Global real time interoperability is in our sights – immediate payments plus the industry consensus that ISO 20022 is the standard ‘de jour’ are paving the way towards a harmonised digital banking future. The first draft of the ‘rule book’ was launched earlier this year by the ISO 20022 Real-Time Payments Group, outlining the correct flows and language for us to use to send and receive immediate payments. Behind the scenes, many others are working tirelessly to enable interoperability.

Yet it is not all blue skies and sunshine. Dark clouds still linger, hampering our vision of how this global interoperability will come to fruition. Perhaps the biggest question on everyone’s lips – including my own – is “how can we handle settlement for cross-border immediate payments?”

There are three main models for settlement in the market today – Deferred Net Settlement (DNS), pre-funding, and real-time (or line-by-line as the Australians call it) – surely one of these will fit the bill?   

1. DNS is simple; payments are sent (funds are available immediately) at one point in time and then netted and settled later according to the settlement cycles. With long settlement cycles this has high settlement risk and can choke innovation, as the longer the settlement cycles (say a weekend), the greater the risk. Smaller players find this environment particularly difficult in terms of participation.

2. Pre-funding requires each party to deposit cash to the expected value of its commitments for the next settlement cycle, so this removes the settlement risk as should a member fail, they have already provided the funds to cover their liabilities. This goes some way to opening up the scheme to the smaller players; however, again if there are long settlement cycles, barriers can still remain due to higher amounts of cash required. This does not suit challenger banks or non-bank Payments Service Providers (PSPs) that have small or no deposits to use for pre-funding.

3. Real-time removes the settlement risk, and the barriers to entry, however the central bank has to run a real-time settlement infrastructure that operates at the same time as the immediate payments scheme (usually 24*7*365) to accommodate this.  For most central banks this is a major new undertaking.

Difficulties can also arise when, for example, someone in the UK which is moving to a pre-funding model and has three settlement cycles a day, and someone in The Netherlands, where the cycle could run every 15 minutes, want to pay each other. Who takes the settlement risk, considering the cash and collateral is held by the central bank in a different country potentially in a different currency? Marrying the two will prove to be difficult.

It would seem that the obvious way forward is real-time settlement – after all, it removes settlement risk and breaks down the barriers to entry. However, the Australian New Payments Platform is going to be the first example of a real-time settlement model, so the technology is as yet unproven. The technology capability required to process the number of transactions in Australia is achievable, however the volumes are vastly larger in countries such as the U.S. and China. Would a real-time system be able to cope? Will other countries’ appetites be big enough to foot the bill to invest in such a system?

Only time will tell. For now, those addressing the interoperability challenge will need to decide on which direction to take regarding settlement. Perhaps then we will be one step closer to achieving full global interoperability.