Conversations with folks within the cross-border payments space, inspiration and valued colleagues.

I have been having some fantastic conversations with folks within the cross-border payments space, including Xuno, Machnet, CFX Labs, friends and colleagues within the Nacha Payments Innovations Alliance, and fellow FX nerds Cole Augustine and Mark Ridley. They have all inspired me in various ways and I would like to share my thoughts and ideas.

The domestic sphere allows instant payments, RTP, FedNow, instant settlement, but at the cost of a greater degree of complexity. The cross-border and cross-currency spaces make that look easy by comparison. Instant payment systems have become a significant trend in the world of payments and financial technology, simplifying and accelerating domestic transactions.

Cross-border payments have long been plagued by inefficiencies, high costs, and inherent risks. These transactions typically involve multiple intermediaries located in different jurisdictions, and often rely on complex and expensive trusted relationships to compensate for the absence of a universally accepted settlement asset and consistent rules and governance.

Fellow payments nerds have been spitballing ideas for the last several years across various white papers and conferences regarding these issues, sharing a compelling vision for a multilateral platform that has the potential to revolutionize cross-border payments, including foreign exchange transactions, trade finance, treasury management, risk mitigation strategies, and broader financial contracting practices. These platforms’ vision hinge on harnessing cutting-edge technological innovations to achieve public policy objectives and address the longstanding challenges in cross-border finance.

FinTech’s ability to help drive innovation and technology has been apparent in multiple aspects, and would be highly applicable to cross-border or cross-currency payments:

Common Ledger: Implementing a shared, common ledger can serve as a unifying backbone for cross-border transactions. This ledger would enable the real-time tracking and validation of transactions, significantly reducing settlement times and the risk of errors or fraud. It would create a single source of truth that all parties can trust.

Smart Contracts: The use of smart contracts can automate and streamline various aspects of cross-border payments and financial contracts. These self-executing contracts can enforce predefined rules and conditions, reducing the need for manual intervention and the associated costs.

Encryption: Strong encryption technologies can enhance the security and privacy of cross-border transactions. By securing sensitive data and communications, encryption can bolster confidence in the system and reduce the risk of data breaches or unauthorized access.

The potential benefits:

Market Efficiency: By reducing friction and inefficiencies in cross-border transactions, a platform can significantly enhance market efficiency. Faster settlement times and reduced costs can benefit both businesses and individuals engaged in international commerce.

Transparency: A common ledger and smart contracts would promote transparency by providing real-time visibility into transactions. This transparency can deter fraudulent activities and improve overall trust in the system.

Reduced Compliance Costs: Automation and standardized processes can help in compliance with regulatory requirements, reducing compliance costs and streamlining processes for financial institutions and businesses.

Foreign Exchange (FX) Considerations: Cross-border transactions often involve multiple currencies, which can lead to foreign exchange complexities. Managing FX rates, fees, and transparency in pricing are essential to ensure fairness and accuracy in cross-border payments.

Settlement Mechanisms: The settlement of cross-border transactions can be intricate, involving multiple intermediaries, clearinghouses, and settlement systems. Ensuring the seamless and efficient settlement of funds is crucial to minimize delays and risks.

Risk Mitigation challenges:

Challenges around Sanctions Screening: Cross-border payments involve compliance with various international sanctions and regulations. Implementing effective sanctions screening processes is critical to avoid legal and financial risks associated with facilitating prohibited transactions.

Legal and Policy Challenges: Developing cross-border instant payment systems requires navigating a complex web of legal and policy considerations. This includes addressing issues related to data privacy, consumer protection, and international cooperation in financial regulation.

Standardizing ISO 20022: ISO 20022 is an international standard for financial messaging that aims to improve interoperability and data consistency in cross-border payments. Standardizing this format is essential for ensuring that different instant payment systems can communicate seamlessly, reducing errors and enhancing efficiency. We believe it's important to note that we have not yet begun to scratch the surface here.

Financial Inclusion: By lowering transaction costs and expanding access to cross-border financial services, this platform can contribute to greater financial inclusion, benefiting individuals and businesses in underserved regions. We can think of no better representation of the need for inclusion than the nexus of Diaspora and cross border payments.

Diaspora and cross-border payments are transactions that involve individuals or businesses sending money across international borders, often to support family members, invest in foreign markets, or facilitate global trade.

Despite advancements in financial technology, there are still several pain points and challenges associated with these types of transactions:

High Transaction Costs: One of the primary pain points is the high cost of cross-border payments. Traditional banks and money transfer operators often charge substantial fees for currency conversion and international transfers, reducing the amount of money that recipients ultimately receive.

Exchange Rate Volatility: Exchange rates can fluctuate significantly, affecting the amount received by the recipient. The lack of transparency in exchange rates and hidden markups by financial institutions can lead to unexpected losses.

Currency Conversion Hassles: Currency conversion can be complicated and costly. Individuals often must convert their money twice – once when sending and again when receiving – leading to additional fees and loss of value.

Lack of Transparency: Tying in with the above points, many individuals sending money abroad are unaware of the fees, exchange rates, and other costs associated with cross-border transfers. This lack of transparency can lead to dissatisfaction and mistrust.

Lengthy Processing Times: Cross-border transactions can take several days to clear and settle, leading to delays in receiving funds. This is especially problematic in emergency situations or for those who depend on timely remittances.

Limited Accessibility: In some regions, access to financial services, including international remittances, may be limited, particularly for those without a bank account. This can exclude a significant portion of the population from participating in the global economy.

Complex Regulatory Environment: Compliance with various international regulations and anti-money laundering (AML) and know your customer (KYC) requirements can make cross-border transactions cumbersome. Different countries may have different rules, making it challenging for financial institutions to navigate.

Fraud and Security Concerns: Fraudulent schemes targeting diaspora and cross-border payments are a concern. Individuals may fall victim to scams, and there's a need for robust security measures to protect both senders and recipients.

Limited Financial Inclusion: Some people in diaspora communities may not have access to formal financial services, making it difficult for them to send or receive money internationally. This contributes to financial exclusion.

Over Reliance on Traditional Providers: Many individuals still rely on traditional banks and money transfer companies for cross-border transactions, which may not offer the most competitive rates or convenient options.

Expanding instant payment systems to the cross-border and cross-currency space is a natural progression in the modernization of the financial industry. While it offers many benefits, such as increased speed and efficiency in global transactions, it also poses numerous challenges that need to be addressed collaboratively by industry stakeholders, regulators, and policymakers. Achieving a seamless, secure, and standardized cross-border instant payment system will likely be a key focus in the financial industry's ongoing efforts to modernize and improve global payments.

Efforts are ongoing to address these pain points. Fintech companies, digital wallets, and blockchain-based solutions are emerging as alternatives that aim to reduce costs, increase transparency, and expedite cross-border payments. Additionally, regulatory bodies are working to streamline international regulations and promote financial inclusion. However, resolving these challenges fully will require collaborative efforts between governments, financial institutions, technology providers, and international organizations to create a more efficient and accessible cross-border payments ecosystem.