The Evolving Payments Landscape: Will The South-South Trade Routes Transform Payment Services?

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1 In Conversation With The Evolving Payments Landscape: Will The South-South Trade Routes Transform Payment Services? Gareth Lodge, Celent Neil Burton, Earthport CELENT

2 In Conversation With The growth of southern hemisphere economies and trade along south-south routes is no longer news. However the nature of that trade, and its impact on the types of products and services that financial institutions need to provide, opens up opportunities for innovation. We ask who could lead this innovation?

3 From the Silk Road to the footpaths of today The term Silk Road describes the routes used in 1BC to connect the markets of Asia to the markets of Europe. This route was one of the busiest trade corridors in the ancient world. But with the rise of maritime exploration and trading, the route fell in importance in the 1400s, and so began the growth of maritime nations of the West. However, Asian economies are emerging again as key players on the global trade market and this renaissance of the Asian world is likely to flourish in the next few decades. As Karen Ward of HSBC predicted in The World in : By 2050, the emerging world will have increased five-fold and will be larger than the developed world..19 of the top 30 economies by GDP will be countries that we currently describe as emerging. In banking, that growth is very visible. Today, three of the top five banks in the world by market cap are Chinese. It is time for a major rethink about the world economy. We are embarking on an extraordinary new phase of economic development dominated by the new superpowers of Asia and the Southern hemisphere. For many people familiar with a US or European-dominated world, this is an uncomfortable idea. It is an idea, however, that we need to get used to. The trade routes are changing too. We are witnessing the formation of new south-south economic connections which will radically change the nature of global economic activity. And it is not only the routes which are shifting. In comparison with the internationalisation of trade which drove the globalisation of the banking industry in the 20 th century, the types of transactions and client expectations of the service providers are also changing. We need to validate whether our current products and services are suitable, and if not, act accordingly. 1. HSBC Report, The World in 2050 (January 2011) 2

4 From globalisation to localisation Debate at Sibos 2012 pointed at perhaps subtle, but nonetheless significant, shifts in demand. Whereas in developed economies, SMEs share of trade is diminishing, the opposite is true in Asia. Chinese SMEs account for 78% of Chinese exports. The United Nations World Investment Report 2 calculates that there are now around 21,500 multinationals based in the emerging world. In response to a question from the audience, panellists at one Sibos session argued strongly that there s still a place for structured financial products such as letters of credit; but in parallel we re also witnessing massive growth in open account. According to Boston Consulting Group, open account related financing and service revenues will grow by a near factor of 3 by Supply chains are also changing shape; the familiar long tail is getting fatter. A century ago, banks would typically follow the internationalisation programmes of their corporate clients, and hence build organisational and operational structures in multiple new countries to support the import of raw material and export of finished product. In effect, they were creating new siloes based on old siloes, based on traditional industries. Today, the world s biggest multinationals are becoming increasingly happy to do their research and development in emerging markets. Cisco is spending more than $1 billion on a second global headquarters Cisco East in Bangalore, now nearing completion. Even payments companies are following suit, the Singapore Visa office is now their second largest globally, since they closed down their London Visa Inc. office. 2. The United Nations World Investment Report 2012 unctad.org/en/publicationslibrary/wir2012_embargoed_en.pdf 3

5 Are current payment services fit for purpose? At Sibos 2004, Heidi Miller challenged the industry: Why do we seem to make our products so complex and difficult to use? How do we expect to help our customers become more efficient, when we are not efficient ourselves? Why is it that so many of the successful innovations in our industry are pioneered by non-banks? If the internet is ubiquitous and free, why should we pay SWIFT for messaging? The industry all nodded sagely in agreement, but what have we actually changed since then? That raises a very important question. If the industry, traditionally predominantly western banks, is raising these questions about services and systems that it owns and runs, are we confident that these payments services will continue to dominate? Or will the new trade routes facilitate the adoption of new methods? History has many examples of dominant incumbents not adapting to the new world quickly enough. Will the industry have its own Kodak moment? 4

6 The old new world or a new new world? Card based payments were invented in the 1950 s. Correspondent banking in its current automated form traces back to 1973, to the birth of SWIFT. SWIFT itself says in Corresponding Banking 3.0: This model is still too bank product-centric, based on inherently inefficient multiple agreements. The world has changed around us. A mobile payment via PayPal is simpler and faster than transferring money from one bank account to another. Today people have become used to a great deal of sophistication at their fingertips with companies such as Apple and Amazon being in a position to rival the payment services provided by banks. New corporate leaders are sourcing apps from developers in South East Asia, to whom they may be paying a few hundred dollars a time. In China over 5m people graduate every year and in India about 3m, respectively four times and three times the numbers a decade ago 3. So how can banks in developed economies, familiar with the requirements of their locally-hq d multi-nationals, ensure their relevance to the very different needs of the fast-growth markets? Will innovators along the fast-growth trade routes find a better way? A way unencumbered with the technology limitations and thinking that developed economies are built upon. 3. The Economist, The world turned upside down (April 2010) 5

7 Change doesn t happen overnight There is something of a conundrum; not much happens quickly in the world of payments. Small changes have little impact, until they have aggregated. To paraphrase Einstein insanity is doing the same thing over and over again and expecting different results. But at the same time, the changes have to be gradual accounting for the impact they will have on existing systems in the wider payment ecosystem. New entrants don t have those challenges. Networks that are decades old are being overtaken by systems born, in relative terms, only last week. For example, Paypal was derided as an upstart when it launched in March According to the EBay annual report for 2011, PayPal now has 106 million active registered accounts in 190 countries. In terms of innovation, there were over $4bn of transactions made on mobile at a time when many banks are still figuring out what they should do. The net total payment volume (TPV) grew 29% year over year to $118 billion, from which they generated $4bn in revenues. In 2010, 23% of the TPV was cross-border. The boards of many banks must wonder where and how they failed to spot and act on the opportunity. And this specific example has been discussed ad infinitum. 6

8 Regulating, or aiding and abetting? There are plenty of reasons for the slow reaction of financial services providers to these emerging payment trends in the industry. One less explored is that of the emerging role of regulators. With one regulator for every 300 people 4 employed in finance, the UK financial services sector is one of the heaviest regulated markets. As a result, UK financial institutions spend a significant share of their budgets and time addressing local regulatory demands. While protecting consumer rights in their local economies is essential, the heavy regulation of the financial sector doesn t encourage international trade. If the UK did not export financial services it would have to choose between having an overall deficit of over 70bn a year 5 (clearly unsustainable), radically reducing its imports or creating a new world class industry. Developing countries have been quick to realise the benefits from establishing regulatory frameworks designed to encourage growth and innovation. A straw poll of delegates at one Sibos 2012 session showed that, of six topics, reducing risk, fraud, legal and compliance costs was the top priority for delegates from EMEA and the Americas; and the lowest priority for delegates from South East Asia. International commerce is undeniably driven by demand; but equally the increasing ease of doing business plays a part too. As a result, existing payments systems are under growing pressure to conform to the demand of the regulators. But are the regulators asking what the user wants? Are they creating an increasingly large gap between what is required and what is actually being provided? 4. The Bank of England, Dog and the Frisbee speech at the Bank of England (August 2012) 5. Open Europe Report, Continental Shift: Safeguarding the UK s financial trade in a changing Europe 7

9 Experience proves we should begin by adopting the same standards Payments and collections are forms of settling a financial obligation between two parties. In mature markets, the assumption has been that if we can standardise the message in the middle between the two transactors, then both parties will know what information to put in and what information will come out. Certainly standards have brought great benefits; but standards are best when open and effective for all. The assumption that every party in every country needs or wants the same thing is flawed. By default standards are based on providing the lowest common denominator and assuming that all parties would be happy. However, this doesn t effectively address the needs of everyone in the payments value chain. Open standards could be the answer. XML schemas have great potential for providing that flexibility. However, they also provide great potential for confusion. Equens, the payments processor, has said that it has seen over 100 variations of the supposedly well-documented SEPA format. But equally, the world didn t come to an end. Equens managed that process, and payments continued to be made. When networks are exploited to support the partisan interests of certain national states, services based on them cease to be open. Open technical standards are by definition, freely available and open to adoption, emulation and modification by others. Perhaps other nation-states, feeling disadvantaged, might seek to establish their own standards bodies, and associated payments schemes 8

10 So what should be done? Payments can no longer be viewed as an isolated market or service. The new business problem that needs addressing is the efficient, open, secure access to all elements of a trade cycle. This includes financial services such as e-invoicing and factoring, but going further still, into insurance and re-insurance and transaction archiving. The payment itself remains essential; without finality, security, and transparency nothing else works. So the greater value and profit opportunity may lie in these adjacent spaces. South-south trade is the missing link in the global economy and perhaps the catalyst for a change in broader payments services. If more comprehensive services are adopted, then we may be on the verge of an economic revolution. The southern silk road will radically alter the dynamics of the global economy in the years ahead. The economic centre of gravity is about to undergo a major shift. It is inevitable that new financial models will evolve. Someone or something will emerge to serve the burgeoning needs of this market. The question is whether the networks of today can evolve to become the networks of tomorrow. 9

11 Gareth Lodge Senior Analyst Neil Burton Director, Product Strategy Read the complete series of In Conversion With' vision papers 10