CLEARING AND SETTLEMENT: THE NEW BATTLEGROUND FOR clearing and settlement options – all while managing

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  • A WHITE PAPER PRODUCED BY FINEXTRA IN ASSOCIATION WITH VOLANTE TECHNOLOGIES OCTOBER 2018

    CLEARING AND SETTLEMENT: THE NEW BATTLEGROUND FOR PAYMENTS INNOVATION How financial institutions can tackle complexity in an ever-evolving payments ecosystem

  • 01 Introduction .......................................................... 3

    02 New frontiers in payments initiation ........................ 4 03 Clearing and settlement complexity on the rise ......... 6

    04 The question for banks ........................................... 7

    05 Cross-border payments and SWIFT gpi… .................. 8

    06 Distributed ledger technology: The banks hedge their bets… .................................10

    07 Cryptocurrencies: Next generation innovation… .......13

    08 ECB’s TIPS: Another alternative solution .................14

    09 The US Context: domestic and cross-border ............16

    10 Mastering complexity: Preparing for the diverse ecosystem… ........................................................18

    11 About ..................................................................20 7 What should financial institutions be doing about blockchain right now? 25

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    01 INTRODUCTION

    There is significant innovation and competition afoot in the world of payments initiation, driven by consumers and corporates on the demand side, and traditional banks, fintechs and challengers on the supply side.

    This is mirrored by what can reasonably be called a revolution in the world of clearing and settlement. Real-time / instant payments, blockchain and distributed ledger, new solutions to the old problems of cross-border correspondent banking, and many other initiatives all have the potential to transform how payments are processed, cleared and settled.

    Financial institutions therefore need to find ways to provide compelling business services based on new methods of payment initiation and novel customer experiences, while keeping pace with the multiplicity of back end clearing and settlement options – all while managing costs, staying ahead of compliance, and growing market share.

    “ Banks also must accommodate competition and innovation in the clearing and settlement space, both domestic and cross-border. Here, too, change is coming thick and fast, with new entrants wading in and incumbents fighting back.”

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    02 NEW FRONTIERS IN PAYMENTS INITIATION

    Competition – and innovation – in the payments initiation space are well- established trends. New regulations to encourage open banking, notably the revised European Payment Services Directive (PSD2), amendments to Japan’s Banking Act, and Australia’s Open Banking Review, as well as the US Federal Reserve’s recent focus on payments modernisation in the US, have an explicit goal of increasing innovation and competition in payments initiation. The fintech industry has also targeted much of its inventiveness at revolutionising how people – and increasingly businesses – make payments.

    Innovations in the peer-to-peer payments arena, driven initially by new entrants, have forced incumbent providers to up their game, as we have seen with the launch of Zelle by a group of major US banks, in an attempt to offer a better alternative to fintech options such as Venmo or Square Cash. The rise of real- time, or instant, payments systems in many markets worldwide, supported by market infrastructures, can also be seen as a response by the financial industry to regulatory demand for, and fintech-driven, innovation in payments.

    Underpinning all of this innovation has been the growing ubiquity of mobile payments, ever more widely adopted by a demanding, tech-savvy generation of consumers. And where consumer payments have led the way, corporate payments are following.

    For financial institutions, though, keeping up with – and ahead of – how people and businesses make payments is only one part of the challenge. Banks also must accommodate competition and innovation in the clearing and settlement space, both domestic and cross-border. Here, too, change is coming thick and fast, with new entrants wading in and incumbents fighting back.

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    It is tempting to examine drivers of innovation and disruption in clearing and settlement—the move to real-time, regulatory pressure, customer demand, new cross-border initiatives, open banking—in isolation. However, these trends are deeply interconnected. Like any other ecosystem, the payments ecosystem is best approached holistically. The Australian government, in its Open Banking foreword, said, “Open Banking should encourage competition. It should be done to increase competition for the banking products and services available to customers so that customers can make better choices.”

    INNOVATION AND DISRUPTION IN CLEARING AND SETTLEMENT

    Europe’s PSD2

    Amendments to Japan’s Banking Act

    Australia’s Open Banking Review Fast, digital services

    The Clearing House’s RTP (Real Time Payments)

    Australia’s New Payments Platform

    India’s Immediate Payment Service

    China’s IBPS (Internet Banking Payment System)

    innovation and disruption in the payments initiation space driven by regulation and consumer demand

    Innovation and disruption

    “ RTP is designed to support not only the transfer of funds but also the ability to both request payments and provide critical information about a payment to efficiently deal with back office reconciliation issues.” – THE CLEARING HOUSE

    “ To build the foundation for a full range of mobile based Banking services..” – NATIONAL PAYMENTS COUNCIL OF INDIA, OBJECTIVES OF INDIA IMMEDIATE PAYMENT SERVICE

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    03 CLEARING AND SETTLEMENT COMPLEXITY ON THE RISE

    The backers of each initiative might believe theirs will become the global standard but, in all likelihood, more than one will prevail. And in this environment of rapid technological development, we will almost certainly see a further acceleration in innovation, with more new initiatives gaining ground, before any consolidation occurs.

    Complexity in clearing and settlement is not a new phenomenon. But it is widely tipped to be a bigger trend in the coming years – with good reason, given the number of initiatives vying for attention. The list already includes SWIFT gpi, Ripple, MasterCard and distributed ledger-based solutions based on R3 Corda, Hyperledger, and Ethereum (to name just a few) and the European Central Bank’s Target Instant Payments Settlement (TIPS).

    Layer these over domestic instant payment systems from national clearing houses, consider the variety of infrastructures and solutions in play across the globe, and think about innovations on the near horizon, such as central bank- backed cryptocurrencies. It’s clear that when it comes to payments clearing and settlement going forward, banks will be operating in a world of multiple options – including DLT-based infrastructures, ISO 20022-based standards, and proprietary data formats. PSD2 / Open Banking will also force innovations in bilateral / multilateral clearing and settlement requirements.

    CLEARING AND SETTLEMENT INITIATIVES

    DISTRIBUTED LEDGER TECHNOLOGYCLEARING AND SETTLEMENT INITIATIVES

    R3 Corda Hyperledger

    Ethereum

    TARGET INSTANT PAYMENTS SETTLEMENT

    TIPS ITS AIM IS TO ELIMINATE CREDIT RISK ACROSS A LARGE NUMBER OF PARTICIPANTS

    LIVE NOVEMBER 2018

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    TIPS (Target Instant Payments Settlement- European Central Bank) Ripple

    Mastercard

    SWIFT gpi

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    04 THE QUESTION FOR BANKS

    The question for banks will be how they can most efficiently and effectively operate in a world which requires them to connect to multiple clearing and settlement mechanisms while managing a plethora of new initiation channels and models. Where can they focus their limited innovation and R&D budgets?

    While the initiation space is certainly strongly connected to something that banks care about deeply – the customer experience – the reality is that banks are increasingly losing control of the customer experience at the point of initiation. With PSD2 essentially allowing any third party to create their own initiation experiences, it is almost inevitable that banks will need to focus more on their ability to clear and settle rapidly and efficiently, across as many national boundaries as possible.

    But this begs several questions. Will they have to participate in all the new solutions, or will they be able to restrict themselves to a few options? Will banks need to actively market different options directly to their clients, or will they be able to route payments in the background without user input? How much visibility will their customers seek over the options available to them – and how much accountability will the banks have when it comes to delivering least cost or fastest routing for payments (a comparable challenge is faced in the capital markets with the best execution obligations of MiFID II)