Fnality International partnered with FNA to help design their new payment system and quantify the benefits for their participants by means of simulation.

Introduction

Financial markets face unprecedented challenges. These challenges include fragmented and inefficient post-trade processes, liquidity constraints and complex and costly risk management.

To address these challenges, Fnality is developing a peer-to-peer payment system underpinned by Distributed Ledger Technology (DLT). The new system will enable quicker, safer, and more efficient exchange of value to the global wholesale financial markets and bring multiple benefits to its participants, including reduced counterparty and credit risk, reduced operational risk and efficient liquidity management.

Challenge

As a new and innovative payment system, Fnality needed to gain the trust and confidence of central banks and regulators and prove its benefits to potential participants. The company engaged FNA to help do so by building a series of simulations to demonstrate the impact of the Fnality Payment System (FnPS)  across various cases.

Fnality chose FNA due to its industry-leading analytics technology, strong reputation working with the world’s largest central banks and FMIs, and significant experience designing, modelling and simulating payment systems.

Together, FNA and Fnality also share a philosophical alignment with a goal to reduce operational risk and increase efficiency within the financial sector.

Solution

Fnality’s first engagement with FNA began in 2019 with the development of the FnPS simulator to use as a basis for real-time gross settlement (RTGS) simulations. This was followed by the first major project, a Liquidity Impact Analysis for wholesale payments in 2020.

In 2020, Fnality and FNA progressed to look at a second use case: Payments v Payments (PvP), with the aim of showing interested central banks that the inclusion of cross-border payments did not cause a significant elevation in liquidity risk. In order to do so, FNA’s intricately connected multiple payments data sources using cutting-edge models and technology.

Most recently, in 2021, FNA and Fnality worked on the Fnality Participant Simulator to showcase the substantial benefits the FnPS offers to users. By modelling payment trials and then consolidating them into the FnPS, the simulation calculates the maximum possible benefits the FnPS could provide to Fnality participants.

Benefits

1. Delivering confidence to regulators 

There is a risk that liquidity needs could increase within legacy systems as a consequence of banks migrating transactions to Fnality. FNA’s initial project with Fnality used simulation technology to look at the liquidity impact for wholesale payment use cases and revealed that if a participant migrated extreme volumes of transactions to the FnPS ecosystem, liquidity requirements increased.

However, the simulation also discovered that relative increases in liquidity tended to plateau depending on the FnPS utilisation levels by participants, allowing Fnality to conclude that there were no significant increases in liquidity requirements within existing RTGS systems -providing the comfort required by regulators and participants that FnPS would not add any further risk to the financial system.

2. Assessing the impact on liquidity 

The second and more significant project saw FNA’s technology simulate five major RTGS systems and PnPS counterparts to examine whether or not Fnality’s system increased risk under normal and stressed scenarios. FNA also explored various Liquidity Saving Mechanisms and their impact within the FnPS.

This analysis concluded that the implementation of the PvP use case alongside the wholesale payments use case did not significantly affect liquidity requirements within the FnPS or respective RTGS under counterparty stress scenarios as well as normal circumstances. The analysis also demonstrated the ability to effectively utilise LSMs across use cases.

3. Proving tangible benefits to members 

The previous simulations delivered clear answers surrounding any potential systemic risk posed by the FnPS. Next, Fnality wanted to understand the potential impact and benefits for individual institutions when onboarding to FnPS.

As a result, FNA and Fnality built the Fnality Participant Simulation – a significantly more complex simulator that required input from multiple stakeholders in order to establish how best to represent various complex configurations, such as group entity structures and the migration of payment rails.

The initial analysis revealed that when modelling the consolidation of multiple and existing payment rails, a banking participant could reduce liquidity requirements by up to 70% – equating to approximately $210m for a global systemically important bank (G-SIB). The findings, therefore, suggest that the effective use of the Fnality Global Payment System could lead to a significant intraday liquidity requirement reduction and help reduce intraday liquidity buffers.

Fnality and FNA are continuing their engagement to refine the simulations, allowing the organisation to confidently prove the value of the FnPS to central banks and participants, now and in the future, as Fnality expands the scope of currencies and participants.

Fnality CEO, Rhomaios Ram, added: 

“Since partnering with FNA in January 2020, Fnality has effectively explored how Distributed Ledger Technology can be used to power a sophisticated peer-to-peer payment system for central banks. 

“Following on from the Global Financial Crisis, regulatory bodies across all jurisdictions have imposed stricture regulatory measures to ensure financial institutions are effectively managing their intraday liquidity risk. The industry understands that any impediment to intraday liquidity flows could have significant ramifications for the global financial system. And as we have seen recently, the pandemic has compelled banks to assess their current intraday liquidity management and stress-testing. 

“At the same time, the digital disruption of legacy financial systems has drastically enhanced the way capital and funds can be traded. Of the technologies being integrated, blockchain is ideally placed to improve the efficiency of intraday liquidity, from reducing funding costs and payment delays to improved security.

” FNA has been integral to the development of the Fnality Payment System, successfully running collaborative projects with Fnality to demonstrate the disruptive advantages of DLT. 

” As the Fnality Participant Simulator shows, blockchain solutions exist for wholesale banks to significantly reduce funding costs. Beyond this, it ensures that intraday liquidity management is keeping up with the rapid pace and scale of daily transactions that are being facilitated through the latest fintech innovations.

“We look forward to building our partnership with FNA in the Future”.