The payment market infrastructure is the backbone of the local, regional, and global trade markets. It facilitates the clearing, settlement, and payment processing, which are fundamental to a well-functioning society. However, what happens during a disruption, and what contingency options are available?
The interconnection and reachability of Payment Service Providers (PSPs) through Clearing and Settlement Mechanisms (CSMs) are fundamental for a smooth and stable flow of payments. While a payment market can continue to function, even if one or some PSPs fail, it will slowly cause a negative chain of events. However, should a CSM fail, it would lead to widespread market disruptions and financial instability.
Overall, this paper aims to provide insights into the critical role of clearing houses in ensuring the stability and resilience of the payment market and the need for proactive measures to address the vulnerabilities within the system. By doing so, we hope to contribute to the ongoing efforts to strengthen the payment market infrastructure and ensure its ability to withstand the challenges posed by a rapidly evolving financial landscape.
Increasing Volumes of Non-cash Payments is a Global Trend
The number of payments exchanged globally and in Europe has steadily increased over the past five years. The trend is driven by a growing demand for faster and more convenient payment options. According to the World Payments Report 2023 from Capgemini Research Institute, the number of non-cash transactions worldwide is expected to reach 1.5 trillion in 2024, with significant growth anticipated through 2027, nearly reaching 2.3 trillion. This growth is particularly pronounced in emerging markets such as China and India.
In Europe, data from the European Central Bank (ECB) shows that the total number of non-cash payments made in the eurozone increased by 10.1% in the first half of 2023 compared to the same period in 2022, reaching 67 billion transactions. This growth was driven by a notable increase in card payments, which accounted for 54% of all non-cash transactions, while credit transfers and direct debits accounted for 22% and 15%, respectively. The proliferation of new digital payment infrastructures, regulations, and open banking initiatives drives this expansion.
Over the past five years, the growing number of payments exchanged has been driven by several factors, including the increasing adoption of digital payment methods, the rise of e-commerce, and the growing demand for faster and more convenient payment options. In addition, the COVID-19 pandemic has accelerated the shift towards digital payments, as consumers and businesses increasingly turned to online and contactless payments to minimize the risk of infection.Overall, the trend towards more payments being exchanged is expected to continue in the coming years. This trend is driven by ongoing innovation and the growing demand for faster and more convenient payment options.
New Expectations from Customers and Authorities
While volumes increase, changing customer expectations, behaviors, and regulations drive new requirements that PSPs and CSMs must meet. Although payment itself is crucial to society, it has more or less become a commodity. Payment market participants have joined forces to meet the requirements through standardization, consolidation, and taking advantage of new technology. Below are four such drivers of new requirements briefly explored.
1. Price pressure
While the demand for payments has increased, there is a low willingness to pay for payment services. This has put pressure on PSPs to find ways to offer instant payments as well as batch-processed payments at lower costs. The global transition towards the ISO20022 standard provides opportunities for PSPs and financial market infrastructure providers to harmonize processing, thereby reducing complexity and costs.
2. 24/7 clearing
The changing behavior of the payments market and specifically increased demand for instant payments have created a need for lower-cost solutions that enable 24/7 clearing of payments. Solutions such as TIPS and RT1 have emerged as viable options for meeting this need. By adopting these solutions, PSPs can offer faster and more convenient payment options while also meeting the needs of consumers and businesses.
3. Information exchange
Legacy payment formats constrain the scope and amount of data that can be exchanged between the payer and the payee. This limits PSPs’ possibilities for developing new and enhanced payment services. The ongoing transition to payment processing based on the ISO20022 standard will allow PSPs to enhance information exchange.
4. Regulations
Increased volumes of non-cash payments, the transition to instant payments, cryptocurrencies, and increased financial crime cause regulators to raise requirements on financial institutions’ AML processes and solutions. The efficiency of AML transaction screening depends on the quality and availability of the data in payment messages. Regulators raise requirements on PSPs, e.g., about payer and payee address data. By November 2025, several payment markets and SWIFT will require that address data is provided in a structured format as opposed to the free-text data used today.
Summarizing the driving forces
Overall, these changes drive PSPs to find ways to reduce costs and enhance services while remaining compliant with new and existing regulations to stay competitive. Adopting new standards such as ISO20022 and collaborating across borders through for example PSPs, can drive down costs while also delivering faster and more efficient payment services to consumers and businesses. However, one aspect now deserves increased attention and remains to be addressed – contingency.
Individual PSPs need to address contingency requirements, as they will differ based on, for example, volumes, values, and payment types provided. However, the CSM’s contingency needs to be addressed by the CSM in cooperation with its participants (PSPs). Although the contingency must be resilient, easily available, and robust, it is of utmost importance that it is highly cost-efficient.
Threats in the Digital Payment Landscape
The threat level to societal functions, including financial market infrastructure, has increased. In parallel, changed consumer behaviors, coupled with increased price pressure on payment services, raise the bar when moving to instant payments.
One of the major threats facing clearing houses is the risk of cyber attacks. With the increasing reliance on technology and interconnectedness, clearing houses are vulnerable to attacks from government-sponsored hacker communities and cyber criminals. These attacks can range from distributed denial-of-service (DDoS) attacks that overwhelm the clearing house's systems to more sophisticated attacks that seek to steal sensitive data or disrupt the clearing process altogether.
Another major threat is if malicious actors were to successfully manipulate payment transaction data, such as altering payee information or changing transaction amounts. Confidence in payment systems would be severely undermined, leading to widespread uncertainty and potential disruptions in financial markets.
A breach of this magnitude would compromise the security and accuracy of financial transactions and result in significant financial losses and reputational damage for the institutions involved. Restoring trust in payment systems would be a time-consuming and challenging endeavor, highlighting the importance of robust security measures and continuous vigilance in protecting the integrity of global financial transactions.
As a result, clearing houses need to take proactive measures to mitigate these risks. This includes investing in robust cyber security measures, implementing contingency plans to address potential disruptions, and working closely with regulators and other stakeholders to ensure the resilience of the financial system.In conclusion, while the payment market is rapidly evolving to meet the demands of consumers and businesses, it is important to recognize the need for contingency solutions should the standard clearing mechanisms fail. The failure of a payment system can have serious repercussions, leading to financial instability, disrupted supply chains, and a loss of confidence in the financial system. Therefore, it is critical to ensure that there are contingency plans in place to ensure that society can keep functioning in the event of a disruption to the payment system. Such contingency solutions may include backup clearing mechanisms, alternative payment methods, or emergency funding arrangements.
Clearing Continuity on an Evolving Payment Market
As the global financial industry undergoes a significant transformation, with all payment flow types converging towards adopting the ISO20022 messaging standard, it paves the way for a streamlined and unified contingency solution. This comprehensive shift allows for the establishment of a single contingency mechanism that can cater to multiple clearing houses, enabling seamless communication and promoting interoperability across different platforms. The harmonization through ISO20022 will not only enhance the efficiency of cross-border transactions but also mitigate operational risks and strengthen the overall resilience of the financial system.
For example, in the event of a disruption to the normal clearing mechanisms, PSPs could use ISO20022-based file interchange to process a batch of payments as a single transaction, ensuring that critical payments such as salaries, utility bills, and other essential transactions can still be processed.
Clearing contingency solutions should be an integral part of a payment market and its infrastructure. The solution should meet several requirements to ensure its effectiveness in the event of a disruption.
● Firstly, a clearing contingency solution should be easy to run without requiring large amounts of extra staff. This means that banks and central banks should require minimal training to operate it.
● Secondly, a clearing contingency solution should be easy to access for all banks and participants. This means that the solution should be interoperable, allowing seamless integration with existing payment systems and processes. It should also be designed to accommodate different payment formats and messaging standards, ensuring it can handle various payment types.
● Thirdly, a clearing contingency solution should be cost-effective. This means that the solution should be designed with cost efficiency in mind, minimizing the need for expensive infrastructure and reducing operational costs. Additionally, the solution should be scalable, allowing for flexible deployment to accommodate changing transaction volumes.
● Fourthly, a clearing contingency solution should run on a separate infrastructure, e.g., without dependencies on SWIFT or SIANET. This means that the solution should be deployed on a separate network and servers, ensuring that it is isolated from the normal payment processing infrastructure. This will help prevent any disruptions to the payment system from affecting the contingency solution.
● Finally, a clearing contingency solution should work 24/7. This means that the solution should be available around the clock, ensuring that critical payments can be processed anytime, including outside of standard business hours. This will help to ensure that the payment system remains resilient and reliable, even in the event of a disruption.
In summary, a clearing contingency solution should meet several key requirements to ensure that it is effective in the event of a disruption. It should be easy to run, easy to connect to, cost-effective, run on a separate infrastructure, have its own network, and work 24/7. By meeting these requirements, a clearing contingency solution can ensure the payment system’s resilience and help minimize the impact of any disruption.
Clearing Contingency Ideas
In a world where transactions are increasingly processed in real time and most payment flows are automated, transitioning to manual routines is virtually impossible. Additionally, the number of banks becoming direct members of the High-Value Payment System (HVPS) continues to grow. This evolving landscape necessitates consideration of various alternative approaches to ensure seamless and secure payment processing.
Looking at different alternatives during a crisis situation, there are a couple of ideas that we would like to particularly shed some light on:
Bilateral File Exchange
One alternative is bilateral files. This would mean that banks send their files directly to each other, streamlining the process and reducing reliance on intermediaries. In a worst-case scenario, manual bookings will be performed at the central bank to ensure continuity of operations. This approach necessitates development efforts within each bank to enable the capability for direct file transfers. Additionally, it requires establishing a common communication network; alternatively, each bank must ensure its availability across all relevant networks. To facilitate this system, comprehensive agreements must be established between all participating banks to send and receive files consistently and securely. Furthermore, it is imperative that banks confirm the receipt of funds for a file before crediting the beneficiary's account to maintain financial integrity and trust.
Thin Clearing Hub
Thin clearing hub would mean that a central actor will operate a small and cost-efficient platform for exchanging files, ensuring that no file is processed without a settlement being performed. This platform can also incorporate central functionalities that allow banks to continue sending their high-value payments (HVP) and instant flows in the same format they currently use. The aggregation of transactions is handled centrally, and files are created in specified cycles. This approach results in shared costs among the participating banks and reduces the need for extensive development efforts at each individual bank.
Contingency Solution Data Center
Another crucial aspect is contingency at a data center level. Depending on the scenario, the solution will vary. The scenarios can be categorized into logical catastrophic events, such as large-scale cyber attacks, and physical catastrophic events, such as widespread electricity outages, fires, or bombings. To protect the contingency solution from logical catastrophic events, the data centers must be logically (or network) separated. This prevents malware from spreading from one data center to another. The level of data center resilience required should be determined based on a risk and threat-based assessment. Geographic separation of data centers is essential to safeguard against physical catastrophic events. In this context, private cloud solutions may be relevant, whereas public cloud solutions might not comply with current legislation.
Conclusion
The ever-evolving payment market infrastructure is essential for maintaining the stability and efficiency of local, regional, and global economies. As the number of transactions and the complexity of payment systems continue to grow, it becomes imperative to address the potential disruptions and threats that could impact the financial infrastructure. The suggested contingency solutions, including bilateral files, thin clearing hubs, and data centers, offer various approaches to ensure continuity and resilience during a crisis.
When looking into a suitable contingency solution for clearing houses during a crisis, several key requirements must be met. Some of these requirements are that the solution must be easy to run and that the need for extensive staffing and training is minimal. It must also be easy to connect to, ensuring interoperability and seamless integration with existing systems. It must run on a separate infrastructure to avoid dependencies. Lastly, the solution also needs to be cost-effective while operating 24/7.
Each idea presented brings benefits and challenges, requiring careful consideration and collaboration among PSPs, clearing houses, and regulatory bodies. By adopting proactive measures, such as investing in robust cyber security, implementing comprehensive contingency plans, and leveraging advanced technologies like ISO20022, the financial industry can better safeguard against disruptions and maintain trust in payment systems.
Ultimately, the goal is to create a resilient payment infrastructure that can withstand unforeseen challenges while continuing to provide reliable and efficient services. By doing so, we can ensure the continued stability and growth of the financial market, especially as a crisis is in play and contingency is needed.
