“The dollar is our currency, but your problem,” said the then US treasury secretary, John Connally, to a European delegation in 1971, as the dollar’s fluctuations played havoc with Europe’s economy. In 2011, US economic worries are affecting a broader church.
During the past 18 months Guido Mantega, the Brazilian Finance Minister, has repeatedly asserted that a currency war is ongoing as countries try to prevent strengthening currencies from damaging their export businesses. Perhaps the most direct antagonism has been exhibited between the US and China. The bone of contention is the route that China is taking as it transforms the renminbi into a free floating, convertible currency. China operates a managed floating exchange rate, pegged to a basket of international currencies including the US dollar, allowing central bank the People’s Bank of China to keep a rein on its movements.
“[The Chinese] can’t take a risk with their growth rate,” says Charles Diebel, head of market strategy, Lloyds Bank Corporate Markets. “During the huge geopolitical project of urbanising their population, having a cheap currency is going to help them to maintain their export sector while that process is under way.”
A study published in April 2011 by the Wharton School of the University of Pennsylvania estimated that the renminbi is undervalued against the US dollar by 37.5 per cent. The US Government has raised concerns that this is damaging its own export sector. In September 2010, a bill that would allow duties to be added to imports from countries with “undervalued currencies” was passed by the House of Representatives, although the bill failed to get through the Senate, America’s other key legislative body. Washington lawmakers have mooted similar plans this year, in the face of warnings from the Chinese Government.
But the US is not an innocent victim of Chinese monetary policy says Nick Beecroft, senior markets consultant at Saxo Bank, an online specialist foreign exchange and capital markets bank. “Whilst I wouldn’t adhere to a ‘grand conspiracy’ theory that puts the US Treasury and the Federal Reserve together in a pre-meditated plan to debase the USD, it’s certainly the case that the Fed will employ any means it deems necessary to achieve the employment creation part of its dual mandate, and a weaker dollar to boost exports may well be part of that,” he continues. “I suspect that the dollar is indeed being used as a covert weapon of economic mass destruction by the US government, with the tacit involvement of the Fed.”
For the corporate treasurer, failing to follow the growth of new currencies and the weakening of reserve currencies, or lacking the tools to manage fluctuations, poses significant risks.
“Getting currency fluctuations wrong means a treasurer has to execute more conversions and he’ll have excess capital sitting in a low yielding currency,” says Steven Victorin, Emea head of sales for JP Morgan Treasury Services. He says the challenge can be made worse if the treasurer is not able to forecast cash flows accurately or is not able to readily convert and deliver foreign currency at short notice, making a diverse currency portfolio imperative.
Vanessa Lin, global product manager for global payments at Citi, says a wider portfolio is also needed so that corporations can hedge their FX risk as up and coming economies establish themselves.
“We are seeing trends like corporations issuing invoices in their home currencies or regional currencies when these are deemed sufficiently stable,” she says. “Additionally, we are seeing rising interest from both corporations and financial institutions in opening up alternative currency accounts such as the Mexican peso, Australian dollar and the renminbi.
According to Beecroft, the practical challenge for commercial banks during currency wars is not only to provide access to currency but also to keep up to date with regulation and support their clients through any rule changes that central banks impose.
“China is a very good example of this,” he says. “There has been a plethora of complicated rules over which industrial customers can buy and sell currencies for delivery. The banks have to enforce these rules or the central banks will come down like a ton of bricks.”
The Chinese Government is making moves to internationalise the renminbi, but they are slow steps. For foreign corporates there are two main strands to this process. One is the use of Hong Kong as a base for investment in renminbi-denominated investment products. RMB bonds, known colloquially as dim sum bonds, have been issued in the special administrative region by western corporates such as McDonalds and Unilever, to raise relatively small amounts of capital. The first Hong Kong initial public offering, which in the event was poorly received, was issued by a real estate investment trust in April 2011.
The other strand is the piloting of a trade settlement exchange rate system, which allows firms to open RMB accounts with approved banks so they are able to receive proceeds and make payments for cross-border trade settlement.
Until recently, foreign firms dealing with Chinese counterparts would use the dollar as the currency of exchange. However since the trade settlement exchange rate system piloted in 2009, Chinese companies are increasingly seeking to transact in renminbi.
“Renminbi-denominated trade with a total value of RMB3.6 billion [$563 million] was conducted in 2009,” says Neil Daswani, regional transaction banking head of North Asia at Standard Chartered. “For the first half of 2011, RMB1.5 trillion worth of renminbi-denominated trade has been conducted. Proportionally that’s moved from 0.1 per cent of total trade in 2009 to 7 per cent of trade in 2011 and is most recently estimated at close to 10 per cent for Q2 2011.”
He estimates that 80 per cent of the business conducted in the first 18 months of the scheme was import transactions, but recently the number of export eligible companies has increased from around 400 to more than 67,000, suggesting a rise in business going the other way.
Corporates moving into the Chinese market need assistance in mitigating the risk associated with integrating a new currency into their cash and trade infrastructure, managing any uncertainty around the convertibility of the currency, and navigating the evolving, and uncertain, regulatory framework.
“Companies doing business with Chinese firms can also benefit from the significant growth in FX hedging instruments, which we support for multiple currencies including renminbi,” adds Victorin. “These instruments can help corporates manage renminbi appreciation and its impact on their renminbi payables, acquisitions or capital expenditure.”
Venkatesh Somanathan, director, regional trade product management, Asia, at Deutsche Bank says he is now receiving enquiries from clients who want a much broader range of services. “We are receiving enquiries from clients who want to be paid in RMB, keep their funds in RMB, open RMB bank accounts, maintain RMB cash deposits and use RMB for transacting with their trading partners in China. They also want to use the RMB funds for exploring investment avenues in the interim should they not be requiring liquid funds in the meantime.”
Despite US Government concerns, there is no rush to make the RMB free floating, although no-one interviewed for this article was in any doubt as to that end.
“Market participants can expect that the timelines will be gradual, because there are implications for the economy, both inside and outside of China,” notes Venkatesh.
Despite the effect this may have on the export businesses of countries such as the US, on a practical level it will allow both corporates and financial institutions time to adjust to the new regime.
“The reality is that we are seeing a global rebalancing but it will take 10-20 years,” cautions Diebel. “For the time being there is no real alternative to the US dollar as a global medium of exchange.”

Heather Schlegel, innovation leader, member of the innovation team, Swift
We are at the dawn of a new age of money. Shifting values and a ‘digitally native’ attitude are opening new transaction channels. Technology, especially mobile, is transforming transaction processing. And alternative currencies are starting to make a real impact.
The alternative currencies influencing the future of money include corporate currencies (like frequent flyer points), virtual currencies (such as Facebook Credits), social value-based currencies (Bitcoin, anonymous, peer to peer) and Ven (international, carbon neutral), and social capital currencies (based on reputation, ratings and influence.) Today, these currencies are typically restricted to niche communities, but many are targeting expansion.
The rise of these currencies is a powerful indicator of the development of new economies such as the trust economy, supported by technology which makes it easy for us to rate and rank our experiences with both people and businesses, and the sharing economy: increasingly, communities are being created around transactions and non-financial transactions tend to create stronger bonds, hence the rising popularity of swap, borrow, loan, or ‘free cycling’ type communities (such as ReUse it and NeighborGoods).
If the future of money is based on trust, relationships, non-financial transactions and communities, then at first glance the news for traditional banks isn’t good.
On closer inspection, there are opportunities for the banks if they take action now and work collectively. A currency that is non-convertible can only ever be niche. Interoperability is the key and the banks have form here. A lot of information will need managing, transmitting and protecting in a seamless way. The banks can build on what they have done in the past to ensure interconnectedness between alternative currencies and in so doing add real value for the consumer of the future.
Interconnectedness goes beyond technology. The banks must also stay connected in a social sense not just to each other but to their current and future customers. They must find out what the next generation wants so they can reinvent their business accordingly, transforming themselves from the keepers of today’s hard currencies to the guardians of tomorrow’s digital assets, and guaranteeing their role as pillars of the emerging new economies.
In short, the banks need information to help them avoid the fate of big media players when blogs came around, or of the music industry when peer to peer emerged. And they can best find it by tapping into industry-level initiatives that are bringing them and their future customers together to foster collaborative innovation.

Jerry Norton, chief client officer, financial services, Logica
Payment methods, technologies and channels are changing and there is a huge opportunity for banks to take advantage and play a key role in digital money. Of course, these new channels may mean that banks no longer have control over the entire payments value chain. Banks need to experiment. They need to deploy these new channels and technologies. This market change is unashamedly technology driven. There is less business and product innovation this time around but more technology innovation. It is all about selecting the technology solutions that best fit the customers’ needs. Banks need to let the technicians own the approach; it is not business led.
The challenge is made more difficult since bank associations in every country seem to want to pursue their own idiosyncrasies, standards and ideas on how to develop these opportunities. This means that there will be many false starts. I think banks need to create a ‘disposable’ model, in the way true retailers approach it. The shop front is just that, a front. It can be thrown away and it can be changed. The goods inside may change far less frequently. The same is true for banking channels. Build

Arthur Brieske, head of product management for the Americas, global transaction banking, Deutsche Bank
The global digital goods marketplace is growing exponentially with millions of applications being downloaded daily and online games, digital content (music, electronic books, etc) and virtual goods are now common place in everyday life and households.
The emerging digital goods space poses both challenges as well as opportunities for the global payments landscape, particularly for banks. Online ubiquity of both payers and payees is enabling payments innovation. Digital money and payments have a distinct advantage over traditional payment methods. Traditional payments methods such as cards pose a significant profitability challenge particularly for micropayments in addition to falling short on a growing market demand for single click payment solutions that are interoperable, convenient, instantaneous and final.
Digital money makes it easier to integrate payments into a game or app, so called ‘in game’ or ‘in app’ functionality, allowing users to pay without leaving or interrupting the game or app. This convenience coupled with the interoperability of digital money across thousands of games and apps for an online game platform or retailer make it easier to spend more in a game or on an app. In the broader payments space this transformational phase is happening as well and banks are not sitting on the sidelines, they are playing a critical role in designing and shaping how payments will emerge in the general marketplace.
Forward-thinking banks are targeting the white space of unmet user needs, expanding acceptance, lowering cost of acceptance to merchants and creating new approaches to incremental sales for merchants. Banks are harnessing existing network effects to create reach and value for end users by embracing digital and mobile technology to provide improved and ubiquitous connectivity to payers and payees. This includes connecting the dots and providing interoperability between traditional payment networks and emerging mobile networks using stored value accounts and mobile technology.
channels cheaply and quickly but let them have a short shelf life. Throw them away. That way banks can play a role in digital money without a hefty price tag.
Banks are 100 per cent relevant for the future of money. I see non-banks wanting to cherry pick across the payments chain and across certain payment types and communities. But I don’t see non-banks wanting to take on the whole process. I also don’t see regulators, even more so in the present climate, encouraging them to do so unless in essence the non-bank is subject to the same rules, in which case it is a bank in all but name.

Cindy Murray, head of global treasury product infrastructure, platforms and ecommerce, Bank of America Merrill Lynch
The banking sector is well aware that the monopoly paper currency once had is slowly in decline and the future of the industry lies in digital money. Both consumers and corporate clients are now beginning to recognise digital money as a necessity and banks are at the forefront of innovation and development, working to meet the needs of their clients.
There is an increasing demand that banks begin to provide electronic wallet solutions, which contain prepaid dollars, debit cards and credit cards, accessed by a mobile device and swiped at the point of sale. While some have argued that the carriers can provide this service, consumers can derive confidence from a model executed and owned by the banks, where their money already resides, and there is presumably a level of trust, especially regarding confidentiality.
In fact, banks have already begun to respond to these calls, with Bank of America, JP Morgan Chase and Wells Fargo teaming up to launch a service called clearXchange, the first bank-owned solution of its kind. The venture will enable their customers to move money more conveniently and securely using a single mobile number or email address. This peer to peer access offers greater freedom and flexibility to customers, while retaining security.
Alongside the development of peer to peer technology, banks have also made large strides forward in providing comprehensive mobile solutions to accommodate clients’ evolving banking needs. There is awareness that the direct transfer of desktop solutions to mobile is not what is required as banking clients are demanding greater accessibility and immediacy. Ease of access, specifically for corporate clients, is critical in initiating account transfers or predefined payments.
With the changing way in which clients are accessing their accounts and making transactions, banks have developed tailor-made, fast and easy to use systems for mobiles and handheld tablets. What will be critical to future success is ensuring that consumers are constantly provided with alternatives in the way they use their bank to fulfil their transactions, particularly as the use of mobile technology continues to evolve and become more ubiquitous.

Richard Dallas, director, transaction banking, Lloyds Banking Group
Banks’ role in the future of digital money will certainly not diminish; this perspective is driven by what we are seeing from the requirements of both the consumer and corporate banking sides of our business. New levels of regulation and evolving aspects of cash and payments means there are relatively few non-traditional banks that can compete effectively in this area.
Critical to banks maintaining their position in this area will be their ability to invest in innovation in order to provide the diversity and choice that customers are increasingly demanding. Due to the way technology is evolving, not only will products and services need to change with the times, but banks will also need to work to anticipate the way their customers interact with the technology they use to access their banking services.
However, the flip side of this is the huge growth such demand creates. In order to answer this market need, we will more frequently see banks working in partnership with each other in the future to deliver the types of services customers now want and crucially, in the way the customer wants to access them.
Consumers’ use of these products is changing and there is far greater overlap and fusion in the way products and services are being accessed and used. Traditional customer services are disappearing at a fast rate to move with the new, technological capabilities and although we are evolving towards a more cashless society, cash will still have a place, albeit reduced to a much smaller role in the future.
Consequently, the plethora of channels being used to initiate payments and manage cash continues to diversify, driven by the adoption of new technologies. Mobile technology, integrated telephony technology, card technology, including both physical and virtual cards and the types of transactions being executed are all coming together to change the payments landscape.

Jiten Arora, global head of sales, transaction banking, Standard Chartered Bank
Banks definitely have a role to play in the future of money. The question is whether they will play a primary (and therefore profitable) role or a passive, subsidiary role. There are any number of different players, such as mobile network operators, handset and infrastructure providers, Google, payment network providers as well as completely new entrants to name a few, that are all innovating in the mobile payments landscape.
The ultimate role that banks play will largely depend on how quickly they react and their ability to create additional value for their clients. We think there are two keys to providing value. One is to focus on ensuring interoperability between the virtual and real money world. Another is to put corporate customers and their information needs at the centre of development and innovation efforts.
Mobile money offers the promise of more convenient payment and collection services. Moreover, digitisation will make reconciliation much easier, unlocking value in the financial supply chain. By integrating information across mobile ecosystems with real-money flows, banks can offer forward visibility and accelerate the receivables process, unlocking working capital.
As digital money becomes more prominently utilised, banks also have a critical role to play in developing capabilities to support anti-laundering and compliance. While a challenge, this presents tremendous opportunities for innovation and as a result, increased client confidence.
In conclusion, without getting into details of technology, the key success factors in digital money are high capacity, real-time processing and extremely low unit costs. We need to think about the payment space as if we were starting afresh.

With some of the world’s best-known banks having effectively gone bust and whole national economies teetering on the brink of collapse, you might think that the circumstances, not to mention the public mood, were ripe for a change in how economics works: is it not time to return to a barter economy? Should we not be looking at how to run financial services, certainly the peer to peer (P2P) ones, in new and innovative ways? Should businesses be looking at how to move money about without having to involve the accepted global financial set up?
Well, in theory, these questions are being answered and change is happening, whether fuelled by necessity, anti-capitalist thinking or just because technology has made it possible. The banking and financial services world is starting to take note, pondering what the future of money actually is.
But first, let’s be clear: money is here to stay, even the paper folding stuff. In fact, even cheques are here to stay, but that’s another story. Until we really do come up with something better, then we will always need money. What the future of money holds is in what people perceive to be of value and how it can be moved around.
The paper money that floats between consumers’ pockets and digital money that sculls between banks and institutions is all really just a notion. Paper money is, as all Sibos delegates know, just a promissory note. So the question really is what is the money of the future going to look like and is there scope for alternative kinds of ‘money’: things of value that also can be traded?
“A lot is being made of ‘virtual currencies’ – digitised value that you can use in virtual worlds,” says Heather Schlegel, innovation leader and a member of the innovation team at Swift. “These cover everything from virtual currencies, to loyalty points, to things such as Bitcoin or Facebook credits that have value encoded in them. But they can also cover things such as reputation, referrals, barter and even kindness.”
These alternative ways of moving value between people don’t as such offer a view of the future of money, more a picture of an alternative value system where consumers in particular, although it could just about apply to some aspects of the corporate world, seek to move value between each other.
Mobile technology is also offering a vision of an alternative way of dealing with money. Mobile wallets, PayPal and even mobile billing are starting to make consumers look again at how they pay for goods, says Schlagel. “The value of many items be they bank balances, mobile credits or even loyalty points are being stored on people’s phones now,” she says. “In the consumer’s mind the journey to this all being one area of value has started.”
In Kenya, for example, the M-Pesa mobile payment system has not only led to millions of the unbanked being able to move money around internationally, but has also created an alternative monetary system where M-Pesa credit is traded rather than cash.
“There is also the self-regulating world of barter and kindness,” says Schlagel, “which about 60 per cent of people are involved in at some time or other and which goes completely untracked anywhere.”
These are social communities, she says, swapping the use of shared garden tools, for instance, or trading part of a harvest of one vegetable they have grown in abundance for the excess of other vegetables from other growers. They do it all the time and essentially are swapping value outside of the financial system to mutual benefit. And these communities are on the increase.
So where do the banks fit in? Well, as John Chaplin, a member of the Payment Markets Expert Group that advises the European Commission and president of Ixaris, an electronic payments system developer, explains: “The problem is that most of these things, perhaps excluding kindness, need to interface with the real money world and be turned into cash at some point to realise their value. And that means banks.”
In fact, it means Bank 2.0; what, in some quarters, is seen as a view of the future role not of money per se, but of banks and how the money system works.
“If banks can hold our money, why can’t they handle our vouchers, credits, loyalty points, air miles and more?” asks Adam Kennedy, product director (transaction services), at UK-based payments processor VocaLink. “And if I have all this in the bank, why can’t I use it all alongside cash? Our research of 10,000 people worldwide, published here at Sibos in Toronto, shows that consumers love this idea and want it. In fact many now expect it.”
VocaLink is very much of the view that where anything like this moves between consumers and merchants and banks there is a need for robust clearing and settlement and the best way to do that is using the existing ‘banking’ world. “Banks may not be the trusted brands they once were,” he says, “but they are still more trusted with this than anyone else.”
Swift’s head of innovation, Kosta Peric, goes a step further: “We are moving from an economy of money to an economy where data is wealth and banks have a massive opportunity to take the expertise they have in handling money to becoming secure handlers of data.”
But not everyone agrees. “I don’t think that [the future of money] will be bank-centric,” says Chaplin. “Banks will always be there to handle the boring transactions such as account to vendor which is low cost and I can’t see anyone else wanting to do these transactions. But when it comes to trusting things like your loyalty points to a bank I just don’t see people wanting to do it. Where there are new opportunities you will see new brands entering the space and they will battle with, rather than embrace the banks.”
Chaplin believe banks have a very low standing among consumers. Google, PayPal, Apple and even mobile network operators are more trusted than banks and, more importantly, “don’t come at it like financial service organisations”, he says. “PayPal and the like just don’t think like banks, while new entrants, unlike banks, have nothing to lose so will try new approaches.”
Chaplin believes that the only way banks will make any headway here is to partner with these newbies; a collaborative approach also being pushed by Swift. “Doing this is like building a highway,” says Peric. “No one player can build a big road between cities; it has to be collaborative. Banks bring solid, secure systems, companies such as Western Union can bring a physical presence, and someone like a mobile network operator can bring reach. New entrants can also add new ideas.”
The problem, though, is how willing the banks are to collaborate. “In the past,” says Peric, “the banks have often needed to work together and haven’t and the industry has been held back. This is a massive opportunity and one that banks really have to take. Swift as a shared utility can help this happen.”
Martin Wilson, chief executive of mobile payments solution developer Luup, thinks the banks really have to get to grips with this or lose: “It would be interesting to see how Facebook, Google and Apple can crack the payments conundrum. They have the profile and the money to steal the retail payments market from under the noses of the banks. PayPal made some waves, but its payments are drawn on banks, imagine what could happen if Facebook got the proposition right and by-passed the banks: people would flock to it as they trust the brand. That could be the future of money.” DNS

Safe and secure?
While many people are quick to write off banks in the brave new world of virtual currencies and new ways of paying, there is one area where they excel and are likely to deliver a killer blow in the new world order of money: security.
Whatever virtual currency, loyalty points or other items are being ‘traded’ between people, at some point, they are going to have to come out of the system as money that we all recognise. Doing this between Facebook credits, or Bitcoin, loyalty points or air miles creates a significant new money laundering and fraud risk.
At a very basic level, today’s mistakes in Facebook credits do nothing more harmful than give the user a few extra goes on Farmville for free, but in the real world and if this sort of ‘currency’ were extended, the risks from simple errors to consumers, merchants, payment providers and banks becomes huge. Add in the fact that they open the door to a whole new world of fraud and such systems start to look shaky.
“In the real world no one feels that they have enough control over virtual money to real money transactions to make it viable,” says John Chaplin, president of Ixaris. “And you can’t currently link virtual credit to the real world money system as you need to work out how to apply all the know your customer rules. We have all this worked out already in the real money world, so why would we go through doing it all again?”
This, believes Heather Schlegel, innovation leader and a member of the innovation team at Swift, is the real opportunity for banks in the new money world. “Many people think that this new way of moving money and value around is trying to replace the existing system: it isn’t, it is looking to extend it and banks need to embrace it. One way to do that is to bring all the security and efficiency in the banking system to bear on these new services that people want.”

Goran Fors, global head of custody, SEB Merchant Banking
Exchanges have been consolidating for quite some time. A good example of this was the consolidation of the exchanges in the Nordic/Baltic region that was created by OMX. This resulted in a more efficient market where participants could access several markets in a similar way, as the same trading system was used. The harmonisation of trading rules was also very positive for the development of the markets and did, in many aspects, reduce risk.
The effect over time of this was an increasing number of participants on the exchanges. The system of remote members on the exchange that was established in Sweden in 1993 was very successfully established in the other markets as well during the following 15 years. After the successful development, with continuously increasing volumes, OMX merged with Nasdaq, which now forms the NasdaqOMX group.
A consolidation of exchanges does not necessarily mean that we increase systemic risk. There is a possible risk as an exchange covers a large number of asset classes as well as markets, but at the same time, as we have had a consolidation of traditional exchanges we have also seen a tremendous increase of other marketplaces and especially multilateral trading facilities (MTFs). Trading volumes have shifted a great deal during the past few years and Chi-X is now among the largest equity exchanges in Europe. The consolidation has been met by fragmentation and I would say that the systemic risk in the area of exchanges is less today than it was in the past. The changing exchange landscape at the same time introduces challenges for the post-trade environment. The consolidation of exchanges has not been followed by the same consolidation in the infrastructure and the increasing number of MTFs has not been accompanied by new infrastructure as well. For the future I believe it is important that the post-trade infrastructure is organised in a way that can support an exchange environment that will continue to develop.

Kelly Mathieson, global custody and clearing business executive, JP Morgan
Exchange consolidation certainly has its benefits, as centralisation has resulted in heightened transparency, improved reporting and governance standards, lower transaction costs and additional resources for technological investment and enhancement. It also allows for the creation of more financially sound and stable organisations. However, there are two schools of thought when it comes to the impact exchange consolidation will have on systemic risk. While some might argue that larger exchanges will create even more risk, there is also a false comfort in today’s marketplace which assumes that by centralising the risk, we have mitigated it. That theory is simply not true. While centralisation can be beneficial, it is not without risk. By creating a larger exchange, the risk has shifted from a bilateral exchange to a consolidated consortium, therefore mutualising it. As a result, the member organisations of the larger exchange face potentially lower qualities of risk standards, bringing the strength of the consortium down to the lowest common denominator of the entity. In order to avoid increased systemic risk, it is equally important to consider the associated regulatory issues that come with centralisation of securities. For example, centralised exchanges must adhere to the correct regulatory rules depending upon the scope of services they offer. If the exchanges branch out to provide more traditional and ancillary banking activities such as collateral management or securities lending, the same regulation, capital rules and compliance standards that apply to the transaction banks and post-trade infrastructures must govern those entities as well. Whether or not exchange consolidation creates more systemic risk, the debate raises a larger question about the interconnectedness of the larger regulatory issues involved. In order to better understand the shifting landscape resulting from this consolidation, we must look at relevant regulation from a diversified asset class perspective, as opposed to the traditional intra-asset class risk management practices, which have failed us in the past.

Alex Walker, senior vice-president, post-trade securities, SunGard capital markets
The wave of exchange consolidations has certainly brought benefits to the market, including the ability to access multiple markets through a single infrastructure. However, it could be argued that it is also increasing systemic risk, as the merged exchanges restrict clearing to their own central counterparty (CCP).
CCPs are designed to manage risk for the financial community by requesting margin from the participants, monitoring the value of their collateral and ensuring that they match a buyer for every seller, etc. As a firm interacts with a different CCP for each market, the CCP manages well its own exposures but not the global picture.
To better control systemic risk, CCPs need to be integrated across trading venues so that activity and collateral can be tracked horizontally. Such an integration has the additional benefit of increasing competition among CCPs and keeping costs down. It also means that new trading participants have fewer CCPs to deal with if they want to seek growth in new trading venues.
Another aspect of the shifting landscape is that the market is moving towards greater transparency from the front to middle to back office. Exchanges, CCPs, general clearing members and central securities depositories can provide real-time information on net positions, valuations of collateral, margin calls, settlement costs etc. Firms need to replicate, capture and distribute this data with the interaction from the buy side to the sell side. And by considering this information alongside a holistic view of their own enterprise-wide risk, exposure and activity, firms will be able to make the most informed trading and risk management decisions.

Rob Hegarty, managing director, global head of market structure, enterprise, Thomson Reuters
It isn’t a foregone conclusion that exchange consolidation will continue, certainly not at its current pace. As we’ve seen from several proposed deals that have failed to complete: LSE and TMX, SGX and ASX, and Nasdaq and ICE’s bid for NYSE Euronext, there are many obstacles that stand in the way when a national stock exchange plans to merge, or be acquired by another.
That said, the emergence of international super exchange groups is a new phenomenon and may actually increase systemic risk on a couple of levels.
First is the operational risk from consolidating multiple markets on to a common technology platform, which magnifies the impact of systems failures. Although that risk can be mitigated with fully redundant architectures, failover and disaster recovery capabilities, systems are hardly ever foolproof, even with these measures in place.
Beyond the operational risk of technology failures lies a more serious systemic risk arising from exchange groups operating their own vertically integrated CCP clearing operations. The attraction of the mega exchange is in its scale; the bigger the exchange, the more cost per unit can be reduced. But most of these mergers are being planned across countries and asset classes including derivatives, where the vertical exchange and clearing model is more prevalent. This could inexorably link our trading venues with their clearing counterparts, increasing systemic risk across the global financial markets.
Whereas pure transaction execution business does not involve assuming liabilities, the CCP business means taking on the counterparty risk for transactions, not only those executed on-exchange but also for a growing raft of OTC trades that are set to be cleared centrally.
In theory, risk models to calculate margin requirements should be sufficient to mitigate the impact of counterparty defaults. But if CCPs compete for business by lowering margin requirements, that theory can be undone very quickly.
The risk that a CCP incurs sufficient losses to “bring down the exchange” could also be heightened by the increasing financial leverage used to push through exchange mergers, which leaves balance sheets more exposed and reduces capital buffers.
So even though it’s no certainty that exchange consolidation continues, if it does, and large international exchange groups operate vertically integrated CCP models, there will be a build up of systemic risk that needs to be considered.

Thomas Zeeb, chief executive, SIX Securities Services
Exchange consolidation has accelerated an industry shake-up with market leaders predicting that there will be three or four international exchange groups with global distribution capabilities in trading and post-trading in as little as five years.
For this to become a reality, such consolidation manoeuvres have to work, meaning they have to be able to deliver real shareholder value without creating a monopolistic advantage. Historically, very few have been able to achieve this and regulators appear somewhat loathe to allow carte blanche when it comes to such moves, at least without a series of concessions to safeguard competition and freedom of choice.

The propositions are not intended to be a comprehensive set of rules for deciding how regulators should intervene in the governance of market infrastructure institutions; nor are they intended to specify how any particular jurisdiction should regulate the governance of market infrastructure institutions; nor indeed is any single proposition intended to be definitive. Taken together, however, the propositions provide a useful and compact aid for choosing what regulatory intervention in the governance of market infrastructure institutions, if any, is optimal in any jurisdiction.

Proposition 1
A four-stage analysis is required in order to answer how best to regulate the governance of a market infrastructure institution:
 Identify the functions undertaken by the institution;
 Specify the goals of regulation;
 Evaluate whether the institution has an incentive to deliver the specified regulatory objectives for each of the functions it undertakes; and, if not,
 Assess which, if any, types of regulatory intervention in the institution’s governance will best further the specified regulatory objectives for each function the institution undertakes.
Many factors may complicate this analysis. A market infrastructure institution may provide any combination of the three core market services – trading, clearing, and settlement. The provision of each service has different risks, affects the delivery of the desired regulatory objectives in different ways and may thus require different forms of regulatory intervention. Some market infrastructure institutions, primarily exchanges, may also undertake regulatory functions in addition to providing market services. Such self-regulatory organisations (SROs) are likely to require particular forms of regulatory intervention.

Proposition 2
If a market infrastructure institution is also a SRO, greater regulatory intervention in its governance is likely to be needed in response to the conflicts of interest it faces.

Proposition 3
The choice of what regulatory measures to adopt to respond to conflicts of interest at an SRO depends on whether it is seen best to eliminate such conflicts or to manage them.
Regulators typically seek to deliver the three core Iosco objectives. Some regulators, however, follow other goals, in addition to, or that replace, these core objectives. The most important of these is the promotion of what is believed to be in the national interest. The existence of multiple regulatory objectives is likely to lead to trade-offs in their simultaneous delivery.

Proposition 4
Of all the Iosco objectives, it is hardest for regulatory intervention in a market infrastructure institution’s governance to promote efficiency.
There are two reasons for this. First, any regulatory intervention in the governance of a market infrastructure institution is likely to give rise to direct costs and may also indirectly reduce the incentives that the institution has to promote efficiency. Second, regulators may sometimes face incentives to promote the other Iosco objectives, and particularly investor protection and the reduction of systemic risk, at the expense of efficiency.
The main forms of regulation of a market infrastructure institution’s governance are interventions in the institution’s ownership, mandate, board structure, management, and other corporate governance processes.
Each of these different forms of regulatory intervention may give rise to different costs and benefits.

Proposition 5
A requirement for a market infrastructure institution to appoint independent directors, public directors, or accept directors appointed by a regulator, may further the Iosco objectives in two main ways:
 Such directors may promote investor protection, fairness, transparency and systemic risk reduction, more than industry-appointed or profit-maximising directors, although these latter types of directors may also promote the desired regulatory objectives appropriately; and
 Such directors may mitigate the conflicts of interests that are an inescapable consequence of self-regulation, again promoting both investor protection and fairness.

Proposition 6
The mandatory appointment of independent directors, public directors, or directors selected by a regulator, may, however, lead to several problems:
 If they are required specifically to advance the Iosco objectives, this is likely to conflict with the requirement that all directors act in the best interests of the institution on whose board they sit, subject to relevant corporate and securities law;
 If they are required specifically to advance the Iosco objectives, this is likely to conflict with the role typically placed on independent directors, namely to ensure management acts in the best interests of all shareholders;
 Such directors may have insufficient incentive to promote efficiency; and
 In many jurisdictions there are few people who are both knowledgeable about the securities markets and also independent in an appropriate way.

Proposition 7
There is no evidence that any one of the main governance models a market infrastructure institution may adopt best delivers investor protection.

Proposition 8
There is no evidence that any one of the main governance models a market infrastructure institution, and particularly a CCP, may adopt best reduces systemic risk.

Proposition 9
Mandatory fair representation on the board of a market infrastructure institution may promote fairness, but may also entrench incumbent interests, reducing efficiency.

Proposition 10
While demutualisation has been associated with enhanced efficiency at some market infrastructure institutions, there is no evidence that mandatory demutualisation will enhance the efficiency of such institutions.

Proposition 11
Mandatory user or stakeholder representation on the board of a monopolistic market infrastructure institution may restrict it from acting anticompetitively, but may entrench incumbent interests, reducing efficiency.

Proposition 12
Mandatory ownership constraints may prevent a single firm from exercising undue influence over a market institution that is also a SRO, but may reduce efficiency.

Proposition 13
Mandatory transparency at a SRO plays a vital role in its delivery of investor protection, but may reduce efficiency.

Proposition 14
Transparency of a CCP’s risk management policies and procedures is likely to provide both it and its market participants an incentive to protect against systemic risk, but this transparency may be delivered by a CCP without a regulatory requirement to do so.
Some jurisdictions and regulators have recommended that market infrastructure institutions follow the same codes of conduct that have been promoted for the corporate sector in their country, and that are also often required of listed companies. In the UK, for example, the Financial Services Authority has encouraged market infrastructure institutions to consider and apply as appropriate the principles set out in the UK’s Combined Code on Corporate Governance for public companies, although the FSA does accept that this may not always be appropriate. Given that the primary goal of these codes is to promote shareholder interests, however, there is no reason to expect that their imposition on market infrastructure institutions would enhance the delivery of the three core Iosco objectives. As the Bond Market Association argues, “SROs [and market infrastructure institutions] should be held to a governance standard that is tailored to reflect [their] . . . unique role, not a standard that is a cookie-cutter application of the listing standards to a new and different context.”

Proposition 15
A requirement for a market infrastructure institution to follow a national code of corporate governance is unlikely to mean the institution delivers the core Iosco regulatory objectives, whether or not it is a SRO.
Regulatory interest and intervention in the governance of market infrastructure institutions has grown to a high level for three main reasons:
 The governance of a market infrastructure institution is seen as critical in determining whether the incentives it faces enhance the core Iosco regulatory objectives;
 The private interests of a market infrastructure institution are often believed insufficient to deliver the public interest, and sometimes even thought directly opposed to it; and
regulatory intervention in the governance of market infrastructure institutions is believed more beneficial than direct intervention in their specific decisions. There are, however, many reasons why regulation of market infrastructure institutions’ governance may not achieve its intended effects.

Proposition 16
Expectations about the extent to which regulatory intervention in market infrastructure institutions’ governance will enhance the delivery of the Iosco core objectives should not be too high. DNS

This is an excerpt from Running the World’s Markets by Ruben Lee. Copyright © 2011 by Princeton University Press. Reprinted by permission.

The use of electronic trade confirmation (ETC) for equities is slowly increasing. Both Omgeo and Swift report rising numbers of electronically confirmed transactions, albeit with small pockets of manual processing among smaller buy-side firms and the US lagging Asia and Europe in adoption. Yet, with the European Union debating a move to T+2 settlement to coincide with the launch of the Target2 Securities (T2S) settlement platform in 2014, there is still much work to be done if ETC is to be a precursor to T+2.
Jitu Parmar, head of broker dealers, treasury and derivatives, UK and Ireland at Swift, says there has been renewed interest in using Swift messaging among asset managers during the past 24 months. “We have been working very hard with buy-side firms to explain that the broker dealers have the ability to send confirmations [MT515 messages] in the global cross-border market. US Rule 10B – 10 confirmations are also available.” Rule 10B – 10 is a Securities and Exchange Commission rule that sets disclosure requirements for confirmations sent by broker dealers to clients.
Since last year’s Sibos, Swift has been matching between brokers on the Accord platform and brokers are ready to extend this by using MT515 messages. “As we match at trade level as well as at settlement level once the brokers have matched we can send the matched trade details to the central counterparties [CCPs], so they would receive a match as if it had been traded at an MTF,” says Parmar. Swift is working on this with EuroCCP, SIX Swiss Exchange and LCH.Clearnet.
“At the end of the day it is about getting as many trade allocations from buy-side firms as possible, then on the same channel the brokers would like to confirm, if possible, on the same day. The hard work is in improving the market practice, so there is no ambiguity,” he adds.
But Tony Freeman, director of industry relations at Omgeo, believes that a move to same day affirmation (SDA), the agreement of all trade details on trade date, is needed before the industry can move to shorter settlement cycles. As of June 2011, the SDA rate on Omgeo’s Central Trade Manager (CTM) was around 93 per cent.
For Freeman, SDA is a very simple concept that does not vary much between asset classes and is globally generic. SDA rates differ widely around the world with Asia leading, followed by Europe and the US. The market in the US is used to finalising trades after the markets close so a very large number of allocations are generated by buy-side firms at the end of the day, making SDA harder to achieve. Freeman says: “This makes the move to shorter settlement cycles in the US more challenging than it is in Europe.”
Scott Sandler, chief operating officer at JP Morgan Securities Services agrees, adding that the delivery versus payment model in the US means that electronic confirmations are informational and do not automate the entire settlement flow, so electronic confirmation does not guarantee timely settlement.
Around 30-40 per cent of asset managers are still manually processing splits and allocations, he says, and they are not being confirmed electronically. Therefore, a move to shorter settlement times in the US would simply lead to greater fails. “There is still too much activity that is not electronic. Moving to shorter settlement times would put more risk and stress on the infrastructure. The focus is still to get more counterparties confirming electronically – whichever solution [Omgeo or Swift]. More links in the whole process, triggers for securities lending recall or collateral substitutions for example, are needed along with higher levels of automation – much closer to 100 per cent than the current 70 per cent that we are seeing among broker dealers,” he says.
Getting the whole industry, particularly the smaller fund managers, onboard would involve serious investment. Sandler believes the best approach is to implement translation tools that automate confirmations from a variety of formats, thus increasing STP rates to all involved parties. The issue of pricing and who should pay for each part of the investment, based on the value derived also must be looked at.
Jason Waight, chief operating officer at Xtrakter, a subsidiary of Euroclear that provides capital markets data, operational risk management, trade matching and regulatory reporting services, believes SDA is a pre-requisite for a move from T+3 to T+2. ETC in all markets remains a challenging long-term goal, he says. “Large volumes of trades remain untouched by ETC mechanisms. Thus, the clock is ticking for middle and back offices to build or buy services that confirm and allocate trades on the same day that trades are executed. It is the only way T+2 will become a reality.”
But is ETC a pre-requisite for shorter settlement cycles? Neil Vernon, development director at financial solutions provider, Gresham Computing, thinks not. “Common sense would say this is the case, but it certainly was not a requirement for Canada to achieve T+1. The regulator did not mandate ETC and then T+1, it simply mandated T+1. The Canadian market is very like the US market in that there is not a high level of ETC but it still achieved very high settlement rates on T+1.”
The bigger issue, he says, is that many of the organisations that need to achieve shorter settlement times are highly siloed, both across product lines and functions, with poor communication channels and lack of visibility.
Attempting to move to T+2 without achieving ETC first would be changing the model and the industry is too far down this route to change now, says Swift’s Parmar. “Broker dealers are trying to work with the model that exists and make it more efficient. They do not want too many models because as a consequence that means an application change as well.”
Meanwhile, work is ongoing to improve ETC rates in other asset classes. Fixed income continues to lag behind equities and there are still quite large segments of the market that are not yet automated. Freeman says: “Fixed income is more of a challenge because of the diversity of asset classes within it, some of which are more difficult to automate. It is not just the workflow; it is reaching the individual desk within the trading firms.”
Omgeo is working on adding a third asset class, exchange-traded derivatives, to CTM. It is also looking at improving settlement instructions. Alert, Omgeo’s settlement instructions database, has gone through several upgrades to make the data much more accurate as a vital part of achieving SDA.
One of the problems Gresham’s Vernon believes the industry may face in the future is having too many confirmation venues, not just in equities but in the OTC market. Firms will be faced with the challenge of connecting to and having visibility across many venues, just as cash managers struggle to find a real-time cash position across multiple nostros accounts. “As everyone jumps on to the ETC and central matching bandwagon, we can get to the point that there are so many of these siloed central matching utilities that organisations will not have the visibility that they need.”

Several years ago, corporates were allowed to join Swift through closed user groups, but getting a critical mass on the network has been a long, slow process. Large companies, especially multinationals, took advantage of secure standards-based messaging and consolidated transaction reporting, and over time Swift developed a suite of products for that customer segment. Now the multinationals are bringing their emerging market subsidiaries into the network. Moreover, an increasing number of multinationals based in Brazil, Russia, India and China (Bric countries) are gravitating towards SAP or Oracle ERP packages with XML messaging over Swift.
Swift’s target for 2011 is to add 50 new corporate registrations from the Americas, 230 from Europe, Middle East and Africa, and 20 from Asia Pacific. As of the end of June, it had added 20, 119 and six from each region respectively.
Western Europe is Swift’s traditional home ground, so not surprisingly about 72 per cent of the corporate volume is from European entry points. Only 12 per cent comes from emerging markets, mainly in Asia Pacific with a small percentage from the Middle East and Latin America.
“It’s quite low in absolute terms but it’s growing very quickly,” says Marcus Treacher, head of ecommerce at HSBC global transaction banking and chair of Swift’s corporate advisory group. “The percentage should shift in time to favour the emerging market participants.”
In emerging economies, Swift’s strategy is to ‘go local’ by becoming part of the domestic fabric. Through joint ventures and partnerships, the organisation is collaborating with regulators, central banks, market infrastructures and participants to create a solution to benefit the local community. For instance, Swift is working with the Reserve Bank of India to build a next generation real time gross settlement system, of which Swift messaging will be one of the pillars. In the past year and a half, Swift has added 11 market infrastructures in Latin America.
Eileen Dignen, Swift’s head of banking initiatives, Americas, says solving problems for the market infrastructures helps the entire community, including corporates that are paying transaction fees.
“We then help onboard the banks to that so it doesn’t become quite a difficult project,” she says. “Therefore, the corporates working with their banks have a much easier transition.”
Clearly, corporates can reap several benefits from being on the Swift network – the primary one being the reliability of the messaging exchange. Corporates want to manage their finances tightly and accurately, and they depend on the messaging between their organisation and the banks. Second, standardisation makes it easier for them to get data from their banks in the specific format in which they need it so they can reconcile it with their ERP systems. By simplifying the communication channels and achieving straight through processing with their financial partners, companies can save time and money by avoiding corrections, adjustments and amendments. In addition, corporates can collaborate with their banks on supply chain initiatives.
Despite the benefits, there are some challenges when it comes to expanding corporate membership in developed and emerging markets alike. Traditionally, Swift is a high volume, high end network for banks. With recent reductions in transaction costs, large corporations also can justify their participation. However, small and medium-sized companies that deal with fewer countries, trading partners and banks find it more difficult to create a business case for joining Swift. Admittedly, Swift has created lower cost propositions such as SwiftNet Lite and service bureaus provide an obstruction layer between the network and users who want to access Swift but do not want to buy the full package. Still, many corporations can get by with one or two instant banking solutions.
To this end, most banks do not push their customers to adopt Swift. From their perspective, their role is to educate their customers about the various alternatives for connecting to the bank and advise them about which route to take.
“We’re agnostic, so the view we take is if a corporate wants to bank with us direct, that’s fine. If they’re using Swift, that’s fine. If they’re using a direct SAP connection, that’s fine,” says Treacher. “Depending on our corporate customer’s set up, we’re going to advise them as to what makes sense for them.”
Companies need to decide whether using SwiftNet can be justified based on their payment volumes and the system enhancements they will need to make. Not all companies need to use a robust ERP system, nor do they all need to adopt Swift. Some may be able to achieve efficiencies by simply interfacing with a regional or local bank. As a company’s payment volumes increase and their needs become more complex, then it may be the right time to adopt the sophisticated offerings of Swift.
In emerging markets, corporates face some specific challenges. One of the barriers to adoption is that the local banks often are not on Swift themselves, or if they are, they do not have corporate initiatives. The large global banks such as Banco Santander in Latin America, Standard Chartered in Asia and Citi globally along with some regional banks are driving the education and on-boarding processes.
“It’s not necessarily the local bank in Ecuador or in Malaysia that will be offering this to a corporate,” notes Marcus Hughes, director of business development at Bottomline. “They’re not really ready yet, I’m sorry to say.”
In addition, some large companies have used consultants to help with their Swift integration with the banks, but the projects have not always been successful.
“A couple of Colombian clients were integrating Swift, and in the middle of implementation, the company they had been working with pulled out,” says Juan Pablo Cuevas, managing director, and corporate sales executive for Latin America at Bank of America Merrill Lynch. “They turned to us for help, and we have been consulting with them ever since to enhance the communication mechanism.”
For the best result, he recommends companies either work directly with banks, or make sure their consultants are partnering with a bank. As Swift members themselves, banks will offer companies a full appreciation of how to realise the functionality offered by the network.
Another drawback is that the infrastructure and integration with the ERP systems is still not plug and play. Kurt Vandebroek, vice-president, product development at SunGard, says the implementation time has been reduced from around 50 days to ten. But to build a critical mass of corporate users, implementation needs to be done in one day. That can be accomplished only if the ERP product and connectivity are integrated. Currently, too many parties – the ERP treasury applications, middleware players, service bureaus, Swift and the banks – have to be coordinated.
For example, SAP can be installed on a company’s premises or obtained through a hosting vendor. The product contains the Swift protocol, but not a managed Swift connectivity service. If a company wants to connect, it either has to buy and implement a gateway from Swift, which is costly, or go to a service bureau that manages that connectivity for them.
“If we can roll out those services in emerging markets at a reasonable cost, then there will be adoption,” says Vandebroek. “But it will not be driven by Swift as such; it will be driven by Swift inside of services applications.”
It is only fair to give credit where credit is due: Swift’s corporate membership is increasing. It is difficult at this stage, however, to say whether the organisation will meet its targets for 2011. Further, corporate members in the emerging markets will likely remain a small minority for the foreseeable future.

It was inevitable that in the wake of the 2008 financial crisis, a wave of new, tougher regulations would wash over the financial markets. Attempts to make the markets safer, more resilient and more transparent, and above all to avoid a repeat of 2008 have been driven by the highest levels of government as politicians want to demonstrate that they are taking action.
While financial institutions publicly admit that they have little choice in complying with financial regulation, there is still a great deal of lobbying about the minutiae of specific regulations and disagreement about the impact regulations will have on their business and on their corporate and consumer clients.
A recent row in the UK over the possible findings of the Independent Commission on Banking (ICB) highlights the tensions that exist between politicians and financial institutions. Set up in June 2010, the ICB has been charged with recommending structural and non-structural reforms to the UK banking sector to promote financial stability and competition. In an interim report, the ICB suggested banks should ring-fence their investment arms from their retail units. In the weeks leading up to the ICB’s final report published on 12 September, lobby groups were voicing their concerns about the possible reforms.
For example, Angela Knight, chief executive of financial industry lobby group British Bankers’ Association, said the UK’s efforts should be focused on economic recovery. “This means allowing banks to finance the recovery first, pay back the tax payer next and only then turn to regulatory change. If more regulation remains at the top of the list then this will only have the effect of risking the recovery which is so essential to our future.”
At the same time, John Cridland, director general of business lobby group the Confederation of British Industry, told the Financial Times that the UK government would be “barking mad” if it ring-fenced British banks’ retail arms from other operations such as investment banking. Employing the same argument as Knight, he said given the fragile state of the UK economy, any changes to banking regulation could weaken the ability of banks to provide the finance that businesses needed in order to grow.
However the UK’s Business Secretary, Vince Cable, countered criticisms with a warning to banks that it was “disingenuous in the extreme” to suggest reforms to the sector would damage Britain’s economic recovery. He told The Times that banks were trying to create “panic” in arguing against reforms. “The governor of the Bank of England and many other people have been arguing that we have to deal with the too big to fail problem. We can’t have big global banks with balance sheets bigger than British GDP underwritten by the taxpayer; this can’t go on and it has got to be dealt with.”
Cable added the concerns over the euro zone and poor growth were an impetus for reform and “all the more reason for grappling with this issue”.
The final report recommended a strong, but ‘flexible’ ring-fence. Only ring-fenced banks would supply the core domestic retail banking services of deposit taking and overdraft provision; such banks would not be able to undertake trading or markets business or do derivatives, supply services to overseas customers or services that result in exposures to financial companies.
Depending on who you believe, the recommendations are either too severe or not severe enough. What did surprise some observers was the generous time line; UK banks have until 2019 to implement the reforms, which is perhaps long enough for the main players to have retired.
At the BBA annual conference in London in June, Hector Sants, chief executive of the UK’s Financial Services Authority, stated that “root and branch” change was needed at both regulators and banks. “This root and branch change must affect both the behaviours and the processes of banks and regulators. Unless we all change all aspects of what we do, real change will not be achieved.”
The financial crisis demonstrated that significant change was needed in relation to prudential issues, he said, but he also pointed up that significant change had to occur in relation to conduct issues. “In the past couple of decades, at least £15 billion of redress has been paid out to consumers in response to the conduct failures of firms and if we include PPI [payment protection insurance] this number is likely to exceed £20 billion.” This was an unacceptable cost to both consumers and to bank shareholders and demonstrated why trust had been lost between the users of the financial services marketplace and the firms operating within it.
The UK is not alone in witnessing such disagreement regarding regulation. In the US, the Dodd Frank Wall Street Reform and Consumer Protection Act has attracted a fair share of controversy since it was signed into law in July last year. Investor George Soros said the bill would impose new regulations on a system before banks had recovered sufficiently to cope. JP Morgan chief executive Jamie Dimon criticised some of the rules within Dodd Frank during a meeting of the Council of Institutional Investors at Washington during April. He cited provisions about the regulation of derivatives, interchange fees for debit cards and the separation of derivative trading desks from capitalised divisions of banks as elements that could harm US economic competitiveness.
Deputy Treasury Secretary Neal Wolin defended the Act, acknowledging there would be critics, but adding: “those who are charged with implementing reform have not forgotten why we needed reform. We needed reform because ultimately, a fragile system benefits no one. We needed reform because we can’t afford another crisis.”
Mark Gem, member of the executive board and head of network management at international central securities depository Clearstream, questions whether there is tension between regulators and the financial industry. “There are interesting examples of regulators or public authorities working with the private sector to solve industry issues. These include the euro settlement platform Target2 Securities, the Depository Trust and Clearing Corp’s depository for OTC credit derivatives and LuxCSD, the new central securities depository for Luxembourg, which is a joint venture between us and the central bank, Banque Centrale du Luxembourg.”
He admits there are “friction points” in the regulation agenda, but that agenda is broadly coherent and is aimed at achieving the policies articulated by the G20.
While financial institutions continue to lobby regulators and politicians, they will have little choice in complying with the regulations that are coming their way. In a June 2011 white paper, Facing the unknown: Building a strategy for regulatory compliance in an uncertain landscape, Swift says banks can “take more of your destiny into your own hands by supporting collaborative approaches to developing operational solutions” that will address aspects of regulation.
Presenting operational solutions that work both for the regulators and for the financial industry is a better way of moving forward, says the white paper. Such solutions are also more powerful if presented to regulators in collaboration with other financial institutions. “Undoubtedly there will be areas in which all parties can reach agreements that work for the industry and the authorities, as the larger regulatory brave new world takes shape during the next few years.”
The regulatory environment is fluid, says Matt Tuck, global head of financial institutions at Barclays Corporate.
“We fully understand and recognise that we are in a different space when it comes to regulation. We hope that by working with regulators directly and taking a proactive choice by being on working groups and committees, we can come up with solutions that make sense for everyone.”
Karen Fawcett, group head of transactional banking at Standard Chartered, says in working with regulators financial institutions are beginning to understand the power of acting as an industry, rather than as individual entities. “Far too often in the past, data was presented to regulators by individual banks. In the past few years, however, by presenting data collectively, financial institutions have been able to engage with regulators in a more holistic discussion about the impact certain changes could have on the economy. An example of this is the sharing of ICC data on trade finance.”
The ideal environment, says Tuck, is one that delivers control and oversight for regulators, but allows businesses to operate in an environment in which they do not feel over-regulated.
A sense of over-regulation is probably inevitable, given that almost every area of the financial industry is under scrutiny. Based on the G20’s response to the financial crisis, regulators are looking at a broad range of areas, including capital and liquidity standards; international accounting standards; remuneration policies at financial institutions; the role of credit ratings agencies; OTC derivatives trading; and the shadow banking industry.
One of the main concerns for financial institutions that operate globally is the lack of consistency in how these issues are being addressed in different countries. This is possibly because there are two drivers of regulation – to protect the economy and to meet the political aims of the moment. Fawcett says each economy will have its own needs and therefore there always will be nuances, but she believes there is greater alignment among regulators now. “Regulators have individual priorities, but they are seeing the benefits of working together and adopting similar stances on issues such as liquidity rules and capital requirements.”
Understanding the differences in regulation is a significant challenge, says Barclays’ Tuck. “We play across three levels – global, regional and local. Regulators will treat issues differently at these different levels and what you can and can’t do will be dictated by where a counterparty is based,” he says.

Wim Raymaekers, head of banking market, Swift
The traditional correspondent banking model is under siege. Real-time transactions and information flows are increasingly ubiquitous and innovative peer to peer payments solutions are spreading. By contrast, cross-border bank payments can still take several days, and often there is very little visibility on flows in transit.
The correspondent banking business needs a redesign if it is to remain relevant in a changing payments world. And if they want to retain their dominance in the space, then the banks need to lead this change.
To do this, they need information. Every message transmitted and received through a correspondent network does two things. It serves a client and it also provides insight into the business performance of a bank. To spot opportunities to improve and grow, it is essential that banks leverage that insight. They need to tap into sources of business intelligence based on real data about real transaction flows globally.
The internationalisation of the Chinese renminbi (RMB) is a clear opportunity for growth. Today more than 11 per cent of China’s cross-border trade is already settled in RMB. And Swift traffic demonstrates that more than 900 banks in more than 70 countries are already doing business in the RMB.
Banks active in international markets must formulate RMB strategies to develop new business – and to fend off the threat from other banks seeking to do the same. Information showing current flows and where the gaps are is crucial to underpin this activity.
It is also crucial to exploit collaborative, standardised solutions to improve automation of RMB transactions and bring down their cost, to the benefit of banks and customers alike.
Indeed, collaborative approaches will be essential in all aspects of the reinvention of correspondent banking, from ensuring interoperability in the mobile payments space to developing industry-standard approaches for liquidity risk reporting to meet new regulatory demands.
As they embark on the reinvention of correspondent banking, the banks must leverage partners able to quench their thirst for business intelligence, while also facilitating the development of collaborative solutions to common challenges.
Email swiftforbanks@swift.com for a free preview of Swift’s new Business Insights report on the RMB

Marshall Millsap, managing director, JP Morgan treasury and securities services
During the summer and fall of 2008, interbank liquidity tightened and correspondent bank risk came back as a factor. Not so much the insolvency of a correspondent as its access to local liquidity and its presumed ‘tiering’ among other banks in terms of longer term risks. Stronger, better capitalised banks experienced a strong inflow of deposits in the classic search for perceived safety. Spreads on bank credit default swaps have become a weekly touch point for those managing correspondent relationships.
With bank profits from balances generally challenged by lower interest rates, the sustainability of traditional correspondent banking approaches also has been re-examined. Banks aspiring to offer correspondent services need to demonstrate not only capital strength and liquidity, but also continued investment in improving products, sustaining service levels, and paying attention to the top clients.
Two items characterise the more successful providers. Transparency and openness in talking about risk is a differentiator, and all types of risk – from operational resilience to balance sheets. More importantly, the professionalism of the correspondent banker needs to be upgraded. With more banks adopting a separate unit for buying services – that is, network management – the ‘sell’ side needs to rise to the new challenge.
On the upside, successful correspondent banks recognise that this is no longer a sleepy area. As buyers of correspondent services become more selective, there should be a consequent recognition that deeper interbank relationships are at a premium and that means correspondent bankers who succeed at building more solid ties will be rewarded for more than just revenues. Simply talking about reciprocity is no longer enough.

Timothy Merrell, co-head FX4Cash, global transaction banking, Deutsche Bank
When managed correctly, correspondent banking can evolve into a strategically critical means of adding tangible banking capabilities for local, regional and global banks. Unfortunately, not all banks have made this transition yet, so while correspondent banking can work extremely well, it is not fully optimised by all banks.
Most banks are facing a similar set of challenges today: how to expand their product offering, thereby growing revenue in a cost-constrained environment in which effective risk management is crucial. Correspondent banking, if managed effectively and fully can be a way to achieve these results.
For most local and regional banks, some of their strongest assets are their solid client relationships, their local distribution capabilities and their domestic product suites. Global banks excel at reach, scale-based processing, technological know-how and international product depth. Correspondent banking provides local and regional banks with the ability to leverage the capabilities of global banks and likewise allows global banks to leverage the capabilities of the local and regional banks. When properly managed, significant value is unlocked.
The end state is an environment in which strategic partnerships between complementary local, regional and global banks deliver significant and tangible value for both the buyer and the supplier of services. Concentration of business to trusted partners who offer the best service at the right price is the logical outcome. As a buyer of services consolidates more business, the buyer becomes more important to the supplier, creating further incentive to work collaboratively. The overall level of business concentration will be constrained by counterparty risk – this is a balancing act between consolidating significant amounts of business with a few providers while preventing over-dependence on one or two banks.
Correspondent banking is evolving to meet the needs of a financial sector facing a regulatory avalanche and a volatile global economy. The cost and challenge of providing correspondent banking services across vastly global, different jurisdictions is causing many major banks to become regional champions, focused on one or two key jurisdictions such as Europe, Africa, the Middle East or Asia. There are very few banks now seeking to be everything to everyone globally.
One reason the regional approach can be attractive for many correspondent banks is that these relationships are normally characterised by collaboration rather than competition, as the two banks will not be trying to take business from each other in their main markets. Another benefit is that ‘regional champions’ are often very well placed to provide detailed, on the ground knowledge of specific jurisdictions, particularly the ever-changing regulatory environment. At Barclays we view knowledge transfer between correspondent banks as vital; the financial crisis of 2008 demonstrated this need when a lack of communication between banks added to financial market contagion. A shadow of that panic has appeared again recently and it is just as important for financial institutions to be in regular contact, offering detailed information to one another where appropriate in order to provide transparency and therefore confidence in the system.
Product capability is also vital in forging successful correspondent banking relationships today. In a recent series of global symposiums we held for financial institution clients around the world, the number one factor in securing new banking clients was identified as product capability. While the correspondent banking model revolves around clearing products, being able to offer investment banking products to correspondent banks is becoming increasingly attractive, with sales teams now joining the dots to provide a full service for their banking clients. The equation of product capability + strength of relationship + execution has been the key to the longevity of many correspondent banking relationships.
The future looks to be one of the long-predicted consolidation among clearing functions within banks, as the cost of regulation and keeping up with technology drives many banks to move out of the space and others to dominate their regional markets even further. From the smallest banking players to the global giants, however, correspondent banking at its most fundamental should facilitate the efficient functioning of world payment systems, providing clarity and certainty in an uncertain world.

Rita Gonzalez, managing director, head of institutional sales, Americas, HSBC Securities
The traditional correspondent banking model has dramatically changed in the past couple of years. While banks continue to service their clients’ growing needs for multiple currencies and locations, the way in which they go about it has been evolving since 2001.
Currently, banks are able to provide services in locations where they have no presence or capabilities through a combination of correspondents, strategic alliances, preferred correspondents, bilateral collaborations, private-label arrangements, etc. However, these arrangements will need to be re-evaluated as institutions take into consideration the impact on the business of higher regulatory requirements, costs of capital, changes under Basel II, Basel III and the various costs associated with these.
Looking forward, I see a greater transformation within this business over the next ten years than during the past decade. This will be driven not only by changes in regulatory requirements, but also by the consolidation of banking relationships as banks start selecting partners based on their financial strength, global network and commitment to the transaction banking business in order to secure future growth and sustainability.
Banks are under pressure to keep up with the pace as the performance bar continues to be raised in terms of higher efficiencies, lower costs and higher revenue requirements. As such, it is inevitable that a forced polarisation of the business will occur where only the top tier banks in each country would be able to access international markets through global banks to provide cross-border international services. Gone are the days where having hundreds of correspondent relationships was the norm. Moving forward, this number will most likely be reduced to a handful of strategic partners. This will have an impact even on large banks that are dominant in a single market or currency, but lack a global footprint or infrastructure. Those banks may have to expand organically, establish equity investment with strategic partners or grow by acquisition in order to meet their own requirements and those of their clients.

Sumit Jamuar, managing director and global head of sales and global clients for financial institutions, Lloyds Bank Corporate Markets
As business becomes increasingly global, touching more remote territories, banks need to continue to be able to scale up to accommodate their clients’ transaction banking needs. For those banks choosing not to invest in bricks and mortar across the globe this means ensuring that a wide and relevant network of correspondent banking relationships is in place to provide the coverage required.
In the evolving regulatory environment, the correspondent banking model has also been answerable to increased scrutiny, the need for faster and more direct delivery channels, more vigorous controls and greater compliance. The Payment Services Directive and the development of new payment channels within the single euro payments area have already radically changed the concept of correspondent banking within Europe.
As we work through the global financial crisis, we have all observed risk rising once again to the top of the agenda. Consequently, banks’ vigilance in proactively checking the robustness of their counterparty relationships also continues. In many cases this has led to banks appointing regional, or even global, providers who offer reliable and cost-effective solutions for delivering transactions into smaller markets where the cost of compliance and regular due diligence cannot be justified by volumes.
The resultant consolidation of relationships allows banks to work more effectively with these strongest, best of breed partners, while deepening the reciprocal relationship they have with them, both in terms of transaction banking and other services. Of course, there are still opportunities to develop correspondent banking relationships with strong local players, especially where these offer opportunities for reciprocal partnerships and where service quality and a strong client experience can be assured.
As correspondent banking evolves, the need for a balance between strong risk and cost management, and the need to satisfy clients’ requirements in a global operating environment, will continue to drive its development.

Nico Agenbag, regional head, bank sector, Standard Bank transactional products and services
In the heady pre-financial crisis days of 2006 I read a quote from a well-known correspondent banker: “To be successful, you have to be a global player”.
At that time few of us would have disagreed with the conventional wisdom that bigger is better and global is better still. However, I suspect that with the benefit of hindsight few of us would still agree with that statement today.
At Standard Bank our view has always been that being successful is not about being large, but about understanding one’s value proposition, retaining focus and achieving scale within one’s particular niche. Standard Bank has a unique focus on Africa and we certainly have scale in our market.
The correspondent banking industry is in turmoil precisely because it abandoned its focus and value proposition. This came about through the severe contraction of the previously highly lucrative investment banking business. This in turn resulted in many institutions switching their attention to transactional banking – more specifically international cash management and conventional transactional trade in the correspondent banking context.
Furthermore, the introduction of Sepa and the Payment Services Directive meant many correspondent banking businesses in Europe experienced contraction of their traditional business, forcing them to re-evaluate their value proposition. On top of that came the swathe of ever-increasing regulation.
As a committed player in the business of correspondent banking, Standard Bank did not escape the aforementioned challenges, albeit to a far lesser degree compared to that experienced by most global players. We remain absolutely focused on our strategy of connecting the world and Africa through our regional value proposition of cash, trade and securities services aimed at capitalising on the relatively safe and fast-growing trade corridors between Latin America and Africa, India and Africa, and Asia and Africa, without neglecting our traditional South African business franchise.

Ramaswamy Madhavan, managing director and global head of product management: banks, Standard Chartered Bank
Correspondent banking is a business where banks provide banking services to other banks.
This business has undergone significant change in the past 20 years and the environment is now highly competitive. A strong suite of products and capabilities, backed by excellent customer service and a strong balance sheet, has become the norm.
Correspondent banks are playing an effective role in facilitating international trade, moving money across the globe as well as settling transactions generated by global markets. Correspondent banks have developed a wide range of products and services for their client banks, who in turn strive to meet the needs of their corporate and retail clients. This has enabled them to access international markets, as well as liquidity/financing when and where needed.
Correspondent banks have also effectively built appropriate partnerships with other banks to tap different markets in a very cost effective manner. Global correspondent banks have also supported domestic banks with valuable knowledge of local markets and regulations. All of this is critical in today’s world where corporations and countries are increasingly going global to grow their businesses and economies.
Providers of correspondent banking services will do well to develop and enhance services which ensure end to end fulfilment and visibility of transactions for the corporate and retail clients of banks that use them. This will reduce the burden on their client banks to deal with the need for speedy execution, as well as eliminate enquiries from their originating clients.
There is also the opportunity to focus on key global trade corridors and provide access, liquidity, transaction support and information relating to the business flows in these corridors.

Eric Campbell, chief technology officer, Bottomline Technologies
From the perspective of a banking software provider, the correspondent banking industry landscape looks ripe with opportunities for all participants. In my opinion, there are three tiers of industry players.
Many FX providers can provide essentially one stop shopping for regional banks. They market their services as partner relationships and split the high-margin FX revenues – essentially servicing corporate customers requiring low value, ‘nuisance’ payments in many different currencies. This likely offers the bank client the lowest cost of entry, but also presents the smallest revenue opportunity.
Two steps up the ladder are the global transaction banks. They can provide one stop shopping and offer higher margins and greater flexibility than the FX providers, but they also represent a possible competitive threat that makes many regional banks nervous.
In my opinion, the ripest opportunity exists at the super-regional level. These banks have efficient and excellent local clearing capabilities. In the past, some have banded together to form special relationships to rival the capabilities of global players. Today, advanced nostro sub-account reporting can create an excellent foundation for offering regional banks cross-currency payments and local currency payments. This provides corporate clients private labelled local current accounts. This allows a regional bank in one country to effectively offer local currency accounts in other regions serviced by other regional banks, and with effective prior day and same day reporting, the corporation would have a truly global banking partner from their local bank.

Gene Neyer, senior vice-president, product management, Fundtech Corporation
Correspondent banking works fairly well for the most part, especially domestically – where language, conventions, relationships and business models are common and well understood. It works less well globally – because of the different languages, business practices, time zones, fees and charges, etc and because it is not logistically simple to manage these different correspondent relationships (nostro management).
Domestically (for example in India) the situation is being improved by regulators encouraging direct connectivity via real time gross settlement systems. Internationally there have been multiple initiatives to improve correspondent banking including the International Payments Framework Association’s work on standard correspondent bank onboarding in a given country; the simplification of cross-border payments in Europe offered by Sepa, which removes the issues of fees via a legislative fiat; and products that provide a low-cost way to leverage FX liquidity and tap into the correspondent banking network without having to invest in additional payments infrastructure.
At the same time, non-banks such as Western Union and Travelex have identified B2B FX transfers as a focus area and we expect that this competition will continue to drive the banks to refine the correspondent banking model further.
More companies are becoming global and transacting business internationally and banks have been forced to respond. When we go on a prospect call we no longer ask “are you doing FX transaction processing?” we ask “who are you doing your FX transaction processing with?” In fact, we recently surveyed our US clients about the trends in their FX business and 66 per cent said they were experiencing strong to moderate growth.
As the market for FX transactions expands as a result of expanding global business, banks will need to improve and enhance their service offerings to stay competitive. More sophisticated services such as forwards and swaps will be made available to smaller banks and their corporate customers. FX processing is a very lucrative business for financial institutions, both the originator and the correspondent bank, so they will certainly be seeking ways to grow their business and make the use of correspondents more seamless and transparent to the customer.