The Replacement for SWIFT

 

Selection_053

Many of us have heard about the creation of a new electronic payment system to replace SWIFT in Russia. Some of us have heard about China doing the same and Russia joining it. Very few know that by now both systems are ready. Will they replace SWIFT? To understand this, let’s see what has urged two countries to act and what these systems were designed for.

First of all, what is SWIFT? Created in 1973 and operational from 1977, the Society for Worldwide Interbank Financial Telecommunication (S.W.I.F.T. or SWIFT) enables its users – banks, securities institutions, corporate customers – to exchange standardized financial information in a secure and reliable way, which is also (by now) extremely inexpensive. Contrary to common belief, trade-related money exchanges only make up only 40% of traffic while the rest is secure messaging and general bulk data exchange1. SWIFT is a member-owned cooperative connecting more than 10,800 organizations in 215 countries and territories.

Selection_052The story begins in 2014 with a purely political agenda when the US and the EU threatened to cut Russia off from SWIFT. The idea was to disable Russian key foreign exchange players in the oil and gas industry processing US dollar payments which are critical to service corporative and bank’ debt, estimated to reach $100bn in 20152. Normal business in Russia would then be severely disrupted, increasing the risk of default.

Can this threat materialize and is it actually possible to disconnect a country from SWIFT? Being a EU-based company (registered in Belgium), SWIFT will disconnect Russia only if the EU authorities make a relevant decision. Otherwise any political pressure on SWIFT is illegal. In practice, SWIFT had to (or chose to) obey external instructions at least twice. Following 9/11, the US obtained access to the private data of SWIFT members and in 2012, SWIFT agreed to de-list 30 Iranian financial institutions (including the Iranian Central Bank) as part of the US/EU sanctions to prevent Iran receiving billions of dollars of oil revenue.

What will happen if Russia is cut off from SWIFT? There are three areas potentially affected: bank transfers in roubles within Russia, exchanges between Russia and outside world and internal USD/EUR transfers used mainly for settlement between companies.

The good news for Russia is that internal rouble transfers will not be affected: they are processed by the Central Bank’s Real Time Gross Settlement System (BESP) which has been operational since 20073 and connected to SWIFT via a gateway in 20114. This actually halves the potential damage to the Russian economy. There is now an alternative to card-based payments systems (like Visa and MasterCard) where money flows are processed outside of Russia. The Central Bank is creating a massive new ‘National System of Payment Cards (NSPK),’ to replace this. The first phase has already been completed (at the end of March). All Visa and MasterCard transactions within Russia are now going through NSPK, the second phase – for other payment systems such as AMEX, Diners, UPI, JCB (plus NSPK’s own card, which is really an extra good-to-have feature) – by this December.

The second area, external exchanges, would indeed be seriously disrupted by a cut-off, taking Russia back to the pre-SWIFT world of telex messages (representing the Middle Ages of financial exchanges 1930-1980), and even paper-based transactions (Stone Age). Operations will be less reliable, less secure, will take much longer and consume more resources. Economies will suffer, however nothing dramatic will happen.

Would Russia be prepared to go this route? Possibly yes but there is another way to go – and thanks to Iran, it has been proven in practice! For two banks to exchange funds it is enough to hold accounts in a correspondent bank that can be in a neighbouring country, not de-listed from SWIFT. For this, a messaging mechanism to this country needs to be built – similar to SWIFT but much lighter, or an independent regional system can be created e.g., for the Shanghai Cooperation Organization (SCO) or BRICS. In a recent poll, the payment industry journal PLUS found that the majority of respondents (62.5%) see the way forward is in creating BRICS/SCO SWIFT alternatives5.

Was the true purpose of the Russian-built system, to provide a workaround system for now and to become part of the regional exchange later? Probably yes, but the system as it is now, available from December 2014 with 91 banks connected, does not do this, it addresses a different problem – and this is the third area of impact – non-rouble internal operations. Technically (for those who are interested) compatibility is achieved via ED503 SWIFT-format messages replacing previous open-format ED501 (introduced in 2010 unsuccessfully). There is a restriction confirming the system’s limited use: sending ED503 is only possible during working days from 07:00-21:00 Moscow time while SWIFT is operational 24/76.

The other consideration is the message cost. No wonder it is higher in the Russian system; it took SWIFT 40 years to achieve true operational excellence and economy of scale. This alone creates high entry barriers for any SWIFT-replacing solution (add to this users’ trust, a large network and critical mass of clients). So Russia does not aim to build such a solution. How about China?

China International Payment System is a Chinese-only system aiming to promote the Yuan and the Chinese economy, which is different from the common SCO or common BRICS system mentioned above, which aims to facilitate trade between these groups of countries and to partially replace SWIFT in the SCO region. CIPS, not to confuse with UPI is reported to be ready, and may be launched as early as September7. 20 banks were selected for testing; among them 7 are subsidiaries of foreign banks. It will process cross-border Yuan transactions allowing market players to deal directly and easily with Chinese counterparts and remove all existing hurdles. Today Yuan clearing is done via offshore/Chinese corresponding banks with coding systems’ differences and language barriers dramatically slowing down their operations. Transaction costs and processing times will be cut, making Yuan payments nearly instantaneous through any CIPS-listed financial institution anywhere in the world8. This will facilitate economic activities and attract investments, but even more importantly this should greatly increase global usage of the Yuan and help it eventually to become a reserve currency, i.e., one that central banks will hold as part of their foreign currency reserve . At the moment more than 60 central banks already do this while many more are waiting. The ultimate ambition for the Yuan is to become the dominant international currency. It is a slow process and such changes happen rarely – last time it was more than half-century ago when the world shifted from sterling to dollar10.

So China’s target is not to replace SWIFT, it is to replace the dollar. Recent international events have only encouraged China to accelerate the roll out of its own international payment system and to show the world that the dollar is replaceable as a reserve currency.

Will Russia join CIPS? Yes, but mostly to make trading with China more convenient. Will Russia be switched off from SWIFT? Very unlikely. Recent news reconfirms this: the US/EU have reportedly ruled this out because “it would cause too much collateral damage”11 and Russia has received a seat on the board of SWIFT due to the increased banking traffic, for the first time since it joined in 198912.

What will happen to the new Russian system? It will probably continue in its niche and stand by as a base for a future workaround, if ever needed.