One well known retail chain here in the U.S. had just introduced “chip and pin” to its point of sale terminals. This appeared to cause some confusion to a number of customers queuing in front of us who had been used to signing the sales slips for so many years before. Moving on a few hours to the restaurant we ate at in the evening, the transaction was paid for again via credit card but, on this occasion, I was presented with both the merchant and customer paper receipts onto which I had to manually add the tip and provide a new total.   This would then require further work behind the scenes for the correct amount to be entered into the restaurant’s merchant system so that the (hopefully) correct amount will be charged to my card.

In contrast, the TV channels here in the U.S. are busy showing adverts for Applepay and the Tech headlines are highlighting the race between Google and Samsung to launch the next mobile Payment software; one for Android and one for Samsung devices. At present, Applepay is only available on the iPhone 6 and above and the iWatch. However, over the next eighteen months many more people will become “eligible” to use this new method of paying as their maturing mobile contracts allow users to upgrade from their iPhone 4’s and 5’s. Ditto, presumably, for where Samgung and Google Android will be heading.

However, seeing where things currently stand in the U.S. retail arena, I could not help wonder how many Companies will upgrade their Point of Sale terminals/merchant systems in the same timescale to use this latest technology?   Some will, but I would lay money (either crypto or physical) on many not having done so given the slow pace of adoption of earlier technology.   Will these businesses then lose ground to more tech-savvy competitors?   Similarly, can the combination of Apple/Samsung and Google Android provide the necessary pressure in terms of the total population of mobile users who would want this functionality to force change at Point of Sale?   I am very conscious that, with all new technology, there is a rash of early adopters.   However, will the silent majority also move sufficiently to force the pace of change?

Broadening the topic further, for some markets, this also then highlights the disparity between those mobile payment mechanisms that can simply be used to pay for something via the credentials of consumer’s physical cards being loaded onto the device versus those that are bespoke to Banking institutions for the transmission of and receipt of customer funds.   Until a mobile payment system can do “everything” will it sufficiently appeal to the wider population to adopt it as opposed to the tech-savvy minority?

Turning finally to the Eurozone, I wonder whether PSD2 and XS2A could be the key towards the full enablement of mobile technology. In a few years’ time, could the purchase of a smartphone enable a consumer to fully link the proprietary mobile payment software embedded within it to all of their accounts held across a variety of banking institutions as well as to their debit and credit cards?   That would then provide a single and straightforward authenticated “portal” to all payment services plus the ability to pay for anything, anywhere and at anytime (either with funds permitting or credit being offered).

As a closing thought, could regulation therefore be the mechanism that finally confirms the full arrival of Mobile Payments and therefore generate the necessary force to bring alignment at point of sale?

Yesterday’s announcement by Earthport Plc of the enhancement of its services to “enable real-time cross-border payments via distributed ledger protocol” via a partnership with Ripple Labs (http://www.earthport.com/pr/earthport-launches-the-first-fully-compliant-gateway-for-real-time-payments-via-distributed-ledger/) has the potential to move things forward in this space given the stated ability for clients to maintain their compliance regimes. The fact that Earthport currently focusses on low value cross-border payments should not take away from the broader opportunities and impact that could arise here.

I must emphasise that I have no relationship with either Earthport or Ripple Labs or any other party in this field.   However, my background in those Market Infrastructures backing the settlement of equities, FX and payments means that I can highlight the potential disintermediation or “disruptive” impact that such advances could bring. For me, the key question is whether we are now seeing the birth of the next iteration of Market Infrastructures and, if so, what happens to the existing ones?

In terms of context, it is less than twenty-five years ago that a raft of Real Time Gross Settlement Systems were built by the major Central Banks (some countries are still in the process of building them) and these provided the foundation stones that permitted settlement systems to access them for real-time, safe, secure settlement (see my last post on Finality in the Payment Chain).   A number of domestic settlement systems were then created, many of which were subsequently subsumed into the major international systems that are around today (eg Euroclear, CLS etc).   It can be argued that these were the first major “disruptors”, creating faster, more cost-effective and more secure means for settlement to take place (either on a domestic or international basis).

New guidelines for their operation were created (under the Bank for International Settlements (BIS) and its subordinate Committee for Payments and Settlement Systems (the CPSS – now renamed the CPMI (Committee on Payments and Market Infrastructures)).   This Committee comprises of the main Central Banks (see www.bis.org/cpmi/membership.htm) and works closely with other key organisations such as the Financial Stability Board (http://www.financialstabilityboard.org/).  It is only three years since the latest set of “Principles for Financial Market Infrastructures” were published (www.bis.org/cpmi/publ/d101a.pdf), which provide the minimum standards across a number of key areas (ranging from Governance to processes around Operational and Liquidity risk) that Financial Infrastructures are expected to comply with and form the basis for assessment by those regulatory bodies responsible for their supervision.   Most key Financial Market Infrastructures are obliged to comply with the PFMIs, with some jurisdictions (eg the Eurozone) only publishing their requirements in this area as recently as last year.

The point of stating the above is to highlight that it is only very recently that the applicable standards and associated regulatory approaches have sufficiently evolved to enable the existing Financial Market Infrastructures to (a) put in place the necessary controls and (b) to be supervised in a consistent fashion to provide the necessary level of comfort to those who are reliant upon them for the safe delivery of settlement services on a daily basis.   These processes move slowly (sometimes by necessity due to the need for legal alignment and sometimes down to the sheer logistical challenge of geography and resources). They now potentially risk being overtaken by the evolution of the next set of “disruptive forces”.

A key question is how large does a new “system” or “combination of systems” need to be before it is considered to be a Financial Market Infrastructure? Are we likely to see those entities who are rapidly moving forward in the payment and settlement space likely to fall within that definition themselves (whether they want to or not) and, therefore, the purview of the international authorities for supervision and oversight (assuming that it is felt appropriate for them to be overseen in the same manner as before)?   Does the nature and manner of their operation mean that the existing regulatory standards need to be reviewed again and, if so, in what timescale?

The latest advances will undoubtedly bring impact in the Market Infrastructure space. That is natural evolution which should be seen as an opportunity rather than a problem.   There is though the final question of what happens to the existing Financial Market Infrastructures?    Do they evolve themselves and become adopters of the new technology or should we expect a natural transition to replacement infrastructures?   That brings with it its own challenge; the cost of running the existing infrastructures should not be underestimated and, in most cases is fixed given the regulatory standards they must comply with.   As such, economies brought to their users is often a volume game and if some of this volume is moved elsewhere (think of a long balloon being squeezed), the cost just goes up somewhere else.  It should also not be forgotten that a lot of the existing Financial Market Infrastructures are “not for profit” industry owned entities which is a very different structure to those driving the pace of change at present.

If ever there was a good reason to “watch this space”, the changes now afoot would be a good justification.

I went on to state that this highlighted the differentiation between the payment instruction, the form of underlying settlement and the finality protection this afforded.  Having reflected further since that post, I think these are key distinctions that many customers of Payment Institutions are not aware of and felt that it would be helpful to make this the subject of a specific post in its own right and what that might mean for future payment types.

In a Payment Chain, an end-customer (the payment originator) will submit an instruction via their Financial Institution to pay away from their account the sum of X for the benefit of someone else (either a corporate or individual).   The latter is known as the end beneficiary and the payment instruction could entail just one intermediary bank (if the originator and end beneficiary both bank at the same institution) or up to several if either the originator’s bank or the end beneficiary’s bank are not Direct Participants in the Payment System through which the payment is settled.   Transactions that settle across the books of a single financial institution are considered “internalised” and merely reflect a book transfer. Most other transactions will “settle” across a payment system unless the institutions on either side of the transaction choose, for whatever reason, to settle outside of the payment system.

What parties on either side of a payment transaction want above all else is certainty around the payment successfully taking place. In particular, that the payment will not be revoked. Whilst this is an obvious concern for the end beneficiary, at a systemic and commercial level, the risks go deeper than the simple question of whether the Payee has sufficient liquid funds for the payment to be successful and centre on whether multiple payments can be revoked owing to the Financial Institutions handling the payments becoming insolvent.

At this point, it is worth differentiating between the protection available to depositors for funds held in a failing Financial Institution (whether that be the UK’s implementation (via the FSCS) of the €100,000 EU Deposit Guarantee Scheme Directive or the intervention of the Central Bank to Resolve a failing Institution by bringing it under protection as a “bridge bank”) and the means of protecting payments made on the day of insolvency in case they are reversed.

For the main UK Payment and Settlement systems, the means of protecting payments “in transit” is provided via their designation under the Settlement Finality Regulations. Specifically, payment and settlement systems that are designated may apply for protection against the operation of insolvency law for instructions entered into their system.   This is achieved via the application of the relevant Settlement Finality law operable in that country.   For countries within the EU it would be the local law passed under the “umbrella” of the EU Settlement Finality Directive (in the UK it is the Financial Markets and Insolvency (Settlement Finality) Regulations 1999 http://www.legislation.gov.uk/uksi/1999/2979/pdfs/uksi_19992979_en.pdf).  By virtue of the application of the regulations, payments then effectively become final and irrevocable at the point in the system’s processes where settlement is deemed to have taken effect.

The list of those systems in the UK that have been designated under the Settlement Finality regulations is set out on the Bank of England’s website (http://www.bankofengland.co.uk/financialstability/Pages/fmis/supervised_sys/systems.aspx).   In order to become designated, the Payment or Settlement system must apply for designation and meet the criteria set out in the Settlement Finality Regulations. Once designated, there are then obligations placed upon the System that must continue to be maintained (in particular, the ongoing provision of information to the Designating authority).  The Settlement Finality Regulations are continually being amended and updated (the latest taking place in March 2015 (http://www.legislation.gov.uk/uksi/2015/347/pdfs/uksi_20150347_en.pdf) which all participating systems must continue to remain cognisant of.

Whilst the above may seem somewhat heavy for a post, it is essential to understand the importance of this in terms of how payments transacted through the designated Payment Systems become final and irrevocable which, in turn, is what generates the fundamental trust present within the UK Payment Infrastructure.

This also highlights a key foundation requirement that must underpin payment innovation; evolution should not result in a reduction in the protection that is currently available.

Payment Services that UK Financial Institutions provide in their role as Payment Service Providers (PSPs) are, themselves, underpinned by the requirements present in the Payment Services Regulations (which, in turn, follow on from the EU Payment Services Directive). They will leverage the underlying functionality that their own internal systems and the relevant backing Payment System can provide. For example, innovative consumer-facing payment products such as the various forms of mobile payments provide a convenient means of accessing funds held at an institution and paying someone else.   However, they all rely upon the core foundation stones that have already been laid.

The next few years are likely to be the most exciting and innovative that the Payment Industry have ever seen. This post hopefully highlights some of the quietly understated mechanisms that exist behind the scenes and the need to ensure that these protections remain available.