Part 1: Marcus Hughes chats to Christina Segal-Knowles, Executive Director for Financial Markets Infrastructure at the Bank of England about Payments in the current landscape. Touching on topics such as: How is the pandemic changing how consumers and businesses pay and get paid? What role does innovation play in financial stability? As well as, how likely new forms of cryptocurrency such as Stablecoin are to becoming mainstream payment systems, or not.

Listen to this in-depth two-part discussion around some of the most talked-about payment topics. This conversation will be featured in the forthcoming Outlook on 2021 book released by Bottomline featuring a number of other industry experts.

 

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Podcast transcript:

Marcus Hughes: Hello and welcome to this edition of The Payments Podcast. My name is Marcus Hughes, I am Head of Strategic Business Development at Bottomline and your host for today’s conversation. I’m delighted to be joined by a special guest from the Bank of England. I’m very pleased to welcome Christina Segal-Knowles, who is Executive Director for Financial Markets Infrastructure at the Bank of England. Welcome, Christina, and thank you for speaking with us today.

Christina: Thanks, Marcus. I’m really glad to be with you.

Marcus Hughes: Before we get into our questions, I’ll just set the scene. The way businesses and banks pay and get paid is changing rapidly. In fact, it’s no understatement to suggest that the payments industry is going through a period of unprecedented change and there are a range of dynamic factors which are driving this fast-moving situation. For example, we’ve got new regulations which encourage greater innovation and competition, there are new entrants in the market, such as challenger banks and non-bank fintechs, and we’ve got new compliance rules for anti-money laundering and fraud and financial crime prevention.

We’ve also got a wide range of new payment schemes, new payment instruments and formats, like open banking, Request to Pay, ISO 20022 and the rollout of real-time payment systems around the world. Of course, where would we be without technology, in particular, the adoption of cloud and the increasing use of APIs or application programme interfaces in the financial services sector. With so much change, there has never been a greater need for trusted advisers, who can make it easier and faster for banks and corporates to comply with these new requirements, whilst still getting maximum benefit from the exciting opportunities that are presented by these changes.

I’d now like to turn to Christina with a question. Given the extraordinary times we’re going through during COVID-19, what impact do you think the pandemic is having on the world of payments?

Christina: I think I’d start to answer that question by putting a bit into context where payments were going into the pandemic. I think the world of payments, as you know and as you alluded to you in your question, has been changing quite rapidly in recent years and we’ve seen a very significant increase, in particular, in the rise of payments using credit card, both in retail in-person and online, over the last several years. From 2017 to 2019, the number of people in the UK using cash less than once a month in the UK doubled to 7.4 million people. We’ve seen declining use of cash across a number of indicators and, at the same time, just an increased dependence on use of cards.

I think people will understand that. They see that in their everyday lives, the number of places that you can walk into a shop and tap your card, rather than providing cash has increased quite tangibly. I think it’s impacting many of us in the way that we personally choose to pay for retail transactions.

So, that was what was happening even before the pandemic. Then, you have the impact of the pandemic itself, which is something that, I think, also, is relatively intuitive. You have a combination of, in most countries, including the UK, you had temporary closure of shops and restaurants, which meant that people were turning, increasingly, to online shopping, so you had an even further bump-up in an already growing way that people were paying for their retail transactions. In April of 2020, online transactions increased to 30% of total retail transactions from just over 18% a year earlier.

Then, you also have the social norms and shops’ preferences and people’s preferences around use of cash changing as a result of perceptions around the virus, so that you have shops encouraging people to use contactless over cash and other forms of payments. I think all that has come together to see just a further acceleration, at least a temporary acceleration of the trend towards real reliance on electronic payments and a decline in the use of cash.

I don’t have any predictions of how permanent that will be, how it changes behaviour over time, but I think it’s very clear that over the last decade or so, the way that people have changed is dramatically. I think that regardless of the pandemic, the way that people pay for things is likely to continue to evolve in the years ahead. So, innovation is probably something that we’ll continue to see in future years.

Marcus Hughes: Thank you, Christina. Really interesting, of course. Perhaps I can just add a few comments on the impact of COVID-19 from the perspective of business payments. I think we’d all agree that the primary impact of COVID-19 on payments is that it’s accelerating digitisation. So, real-time information, digital payments, the API-driven exchange of data and electronic documents, such as e-invoicing, are all being adopted at a faster pace than ever before. The increasing acceptance that working from home is becoming the new norm is definitely bringing radical changes to the working lives of just, you know, financial decisionmakers and their teams and we’re all affected by this change, whether we work in banks, fintechs, corporate treasury, or accounts payable and accounts receivable departments.

Technology is a key enabler to making this new way of working easier and more secure. This changing world fits perfectly with the growing importance of mobile and easy access to cloud-based technology, but given the new home environment in which most of us now find ourselves, signing paper cheques or physically circulating paper invoices around the office, so they can get approved, that’s simply no longer practical, nor desirable.

So, the adoption of electronic payments and data exchange for e-invoices is now more compelling than ever, especially for personal safety and hygiene reasons. That’s in addition to the well-established benefits of lower costs, faster processing and reduced fraud. So, I think that digital signatures, multi-factor authentication, biometrics, configurable workflow for the preparation, and distribution and approval of payments and electronic documents, like e-invoices, is all going to become more important and ubiquitous.

During the pandemic, I think any treasury’s number one focus has been maintaining liquidity in order to meet a business’s ongoing financial obligations as they fall due. That means important activities like servicing debt, managing investments, settling expenses, of course, and paying employees and suppliers. The well-known expression, “Cash is king,” is proving more important during COVID-19 than at any other time, probably, in the last 30 years, even during the global financial crisis of 2008 to 2009. So, visibility of cash balances, liquidity management and effective cashflow forecasting across multiple bank accounts, they’re now all more essential to make any business efficient.

Now, let’s turn to discuss some of the unintended consequences of the increased competition and the emergence of new entrants in the payments landscape. It’s evident that each of these providers is typically playing an increasingly atomised role, often resulting in a large number of participants in the payment chain and each of them providing a specialist service to each other.

Many of us do, of course, strongly support new regulations, like open banking and PSD2, which were introduced to drive innovation and increased competition, but I do observe that a growing number of regulators, like the Bank of England, are increasingly concerned that some of the unintended consequences of these new regulations mean that a number of the organisations which are gaining importance in the payments chain are not as highly supervised as, say, commercial banks and traditional clearing and settlement mechanisms.

Having worked in a bank myself, in banking for many years, I’m very much aware that banks are heavily regulated and for good reason, of course. That’s why they have to support quite demanding capital, and liquidity ratios and other regulatory risk management requirements.

On the other hand, some of the non-bank fintechs, such as payment institutions and processes, they enjoy a much lighter regulatory and capital requirement. Yet, in some cases, these entities play a key role in payment chains and they’re supporting mission critical processes and functions, often with large volumes of transactions and involving many other financial institutions. Of course, any weak link in the chain can destruct that whole payment process and many other participants.

So, Christina, I’d like to ask you whether there is a case for levelling up or modifying the regulatory landscape or do fintechs and smaller digital banks still struggling to achieve profitability actually deserve a lighter-touch approach than the larger incumbent banks and clearing and settlement mechanisms? I expect there’s quite a hard balancing act somewhere within that conundrum.

Christina: Thanks, Marcus. I mean, I think taking a step back, I think it’s important, in thinking about that balance, I think it’s important to actually think about the role that innovation can play in supporting the bank’s objectives in financial stability. I think that helps to…

Then, also, thinking about what is the purpose of the regulation that we currently do provide in the payment space and also across the financial system. I think that helps you get to an answer that, actually, maybe isn’t so much a tension. I don't think and don’t accept that there’s necessarily the tension between having the right regulation and supporting innovation. I think they actually can be very consistent with each other.

I think that’s important because the bank supports innovation, including in the payments space, but right across the financial system. That’s not just because it’s good for consumers, it can be. It’s not just the case because it can support economic activity. That’s also a positive benefit, but I think it also can, if done properly, be a positive for our financial stability mandate. That’s because new alternative and new ways to pay can give people less dependence and less reliance on a single source and a single way to pay, which then could cause a financial stability problem if that single way to pay had an issue.

It can have other, sort of, knock-on benefits for other parts of the financial system as well, when you have more diversity in what’s offered to consumers in the way that they are making payments. I think that’s something that the bank very much supports. The bank also has been looking to support not just through its regulation, but also through the central infrastructure that the bank provides directly, where we’re undergoing a very significant project of RTGS renewal to support greater access, so to support the innovative new firms, as well as make sure that our central processing architecture is at a standard that supports innovation.

Then, turning to your question on regulation, to me, I think an important part of supporting innovation is ensuring, first of all, that regulation is clear upfront, you want firms to be able to develop, knowing what the rules of the road are going to be, and you want to make sure that you’re getting that regulation right, so that you don’t end up with a situation where something comes along, it’s a promising innovation, it doesn’t have the right regulatory structure and leads to a problem, whether that’s a financial stability problem, a problem for consumers, which can really set innovation back.

So, you want to have innovation that provides, sort of, the rules of the road, gives clear guidance to firms that allows them to develop based on certainty about how they’ll be regulated in future. That doesn’t mean, sort of, a one size fits all solution, but it does mean that you have innovation in place that gives people confidence.

I think that’s particularly important when it comes to payments. People need to be able to know that when they make a payment, it’s going to get to the intended recipient securely and on time. You don’t want to have a situation where people think, “Well, if I use this form of payment or that form of payment, it creates new risk for whether that payment is actually going to get made.” You don’t want merchants to have to evaluate the various cards that people could tap, the various apps that people could use on their phone and scrutinise them in terms of, “Is this really safe to accept that payment?” You want people to be able to use the main ways of payment available to them interchangeably and with confidence.

So, that doesn’t lead you necessarily to regulate all firms to the same degree. I think throughout financial system regulation and consistent with what we do with firms already, whether that’s in the payment space or the banking space, the risk, going back to that, sort of, purpose of the regulation, the purpose is to address the risks that the firm and the activity that the firm is doing poses to the wider financial system. That doesn’t necessarily lead you to think that every firm should be regulated in the exact same way based on what activity it’s doing.

Firms that are more systemic, that people are dependent on, and where there are not alternatives and that are involved in certain types of activities are going to pose a different risk than other firms that might have ready alternatives available.

I think that can lead you to a way of structuring your regulation that, really, is based in a principle which we call, “Same risk, same regulation,” in which you look not at the type of firm it is, not at its legal form, what technology it’s using, does it tick the box in this way or that way, but going back to your example in your question, you talked about the importance of these new payments chains, these new firms that are in a payments chain that could pose a risk to the entire chain.

I think the, “Same risk, same regulation,” principle gives you an advantage where you can take a step back and say, “Well, is that chain essential to financial stability? Is it essential… do the financial systems functionally depend on that payments chain?” That could be the people’s ability to pay in a shop, it could be people’s ability to receive their salary. How important is it that that payment be made in a timely way?

Then, look at the individual firms in that chain and think about, well, which ones are critical to that chain’s functioning? Which ones are easily substitutable? Not every firm in the chain would take out the entire chain or disrupt the payment if they had a disruption. Then, you can apply regulation based on that principle and get firms into the right level of regulation.

I think it's very important that we think about it in that way, rather than get pigeonholed into, sort of, it depends on whether you check the box of being this type of firm and payments or that type of firm. That will create an opportunity to really futureproof our regulation and also just provide much more clarity for firms and a level playing field, so you don’t end up with firms for relatively arbitrary reasons that are posing the same risk regulated in different ways, which won’t provide a good basis for competition, a good basis for innovation going forward.

Marcus Hughes: Christina, thank you for that really helpful viewpoint. “Same risk, same regulation,” that makes a lot of good sense to me. So, moving onto another hot topic, let’s talk about blockchain and cryptocurrencies, as well as the new kids on the block, stablecoin and central bank digital currencies.

So, as we know, over the last 8 to 10 years, there has been a lot of excitement and dare I even say hype about blockchain and crypto assets, but this phenomenon and its, kind of, underlying distributed ledger technology hasn’t yet really delivered on their potential. I admit there are perhaps a few exceptions, such as areas like trade and supply chain finance, where distributed ledger technology is being used to make it easier to track the provenance and the movement of merchandise and to exchange data that’s relating to ownership and trade finance documents, for example.

This complex process involves many participants, like exporters, importers, banks, and insurance providers and even transport companies. Their interaction with each other has historically been highly paper-intensive, but it’s very important to note that these new DLT-based trade finance platforms, you know, with names like Marco Polo, Contour and we.trade, they’re not using cryptocurrencies to pay for goods or to provide finance. Instead, they’re actually settling these transactions in traditional fiat currencies, like US dollars and euros.

When it comes to cryptocurrencies themselves, so far, they haven’t really lived up to the initial high expectations that they’d become an instant global payment instrument. Cryptocurrencies have, understandably, faced some resistance and regulatory concerns about anonymity and fears that they might be used for money laundering, terrorism, you know, and financial crime. So, other practical barriers to more widespread adoption of cryptocurrencies are things like scalability challenges. That’s typically due to crypto validation requirements, known typically as proof of work or mining, which can be quite slow and costly, especially when higher volumes of transactions are being processed.

So, meanwhile, the volatility of cryptocurrencies has meant that it’s way more popular as a speculative investment instrument, effectively, an unpredictable commodity, which goes up and down in value, not as a payment instrument. Recently, we’re now seeing the emergence of a new form of cryptocurrency, known as stablecoin. These new digital coins have potential to overcome those volatility issues of cryptocurrencies because they’re pegged 1:1, typically, against fiat currencies, such as they US dollar.

So, Christina, I see the Bank of England has been looking closely at stablecoin and there appear to be some concerns at the bank and other regulators to ensure that these new digital coins are properly supervised in a way that’s consistent with mainstream payment systems. Could you please explain this thinking and could you also comment on the work by the Bank of England in exploring the possible issuance of a central bank digital currency here in the UK?

Christina: So, thanks, Marcus. You did a really nice job in your introduction, actually, setting out the key, sort of, crux of the issue and why the Bank of England might be interested in stablecoins and might be concerned around their future regulation. I think this is true for central banks and other regulators globally.

The real issue here is, as you said, so far, we’ve seen cryptocurrencies not be taken up for significant use in payments and that’s really because people want to pay in a form that has a value that’s stable and predictable. You’ve seen this throughout history. When ways that people could pay are volatile, when there’s not assuredness around that value, they don’t ultimately… they tend to be unsuccessful, either unsuccessful in their take-up initially or people move away from them to have something that is going to provide that level of confidence.

Stablecoin is aiming to address that in the crypto asset space. So, given that their aim is to provide a stable value that could be more useful in payments and potentially become widespread in use of payments, they, going back to that principle that I was talking about in my earlier answer of, “Same risk, same regulation,” could start to pose the same risk to the economy as existing payment systems that are regulated, because if you’re able to use the stablecoin to pay for goods and services, to make your online purchases, if people start using them in the same way that they’re using existing payment systems, then logic suggests that if a stablecoin were to fail, then it would pose the same risk to the economy as if a traditional payment system were to fail.

Failure could come in different forms. It could be an operational or financial failure of the firm. It could also be that stablecoin goes from being something that’s very stable and people are willing to pay in to something that is very volatile and not really fit for purpose in use in payments. So, I think taking a step back and thinking about how do, again, we get into a world where we feel confident that our regulatory system delivers that principle of, “Same risk, same regulation,” we need to be thinking about stablecoins that are used widely in payments in the same way that we’re thinking about existing payment systems.

I think once you start thinking about it in that way, there’s a second piece to the, sort of, puzzle of regulating stablecoins, which is stablecoins are actually doing something that’s in addition to what existing payment systems do.

Existing payments firms, traditionally, are not issuing the money that is flowing through their chains. They are transferring either central bank money, so in the form of central bank reserves, or they’re transferring, effectively, deposits in people’s bank accounts, which can also be called commercial bank money. So, they’re transferring money that is creating by someone else and there’s regulation and protections in place to make sure both that the payment system that’s doing the transferring is safe and secure, but also the money flowing through that system and the ultimate settlement asset is going to be reliable and fit for purpose.

So, when you put those two things together, that leads you to two things that you’re going to need to do if you’re going to get to the point where stablecoin systems have that, “Same risk, same regulation,” principle met and the regulatory system delivers that, which is why, at the Bank of England, the Financial Policy Committee, which is our committee that is in charge of looking at financial stability risks across the financial system, has set out two key principles they want to see in the future regulation of stablecoin systems.

The first is, basically, just a longwinded way of restating that, “Same risk, same regulation,” principle, which is that payments chains that are using stablecoin should be regulated to the standards equivalent to those applied to traditional payments chains. So, “Same risk, same regulation,” firms that are in stable client-based payments chains that are critical to their functioning, those firms that I was talking about earlier that could just take out the entire chain and disrupt the way to pay, should be regulated accordingly.

So, it’s pretty common sense, but it’s providing a framework on which we can base a future regulatory system that brings them in and makes sure that we end up with a level playing field between stablecoins and other forms of payment systems.

Then, the second one is thinking about that issue of the money flowing through it and the fact that stablecoins are doing this thing that is additional to most payment systems. There, again, this is pretty logical based on we don’t want to introduce new risk, we don’t want to make payments less secure in the United Kingdom.

So, we’ve said where stablecoins are used in systemic payments chains as money-like instruments, so where they’re used in chains that are widely used, that are really important to the functioning of the financial system and the economy, they need to be standards equivalent to those expected of commercial bank money, the money that we’re using traditionally in existing payments chains, the money that gets transferred when you tap your card for a card transaction, the money that gets transferred in most bank-to-bank transactions.

It needs to meet those standards for commercial bank money in relation to the stability of its value, the robustness of the legal claim provided to the person holding that stablecoin and the ability to redeem at par in fiat. In other words, you know, one of the things that gives us confidence in our bank deposits and our willingness to take payment and card or bank transfer in the same way that we would accept cash is that we know that we can show up at our bank and exchange our bank… withdraw that bank deposit. In other words, exchange the bank deposit for cash and at any point.

We need to make sure that when you’re introducing new ways to pay, that you have that ability to convert it into cash. That will give you the confidence that it can be used interchangeably with other ways to pay.

I think the second part of your question was about CBDC, which, of course, is a different new form of electronic way to pay, which would be, basically, an ability to transfer and have an electronic form of central bank money. So, this could be used by households and businesses to make payments, it could be used interchangeably with cash and different from a stablecoin, rather than a private issuer, it would be issued by the Bank of England or other central banks.

We’re looking at this because CBDC could bring a number of benefits. It could provide additional access to central bank money. As we’ve seen that decline in cash, people may want to have an electronic form, ability to hold onto money issued by the central bank. It could also, like other forms of innovation, support resilience and competition in payments, because as I talked about at the beginning, it’s good to have multiple alternatives, that’s good resilience overall, but, also, we need to think a little bit more about and make sure that we’re able to understand broader implications for the financial system, which could include changes and challenges around monetary stability, financial stability.

So, we’re still in the mode of consultation and thinking about this. We think that there could be some real benefits, but we’re still in the consultative phases. We consulted in March 2020 on views on introducing a CBDC and we are planning on issuing a further discussion paper in coming months that will develop those points further, including in the context of how does that fit in with the stablecoins, the privately issued new digital currencies that I was just speaking about and how those two might operate alongside each other.

So, I think, overall, this is an important area to think about, again, when we’re thinking about how do you support innovation, how do you support reliability of payments and how do we make sure that we, as the Bank of England, are ready for the future of payments as that innovation continues.

Marcus Hughes: Christina, thank you for that really fascinating insight on stablecoin and, of course, central bank digital currencies, a great topic there. I saw the Bank of England’s latest financial stability report that was published just a few days ago. Are there any other big topics the report covers that you would like to highlight?

Christina: So, yes, so we published our Financial Stability Report just a few days ago and there was an entire chapter on stablecoins that goes over many of the points that I just highlighted. I think, beyond that, I think there were a number of things that may be of interest to readers, particularly in thinking about the readiness of the financial system in the context of the strains around coronavirus, in the context of preparedness for the UK’s exit from the European Union, that may be of particular interest to readers.

Marcus Hughes: Thank you, Christina. Looking at our agenda so far, we’ve discussed a range of exciting topics about the fast-changing landscape in payments. As we’ve got several other big questions to cover while we’re together, I suggest we maybe take a break here and then we’ll come back with a second podcast, in which we’ll cover some more hot topics, like modernising the UK and international payment systems, the impact of Brexit, of course, and even our predictions for 2021 and beyond. In the meantime, a big thank you to Christina for sharing her views with us today.

So, on that note, it’s a goodbye from me, Marcus Hughes. To our listeners, I’d say, simply, look out for the second part of this keynote conversation with Christina Segal-Knowles from the Bank of England on the Bottomline Payments Podcast. Thank you all and we’ll speak again soon.

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