Payments are undergoing a steep evolution, and a holistic approach to the field spanning a variety of technology types will benefit banks and corporate treasurers alike.
A report published last month by BNY Mellon, A Spotlight on Digital Currencies, takes a dive into one, specific technology area with significant, transformative potential.
In this piece, Todd McDonald, chief product officer and co-founder of DLT-powered enterprise software platform R3, gives his view of the implications.
First, though, let’s examine what the Spotlight report says about how digital currencies are set to reshape liquidity management in the payments arena, and what that will mean for the working relationship between corporate treasurers and banks.
BNY Mellon foresees a world in which transactions will be increasingly carried out through digital tokens, rather than fiat money (ie currency not backed by a commodity, such as gold). And the primary effect of that shift will be a major ramping up of speed in financial activity.
Although most treasurers will have long-dated forwards and swaps, many transactions in cash, securities and FX markets currently settle on a T+2 basis, with the time lag allowing treasurers time to either:
a) collect or move money to ensure funds are available for payment; or
b) to invest the money for a short term to maximise yield.
“As that begins gradually to change to an instant-payment model through the use of digital tokens,” it points out, “cash will instead debit on a T-instant real-time basis. Organisations will therefore have to fundamentally change their approach to intraday liquidity management and optimisation.”
Beneficiaries, the report notes, will receive the cash straight away. However, the originator – used to having the cash available for an additional period as a result of longer settlement times – will be required to factor in the need for the availability of money there and then.
“For example,” it explains, “many US bank treasurers currently manage their intraday liquidity using their intraday Fed overdrafts, holding back payments and waiting for new payments to come in to keep overdrawn positions to an absolute minimum.
“If service-level agreements (SLAs) are instant, treasurers will need to factor this in and potentially rely on a different way to manage their payments and intraday liquidity.”
As a consequence of this new environment, there will no longer be a logical ‘end of day’. Settlement will be occurring 24 hours a day, 365 days a year – with different deadlines to meet in different countries.
With that in mind, treasurers will need to ensure that accounts are not underfunded. Funding requirements, the Spotlight report notes, will naturally depend on each specific use case and the nature of the transaction – for example, is it an FX swap, or a tokenised asset settlement?
In this world of real-time liquidity management and forecasting, the report stresses, having a dependable partner institution will be key for many organisations – whether corporates, or financial institutions themselves.
It explains: “A provider is needed that can not only act as a gateway to digital payments – including providing tokens and settling on a third party’s behalf – but also with which a robust relationship is in place that enables effective liquidity support, when and if required.”
As such, banks “will need to ensure clients are positioned to manage liquidity more efficiently and effectively, delivering intraday liquidity options should scenarios arise in which money to pay for an instant transaction is not instantly accessible.”
In the report’s judgement, the technological advances that will emerge from these shifts will ultimately spur the introduction of liquidity models and products “that no one has as yet thought of”.
The report also notes that banks may have to alter the way in which they manage their own intraday liquidity to enable clients to make T-instant payments. Steps they will need to factor in include ensuring that:
1. they are liquid enough;
2. they employ efficient, cutting-edge systems to avoid instances of trapped liquidity; and
3. they work closely with clients to fully align time frames for when liquidity is required.
If the cash is not available precisely on schedule, the report warns, the trade will fail.
It adds: “Real-time liquidity could also [introduce] changes to the way in which interest is calculated, as well as ways to consolidate cash and maximise its value once it has been received into an account.
Enterprise software provider R3’s core technology is Corda – a tool perched on the leading edge of the DLT ecosystem of which digital currencies are part. Given the firm’s vantage point on this terrain, The Treasurer asked its chief product officer and co-founder, Todd McDonald, for his view on BNY Mellon’s report and the wider implications of its argument.
What is your overall reaction to the report’s assessment of how digital currencies could affect liquidity management?
Payments are part of a much larger ecosystem of interconnected financial markets processes. As such, transitioning to T-instant payments would significantly impact other parts of market structure – such as liquidity management, as the report suggests.
With the emergence of purpose-built enterprise blockchain platforms, the technology now exists to support real-time payments and payments on ledger. But any changes to such an important financial process must be given careful and detailed consideration, in close collaboration with the regulatory community in particular.
Which measures will banks and their corporate clients have to implement to ensure they can harness the benefits the report highlights?
Any institution deploying blockchain must focus on applying the key benefits of this technology in a way that is safe, regulated and achievable within the near future.
In practical terms, what this means is seeking blockchain platforms that integrate seamlessly with the existing internal and external infrastructure that enables banks and corporates to operate in this complex and highly regulated market.
It also means being on the lookout for other complementary applications and solutions also being built out on blockchain networks.
What sort of role would fintech providers have in this dynamic – and how could this new era benefit not just banks and corporate clients, but the fintech industry, too?
Purpose-built enterprise blockchain platforms like Corda can form the bridge that connects the new world of decentralised finance and traditional, centralised finance.
As these worlds edge closer together, fintech providers will play a critical role in ensuring existing and new technologies work efficiently and effectively in tandem.
The report talks a lot about the potential benefits of digital currencies being more integrated with liquidity management – but not so much about risks. Given the volatility of some digital currencies, which sort of risk factors should banks and their corporate clients watch out for in this context?
The question of digital assets replacing traditional cash is no longer if, but when.
However, as money goes digital, two common denominators for any digital currency are privacy and stability – any digital currency that fails to protect the data involved in a transfer of value will burn out as fast as it booms.
For banks and their clients, this means being judicious in assessing the different digital currencies that they use and implement, keeping privacy features and volatility at front of mind. The underlying architecture of the chosen system will ultimately inform its risk profile and longevity.
How should regulators approach this terrain to ensure continued innovation, rather than a chilling effect?
Regulators should seek to work in collaboration with industry players.
For example, in the case of CBDCs, collaboration between central banks and regulators and their foreign counterparts is key to enabling a more efficient, frictionless cross-border digital payments system.
This is by no means an easy task, but is essential to ensuring continued innovation of a standardised infrastructure for today’s interconnected – and increasingly complex and globalised – financial markets.
Read the full Spotlight report here.
Matt Packer is a freelance business, finance and leadership journalist