flow sets out how the financial services industry’s infrastructures have responded to external shocks and market demand, and explains the significance of further ISO 20022 roll-out and adoption
The global financial system has come a long way. Ever since economic globalisation propelled what had, up until around 1870, been a double-act between London and Paris into the framework of legal agreements, regulated entities, regulators, supervisors and institutions we know today, its success has been based on its universal acceptance and its interconnectedness.
Having survived and been shaped by financial crises from the South Sea Bubble in 1720 through to the sub-prime crisis in 2008 1, finance acts as an engine of growth, provided everyone trusts it.
But is the technology revolution another crisis in waiting? Or an opportunity? And can the industry count on its frameworks to support ramp-ups in scale and speed?
“The global financial system is undergoing perhaps its largest, most extensive transformation in recent history,” reflects Paula Roels, Head of Market Infrastructures and Industry Initiatives at Deutsche Bank.
Fast-moving technology has meant that market infrastructures, one of the three core components of the financial system together with markets and institutions, are undergoing a two-pronged metamorphosis with completely new infrastructures being built, along with upgrades to existing ones. These upgrades will lay the foundations for a technologically sophisticated, optimally efficient and resilient industry.
However, the scale of the changes and the resources required to implement all of this means that the entire financial services industry has to move forward as a whole. Christian Westerhaus, Deutsche Bank’s Global Head of Clearing Products, observes that “objectives pursued at a local level, a currency level and a regional level must align with global developments.”
The Eurosystem has the statutory task of, as the European Central Bank (ECB) puts it, “promoting the smooth operation of payment systems”, and it does this to achieve a sound currency, the conduct of monetary policy, the functioning of financial markets, and to support financial stability. The Eurosystem consists of the ECB and the national central banks of the 19 member states currently part of the Eurozone.
It operates the TARGET2 system, which was updated in 2008 from TARGET, the first-generation system. More than 51,000 banks around the world (and therefore all the customers of these banks) can be reached via TARGET2, which enables central banks and commercial banks to transfer money between each other in real time (see Figure 1)2.
To enable this, banks hold real-time gross settlement (RTGS) accounts with a consistent balance above a minimum threshold – which can contribute to fulfilling high quality liquid assets (HQLA) requirements 3, in line with Basel III. Such speed and consistency is beneficial to other financial sectors that require high-value settlements. This is precisely why the TARGET2 infrastructure was extended to securities settlement in June 2015, under the TARGET2-Securities (T2S) banner. Where TARGET2 enables central banks to provide core, borderless, neutral securities settlement services in central bank money, T2S empowers central securities depositories (CSDs) to do the same.
The most recent release of T2S – incorporating a number of incremental upgrades, including enhanced operational resilience in multi-currency contexts – deployed in June 2018 4 demonstrates that existing infrastructure changes are continuous, along with ongoing development of new ones.
"Objectives pursued at a local level, a currency level and a regional level must align with global developments"
Christian Westerhaus, Global Head of Clearing Products, Deutsche Bank
The Eurosystem’s next release is the Target Instant Payments Settlement service (TIPS), scheduled to go live on 30 November 2018 5. TIPS will settle payments for banks and other payment service providers offering real-time payment settlement of SEPA Instant Credit Transfers (SCT Inst) 6, for a mere €0.002 per transaction. TIPS is one of the TARGET services offered by the Eurosystem in an effort to enhance and optimise its financial market infrastructure. “It is about creating an efficient and resilient domestic infrastructure within Europe and for the euro, with smooth transaction functions,” says Marc Bayle de Jessé, Director General, Market Infrastructure and Payments, at the European Central Bank (ECB).
This future-looking attitude is also the motivation behind the RTGS upgrade scheduled for 2021. Logistically speaking, it’s no small task – the entire TARGET2 platform will be down for a weekend, in order to shift the RTGS functions to a simpler transaction flow, streamlining the number of incumbent parties.
Disruption doesn’t have to be disruptive
While TIPS will operate on a 24/7/365 basis, it is not the same for all TARGET Services. TARGET2, the Eurosystem’s RTGS service which has a new release planned for 2021, need only operate in trading hours, although the infrastructure design would in principle also allow for wider operating hours up to 22/7 service. However, the sectors supported by each infrastructure have different service requirements – Bayle says that it’s a case of listening to industry bodies to gauge when enhanced facilities will become useful, before then deploying them.
banks reachable on TARGET2
(European Central Bank)
Deutsche Bank’s Westerhaus, concurs with this approach: “For all-hours functionality, the question to ask is: where do clients have real requirements for it?” He explains that Deutsche Bank addresses time-zone requirements for payments from Europe into Asian markets simply by opening earlier.
The “right” infrastructure upgrades should solve less straightforward problems. For example, infrastructures with slow processing times cannot compete with client expectations for real-time facilities. Infrastructures which are indifferent with respect to supporting compliance procedures will also likely need to be augmented. These upgrades are not designed to make these infrastructures functional. They’re functional already. So, the upgrades and new-build infrastructures that are driven to market will be those that add compelling value.
While the promise of slicker, more robust payments infrastructures is encouraging, it is important to ensure that the strengths of existing infrastructures are not sacrificed in pursuit of upgrades. “Today, we have a network and reach that successfully responds to the needs of our clients when paying or receiving money. Fulfilling these expectations is the foundation that upgrades should be built upon,” notes Westerhaus.
He explains that no matter the value proposition of an upgrade, its implementation should not interfere with the treasury’s day-to-day operations. The trick is “to drive disruptive technologies without actually disrupting clients.”
Financial messaging issues
A crucial element in any market infrastructure will be transparency and standardisation, to ensure that the framework is scalable and resilient. Market infrastructures are the mechanisms that move funds – but messaging standards provide the information that instructs payment. Without the support of a standardised methodology, even the most sophisticated infrastructures will be at risk of having their messages misinterpreted.
Picture this: you are a German corporate paying a new supplier in Spain. Having input the supplier’s account details into your bank’s payment platform, the payment instruction is sent to transfer the funds from the master account. The funds are taken from the account, so you assume that the transaction has been executed. However, the following morning you receive a call from the supplier: the payment did not arrive. Upon troubleshooting, you discover that no input errors were made in adding the supplier to your system – so what happened?
“It is important to remember that the original financial messaging standards were designed in the days when bandwidth and storage were expensive,” says Stephen Lindsay, SWIFT’s Head of Standards. “At that point”, he adds, “the goal was to minimise the amount of data exchanged and to ensure messages were unambiguous and easy for machines to process.”
These semantic barriers can arise from regional differences in terminology, or from individual companies having their own technical jargon. Different words may refer to the same concept, or one word could have multiple meanings. For example, in a direct debit, the payment originator can be referred to as a ‘creditor’ or ‘payee’, while in a credit transfer, the same party can be referred to as a ‘debtor’ or ‘payor’. This is one of the more glaring examples, but it demonstrates how easy it is for financial messages to be misinterpreted and obstruct payments.
ISO 20022: a common repository
Confronted with these messaging standard conflicts, the ECB’s new suite of market infrastructures – including T2, T2S and TIPS – will all run using ISO 20022, an International Standards Organization (ISO) standard for electronic data interchange between financial institutions, as a common messaging standard.
SWIFT began work on ISO 20022 in 2004; a “clean slate” approach to create a single set of international messaging standards that enable users to send consistent, syntax-independent messages. According to SWIFT, ISO 20022 has replaced domestic or legacy formats for payments and securities businesses and has been adopted by market infrastructures in more than 70 countries. It is, notes SWIFT, the principle standard in the instant payments market, implemented in hubs such as Europe, Australia, the US, Canada, Sweden, Denmark and Singapore 7.
ISO 20022 is unique in the three-layer methodology that supports its messages: preceding message structures have combined the top and middle layers, symptomatic of cost-saving efforts. SWIFT’s pragmatic approach to structuring its logical messages allows for variation in technical language without compromising the terms’ intended meaning.
This has also contributed to ISO 20022’s high-quality data turnover. By relying on granular, reusable data, ISO 20022 catalyses straight-through-processing (STP) rates – meaning users will experience fewer errors, and save time, cost and administrative effort. Clear, thorough data supports sanctions screening, know-your-customer (KYC), anti-money-laundering (AML) and counter-terrorist-financing (CTF) practices.
At the centre of SWIFT’s ISO 20022 development is the need for clarity. “You have to ensure that what goes in at one end of the pipes is what comes out the other end,” says SWIFT’s Lindsay. “To do this, you need common business definitions for the data in each step of the process, even if the technology requires it to be expressed in different formats at different points.”
Especially in cross-border transactions, disparate data semantics can both obstruct payments, and make it incredibly difficult to identify exactly where they are stuck. With clear messaging standards implemented internationally, this problem will be significantly mitigated.
We have already noted that the Eurosystem’s TARGET Services – T2S, TIPS and the renewed TARGET2 – will all be underpinned by ISO 20022, due to what the ECB’s Bayle calls “its universal reach in financial services – adopted globally more and more and across all financial services”. It is also now predicted that the world’s top five currencies will all have migrated to ISO 20022 in the next five years – meaning it will cover 80% of transaction value worldwide 8. On the back of this momentum, ISO 20022 is developing into the de facto messaging standard for the global transaction banking industry.
Convincing stakeholders to switch
To achieve this ubiquity, banks will have to rip and replace old standards – creating the clean slate required to apply ISO 20022. Technology neutral, they are compatible with existing legacy systems. However, for many organisations, existing standards are passably functional. Faced with the costly task of ripping and replacing in order to benefit from ISO 20022, stakeholders may not deem the benefits sufficient enough to balance the migration cost. At a glance, these concerns have substance: a Deloitte study found that corporates adopting ISO 20022 will amortise migration costs in roughly two-and-a-half years – whereas it will take financial institutions more than three times that 9.
But the same report also found that corporates and financial institutions will likely be shouldering the transition cost equally. Adopting ISO 20022 should therefore be treated as a long-term investment, a vital step towards future-proofing organisations faced with fast-developing technologies and new infrastructures.
Most corporates are already familiar with the standard, owing to its use in enterprise resource planning systems. Any confusion regarding their interpretation can be quickly clarified using the ISO 20022 dictionary, which contains more than 750 business components and 400 business definitions. Since ISO 20022 is based on commodity technology, the transition should be minimally disruptive to client services, bringing many opportunities for better, more consistent business based on scalable, resilient messaging standards.
"It is about creating a resilient domestic model infrastructure within Europe and for the euro, with smooth transaction functions"
Marc Bayle, Director General, Market Infrastructure and Payment, at the European Central Bank
“Successful market migrations require orchestration and harmonisation across the whole ecosystem,” explains Roels. She adds that benefit realisation following ISO 20022 adoption will require a collaborative approach to implementation, and ample communication to ensure the final result is a fully functional, interoperable service running at optimum capacity.
This has already got off to a good start with industry bodies, financial institutions and their corporate clients including ISO 20022 infrastructure upgrades in their dialogue. In addition, the consultation paper published by SWIFT in April 2018,7 engages with Bank of England and the Eurosystem and synchronising their respective migrations to ISO 20022. Importantly, SWIFT will offer continuous guidance to adopters and users, complemented by numerous learning materials and a detailed adoption roadmap slated for publication.
“The transformation of infrastructures and market standardisation can only work out if matching goals are being pursued, reflects Westerhaus.” So, while market infrastructures and messaging standardisation are respectively large projects, the successful – and harmonised – achievement of both will lay solid foundations for a future-proofed, modern industry.
1See The Economist essay, ‘The slumps that shaped modern finance’ at https://econ.st/2NdhE0P at economist.com
2See https://bit.ly/2o3vkQP at ecb.europa.eu
3See https://bit.ly/1e1VwjY at bis.org
6See Deutsche Bank’s ‘The road to real-time treasury’ for further explanation of this at https://bit.ly/2MR8N7M at db.com/flow
7See https://bit.ly/2w99f7Z at swift.com
8See https://bit.ly/2MNlnoL at pymnts.com
9See https://bit.ly/2OWV90v deloitte.com
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