A payments conversation with Bank of England's Christina Segal-Knowles:
Part 2

Marcus Hughes: Welcome back to this second part of Bottomline's Payment Podcast, in which I am very pleased to be joined again by Christina Segal-Knowles, who is Executive Director for Financial Markets Infrastructure at the Bank of England. I am Marcus Hughes, Head of Strategic Business Development at Bottomline and your host for today's conversation. Welcome back, Christina, and thanks for joining us.

Christina: Thanks, Marcus. I am really pleased to be here.

Marcus Hughes: So, just to recap, in our last session we covered the impact of COVID-19 on both consumers and businesses in terms of their payments activity. We also explored the unbundling of payment chains, which is potentially increasing systemic risk as different participants are in some cases subject to different levels of regulatory oversight.

Then we talked about the emergence of stablecoin, which is intended to overcome the volatile ups and downs which traditional cryptocurrencies are experiencing. We also discussed the possibility of central banks deciding to issue central bank digital currencies. Finally, Christina described some of the important findings covered in the recently published Financial Stability Report.

So kicking off with another question for Christina, with so many changes in the UK payments landscape, like proposals to create a new payments architecture, what are the Bank of England's priorities for retail payments over the next few years, please?

Christina: Thanks, Marcus. I think, as I was explaining earlier, the Bank really sees innovation and change not as something that is in tension with our mandate but something that we want to support and is very much supportive, provided that it has got the right regulatory framework and provided that we are ready to respond to it.

So I think our goal is to make sure that the UK payments landscape will be resilient and provides that level of confidence for users that I was speaking about as being so essential to financial stability and so essential earlier.

So we want to be in a place where change can happen, and it can happen in a way that is safe and that our regulatory system keeps us, and also that the technology and infrastructure the Bank provides is also keeping pace.

I think as people change the way that they pay, it may change the way that our priorities shift. We need to make sure that we are ahead of the game when it comes to knowing when something is becoming very much systemic, when it is becoming core to the way that people pay to make sure that it is regulated appropriately.

Ideally, we want to be helping to provide a framework so that innovation, as it happens, and new forms of payment add to resilience rather than detracting from it. I think that is very much possible when people have more alternatives. As I have said a couple of times in this podcast, that can create just a more stable system and one in which you have fewer critical nodes that could affect resilience if something goes wrong.

So I think through all of that there are all of the regulatory pieces that I spoke about before, in terms of making sure that the UK is moving to a world where we really have that same risk, same regulation basis for our regulatory landscape.

I think that is something that we have been discussing, not just in the Bank of England but across UK regulators, and something that HMT, Her Majesty's Treasury, has consulted on in the context of their Payments Landscape Review. So thinking about how do you make sure that that payments landscape has that level of resilience going forward and that the regulatory framework is appropriate?

It also means that, in addition to that regulatory piece, making sure the regulation is fit for the future, we also need to be implementing these principles in some of our other Bank of England activities, which include the supervision of existing payment systems, as well as provision of infrastructure.

So I think, overall, we are looking to build the resilience through the design. So we are trying to make sure that all of the pieces, whether that is the central bank provided infrastructure or the regulated private sector, can adapt and evolve over time for changing circumstances, and that we can make sure that we are supporting both the private sector and ourselves in making sure that we are not relying on legacy technologies, that we can evolve, that we can also adapt to evolving threats, for example cyber.

I think we want to, and I have talked about it quite a bit, increase resilience by creating and encouraging a wider range of available payment methods at the point of sale. I think that is quite important so you don't get that over-reliance on a single piece of infrastructure, a single way to pay.

I think we need to make sure that, through all this change, we are thinking about how do you make sure that the change itself doesn't lead to risks as you are switching over, that you don't end up with transition risk between systems, between technologies, that cause risk to the system and threaten that reliance?

Then, finally, one that is a bit more technical in nature is that we also are looking to move to adopt ISO 20022 data standards, because there are new standards, and for people who aren't following this closely, it may be that most of the podcast listeners are familiar with data standards, but I think there are new ways to ensure that we have richer data that is going to support resilience for critical payments. I think, importantly, then also provide the basis for greater interoperability between payment systems, which, again, then reinforces that overarching goal of having more ways to pay that are interchangeable, which means a more resilient system overall and more options for consumers and users in the UK.

Marcus Hughes: Great. Thank you, Christina. Very interesting. So greater resilience, more choice in payment instruments and channels, all very important themes. I will pick up on that ISO 20022 point that you mentioned as well.

So, as mentioned earlier, another major change in the UK payments landscape is, of course, the Bank of England developing its new real-time gross settlement system to replace the CHAPS high-value payments system. This will involve an important new messaging format here, known as ISO 20022.

The adoption of this format in the UK is part of a massive programme to migrate many of the world's market infrastructures to this new format. It is an ambitious programme, under which this messaging standard is being rolled out across the entire world over the next five years, really.

The good news is that this data-rich messaging standard is now globally accepted as the best way to standardise and to modernise payments and other financial messaging, such as securities processing. Global adoption of this standard will make interoperability between payment systems and security systems so much easier, whether they run on SWIFT or other proprietary networks.

An important part of the overall migration programme is, of course, the transition plans of major market infrastructures. So not only in the UK, for the Bank of England, the new RTGS, but also the European Central Bank's target, too, and also the US Fedwire network.

The migration to ISO 20022 is going to allow payments to carry more structured data and much richer data than conventional payment formats today, like SWIFT MT, FIN messages. Importantly, this structured data is machine readable, and this will greatly increase the efficiency of payments with greater automation and greater real-time straight-through processing.

A major reason, why I understand, regulators are keen to see the widespread adoption of ISO 20022 is that it is going to make it easier to ensure compliance with anti-money laundering requirements. ISO 20022 has many structured fields which can be made mandatory to ensure that important details are provided. So that would be, for example, the name and address of the ultimate beneficiary, as well as full details of the originator and any banks involved in processing that transaction.

This means payments using ISO 20022 can be mandated to include, in a structured, machine-readable way, all the information necessary to comply with rules like FATF 16 and the EU Wire Transfer Regulation. This comprehensive, structured data will improve automation and reduce the number of false positives when screening payments against sanction lists and watch lists.

The increase in information provided can also be used to make it much easier to track payments in real time across multiple banks and across payment systems. So this will reduce the risk of errors as users are going to be able to include additional payment details and references. Using this richer data in a structured way will also make it easier for parties receiving payments to achieve higher levels of automated reconciliation. It would enable, really, a much richer level of data analytics and insights, which in turn will be able to drive better decision-making.

ISO 20022 even carries non-Latin characters, so names and other details in languages such as Mandarin or Arabic can also be accommodated.

So migration to ISO 20022 for SWIFT's cross-border messaging network is going to start in November 2022, and the coexistence of the older legacy MT standard will continue until November 2025. But during this period there is quite a risk that some of the richer data carried by ISO 20022 will become truncated or cut off when these XML messages are converted into legacy MT, FIN messages, for processing by those banks which have not yet migrated to the new format.

So, unfortunately, FIN messages are not able to carry so much structured data as the new ISO 20022 format, so SWIFT is therefore working with fintech solution providers, like Bottomline, to help financial institutions through this transition period. We will be providing mapping and translation services, as well as cloud-based data vaults to ensure that the data is not going to be lost.

Anyway, so moving on to our next topic. We really couldn't have this conversation without addressing another highly controversial subject, which remains at the centre of much debate and uncertainty. I am sure you can guess, by that I mean, of course, Brexit.

So when clocks in the UK strike 11:00pm on 31st December, that is already midnight in Brussels, this will mark the end of the UK's transition period for leaving the European Union and ceasing to be members of the single market and the Customs Union. So even today, in mid-December, we still don't know whether the UK will actually have a trade deal with the European Union, one which preserves tariff-free and quota-free trade in goods, or whether, actually, World Trade Organization arrangements are going to apply, but, either way, it is going to be a big change with more forms to complete and more checks to perform.

What is clear is that it is likely that we are going to see some major disruption and delays as these new border arrangements come into force. Worryingly, a recent EY survey found that 80% of UK businesses don't yet know the full extent of Brexit risks and they don't have sufficient preparations in place. That is a pretty high percentage, and, of course, the situation hasn't been helped by COVID-19.

So, Christina, from the Bank of England's point of view, do you have any advice for UK businesses that are trying to prepare themselves for Brexit?

Christina: I mean I think the first principle for all businesses is that you should ensure fully how regulations that impact your business may change on 1st January and have plans in place to mitigate any resulting risk to your business. I think that is consistent with advice that the Bank has given from the beginning of this process.

I think something that podcast listeners should be aware of is also that the Bank has engaged very closely with all regulated firms, including payment systems, to assess potential issues and ensure that these are addressed ahead of our exit at the end of the implementation period at the end of this month.

The Bank has been very, very active in preparing for Brexit for a long time now, including monitoring, with a great degree of detail, potential financial stability risks and potential financial stability issues that could arise, and stands ready to make sure that the Bank's mandate to monitor financial stability will be met, should market volatility increase throughout this period.

I think one of the things I mentioned earlier in the podcast was the FPC's Financial Stability Report, the latest edition of which just came out last week, and it is available on the Bank of England's website. That provides a full set of assessments of potential risks in the financial system and the mitigants that have been put in place and an assessment of preparedness.

I think the real headline takeaways are that the financial system broadly is prepared and that we think that the key financial stability risks associated with Brexit have been mitigated. That doesn't necessarily mean, however- There is a difference between financial stability and market disruption, and people should understand that even if they do see market disruption, that does not necessarily mean the same thing as financial stability disruption. As I just said, the Bank stands prepared to respond in the event of market volatility to make sure that monetary and financial stability can be maintained.

Marcus Hughes: Thank you for those reassurances about the Bank of England's preparations regarding ensuring stability, even if there is some market disruption, as you were saying. Perhaps I can also add some thoughts on how the UK financial services sector has been impacted by Brexit and the preparations they have been having to make.

The UK's exports in financial services to the European Union are worth more than £26bn, according to the Office of National Statistics. Despite the scale of this major business flow and four years on now from the referendum, the future business relationship between the UK and the European Union does remain uncertain.

However, we do know that the European Union has been insisting that it will not allow the UK financial services sector to have their cake and eat it. By that, I mean the UK can't retain access to the benefits of the single market without the obligations, which include, for example, the free movement of labour and the acceptance of European Union regulations.

So as from 1st January 2021, the European Banking Authority is no longer going to allow UK-based financial institutions to continue to passport their FCA, Financial Conduct Authority, licences into the single market. This effectively puts an end to any cross-border operations within the European Union.

The European Central Bank has also taken a hard line here, emphasising that all activities related to European products or European customers should, as a general principle, be managed and controlled from entities located inside the European Union.

There has been quite a lot of talk of future access to Europe being based on equivalence, but this is a system of regulatory approval that can be withdrawn by the European Commission unilaterally and with as little as 30 days' notice in some cases. So, in addition, the European Commission has specified it will only grant equivalence in those areas where it is clearly in the interests of the European Union. So, unlike single market membership, equivalence is not a comprehensive system and core sectors, such as insurance, lending and deposit-taking, won't be covered by equivalence.

For such activities, UK-based firms are left with a choice of either having to obtain new licences and setting up regulated subsidiaries inside the European Union or, alternatively, applying for permission from individual national authorities to market their services literally country by country.

So, for these reasons, the position adopted by most financial services firms in the UK has been to hope for the best and prepare for the worst. Over the last few years, many large financial services firms in the UK have beefed up their existing operations in Europe or established new regulated subsidiaries within the European Union, through which UK institutions can then manage their European businesses.

Undoubtedly, this brings extra costs, including dedicated capital, premises, staffing, compliance functions and so on, and this will potentially make their offerings less competitive.

It is probably even worse for smaller and medium-sized UK financial firms, which lack the resources to create separate subsidiaries, as they now face expensive and time-consuming licence applications to individual national regulators across the European Union. They will have to decide if this piecemeal benefit of limited cross-border access is actually worth paying for.

According to KPMG, the European financial centres which have attracted most UK-based financial services firms are actually Dublin and Luxembourg, with more than 70 new firms each. That compares really well with 35 firms going to Paris, 31 opting for Amsterdam and 30 selecting Frankfurt. So, in this way, the European banking and financial services community looks set to become more fragmented than historically, and this may present challenges going forward.

Investment banks have generally gone for the major political and economic centres of Paris and Frankfurt, but Luxembourg has attracted the most asset managers. EY estimate that, overall, banks and fund managers have been moving more than a trillion pounds of assets out of the UK and into the European Union as a result of Brexit.

They also estimate that more than 7,500 financial services employees have now been re-located to Europe, which is a lot lower than was originally anticipated or feared. That 7,500 is in addition to some new hires within Europe, of course, as well. Some of that relocation has been delayed by COVID-19, so the timing of the UK's exit from Europe and the additional red tape it has created for financial service firms really couldn't have been worse, coinciding with the pandemic.

Turning back to yourself, Christina, as we draw to a close on this conversation, perhaps you could share with us any predictions you have for 2021 and beyond. In particular, what changes or innovations are we likely to see in the payments landscape?

Christina: Thanks, Marcus. I mean I think I should put the disclaimer on the top, that if 2020 has taught me anything, it is to stop making predictions about the world, but in the payments space I think there are a few things that I would certainly expect.

I think the first is that the UK regulatory authorities, working with the government, will continue to make strides to move to make sure that the regulatory framework for payment, including emerging payments like stablecoins, are fit for purpose, that we are paying attention to risks that might come, and also making sure that the regulatory framework is there to support innovation.

So I would expect things to watch out for in that space would include, for example, HMT's response to the Payments Landscape Review, which I mentioned earlier. I think you will also see additional insight and leadership from the Financial Policy Committee at the Bank of England, who will be really thinking about how do we make sure that the regulatory framework for payments really is in place and is future-proof to support innovation in the UK and make sure that we can continue to be a place that is leading for that when it comes to payments innovation, while also making sure that UK consumers really can continue to have that confidence in the ways they pay?

So I think I expect to see more from ourselves, working alongside HMT and the FCA and PSR, in the space of making sure that that legislative framework is fit for purpose.

Second, I would expect to see more from us and more conversations, both from the Bank of England and also internationally, around CBDC, which I mentioned earlier. We are planning, as I mentioned, a discussion paper relatively early in the year that will think about both those regulatory options for stablecoins and how CBDC and stablecoins and other private payments could sit alongside each other, and also covering some of the financial stability and monetary stability implications of some of these innovations in payments.

So expect to see more on CBDC and more, in particular, from the Bank of England on how CBDC interacts with private innovation as well.

Then, finally, I would expect there to be just a continuing international conversation about these issues. I think if somebody had told me six years ago, five years ago, even three years ago, that one of the focuses for discussion for the Financial Stability Board, at the G20 and the G7 and these big international fora, would be the future of payments, I would have been surprised.

But I think this innovation in payments is so important to financial stability, it is so important to the way that the financial system works, and it is so important to get right, and there are a lot of opportunities, actually, that I would expect that international conversation to continue.

So I think there will be continuing activity, continuing output, from international bodies, including standard setters, on how did they provide that leadership to create not just individual national frameworks but an international framework that works for innovation in payments.

Also, leadership around how do you harness innovation in payments, how do you harness not just the things that are coming out of the private sector but also things like our RTGS Renewal project, things like ISO 20022, to improve cross-border payments in particular but domestic payments as well, and provide solutions to challenges that we have seen in that space?

So I would say I would look out for just a lot more attention, a lot more activity in this area. Hopefully, some exciting steps forward in terms of getting the regulatory framework in place, encouraging some of the innovation, whether that is in terms of how the central banks are providing things or supporting innovation in the private sector. Also, thinking about where do central banks go when it comes to central bank digital currencies, which would be just another area for a significant step forward potentially in the way that people are able to pay.

Marcus Hughes: Fantastic. Thanks, Christina, very good. So a very busy 2021 ahead for the Bank of England with such a comprehensive to-do list.

I also have a couple of predictions of my own, which I am happy to share now.

First, I agree on central bank digital currency. I do sense that the market is reaching the next level in the evolution of blockchain, especially relating to digital currencies. Recent work and statements by various central banks around the world makes it increasingly likely that quite soon one or more central banks will issue their own central bank digital currency. A number of central banks are announcing initiatives to create a currency, while others may want to make sure that they are ready, on the sidelines, just in case adoption suddenly gains rapid attraction.

Ironically, I think the controversy around Facebook's Libra stablecoin, which I think has recently been rebranded as Diem, has actually made the launch of a central bank digital currency more likely than ever. So, for me, it is now more a question of when, not if, a central bank digital currency is launched.

We know a number of central banks are exploring the best way to approach this. For example, the central bank of Sweden is quite advanced apparently in developing a retail e-krona, which may be one of the first to launch.

But I think it is probably the People's Bank of China which is most advanced of all. They have been holding large-scale pilots for their e-yuan in various cities across China. For example, in the massive tech hub, Shenzhen, just across the border from Hong Kong. Typical use cases there have been tested on bill payments, transport, shopping, government services.

So, for me, after many years of experimentation and investing huge sums of money in blockchain, I think central bank digital currencies are now emerging as one of probably the most exciting and practical applications of this new technology.

My second, and completely unrelated, prediction is that there will be greater integration between treasury, corporate payments and payables and receivables, and thereby capitalising on the rich data that is contained in messages such as e-invoicing and ISO 20022 payments.

This will drive greater insights and far better decision-making about spend management, buyer and supplier behaviour, and working capital performance. This, in turn, will encourage wider adoption of supply chain finance and other payment programmes, which can help buyers and suppliers manage their cash flow more efficiently and optimise returns on any spare liquidity, of course.

As an important part of this big push to achieve greater transparency and better cash flow management, I think we are going to see a growing number of governments mandating the adoption of e-invoicing. Around the world, these new government-mandated e-invoicing programmes are driving much of the current growth in e-invoicing. Currently, it is about 20% a year growth.

Some of the obvious benefits of e-invoicing include greater processing speed, lower cost, improved visibility and control, as well as reduced risk of fraud, but this is only part of the explanation.

Another highly compelling reason why a growing number of countries are introducing mandatory e-invoicing is that tax authorities want to close the unpaid tax gap through better VAT reporting and more efficient tax collection. In other words, tax authorities want to capture more tax from businesses which have been going unpaid due to poor visibility of businesses buying and selling from each other.

E-invoicing that uses a model known as clearance makes tax collection much easier and faster, and hence it is really growing in popularity, with more governments mandating this system.

Of course, another good reason for adopting e-invoicing is that the rapid delivery and approval of invoices puts a buyer in a really strong position, not only to pay invoices on time, which is important, but also to offer early payment programmes for selected suppliers. If these are well structured, these supply chain finance programmes can be highly collaborative and they offer great benefits for both the supplier and the buyer.

So, for example, the supplier improves cash flow by getting paid early and at a rate of interest which is generally better than what can be achieved by their own direct bank borrowing. Meanwhile, the buyer can receive a revenue share from the finance provider which effectively reduces the cost of goods which the buyer is purchasing. So, alternatively, in some scenarios buyers can extend their payment terms further, but, even in these situations of extended credit for the buyer, the supplier still gets paid early, with the finance provider bridging this funding gap and earning some interest for this early payment service.

So, therefore, we achieve what is really a win-win situation, for both the buyer and the supplier. Arguably, it is also a win for the finance providers, too, as they are getting a good return on a low-risk asset class which is self-liquidating.

So the cash flow benefits of this supply chain finance model have really been reinforced during COVID-19, but, although I am convinced it will grow rapidly in 2021 and beyond, I would add a word of caution.

There have been a few isolated cases where some of the credit terms being applied are unnaturally long and where almost all supplier invoices are being paid early under the supply chain finance programmes.

That is kind of unbalanced, and in a few of these extreme cases this has resulted in credit agencies raising doubts when assessing the credit worthiness of big corporates since it is hard to get a clear view of the corporate's total liabilities. These credit agencies have therefore questioned whether these liabilities should actually be classified as bank borrowing instead of trade creditors.

So I would really emphasise the need for supply chain finance techniques should be put into practice with balance and with moderation, and, also, with proper accounting opinions on suitable balance sheet treatments. So those are just two of my personal predictions, but I do think the time is right for both these trends to take centre stage.

So, Christina, perhaps with these predictions we should meet at the same time next year to see if we were even close to being correct about our predictions.

Christina: Sounds good.

Marcus Hughes: So that is all for today. The Payments Podcast will be back soon with more insights into the fast-changing world of business payments. We do hope our listeners find this session useful.

It just remains for me to thank Christina very much indeed for being with us today and sharing her great thoughts and expertise.

Christina: Great. It was my pleasure, Marcus. Thank you for having me.