Chapter Six

The Movement of Money

IN THIS CHAPTER, we look at the various forms of money and the methods in which money can be moved within a city, country, and internationally. We review some of the global payment systems in vogue and explore China as a case study of great improvement in the payments space.

MONEY TRANSFER MECHANISMS

Various methods have been used to move money over time, and different countries, depending on their state of evolution, use combinations of methods. Figure 6.1 shows some of these mechanisms for money transfer. These are:

FIGURE 6.1 Mechanisms of Money Transfer

• Currency notes and coins
• Cheques and drafts
• Cards
• Bills and negotiable instruments
• Electronic funds transfer

Bills are covered in more detail in Chapter 14. The other mechanisms are covered here.

Currency Notes and Coins

One of the earliest forms of exchange of value, currency notes and coins are still used for corporate transactions in many parts of the world. One of the benefits of using cash is that credit risk is eliminated, as is possible float—the cash is available in physical form and can be used immediately. However, some of the reasons for the reduced popularity of physical currency and hence for its being replaced as a transfer mechanism are:

• Loss of value (interest)
• Incremental operational issues
• Movement across a geography
• Only used for local currency settlements
• Storage
• Reconciliation/counting
• Security while in transit and in storage

Cheques and Drafts

Cheques and drafts, issued in paper form, are one of the most common forms of payment. These need to be presented physically and in most cases need to travel physically to the location where they go through a presentation or clearing process for purposes of settlement.

Different types of cheques are depicted in Figure 6.2. Cheques may be distinguished by the paying entity—the payer of the funds, the payer’s bank, or a third party, which could be the correspondent bank of the payer’s bank, generally a participant in clearing in the currency or location where payment is desired. Cheques can also be distinguished by location of payment; either they can be presented in a specific location, or they can be payable at par across locations. Finally, cheques may be distinguished by the time at which the payer’s account is actually debited—at the time of instrument issuance (usually the case when the payer of the draft is the bank) or at the time of instrument presentation and clearing, as is the case with most ordinary cheques.

FIGURE 6.2 Types of Cheques

Figure 6.3 shows the typical process for clearing of ordinary cheques through the banking system and clearinghouse, which in most cases is run by the central bank or a nominated bank usually from the public sector.

FIGURE 6.3 Typical Clearing Process for Cheques

Cards

Cards (electronic charge, debit, or credit) are finding increasing use in the corporate world. Cards are virtual or physical devices that involve the use of a specific card number along with a verification tag for authenticity. The verification tag could be:

• Physical (chip or magnetic strip)
• Data, such as a verification code printed on the card
• Signature and photograph, as established on the card itself
• Password, which could be generated at the time of the transaction or a standard

Credit cards are those in which the card issuer takes on a specific credit risk of the card holder, which allows the card holder to transact or purchase goods or services at a merchant site (either online or physically), and make the payment to the card issuer at a later time. Credit cards also allow for delayed payment of card dues, subject to some minimum servicing, on which interest is levied.

Debit cards are cards that provide, like an automated teller machine (ATM) card, debit access to the card holder’s account at the time of the transaction, reducing credit risk for the issuing bank and potentially cost for the card holder while reducing opportunity of using the funds for an extended period.

Charge cards are typically like credit cards, except that the credit period is fixed (within the month), and late payments are treated similar to a default, resulting in severe late fees and restrictions on card use.

Figure 6.4 shows a sample settlement process where the card issuer and the merchant’s acquirer (acquiring bank) are both banks, and the cards are issued for networks provided by corporations such as Visa or MasterCard.

FIGURE 6.4 Typical Card Settlement Process

Electronic Funds Transfer

Electronic funds transfers, both domestic and international, are important aspects of any corporate’s funding and operations. These transfers may be either domestic, which involves payments and settlements in the same country, or international, which requires flows of money across borders.

The next part of this chapter describes some of the elements of domestic payments, followed by the international payments aspects. Table 6.1 summarises the various benefits and disadvantages of common payment mechanisms. Here, Push refers to the payment being initiated by the entity making the payment, pushing the payment to the beneficiary. Pull refers to the act of initiation by the beneficiary.

TABLE 6.1 Snapshot of Common Payment Mechanisms

DOMESTIC CLEARING AND SETTLEMENT SYSTEMS

Domestic electronic funds transfers cater to quick and efficient payments usually in the local currency. These transfers typically are divided into two processes in most locations, based on the size of each transaction: high-value transfers and ordinary-value payments.

In this section, we discuss the mechanics of both types of payments and run through some of the systems across various countries.

I get asked this question: “What is the difference between clearing and settlement?” Indeed these terms are generally used (incorrectly) interchangeably or together. The note below provides a brief answer to this question.

High-Value Payments

High-value payments use the same real-time gross settlement (RTGS) concept across various countries. Each of the characteristics of the RTGS systems is important. The payments are real time, which means that they come into effect as soon as they are processed, not in batches but immediately. The settlement happens in a gross manner (not in a net or consolidated manner). This means that if A has to pay B 100, and B has to pay A 60, two separate settlements (100 from A to B and 60 from B to A) happen, instead of a single net payment of 40 from A to B.

In most instances of RTGS implementation, the central bank acts as the principal host for operations (see the note titled “Role of the Central Bank in Clearing”). Figure 6.5 shows the typical operations for an RTGS system.

FIGURE 6.5 Typical RTGS Operation

Bilateral settlement occurs instantaneously through the settlements account with the clearing agent, usually the central bank. Intraday positions are covered by banks through credit facilities with the central bank that are typically collateralised.

Ordinary (Low-Value) Payments

Ordinary or low-value payment systems are used for high-volume payments of identical nature that require bulk processing, such as retail payments. Low-value payments usually run off the backbone of RTGS for interbank settlements and are processed in batches to enable more efficient time windows and consolidation of payments. Figure 6.6 shows a typical operation for ordinary payments. The payment system in the United States, referred to as an automated clearinghouse (ACH), has set the trend that many other clearinghouses follow.

FIGURE 6.6 Ordinary Value Payments (ACH Model)

Low-value payment systems can be used, depending on the country of operation, for ATM and retail settlements and also direct debits, which are payee-initiated pull transactions with prior authorisation by the payer (see Figure 6.7).

FIGURE 6.7 Direct Debit Mechanism (ACH Model)

The ACH or ordinary payments model is a more-cost effective solution than RTGS since the transaction cost is divided across multiple payments.

We now provide a short note on key operational aspects of payments that should be kept in mind.

The note below introduces the core principles for payment systems, an interesting concept that is bound to evolve as payment systems and mechanisms themselves undergo transformation.

We now explore the advent of state-of-the-art payment infrastructure in one of the largest economies in the world: China.

CASE STUDY: PAYMENTS IN CHINA

China has made much progress in developing its payments and settlement systems. The People’s Bank of China (PBOC) and other regulators and market participants have made some fantastic progress in the development of payment mechanisms in a nation of extreme geographic dispersion and technological and communication disparity. While currency notes are still common for local payments, and paper-based instruments are still in wide use, the PBOC’s efforts to increase electronic and paperless forms of payments have increased quite dramatically.

What make this progress even more inspiring are the pace and the scale of their development and operations. The opening up and creation of payments infrastructure is a model for any large country seeking to increase efficiencies and scales of their payment systems.

Figure 6.8 shows the current state of the payments systems in the People’s Republic.

FIGURE 6.8 Payments Systems in China

Source: International Monetary Fund Country Report 12/81 (April 2012)

The PBOC has carried out significant reform of the China National Payments System (CNPS). Some of the components of the CNPS are:

• China National Advanced Payment System (CNAPS)
• Automated clearinghouses
• China Union Pay (CUP)
• Cheque imaging systems (CIS)
• Foreign currency clearing and settlement systems

CNAPS

CNAPS is a nationwide electronic clearing system set up for both intracity and cross-city RMB payment clearing and is administrated by PBOC. It provides payment clearing services for commercial banks, clearing organisations, and other Treasury or financial institutions. Settlements amongst participants are done through their accounts with PBOC. CNAPS comprises of the High-Value Payment System (HVPS) for large-value transactions and the Bulk Electronic Payment System (BEPS) for ordinary clearing.

High Value Payment System

The HVPS is the RTGS module of CNAPS primarily for large-value or higher time efficient RMB interbank funds transfers. It uses message-based payment instruction for instantaneous and irrevocable settlements.

The HVPS currently operates in a tiered way with multiple entry points for participants either directly or indirectly, backed by a central national processing centre (NPC) and 32 distributed local processing centres (LCPs). The HVPS is connected to other trading, payments, and securities settlement systems to enable automated settlements for central bank transfers. The HVPS has become the backbone of the national payments system in China.

Bulk Electronic Payment System

The BEPS is the netting settlement module of CNAPS used primarily for cost-efficient, high-volume interbank small-value credit and paperless debits. BEPS offers 24/7 batch-based transaction processing for market participants, supporting all payment instruments.

One of the highlights of the BEPS is the credit and liquidity risk management measures adopted:

• Access is provided only to institutions that meet the targeted risk profiles and specific requirements.
• The BEPS works off the HVPS framework; hence participants use their HVPS settlement accounts and have access to HVPS liquidity facilities.
• There is a fully collateralised net debit limit for direct participants.
• Participants are can adjust their debit limit by managing their funds or collateral provided.
• Multilateral offsetting mechanisms add to the efficiency of the clearing process.

The BEPS uses a queuing system and exercises adequate control over payment orders executed by participants, managing liquidity dynamically.

China Union Pay

CUP handles the clearing and settlement of card transactions whose balances are settled in the HVPS. The key components and processes are:

• Transmission of transaction authorisation orders
• Clearing infrastructure
• Rules and norms
• Pricing implementation
• Role of counterparty for all transactions in the settlement cycle

The member banks, which act as both acquirers and issuers, use internal payment card acquiring and issuing systems that are connected to the CUP’s own system. In some cases, CUP acts as an acquirer. Settlements happen on a multi-lateral net settlement basis in the HVPS system itself, on a T+1 basis. Participating banks either have settlement accounts with the PBOC directly or use a correspondent banking services of a bank that has such a settlement account. Importantly, the CUP provides settlement guarantees for all the transactions cleared through its system. To enable these guarantees, it operates a settlement reserve fund funded contributions from participants.

Cheque Imaging System (CIS)

The nationwide CIS system enables electronic exchange of cheque images, automated clearing of the exchange “paper” instruments, and multilateral net settlement of exchange instruments at the HVPS. Institutions that do not have direct access to the CIS (including rural financial institutions) can use bureau services offered by PBOC and many of the local clearinghouses and financial institutions.

The CIS is used primarily to clear and settle cross-region cheques and to support the 1,200+ local clearinghouses operating in China in handling local cheque clearing and settlement.

Foreign Currency Transactions

Many foreign exchange (FX) transactions are executed domestically at the China Foreign Exchange Trade Centre (CFETC). While most participants settle their transactions bilaterally, others use a net clearing model where the CFETC acts as the central counterparty. Settlement of the local currency leg occurs through the HVPS while the domestic settlement banks (which house participants’ FX accounts) handle the foreign currency leg.

The Foreign Currency Payment System (FCPS), an RTGS system, was created to handle clearing and settlement of domestic transactions in various foreign currencies.

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CROSS-BORDER PAYMENTS AND COLLECTIONS

In this section, we cover some of the key aspects of cross-border payments. We discuss the issues with electronic payments and communication, how they were resolved with the emergence of the SWIFT network, and conclude with an overview of how the continuous link system clearing system for foreign currency instruments increases efficiency and reduces risk.

Background: A Foreign Currency Remittance

A foreign currency remittance between buyers and sellers in different countries with the possible invoice and settlement in a currency different from that of either country can be a complex and time-consuming affair (see Figure 6.9).

FIGURE 6.9 Foreign Currency Payment

There are two critical aspects of such a transaction:

A few decades ago, telex messages with test words or test keys (Tested Telexes [TTs]) were transmitted that would reduce the first risk. There were not too many ways in which the second was reduced—hence banks would wait to sight the funds in their account prior to making the onward remittance. With time zones and manual processing, the delay in sending through the next leg of each remittance was fairly large, sometimes impacting the underlying trade transaction itself.

SWIFT

The advent of the Society for Worldwide Interbank Funds Transfer (SWIFT), a worldwide cooperative of the financial industry, changed the playing field. SWIFT put in place a secure, standardised messaging services network with interface software to connect banking systems.

The SWIFT network, which became operational in the 1970s, made three big differences in financial transfers:

Figure 6.10 shows how the SWIFT messaging network could reduce potential delay in the funds transfer process.

FIGURE 6.10 Simple Funds Transfer Using SWIFT

The SWIFT community today includes banks, broker-dealers, investment companies, and even corporates that are hopping on to the network. The market participant infrastructure covers:

• Payments
• Securities
• Trades
• Treasury
• Account information

Each member entity has a SWIFT code, and each of its branches or departments could have its own SWIFT code. This makes it easy for us to identify, say, the London Strand branch of Citibank or the Pudong commercial branch of the Overseas China Banking Corporation. The SWIFT code for the institution or entity is comprised of an alphanumeric code of 8 to 11 characters (with the last three characters being made up of X’s in case the length is under 11). Any SWIFT code can be represented by:

For example, CITIUSNY33 or CITIUSNY33XXX depicts Citibank (CITI, which is common to all branches of Citibank), in the United States (US is the standard ISO two-letter mnemonic for the United States; every country has a two-letter mnemonic), New York branch 33 (NY33 for the specific code for Citibank New York).

The SWIFT network allows for transmitting different types of messages (Message Type [MT]) with each message type having its own purpose. The nomenclature format for the Message Types is MT$##, where $ is the number denoting the broad category (see Table 6.2) and ## is the two-digit number indicating the type of message within that category. Each message is structured with headers, message body text, and trailers that are standardised across the financial world.

TABLE 6.2 SWIFT Message Categories

Source: SWIFT

Another variation, SWIFT Net File Act, was introduced to enable users to send files containing many financial messages and large reports in standard formats with local language capabilities; it enables high-volume automated processing. SWIFT has also developed a next-generation standard called MX that uses an Extended Markup Language (XML) format based on the International Organization for Standardization (ISO) standard 20022.

Overview of SWIFT Message Types1

Table 6.2 provides the broad categories of SWIFT MT messages. For example, category 1 (MT1##) represents any customer payment messages, MT7## represent trade and documentary credit or guarantee-related messages.

Table 6.3 describes many Category 1 (customer payment) MTs.

TABLE 6.3 SWIFT Message Types: Customer Payments

Source: SWIFT

Table 6.4 shows the format or structure of a typical MT103 message. As can be seen, each field tag has a specific purpose, and the automation is assisted by reading the tag of the field, immediately using the ensuing data items to mean the items referred to in the field tag. Each tag is preceded by a colon (:) to enable easy identification.

TABLE 6.4 MT103: Message Format or Structure

Source: SWIFT

MT9 is used for cash management and status messages. Various MT9 items are provided in Table 6.5.

TABLE 6.5 SWIFT MT9: Cash Management/Status

Source: SWIFT

Finally, we look at the various elements of a 90 series of MT message. The 90 series of MTs—for example, MT191, MT 799—have a specific purpose within each category, usually for advices or queries. Table 6.6 shows the relevant purpose of each 90 type of message. The letter n before each number in the message type is the message category—for example, for advice of charges for customer payments, the MT190 message will be used.

TABLE 6.6 SWIFT Message Types: Category MTn9#

Source: SWIFT

The use of SWIFT has now become universal—yet, the degree of automation implies that incorrect or inadequate information might lead to delay in processing. The following note explains why.

SWIFT Corporate: Standardised Gateway

SWIFT Corporate Solutions offers corporates the opportunity to achieve a single standardised gateway of payments. Historically, owing to the costs involved of setting up SWIFT and being a member-participant, and the scales of corporate compared to banks, corporates used the bank route to send SWIFT messages, outsourcing this activity to the banks.

With increasing efficiency and thereby lower cost of automation, and payment scales for large global companies increasing with geographical diversity and depth, as well as increased globalisation of suppliers, operations, and customers, corporates are increasingly joining the SWIFT platform.

Next we present a brief note on the corporate programme of SWIFT and some of its aspects.

SWIFT for Corporates

SWIFT expanded its community in 1998 for corporations. SWIFT for Corporates is an industry solution that extends SWIFT from its original space between its members and their market infrastructures, toward the space between its members and their end-user corporate community.

While the early adapters included large corporates, SWIFT for Corporates continues to g ain acceptance by mid-cap corporates. These seek to utilise standardised file formats (e.g., XML-based ISO 20022 and consistent usage of FIN) to promote straight-through processing and ease integration with Enterprise Resource Planning (ERP) systems and Treasury Workstation(s).

The current economic situation urges corporates to reconsider their cash management operations and focus on more efficiency and STP, cost reduction, risk spreading (rather than account consolidation), immediate visibility, and more accurate forecasting of their cash positions. The changing banking environment requires a corporate to better manage its banking relationships and integrate with new and/or other banking applications quickly and easily.

By giving corporations access to SWIFT, banks offer them the means to achieve these goals. Testimonials of the first corporates that joined prove that all their expectations are met.

The value of SWIFT for corporate treasuries is summarised in Figure 6.11.

FIGURE 6.11 Value of SWIFT and Priority on Treasury Projects

SWIFT’s Messaging Services

SWIFTNet offers different data transfer mechanisms, called messaging services, which define how the information is exchanged between two parties, for example, a corporate and a financial institution as shown in Figure 6.12.

FIGURE 6.12 Corporate-Bank Interface

• FIN: a message transfer–based store-and-forward system. FIN is the main messaging mechanism used today on SWIFTNet and is used by corporates for liquidity and risk management purposes. For example, corporates can:
  • send Treasury payments, such as MT 101
  • receive intraday/end of day statements and credit/debit advices, such as MT 940
  • exchange FX/interest rate/money market deal confirmations, such as MT 300
  • exchange trade data on letters of credit and guarantees with an MT 798
  • send instructions to deliver/receive securities, and receive statements of holdings
• FileAct: a secure, reliable, and flexible file transfer system. It is suitable for batched messages or large reports and is typically used to send mass payments, such as disbursements, collections, and payroll, irrespective of the format and/or syntax (XML, EDIFACT, domestic, proprietary, JPEG, PDF,. . .).
• InterAct: a secure, reliable, query/response-based messaging application, oriented to straight through processing, using new Standards XML messages. Suitable for single messages and short reports such as Exceptions & Investigations.

At this stage, FIN and FileAct are the two main messaging services used by financial institutions to deliver their services to their corporate customers.

SWIFT’s Connectivity Models

In addition to providing banking services over SWIFT, banks may offer support in connecting to SWIFTNet. There are several options in terms of technical setup:

• Alliance Lite offers connectivity to clients with lower volumes. Lite is aimed to realise a quick time-to-market for SWIFT message types.
• In a Shared Infrastructure model, a third party offers an infrastructure that corporations share with other users, to indirectly connect to SWIFT. Banks may in that case provide a complete package, including connectivity, registration and administration, billing, etc. . ..
• A corporate may also acquire and operate its own infrastructure to connect to the SWIFT network and to exchange data with its financial institutions (“direct connectivity”).

Connecting via SWIFT

SWIFT offers corporations three access model(s): SCORE (Standardised Corporate Environment), TRCO (Treasury Counterparty), or MA-CUG (Member Administered Closed User Group).

A SCORE member has access to all financial institutions that are registered in SCORE, a standardised, SWIFT administered environment with a limited set of well-defined messages (Figure 6.13).

FIGURE 6.13 SCORE Model for Corporate Messaging

A Treasury Counterparty can exchange all FIN Category 3 messages (i.e. Treasury deal confirmations), and only these messages, with any financial institution on the SWIFT network.

Alternatively, a corporate may subscribe to one or more of its banks’ MA-CUGs. That allows it to communicate with these bank(s), and only these banks, under the rules that are set by the bank for its MA-CUG (Figure 6.14).

FIGURE 6.14 MA-CUG Model for Corporate Messaging

In any of the models, traffic between banks and corporates is allowed. Traffic between corporates is never allowed.

Standardising Banking Services with SWIFT

Financial instructions are exchanged over SWIFTNet in a standardised format. It allows any SWIFT participant to automate its services and build applications that communicate without manual intervention, i.e., full STP.

Contributed by Carlo Palmers, Corporate Market Solution manager, SWIFT

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Local FX Clearing

If a cheque payable in a foreign currency is presented in another country, the usual process is for the cheque to be couriered physically to the country of issue by the payee’s bank, handled by the correspondent bank of the payee’s bank, and cleared, with funds credited to the account of the payee bank in the clearing currency (foreign currency for the payee bank). Only on sight of the funds does the payee’s bank credit the payee’s account. Because this process could take weeks, some countries, such as Singapore and Hong Kong, have put in place processes to clear foreign currency (USD) transactions locally (i.e., within the respective cities).

Continuous Link System

The continuous link system (CLS) is the process by which many of the world’s largest financial institutions settle FX between themselves. The process is managed by the CLS Group and its subsidiaries including CLS Bank International, which is regulated by the Federal Reserve Bank. The CLS system uses a payment versus payment (PvP) process that eliminates settlement risk and matches FX trades across 17 currencies around the world. Settlement generally takes place during a five-hour time window when most international RTGS systems are operational and hence able to make and receive payments. One of the biggest advantages of the CLS system is the reduced settlement risk owing to the parties facing the CLS system directly instead of each other.

The CLS system provides the incremental flexibility of multilateral netting of all obligations per value date and provides support across instruments: FX spot, deliverable and nondeliverable forwards, options, swaps, and credit derivatives.

SUMMARY

In this chapter, we looked at various methods of moving money within a country and around the world. Local payment systems were examined in detail, and payments systems in China were explored as a case study of successful evolution of systems. We also explored the advent of SWIFT and CLS and how increased security and authentication is enabling the seamless and more efficient delivery of payments around the world.

1 The standards provided in this section are based on SWIFT Standards information, the permitted use of which is governed by the SWIFT Standards intellectual property rights (IPR) policy in effect at the time, available on www.swift.com/about_swift/legal/swiftstandards_ipr_policy.page