Cross border payment innovation and regulation drive each other

By Chrissy Chiu

14 February 2019

Unheard of today, the New York & Mississippi Valley Printing Telegraph Company was founded in 1851. Five years later, the company was renamed Western Union. Arguably one of the first companies to transact across borders, Western Union tapped into its telegraph network to transfer money from one location to another. By 1872, cross border payments were changed forever, as remittances became normal, and wire transfers became increasingly popular as people moved overseas and sent money home.

Leapfrogging to the present day, cross border payment innovations have led to global payment infrastructures. No reputable financial institution can escape the global hegemon SWIFT, its protocol and network: the basis of the Society for Worldwide Interbank Financial Telecommunication is the standardisation of secure messages to instruct banks and intermediaries to transfer funds. Banks settle the funds themselves as SWIFT has ensured the veracity of each message. Building more trust into the network, national regulations of the banking industries have legitimised connections.

Inherently cross border in activity, SWIFT’s payment network has also spurred innovation in the fintech space. Most recently SWIFT has opened its system to developers, making it possible for customisation. In a bid to compete with fintechs, SWIFT has set API standards for payment pre-validation and loan approvals. The programmes allow fintechs to work within the SWIFT network to develop new products for financial institutions. It’s proved a popular protocol, with the pre-validation pilot programme being taken up by 14 banks. The Pay Later standards allows fintechs to develop APIs to approve loans between clients and banks.

Fintechs now stand to gain the most by providing further integration and facilitating options to adopt financial products. 

Cross border trust

Outside of traditional networks, fintech innovations have shaped cross border payments by initiating trust between peers. One of the first firms to make use of trust is PayPal, which pulled in banking information from customer accounts to settle e-payments. Closely linked to PayPal is eBay, which has enabled e-payment ecosystems to take-off.

P2P lending has exploded, facilitating investment between two counterparties which may be some distances apart. Funding Circle, for example, is operational in the UK, Germany, the Netherlands and the US, and has helped growing businesses by matching investors with mid-sized companies.

The nature of these P2P payments and transactions has also attracted the watchful eye of the regulators. In 2014, the UK’s Financial Conduct Authority (FCA) decided to regulate P2P lending activities to reflect the risks that investors are taking.

“The FCA regulation is a very positive step forward for consumers. There is a strong emphasis on the transparency and availability of information on platform providers’ websites, particularly relating to the risks and rewards involved in P2P lending,” according to Lending Works, a P2P lending network for personal loans.

While regulation in cross border loans has made the loan market more transparent, other areas are still opaque.

Digital ledger technology (DLT) has exploded into society’s wider consciousness. The technology behind bitcoin’s secure, private transactions has been tracked carefully by industry watchers – cryptos have captured the imagination of volatility chasers.

DLT, which can be utilised as a form of anonymous cross border payment technology is on its way to becoming mainstream. The technology behind DLT is relatively simple. Individual ‘nodes’ across the network build and verify a ledger or record of transactions. With each consequent transaction, these independent nodes verify the transactions as true and record it. Anonymity of these transactions are secured by a crypto key.

“DLT has been an incredibly popular technology tested in our regulatory sandbox – with almost half of the fourth cohort using some form of DLT or cryptoassets,” said Christopher Woolard, executive director of strategy and competition at the FCA, speaking at a cryptocurrency event.

The initial findings of the FCA sandbox “demonstrate that cryptoassets can be used to make existing processes, from international money remittance to traditional issuance of debt instruments, cheaper and easier at small scale,” said Woolard, ahead of concluding that the FCA has not yet definitively decided on its stance on the bitcoin and crypto market.

PSD2 regulation opens payments accounts to innovation

Europe’s second payment services directive (PSD2) is expanding the possibilities for fintechs to provide payment or third-party account services within the labyrinth of banking connections. Requiring banks to open up their payment infrastructure, PSD2 stands to change the face of the payments industry by ensuring that innovative providers are regulated and compliant. The effect of PSD2 has been manifold.

“Before PSD2, you have to have one-to-one interactions [with each customer banking counterpart]. Going forward, there will be providers in between that act as a single gateway that make it for you, a payment services user much more lean to interact,” said Christian Fraedrich, product manager, treasury payments and euro clearing at Deutsche Bank, in a presentation. Fraedrich also believes that by removing barriers to the ecosystem, fee transparency will increase over time as the consumer becomes empowered.

Third party providers have emerged to provide better data to consumers. Aggregators like Asto have made bank account information more accessible. Asto, an online, mobile application allows customers to link their bank accounts on a single platform. Information on balances and transactions are made available – key to the platform is the ability to make payments. Powerful for small businesses, platforms like Asto allow workers to manage finances across multiple bank accounts while on the go.

Regulated payment initiation service provider (PISP) and account information service providers (AISP) provider Truelayer and similar entities epitomise the new ecosystem, by building application programming interfaces (APIs) for other firms. Fintechs looking to tap into PSD2 can invite Truelayer to provide services to consolidate account information, initiate payments, analyse consumer habits, and mitigate fraud.

With new innovations comes new risks

Technology in cross border payments have spurred new technologies from the telegraph network, SWIFT network, P2P direct payments, bitcoin, to new API standards. Regulations have come hand in hand with these evolutions, in order to protect users from fraud and bankruptcy.

Cross border payment technologies have incentivised innovations in cybersecurity. Protecting financial transactions from hackers is paramount to ensuring that customers continue to use any technology. Hacking is a real risk – fintechs with expertise in factor authentication, customer verification, and fraud detection can protect the consumer. Firms like Onfido, an artificial intelligence (AI) powered identification verification application, ensures that customer identities are safe.

Governments too are preparing for further integration in cross border payments. As the payments services market moves to orient around the customer, governments have seen the need to share basic information to prevent cyber hacks. As early as 2015, the Obama Administration announced legislative efforts to prepare the US government; at the end of 2018, the EU gave a permanent mandate to the European Union Agency for Network and Information Security, acknowledging the demand and need for coordination, information, and ultimately, security across internet exchanges. Tied intimately together, innovation in payment services and government oversight come hand in hand.

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