get the benefits of the auditable timeline of activity with the ability to manage data in a more effective and efficient way.”
Bajaj believes roadblocks for some types of payments will always exist but using rules-based technology and improving the rules by training them on historic transactions can help address most of the exceptional cases and turn them around quickly.
Pasha Bank’s Naghiyev believes fintech companies are challenging banks in the payment business and real-time payment is “already happening” via Venmo, Ripple and other new fintech companies. “But banks still have the competitive edge of being regulated and secure so we have to utilise these competitive advantages before it’s too late by cooperating with these new market entities.”
He adds that “compliance procedures, AML and KYC rules will always exist; however due diligence processes will be very fast and seamless due to the increasing availability of data about individuals and corporates and their operations worldwide. I wouldn’t consider those things as a challenge, but rather as a new reality that we have to face and adjust to. I think the new world will be data driven and we can’t miss that train as financial institutions are a major data holder.”