UK can learn from others on payments architecture

The launch of the new payments platform in Australia promised to deliver real-time transactions and assist businesses in providing innovative new services, with a consumer focus at the heart of the reforms. However, lapses in information security, questions over governance and a range of other issues mean the revolution in payments that was envisaged has still to fully materialise.

In the US, the market is significantly larger and more complex and as a result reforms have been slower to develop, but recently-unveiled plans to develop a real-time 24/7 payment service represent an attempt to bring the country's payment systems into line with the requirements of the digital age. With a heavy emphasis on industry to drive change, there are questions over whether consumer interests will be side-tracked.

UK industry, regulators and policy makers should consider the initiatives in Australia and the US to deliver the world class infrastructure necessary to maintain the UK's position at the forefront of the payments world.

The UK's new payments architecture project

The new payments architecture (NPA) reforms promise an overhaul of the infrastructure currently used to support some of the UK's major payment systems, through which trillions of pounds' worth of payments are processed annually. New digital infrastructure is envisaged to support a future of real-time, 24/7 transactions and innovative new features.

More specifically, the aims of the project include:

• the merger of three separate UK payment systems – Faster Payments, Bacs and potentially cheques – into a single clearing and settlement system;
• the upgrade of the clearing and settlement system to provide for real-time and bulk payments on a single platform;
• the development of individual consumer- and business-focused tools such as 'Request to Pay', and 'Confirmation of Payee'

The NPA project emerged from a strategy paper published in November 2016 by the Payment Strategy Forum, and the plans were endorsed by the Payment Systems Regulator. Subsequently, Pay.UK, the body tasked with designing and implementing the NPA, has opened a procurement exercise to find a provider to deliver the NPA.

The procurement prospectus stresses that the clearing and settlement system will be a 'layer' of the NPA, not its entirety. It indicates that this layer should be designed to "flex and accommodate future volume changes that arise as a result of the ‘internet of things’, PSD2, interoperability demands, the predicted consolidated traffic of Bacs and, potentially, cheque payments".

The prospectus further states that the NPA's design "should be: flexible so it can incorporate new thinking in payments services; a platform for innovation and competition in the UK payments ecosystem; and capable of supporting different end user propositions’ outcomes".

The UK's existing payments architecture is currently directly accessible to only a small number of banks and non-bank financial institutions, but the intention is clearly to catalyse innovation by merging the 'core' functions into a single operation and allowing greater freedom to 'plug in' at either end of the payments flow. This mimics the policy behind the EU's second Payments Services Directive (PSD2), which has been moderately impactful so far and which still leaves ample opportunity for innovation and growth.

The timescale for the development of the NPA currently runs well into the next decade. As such, the UK falls behind some other advanced economies in this regard, although the existing Faster Payments system is accessible to non-bank and e-money financial institutions following the implementation of the Payment Services Regulations 2017. It processed 218.5 million transactions in July 2019, worth £179 billion. This is an indication of the relative advancement of the UK's existing payments architecture, but also of the demand for sophisticated payments solutions – the value of real-time payments increased by 19% from July 2018.

Australia's new payments platform

In Australia, the New Payments Platform (NPP) was launched in February 2018. The NPP was developed by a consortium of 13 financial institutions including the Reserve Bank of Australia, with the aim of enabling real-time settlement of transactions between those institutions, the benefits of which could then be passed on to businesses and consumers. In addition, it provides 24/7 service, allows fuller remittance information to accompany payments and allows payments to be directed to email addresses or mobile numbers rather than traditional bank account details, which can require those making payments to enter up to 15-digit numbers.

Like the NPA, the NPP has already made provision for 'overlay services'. The first of these – 'Osko' – was developed by BPAY to enable push payments accompanied by up to 280 characters of data.

Although the NPP has been operational for 18 months, the Reserve Bank of Australia (RBA) voiced a range of concerns following its recent consultation. These include:

• delays in the rollout of the NPP by financial institutions to their account-holders;
• delays in the development of any overlay services in addition to Osko – the RBA explained its assumption that member institutions would respond to commercial and competitive pressures to develop and provide additional services to their account-holders;
• the difficulty for non-bank institutions, such as fintechs, in meeting the eligibility criteria for NPP membership – the necessary authorised deposit-taking institution (ADI) licence involves extensive prudential controls which are more demanding than those required of participants in other Australian payment systems;
• the commercial difficulties faced by non-NPP members who wish to develop overlay services but cannot access transaction data and who must therefore negotiate with each member individually to offer their services to end users;
• that the API framework which the members have so far developed is not available for third parties, such as fintechs, to use to provide services, such as those services facilitated by PSD2 in the EU.

Criticism of the NPP can largely be attributed to its consortium nature. There is a view that having 13 founding members with powers of influence creates adverse incentives, which may be stifling the full potential for innovation and especially competition.

Those concerns are particularly prevalent in the context of access to the NPP, as this can only be achieved through membership or by a negotiated contractual relationship with an existing member. Critics of this position argue that fintechs which cannot meet the demanding eligibility requirements must compromise on their competitive advantage, giving at least one financial institution access to proprietary data and operating without access to the transaction data from which the 13 members benefit.

Despite these concerns, the NPP is processing about 600,000 payments daily, worth an average of AUS$500 million ($306m).

The US 'FedNow' initiative

On 5 August 2019, the US Federal Reserve (the Fed) announced its plans to develop a real-time 24/7 payment service, ready for launch in 2023-24. This follows extensive consultation which began in 2013.

The new service will be available for payments and settlements by the 3,000 banks across the US, and falls within the Fed's mandate to provide interbank settlement services without introducing liquidity or credit risks.

In the foreground, FedNow will enable a range of 'auxiliary' payment services to be provided to end users by banks or other payment providers. In the background, liquidity management tools will be developed to alleviate the stresses of real-time gross settlement systems. This is a much more significant task in the US, given the vast number of banks as compared to the UK and Australia.

Notably, the Fed is keen for its service to exist alongside multiple private-sector real-time settlement services, in order to encourage competition and innovation and reduce the likelihood of a single point of failure. But as the 12 Federal Reserve banks are the major source of liquidity and transaction volume, the new system will rely upon them being willing to participate in this public-sector service as well their own private-sector systems.

In its public consultation, the issue of interoperability was raised. Whilst many participants were in favour of the Fed playing a role in facilitating interoperability between real-time gross settlement services, larger banks expressed significant concerns about the technical and operational challenges which this would pose.

Concerns similar to those raised in the Australian NPP consultation were raised by non-owner banks – those which are not Reserve banks and so would not be the 'owners' of FedNow. Specific issues include exclusion from the governance processes which determine access and pricing, and the need to expose proprietary data to their Reserve bank competitors.

The Fed addressed the issue of whether the "inherently risk-free nature" of deposits with the Federal Reserve would have an impact on the competitive landscape of payments services. It responded, however, with the argument that the reduction in prefunding liquidity which a 24/7 service would allow will directly benefit the balance sheets of banks which offer competing payment services.

Although the Fed is dealing with a vastly different payments infrastructure, the Fed may be able to draw on some of the experiences in Australia and the UK's proposals.  In particular:

• the provision of a service by a core group of members to a wider ecosystem may produce adverse incentives which stifle competition and therefore innovation;
• reducing the barriers to access increases competition, and may be possible at minimal risk due to the Fed's second function as the proprietor of the US Reserve;
• applying traditional risk-based thinking to the core of clearing and settlement services, and mandating competition and end user access to a wider range of commercial entities – whether through 'auxiliary' or 'overlaying' services – may allow a diversified range of services without compromising on the integrity of the core service.

Lauren McCarthy and Rory Copeland are experts in payments at Pinsent Masons, the law firm behind Out-Law.