Environmental Scan - International Interoperability Standards -

Environmental Scan - International Interoperability Standards -

Environmental Scan - International Interoperability Standards - February 2009

TABLE OF CONTENTS EXECUTIVE SUMMARY 1 I INTRODUCTION 2 1. PURPOSE 2 2. BACKGROUND 2 3. CROSS-BORDER PAYMENT ARRANGEMENTS IN CANADA 2 II INTERNATIONAL INTEROPERABILITY OF PAYMENT SYSTEMS 3 III KEY TRENDS IN CROSS-BORDER PAYMENTS INTEROPERABILITY 5 1. ISO 20022 5 2. EPN STP 820 6 3. FEDWIRE & CHIPS 6 4. INTERNATIONAL ACH TRANSACTION (IAT) 6 5. THE INTERNATIONAL PAYMENTS FRAMEWORK 7 IV CROSS-BORDER PAYMENT CHALLENGES FOR CANADIAN FIS 7 1. AUTOMATION AND INTEGRATION OF INFORMATION 7 2. MAPPING 8 3. TRUNCATION 8 V GLOSSARY OF ACRONYMS 9 Page 1 of 9

EXECUTIVE SUMMARY Standards for payments messages have been touted as significant enablers in innovation, global interoperability, competition, and efficiency and cost reduction. The implications for payment system participants, whether they are corporate clients, financial institutions (FIs) or large infrastructure providers, means that these must be looked at closely from a business perspective as well as technological. New developments in standards create opportunities, and risks, for businesses. Projects such as the Single Euro Payments Area (SEPA) have pushed European payments players to adopt a new standard based on the International Standards Organisation (ISO) 20022 framework, which takes full advantage of the flexibility and convenience of internet technology. In the United States (US), some larger FIs have moved to adopt the ISO-based standard to ensure interoperability with players abroad; while others have moved to the domestic Electronic Payments Network (EPN) STP 820 standard. This standard is based on a lighter version of the full Electronic Data Interchange (EDI) standard. Despite the popularity of the EDI-light standard, products such as the United States Fedwire and Clearing House Interbank Payment System (CHIPS) are responding to business demand to improve the ability of payment messages to carry invoice detail by considering global interoperability with the new ISO 20022 standard. Canada has yet to make a decision on which standard to align itself against. Developing the short term business case for standards alignment presents challenges not the least of which is spending money to replace existing payments message types and technology that may currently meet users needs reasonably well. Often the long term view is not taken into consideration which can lead to significant and costly band-aid solutions being applied at a later stage. There is therefore an even greater need for strategic decisions regarding message standards alignment to incorporate both local and global interoperability. Domestically, Canada needs to consider and plan for the future of message standards with both retail and wholesale payments. This document provides an overview of Canada s more common current cross border payment arrangements between FIs, as well as the leading standards currently being adopted to enhance global interoperability of payments. Page 1 of 9

I Introduction 1. Purpose The purpose of this report is to provide a high level review of various interoperability standards that govern international payments and identify the compatibility challenges for Canadian FIs. 2. Background The global economy continues to drive efficiencies in both domestic and international payments systems. International trade expansion is growing the demands for international payments and putting traditional international payments models under pressure. As payment systems have evolved, so have the processes associated with these systems. Initially, payment systems were domestic in nature and the processes (technology, systems, standards, oversight, etc.) were developed to accommodate the requirements of individual countries or geographic areas. However, commerce has required that payments now accommodate the needs of users regardless of geographical boundaries. It is important that there be some level of interoperability between payments systems around the world. To this end, many countries are moving towards the adoption of new international standards and technology to become more integrated and to permit more efficient cross-border payments. In this regard, Canada is no different than any other country in that industry requires an efficient and safe method to conduct business with customers in many other parts of the world. 3. Cross-Border Payment Arrangements in Canada A number of cross-border payment arrangements currently exist in Canada: In accordance with standing correspondent banking arrangements, there are cross-border automated/electronic funds transfer (AFT/EFT) arrangements in place between US and Canadian FIs, however, data formats can vary and compliance screening requirements can pose problems. In parallel, the United States (US) Federal Reserve Bank (FRB) offers an international ACH service for which it acts as a gateway operator of international transactions. Transactions initiated via this service are processed through a gateway FI in Canada, Scotiabank. Subsequent domestic clearing of transactions is executed via Canadian Automated Clearing Settlement System (ACSS) participants. In accordance with standing correspondent banking arrangements, Canadian FIs may also leverage a wire payment network for the processing of information and payments information between participating members. Wire payment message formats make use of the Society of Worldwide Interbank Financial Telecommunication (SWIFT) network and standards. Page 2 of 9

II International Interoperability of Payment Systems The network of domestic and cross-border systems that comprise the global payment and settlement infrastructure has evolved significantly over recent years. These systems, like the financial markets and economies they support, are increasingly connected through a wide array of complex interrelationships. As a result, the smooth functioning of an individual system often depends on the smooth functioning of other related systems. According to the Bank of International Settlement (BIS), international interoperability of payment systems may be defined as a situation in which payment instruments belonging to a given payment scheme may be used in other countries and in systems installed in separate schemes. 1 In this regard, interoperability requires technical compatibility between the systems, but can only take effect as per the regulatory frameworks that have been established and where commercial agreements have been concluded between the schemes concerned. To work with or achieve technical compatibility between systems, there are many parts of the payments system that need to be considered. International Interoperability of Cross-border Payments Business Process Interface Financial Institutions, Businesses, and ERP Payment Message Formats Standards & Rules Interconnectivity Access Commercial Agreements Regulatory Frameworks International Clearing & Settlement Mechanisms, and Standards Bodies Telecom Providers and Financial Institutions Financial Institutions Government Regulatory frameworks: A number of regulatory initiatives in various countries shape the clearing and settlement of domestic transactions and by extension that of cross-border payments within respective domestic jurisdictions. Primarily there are anti money laundering (AML) regulations that have been developed as domestic requirements based on international AML regulations and laws. 2 1 A glossary of terms used in payments and settlement systems - Bank for International Settlements - Committee on Payments and Settlement Systems March 2003 - http://www.bis.org/publ/cpss00b.pdf?noframes=1 2 The Financial Action Task Force (FATF) is an inter-governmental body whose purpose is the development and promotion of national and international policies to combat money laundering and terrorist financing. It has made 40 recommendations and 7 special recommendations in regards to AML. Page 3 of 9

Commercial Agreements: To this day, correspondent banking relationships are the cornerstone to developing international payments between FIs. These agreements allow bankers and large commercial customers to initiate payments and negotiate financial instruments in other countries through arrangements with local FIs. These standing correspondent banking arrangements underpin both the cross-border AFT/EFT and wire services provided between Canadian FIs and their international counterparts. In Canada, Scotiabank acts as the gateway operator of international ACH transactions. Wire payment senders/receivers generally leverage SWIFT s network and standards. Interconnectivity Access: The connection to various payment networks, whether through established telecommunications networks or using internet technologies, such as Virtual Private Networks (VPNs), to establish secure connectivity is an essential base in providing the communication facilities for FIs to exchange electronic messages. As technology developments march forward, banks and payment processors have the opportunity to invest in technology upgrades to payment networks and office systems. Standards and Rules: The development of standards and operating rules is an essential component of cross-border payment processing, but is also important in enabling the migration of domestic electronic payments from paper-based payments such as cheques. Several industry efforts are under way to facilitate the migration to, and harmonization of cross-border electronic payments. It is anticipated that the CPA would have a role to play in this arena. Payment Message Formats: There are a number of message formats that can be leveraged to exchange electronic cross-border payments; however, three are more commonly used: AFT/EFT, EDI, and wire payments. Although EDI and wire payments have seen greater standardization thanks to the EDIFACT and X12 standards for EDI, and the SWIFT messaging format for wire payments, a number of AFT/EFT payment message formats co-exist with domestic variations. It is anticipated that the CPA would also have a role to play in this arena. Business Process Interface: Cross-border payments allow FIs and other businesses to offer a number of international services to clients. As businesses grow, there is more demand from corporate cash managers to be in a better position to manage the finances of their companies. This includes ensuring that accounts payables are remitted and accounts receivables are collected regardless of location. This ability to manage a corporate s cash position is provided as a service by FIs using commercially available software and processes that have been adapted to the institutions internal payments processing applications. Page 4 of 9

III Key Trends in Cross-Border Payments Interoperability The development of standards is an essential component of cross-border payment processing, but is also important to enable the migration of domestic electronic payment types. Several industry efforts are under way to harmonize electronic payments by structuring the remittance information included therein. 1. ISO 20022 All Payments Types ISO 20022 is an extensible Markup Language (XML) schema for the development of financial messages 3. The schema is driven by payments industry bodies including SWIFT and the Treasury Workstation Interface Standards Team (TWIST). ISO 20022 is being adopted as the framework for payments messaging under SEPA rules throughout Europe, and for the new SWIFT MX message category. The SWIFT-driven ISO 20022 XML structure is capable of supporting multiple payment types and forms the backbone of payment messaging required to support SEPA integration in Europe. The result is a groundswell of major payments market participants investing in ISO 20022. Software vendors such as SAP, Clear2Pay and IBM Corp. are adopting this as the internal data structure for payments delivery within their payments processing solutions. This means the ISO structure can be supported from payment initiation in an Enterprise Resource Planning (ERP) 4 system, through the FI processing applications to the Clearing and Settlement Mechanisms (CSMs) and SWIFT. The effect in Europe is that major FIs are investing in ISO 20022 as core infrastructure. The rationale for adopting this standard is that payments represented in this structure can be mapped to the data requirements of any major clearing system or payments process. 5 In other words, it forms the core of payment processing and offers the possibility of true global payments services interoperability. Major North American FIs are implementing the standard, especially those with international operations in Europe. There is, however, a strong opportunity to use this standard for the development of new domestic financial messages as well, thereby streamlining all communications for FIs. 6 ISO20022 schema includes various message types for credit push payments such as PACS 008 for AFT/EFT payments, and SWIFT MT103, FedWire BTR and CHIPS non-bank payments for wire payments. Comparisons between the various schemes are underway to understand the changes required to accommodate ISO20022 messages. 3 The ISO 20022 standard does not define electronic financial messages. Instead, it codifies a process for defining such messages. 4 ERP is the automation of core business functions, including production, accounting, distribution, supply chain and human resources. ERP uses technology to integrate the information from all key business within an organization. 5 ISO 20022 remittance fields include: referred document information (a description of what is being paid such as commercial invoice, commercial contract, etc. and its reference number), referred document date, referred document amount, creditor reference information (additional information that is meaningful to the receiver such as a purchase order and purchase order number), invoicer (payee), invoicee (payor) and additional remittance information (free text). 6 www.iso20022.org Page 5 of 9

EDI Payments 2. EPN STP 820 The EPN STP 820 standard was developed by the Electronic Payments network (EPN), one of two ACH processors in the United States. The objective was to standardize the use of ten remittance fields 7 to ease payment file integration with corporate ERP solutions, thereby encouraging use of ACH payments. This standard is approved by the American National Standards Institute (ANSI). As a derivation of the Electronic Data Interchange (EDI) X12 820 standards commonly used for payment files within the United States EPN STP 820 is known as EDI light. In the US, the EPN STP 820 is considered to be a format that is fast and cheap to implement that is compatible with CHIPS and Fedwire transfers. The standard is supported by the Association of Financial Professionals and NACHA and has been adopted by providers of accounts payable, accounts receivable and cash management systems as well as other technology providers. 3. Fedwire & CHIPS Wire Payments Fedwire and CHIPs, owned and operated respectively by the New York FRB and The Clearing House (TCH), maintain their own proprietary payment formats for wire payments. FIs wishing to use this payment format required add-on software messages because the payment format is not SWIFT based. It is anticipated that the next release of these payment formats will be able to map to SWIFT messaging. The information in these payment formats will also be compatible with STP 820 and ISO 20022. In regards to CHIPS payments, the remittance field under this payment message format will allow for 9000 characters of structured information. In Canada, the SWIFT MT103 payment message, used for the Large Value Transfer System (LVTS), cannot accommodate this many characters at this time. AFT/EFT Payments 4. International ACH Transaction (IAT) In 2007, NACHA began the development of a new International ACH Transaction (IAT) rules and requirements with a proposed implementation date of September 2009. The main objective of the IAT is to align NACHA s rules with the US Office of Foreign Assets Control (OFAC) requirements. An IAT payment refers to an ACH transaction entry involving a financial agency s office that is not located in the United States. 7 These fields are: customer account number (mandatory), customer name (mandatory), and for each invoice being paid: invoice number, invoice date, invoice gross amount, amount paid, purchase order or other reference number, adjustment amount, adjustment code, adjustment description notes. Page 6 of 9

5. The International Payments Framework The International Payments Framework (IPF) initiative comprises over twenty members from various nations and aims to develop rules for the exchange of cross-border AFT payments (and the equivalent types of EFT payments in other participating countries). Organisations comprising the IPF include primarily financial institutions (FIs) and Clearing and Settlement Mechanisms (CSMs), as well as associations, standard setting bodies, industry vendors, and other users of payment services The IPF is seeking to better enable interoperability between existing domestic and/or regional payment systems. As such, it seeks to establish rules and procedures for the exchange of transactions in multiple currencies based on existing clearing and settlement practices internationally. In doing so, the IPF will leverage one common standard, the ISO 20022 standard. This standard provides the financial industry with a common platform for the development of XML-based messages and is increasingly becoming the global standard for processing payments. It is the IPF s vision that an FI using the IPF framework could send or receive cross-border AFT/EFT credit payments and translate its domestic files to/from only one format, an ISO 20022 payment format. As a result, FIs could streamline their correspondent banking arrangements for multi-currency transactions and enhance the cross-border payment process for the parties involved in the transaction. IV Cross-Border Payment Challenges for Canadian FIs 1. Automation and Integration of Information Over the past few decades, many countries have established both high and low value payment systems that are based on proprietary communication and security standards. As a result of largely independent development, there is a lack of standardization and automation in inter-bank and intra-bank networks. This adversely affects banks and businesses alike and results often in manual intervention to collect and repair data. The Corporates Perspective Many large multi-national companies must deal with any number of banks in order to be able to manage their financial positions and this may require that corporate offices maintain and operate multiple payment applications to accommodate their corporate cash management processes. Not surprisingly, multiple applications may incur additional costs for corporate customers. The SME Perspective Small and Medium Enterprises (SME s) are expanding their markets and have a need for cash management services that fit their needs and budgets. Although SME s may not have the same global reach as large corporate entities, they may have cross-border ties that require access to payments schemes. In many cases SME s are currently relying on third party payment services since alternative methods are cost prohibitive. The Canadian Financial Institutions Perspective In many cases large FIs have achieved their growth through mergers or acquisitions over the years. However in order to accommodate this growth, the payments systems associated with Page 7 of 9

each entity may not have been completely assimilated, thus leaving overlapping layers of payments systems technologies that require support and maintenance. Similarly in the case of interoperability, some FIs may have made strategic decisions to implement specific payments initiatives that, at the time, were appropriate for the markets in which the FIs may have done business. With the expansion of global markets and global acquisitions, many FIs are reconsidering their enterprise solutions and will need to include a complete and thorough review of their payments strategies to ensure a consistent delivery of services to all markets with as little overlap as possible. Consolidation of payments systems on one payments platform would result in reduction of costs (that may have been considerably higher where multiple systems performing similar functions were in place). 2. Mapping The emergence of the Internet has fuelled the need for technologies that foster real-time application to application, web to application, and web to web integration. XML accomplishes the need for real-time, Internet-centred solutions, providing businesses a flexible and extensible environment for integrated and interoperable data exchange. For this reason, many interoperability standards, like ISO20022, have moved to adopt this protocol as the basis for their standards. In this regard, many ERP solutions have been developed to accommodate the (ISO20022 based) PACS008 standard for AFT/EFT payments. Though many companies have begun developing or modifying their payment applications to accommodate XML, many legacy systems like those found in certain FIs are not XML-enabled at this time. 3. Truncation In order to meet compliance and reporting requirements in any FATF countries, certain information must travel with a transaction. To this end, truncation of payment messages is disallowed under certain jurisdictions, such as the US in other words, a sending and receiving FI may not change or leave out a payment s message remittance information to accommodate compatibility issues between payment file formats of various systems. Currently SWIFT-based messaging, which is leveraged in Canada for LVTS payments, provides a field with 140 characters in free format for remittance information. The field is optional. STP 820 and/or ISO 20022 allows for the accommodation of a much greater amount of structured information (i.e. up to 9000 characters) and therefore any translation/mapping from one standard to another where information is truncated may raise regulatory reporting concerns. The CPA is currently participating in the High Value Payment System (HVPS) Operators Group, whose goal is to extend the value of immediacy and financial certainty of domestic wire transfer systems to cross border transactions. The Group is focussed on identifying and eliminating, where possible, the barriers to interoperability and straight-through processing in the current environment by sharing information about systems, message formats and market practices. Page 8 of 9

V GLOSSARY OF ACRONYMS ACH: ACSS: AFT: AML: ANSI: BIS: CHIPS: CSM: EDI: EFT: EPN: ERP: FATF: FI(s): FRB: HVPS: IAT: IPF: ISO: LVTS: NACHA: OFAC: SEPA: SME: STP: SWIFT: TCH: TWIST: US: VPN: XML: Automated Clearing House Automated Clearing Settlement System Automated Funds Transfer Anti-Money Laundering American National Standards Institute Bank of International Settlement Clearing House Interbank Payment System Clearing Settlement Mechanism Electronic Data Interchange Electronic Funds Transfer Electronic Payments Network Enterprise Resource Planning Financial Action Task Force Financial institution(s) Federal Reserve Bank High Value Payment System International ACH transaction International Payments Framework International Standards Organisation Large Value Transfer System National Payment Clearing House Association Office of Foreign Assets Control Single European Payments Area Small-Medium Enterprises Straight-Through Processing Society of Worldwide Interbank Financial Telecommunication The Clearing House Treasury Workstation Interface Standards Team United States Virtual Private Network extensible Markup Language Page 9 of 9