CEO, Fnality International
FNA roundtable event summary (19th October 2021)
This FNA roundtable offered an insight into the latest in payments innovation and modernisation, featuring presentations and case studies from industry experts, followed by a senior-level roundtable discussion with market participants from high-value payment systems, FMIs and Central Banks.
FNA President Philip Straley opened the session, which featured presentations by Fnality, RTGS.global and FNA, and covered a range of topics influencing the concluding roundtable.
The overall themes included:
- The need to build resilience into any payment system
- Limitations of the current global settlement systems, particularly cross-border/cross-currency
- The need to address myriad risks in the system effectively for FMIs to gain and maintain both adoption and regulatory approval
- The value that simulation & analytics can drive across payment systems – from design, through to regulatory approvals and operations
The first presentation explored resilience concerning the design and stress testing of payment systems.
Resilience, defined as the ability to recover from disruptive events, is a vital characteristic of any successful organization. By anticipating events, preventing and planning for recovery, organizations can overcome unexpected situations as quickly as possible.
Three factors are currently driving an increase in regulatory focus on resilience.
- Cyber attacks and operational errors
- New technology adoption and execution risk
- Increasing market disruption events
When looking at resilience and FMIs, the presentation outlined two approaches. The traditional method looks at financial markets as a machine. Whilst most people often assume that an established machine is safe, it can be quite brittle. A complex machine may be harder to break, but it shatters and amplifies disruption across the entire system when it does.
The second view looks at financial markets as a set of interactive organisms. While the organism model may not be perceived to be as robust as the machine approach. But as it gives way more frequently, it does not break completely, offering protection against multiple threats.
Distributed Ledger Technology (DLT) to create a simpler, peer-to-peer settlement model follows the organism approach to provide unprecedented resiliency and reliability. This novel method for solving and mitigating risk ensures that there is no single point of failure or single points of trust to provide resilience while maintaining the right incentives for each participant involved through mutual accountability and ownership.
As a result, the system is tolerant of faults and more resistant to attacks and collusion. It is also more cost-effective as DLT can operate on a commoditized cloud service catering for redundancy.
This decentralized approach also applies to organizational structures. A distributed system boosts resilience by resolving the trade-off between efficiency and risk by aligning real-time information and decisions to a collective purpose. However, a teams-of-teams approach requires transparency, as raises the question, will this approach satisfy regulators? But if this approach meets operational resilience outcomes and the goals set in place achieved, then should the method be much of an issue?
The second presentation provided an overview of simulating payment systems, stretching back to 1999, when simulation, based on data collected from Finnish banks, helped assess the liquidity impact of joining the euro.
Since 1999, simulations of payment systems have helped:
- Map the interdependencies of financial systems
- Identify systemically important banks
- Assess the impact of attacks on critical financial infrastructures
A more specific example looked at the Bank of England regarding Liquidity Saving Mechanisms in CHAPS. Here, simulations provided the bank with a design that resulted in £4bn of collateral savings.
Looking further ahead, a new CBDC simulator will help Central Banks optimize the design of digital currencies by assessing and stress-testing their implication on the wider financial system, allowing for the safer and more cost-effective adoption of CBDCs.
Today, however, the motivation to stress test payment systems come from:
- Key Suptech Innovation Priorities
- Covid-related liquidity and solvency risks
- The need to comply with international standards, including the PFMI
By testing scenarios on replicas of an existing FMI, including bankruptcy, liquidity events, cyber-attacks and environmental changes, there’s a better chance to safely understand how an event may manifest – whether that’s an outage or a failure of processes as well as its likelihood.
This information can then feed into designing and optimizing effective systems and to engage and reassure stakeholders that a new system is safe to launch.
Currently, the IMF Financial Sector Assessment Programs (FSAP) are driving RTGS Stress Testing simulations globally for Central Banks. However, simulation can be used as a benchmark for RTGS projects, i.e. using simulations before the system is designed and built to drive down the cost of the project.
The third presentation offered an insight into a new approach to modernize cross-border payments and remove associated risks.
Today, current approaches to cross-border payments place $14tn at risk each day. But what alternative exists?
To set the scene, the presentation provided an overview of historic payment systems dating back to the middle ages where messages are sent, a bank opens an account with the other, and the payment is settled separately, often at a later date.
Although messaging systems instructing a payment have evolved as new technologies come into play, the actual methods of settlements have not developed significantly. Today, we still have a system based on the bifurcation of messages and settlements.
As a result, cross-border payments are asynchronous. With messages and settlements not taking place at the same time, transactions can take several days to complete. Delays and slow processing often result from:
- Limited opening hours
- Legacy technology platforms
- Complex processing of compliance checks
A Bilateral Atomic Settlement system modernizes cross-border payments to offer an ‘always on’ and instant payments v payments system. Based on PFMI standards, this approach uses fiat currencies or Central Bank money and streaming technologies to settle payments in real-time while reducing settlement risk.
Following the presentations, the floor then opened for the rest of the participants to join the roundtable discussion, which started by looking at the future and how the Financial Market Infrastructure world is likely to change over the next five to seven years.
Looking towards the future inevitably brought cryptocurrencies into the conversation, with the vision that regulatory markets will eventually move into the arena.
Continuing on the theme of regulation, it is likely that rules will start to realize the problems associated with centralization and will, in the future, move towards distributing risks while maintaining transparency through infrastructures based on blockchain technology.
But technological innovation doesn’t necessarily mean that existing systems are inadequate. Creating the best state for the future means taking what works now, for example, the PFMI framework and some existing processes within Central Banks and focusing on areas for improvement. Organizations must introduce technology quicker and with less risk as incremental and slow change can be more disruptive in the long run.
The discussion then returned to blockchain, exploring how technologies like DLT and blockchain will impact SWIFT and card systems.
While the technology discussed in the presentations has the potential to replace SWIFT messaging systems when it comes to cross-border payments, the consensus remains that SWIFT will always be a messaging platform for many other things in the financial services world.
Regarding consumer habits, it remains unseen whether these technologies will impact how consumers pay by card. Furthermore, many unknowns exist about how digital currencies, including CBDCs, will operate across currencies.
Today’s roundtable highlighted the many opportunities emerging to modernize payment systems, but what’s holding the industry back?
Technology implementation depends on several factors. Change can often be slow, but that’s not down to a lack of appetite. Technology must be easy to integrate and use. However, the processes in place to remove the risk posed by new technologies can result in a timely and expensive process, often making change unappealing for some organizations. Furthermore, the pace of technological change often outpaces the implementation programme itself.
Regulatory approval, funding and achieving a critical mass of market participants can all help to drive innovation across the industry. Ultimately, banks and financial institutions will realize that change is unavoidable to stay competitive in an ever-evolving environment, especially where everyone has the same challenges to overcome.
Collaboration is key to solving the common challenges faced by organizations. By creating a network of relevant participants and sharing knowledge and lessons learned, everyone can benefit by innovating together and solving risks through a cooperative model. The industry won’t change with an individualistic approach, so if organizations want to make the financial world safer and change things for the better, it’s better to collaborate.