Confusion over faster payments, and what it could mean for bitcoin

The Spanish press has been reporting today on the rollout of TIPS, a payment system that allows instant reconciliation, even across borders within the European Union.

Only they’re wrong.

why pass up an opportunity to insert a Ryan Gosling gif?
(why pass up an opportunity to insert a Ryan Gosling gif?)

TIPS, which stands for TARGET Interbank Payment Settlement, launches in November of 2018. Seriously, the European Central Bank bringing forward the launch of a new payments system by a whole year would be pretty big news. Only, it didn’t happen.

email from ECB

Did a careless journalist just get the year mixed up?

Possibly, but it’s more likely to be a case of alphabet soup.

What does launch today is SCT Inst, which stands for SEPA Credit Transfer Instant, a different faster payments system.

Why the confusion? Because they’re similar, but not the same thing at all. And the difference may seem trivial, but it’s not.

Both promise almost instant payment finality within the Eurozone. Up until now, payments generally settled at the end of the day as totals were added up and net amounts were transferred. With the new, faster systems, settlement occurs on a transaction-by-transaction basis, generally within 10 seconds or so. Even across borders. I live in Madrid – if I make a transfer using this system to a friend in Paris, for example, it will get to her account almost immediately.

One drawback is that you can’t “change your mind” during the day, as you can with the current batch settlement system. But the benefits are many, and go beyond more immediate access to funds, a better service for clients and the possibility of new business models (more on this in a later post).

The main difference between the two systems is the promoting organization.

SCT Inst (the one that launches today) is organized by the European Payments Council (EPC), a not-for-profit group representing payment service providers (PSPs). It is not an EU institution. It was created by the banking industry in 2002 to develop harmonized electronic payments. In other words, it works for private companies, and it is these private companies that execute the payment settlement.

TIPS is organized by the European Central Bank (ECB), which represents central banks.

Private companies… central banks… not the same thing.

With SCT Inst, the private payment service providers settle the transactions, for a fee. With TIPS, the payments settle in central bank money – at 0.2 cents for the first two years, and a maximum of 1 cent thereafter. SCT Inst will have a hard time competing with that.

Plus, it’s fair to assume that the reach of TIPS will be greater, not just geographically, but also sectorially through the possible roping in of automated clearing houses (currently left out of SCT Inst).

However, SCT Inst is here today, and TIPS isn’t. Although the launch is relatively modest – almost 600 PSPs have signed up (about 15% of the possible pool), and it’s available in a limited list of countries: Austria, Estonia, Germany, Italy, Latvia, Lithuania, the Netherlands and Spain (so you’d think they’d report on it correctly?). Others are expected to follow in the next two years.

For participating institutions, it means an opportunity to offer a better service to clients. The focus is likely to be on consumer payments, at least to start with – the transfer limit is currently set at €15,000, which rules out most B2B payments.

TIPS and SCT Inst will co-exist. The TIPS documentation insists that messaging will be compliant with the standards adopted by SCT Inst. But it will be interesting to see how the launch and take-up affect the movement of funds, and which system ends up impacting the market more.

I confess that I have some more digging to do to unravel the relationship map (it looks like spaghetti), after which I hope to uncover more differences.

Meanwhile, we should focus on the big step forward that SCT Inst represents, and the bigger push that its colleague/competitor TIPS will give the payments sector. And on the removal of one of bitcoin’s supposed advantages: that cryptocurrency will replace fiat transfers because of speed.

The envelope, please… Blockchain and shareholder voting

Who knew that shareholder voting could be so… suspenseful?

If you missed the news, Proctor & Gamble has been locked in a bitter battle with shareholder activist Nelson Peltz, who wants a seat on the board. This led to the biggest shareholder battle to date, with over 2.5 billion votes (for 2.5 billion issued shares) in play. Robocalls, social media ads and a flood of mailings… the tactics got fierce.

suspense

At stake is the structure of the consumer goods conglomerate. Peltz – CEO of asset management firm Trian Partners – wants a seat on the board, and to break P&G up into three distinct units, to streamline operations and add flexibility. P&G says that the recent restructuring is already showing positive results, and changing the composition of the board would bring unnecessary disruption.

At the annual general shareholders’ meeting, P&G announced that Peltz’ bid had been defeated. Shareholders had voted to not give him a seat on the board, by a margin of 6.15 million votes, which sounds like a lot but when taken in context of the overall number of outstanding shares, was only 0.2%. A statistician would argue that is well within the margin of error.

And she would be right. Yesterday the FT reported that a recount by an independent expert found that the margin was only 43,000, in favour of Mr. Peltz. Effectively, a dead heat. The final, definitive results are not yet in. But Mr. Peltz could well get his board seat.

Why the lack of clarity in the outcome?

As you have most likely seen with national elections, counting votes is cumbersome, and largely manual. Even today, there is no definitive way to ensure that votes are not double-counted or falsely filed. One of the main problems is collecting all the votes, which are still mainly submitted on paper, either at a company’s annual general meeting, or sent in via physical mail (although some firms allow online voting). Another is making sure that the count is not manipulated. This requires rigorous identity verification, and a decentralized process of tally.

A separate issue is identifying who has the right to vote – with shares held at central depositories and “ownership” represented by a type of cession of rights, this is often not as clear as it should be.

Could blockchain technology, with its security and automation, help? Several large proxy voting managers believe so.

Last year, Russia’s National Settlement Depository announced that it has tested a blockchain-based voting system. The Abu Dhabi Stock Exchange unveiled a blockchain-based voting service that allows shareholders to both participate in and observe the process. And Nasdaq ran an e-voting trial, which recorded stock ownership on a blockchain platform, and issued digital voting right assets and tokens.

Earlier this year, Broadridge – the world’s largest provider of proxy voting infrastructure – revealed that it is building a blockchain platform on ethereum to streamline the sharing of information between custodians. A pilot run was successfully executed (in parallel with voting using traditional software) with JP Morgan, Northern Trust and Banco Santander.

Around the same time, financial services company TMX group (operator of the Toronto and Montreal stock exchanges, among others) revealed that it had completed a proxy shareholder voting prototype built on Hyperledger

And just last week, a group of central securities depositories (CSDs) announced progress on a distributed ledger proxy voting platform. Swift is among the institutions participating, to assist in ensuring compliance with international financial messaging standards (which would open up the platform to uses other than voting).

Timelines on any of the above projects going into the production are at the moment vague. Will any of them even happen? With shareholder voting generally an in-network activity (with limited, if any, need for participation from outside organizations), why use blockchain at all? Why not just go for a robust, efficient database?

Because of the vulnerabilities of centralization, which in many cases doesn’t matter – but when it comes to voting, that’s a different story. First of all, even a distributed database can be hacked and manipulated. Second, shareholders need to be certain that the vote was fair, and that the company in question has not tried to influence the tally. If they are granted real-time transparency into the voting process are more likely to trust the system, and therefore more likely to vote.

Plus, as shareholder voting becomes even more important, propelled by improvements in the technology (reduction of friction) and increased activism, audits of processes by external parties are going to become even more of a regular feature. An access node would facilitate that, as well as reduce the costs.

And finally, proxy polls are not cheap. According to FactSet Research Systems Inc., a “typical” proxy battle costs about $1 million, mainly from printing, mailing and legal fees. For context, the P&G battle is expected to cost the company over $35 million (small change compared to its Q2 income of $2.2 billion, but still…).

And even with that expenditure, it might not win. Final results are yet to come, so the battle isn’t over yet.

But the drama and nail-biting suspense sheds light on the urgent need to reform shareholder voting technology. Current platforms are, in general, inefficient. And electronic voting systems run by any one organization, even audited ones, will always have a cloud of doubt over the controlling interests. The transparency and security of distributed ledger systems could offer a more robust, lasting and scalable solution. Widespread use is still a long way off, though, and they’re unlikely to be practical until the murky issue of stock registration is solved.

While perhaps not the decentralize-the-organizations disruption that blockchain technology originally promised, it would be a step towards a more democratic governance, enabling shareholders to participate in corporate decisions more frequently and with less upheaval. It could end up giving shareholder activists more firepower and motivation, even perhaps going as far as to change what we understand by “shareholder capitalism”. Or capitalism overall, for that matter.

And when it comes to letting the market decide, it must be galling for the P&G board to see the positive price reaction to the news that they might not get their way. If the close outcome of the voting doesn’t send the board a strong message (in other words, when almost half of your shareholders side with your most vocal critic, you’re doing something wrong), perhaps the voice of the market will.

FX trading fines and regulation catch-up

Photo by Ben Rosett on Unsplash
Photo by Ben Rosett on Unsplash

In my last post I mentioned some hefty fines incurred by foreign exchange dealers for trading infractions. The amount keeps climbing.

Yesterday the Financial Times reported that Credit Suisse has just been fined $135m by New York state’s financial regulator for “unsound” conduct between 2008 and 2015. Apparently the traders shared client information with other global banks to manipulate foreign exchange (FX) prices and maximize Credit Suisse profits.

What’s more, the bank was found guilty of front-running (putting your order in just ahead of clients’ orders to take advantage of resulting price movements) between 2010 and 2013.

And (this ties in to my previous post) between 2012 and 2015, traders took advantage of the “last look” feature of their electronic trading platform, which allows dealers to back out of a trade before execution, by applying it to all client trades. To make matters worse, it lied to clients about why trades were rejected.

It’s one thing to use the system to profit your own book over your clients’. It’s quite another to lie about it.

This is one of the reasons for the increasing volume of calls to reform the last look practice. Many traders think it should be banned. Others believe that it should be allowed, but that traders should be honest and upfront with the conditions in which a previously agreed trade would be rejected.

Going back to the Credit Suisse infringements, what blows my mind is that they openly talked about frontrunning and using proprietary information in electronic chat rooms. And get this: one of chat rooms was known as “The Cartel”. It’s not the stupidity that surprises me, it’s the arrogance. If everyone’s doing it, it’s fine, right? Why even try to hide it?

The sentences are coming thick and fast. In September, HSBC was fined $175m by the Federal Reserve for “unsafe and unsound” FX trading practices. In July, the Fed ordered BNP Paribas to pay $246m for charges relating to its FX conduct between 2007 and 2013. These fines follow others of more than $5.7bn levied on a handful of major banks in 2015 by the US Department of Justice, and over $3bn handed down by the US Commodity Futures Trading Commission and the UK’s Financial Conduct Authority in 2014.

While we may be blinded by the volume of fines, we need to put them in context of the overall size of the FX market. The largest market in the world, it trades over $5tn per day. Apart from the massive profits the rogue traders earned for their banks (no doubt largely reflected in handsome bonuses), the fines also reflect the gravity of the infringements. Damage to its reputation and a loss of trust would pose a risk to global commerce and trade.

The high profile of these cases could add momentum to the move towards trading platforms that offer greater transparency to clients and to the regulators.

The FX market, already of systemic importance, is likely to expand as world trade continues to grow. Until recently, large clients didn’t have much of a choice – to get big deals done, you went to the big dealers. Now, however, newcomers with shinier platforms are nibbling away at market share. Increasing compliance adds to costs, and the advantages of largely manual, opaque and relationship-based execution are becoming less apparent. Especially with increasing scrutiny.

The embarrassment for the regulators at the revelations that this was going on for as long as 10 years before anyone noticed will surely give them a good incentive to push for better reporting and greater access to trading records.

So, distributed ledger-based trading platforms in which the regulators have a node that allows them to see in real time what’s going on? Confidentiality issues aside (because they can be solved), it is likely to happen in some form.

Regulators monitoring electronic chat rooms? That’s a different story.

FX trading and last look doubts

photo by Veri Ivanova for Unsplash
photo by Veri Ivanova for Unsplash

The murky world of foreign exchange trading could be about to get a bit more transparent.

A few days ago, the sovereign fund of Norway (NBIM) – the largest in the world, with over $1tn under management – published a report calling for improvements in the foreign exchange (FX) market. It feels that the market’s friction and opacity tilts profits unfairly towards the dealers, and that the lack of transparency is weakening trust in the system.

It points to three particular aspects of FX trading, specifically: last look, algorithms, request for quote feeds and their relationship with interdealer prices.

While each is intriguing and worthy of further digging, I want to take a closer peek at “last look”, since it exemplifies how new technologies can both improve and complicate trading, and how evolving infrastructure requires a regular re-think of established processes.

Looking back

What is “last look”? It’s a “way out” for the dealer, who can renege on an agreed trade if certain conditions are not met. It could be that the client doesn’t pass the credit check. Or it could be that the price moves against the dealer.

This last aspect gives last look the whiff of unfair advantage. Critics claim that it can be used to “cherry pick” trades, only following through on the profitable ones, which would negatively impact market confidence and liquidity. It could also lead to “front running” of trades, whereby information from client orders is used for the dealer’s own profit.

Others argue that its use as a latency buffer – protecting against price moves between order agreement and order execution – is no longer necessary given technology improvements that make that time gap almost negligible. And the lack of information – often clients are not told why their trades fell through – weakens confidence, which could impact order size and even willingness to operate in the market.

Proponents claim that the practice allows dealers to quote better prices – with less risk in a trade, the spread can be narrower, which implies a better deal for the clients.

What’s more, the option of backing out of a trade enables dealers to post their price on several exchanges at once. Without that option, the dealers run a higher risk that the market will move against them. With posts on several exchanges, changing all of them takes time (seconds, but that’s a long time in FX). So, last look encourages a wider spread of trading venues, which in theory enhances liquidity.

Wait a second

Norway’s sovereign fund is not alone in its concerns about the practice, which has been coming under increasing scrutiny.

Vanguard (the world’s largest mutual fund manager), Citadel (one of the world’s largest alternative asset managers) and others have called for its elimination. Several exchanges have echoed that sentiment. XTX Markets Limited, one of the world’s biggest spot currency traders, officially stepped back from the practice in August. The Bank of England has been publicly questioning the practice since 2015.

Global regulators are also taking a closer look. In 2015, Barclays was fined $150m for what was deemed abuse of the practice – not only did the bank filter all trades in which the market moved against it (as opposed to using last look as a sporadic protective measure), but it denied doing so. (2015 was a ripe year for FX manipulation – Barclays was fined a further $2.3bn for other FX infractions, and penalties levied on Citigroup, JP Morgan, UBS, Bank of America and the Royal Bank of Scotland brought the total to almost $6bn.)

However, removing the practice will leave end users vulnerable to predatory manoeuvres, especially given the prevalence of high-speed trading. It could also constrict liquidity as dealers protect themselves against risk.

Rules, please

Why can’t the regulators step in and establish certain rules? Because the FX market is notoriously difficult to regulate, largely due to its cross-border nature. Which jurisdiction would apply?

In an enlightening example of self-regulation, the Global Foreign Exchange Committee (GFXC) was created in May 2017 as a forum for FX market participants (including central banks). Its first act was to issue an updated FX Global Code, a set of “best practices” for the foreign exchange community.

It does not rule out last look, but does ask practitioners to disclose the criteria, in order to allow end clients to make the appropriate adjustments. The GFXC simultaneously issued a request for feedback on the practice, demonstrating a willingness to contemplate adjustments.

So why are the Norwegian sovereign fund and others protesting now? Just two years ago, NBIM publicly came to the practice’s defense, citing its potential to improve available liquidity for investors.

It turns out that their positions are not inconsistent. Even now, it is not advocating the removal of last look. What it wants is more transparency.

Furthermore, it is no doubt aware of the deteriorating levels of trust in FX trading. The previously mentioned scandals and fines are probably the tip of the iceberg when it comes to abuse, especially since the rules have been vague and the FX market is opaque to begin with.

And, the protests could be influenced by fund managers’ need to increase revenue and lower costs through narrower spreads and more transparent pricing. Quoted in the Financial Times, the co-author of the report said:

“We want to be more explicit about the risk sharing between us and the dealer. The client is providing optionality for the dealer. We would like to be rewarded for this option.”

Large market participants no doubt understand that the system is changing, and so are expectations. Calls for market reform are both timely and self-serving, contributing to a cleaner image and hopefully a more robust system.

Looking forward

So, what would a solution look like?

While blockchain technology is by no means the solution to all things financial, it could offer a useful tool for a platform that allows transparency, immutability and decentralized (but permissioned) participation. A major drawback would be the latency – it’s not the fastest way to share data, and the FX market is used to split-second speed.

It is clear that enhanced disclosure is a stop-gap remedy. Once the goal posts start moving, it’s impossible to see where they will stop. What’s more, temporary solutions are not conducive to a lasting realignment of trust. And with self-interest up against community fairness, and a huge economic sector in play, a more durable solution is urgent.

Will blockchain technology end up playing a part? It’s possible, perhaps even probable, especially as new features emerge and work-arounds gain strength. It’s unlikely to be the only solution, though, as database technology and communications infrastructure also continue to evolve. And as long as speed remains a competitive advantage, decentralized resilience and transparency are unlikely to be the main priority.

What’s more, the FX sector is unlikely to see a sweeping change in the near future – it’s just too big and important for that. However, the processes that keep the system running need revision and updating, to continuously improve efficiency and trust.

And eventually, the patchwork of solutions to specific problems will point to a deeper evolution, one that favours interoperability over universality, reliability over speed and trust over profit.

Bits and stuff: talks, takes and transparency – November 1, 2017

You’ll have noticed that there hasn’t been much activity here in October – too much overwhelm from other areas. Priorities are being juggled.

I chaired The Blockchain Summit in London yesterday. The organizers Marketforce did a great job – an excellent event, stimulating and knowledgeable speakers from a wide range of experiences. We had executives, technologists and entrepreneurs talking both big picture and small applications.

blockchain summit

There were a lot of fresh faces up on stage, too, people who know a lot but who I hadn’t heard speak before. I confess that I wasn’t paying full attention to the talks, since the next panel’s questions needed formulating, but there are some presentations that I will be going over again. Vinay Gupta’s opening keynote did not disappoint, and the LSE Group’s David Harris revealed a lot of stuff I didn’t know (and am particularly interested in) – he’s a fun speaker, too. Peter Stephens from UBS gave a thought-provoking talk on identity – I would have like to pay more attention to that. There were many other highlights, too many to mention them all.

The audience seemed to be knowledgeable and focused, and I met some fascinating people from several countries. That’s one of the aspects I most love about these gatherings – meeting smart individuals with smart questions, everyone coming at this from a different angle.

Claudia Coppenolle gave an eye-opening talk on diversity
Claudia Coppenolle gave an eye-opening talk on diversity

— x —

Now I’m off Stockholm for a brief break, then Lisbon for WebSummit (which should be intense).

There’ll be lots to talk about when I get back, that’s for sure. Assuming my brain still works.

— x —

My article on CoinDesk this week, on why banks don’t want to give accounts to cryptocurrency startups:

It’s my last weekly opinion column. And Sunday’s newsletter was my last for CoinDesk. I handed over the daily newsletters to our Editor in Chief Pete Rizzo a while ago. Next week our Managing Editor Marc Hochstein takes over the weekly. It’s in good hands.

My last day at CoinDesk is the end of November. As for what I’m going to do afterwards, I’m not sure yet – plenty of ideas, some interesting options, but no firm decisions yet. I’ve always believed that the big decisions sort of make themselves, so we’ll see where inspiration strikes.

— x —

An interesting take on bitcoin and ethereum from investor Albert Wenger.

“In summary then: for the time being I am cautiously bullish on Bitcoin and at best neutral on Ethereum.”

Obviously, Albert knows much, much more than I do about investments – but why hold on to something when you are “at best” neutral? It doesn’t sound like optimal allocation – even if neutral, shouldn’t the funds be put to better use in an investment with more conviction?

Perhaps ideology is in play…

— x —

… perhaps something along these lines:

“People who are angry and cynical about venture capitalists and the Silicon Valley ecosystem — and I know many — often don’t appreciate the extent to which VCs genuinely believe, in good faith, that what they do makes the world an enormously better place, by nurturing green shoots of innovation into a mighty forest of progress, and are genuinely baffled by the counter-narrative that they reinforce pre-existing social stratification while mostly just helping the rich get richer.”

This is from Jon Evans’ brilliant article “Ether fever dreams” on TechCrunch, about hype and winnowing.

— x —

Venture capitalist Fred Wilson also poked the hype:

“If you read Carlota Perez, you will understand that most important technological revolutions have been fueled by rampant speculation that almost always comes undone right as the sector is moving from the installation phase to the deployment phase.”

Although he takes a more emotional tone:

“So this ugly speculative phase comes with the territory and always has. But that doesn’t mean I have to like it. I hate it.”

So, it seems that the hype-bashing is increasing in volume. Relief, bring it on. And I agree that when we get through to the other side, we’ll realize that some valuable work has been going on amongst the razzle-dazzle.

The next phase is going to be the most interesting.

— x —

This just doesn’t seem right:

photo by Grant Achatz
photo by Grant Achatz, via MyModernMet

A transparent pumpkin pie???? Very pretty, but… Although I work in a sector based on innovation, so of course I would try it. But… (I need to reexamine my open-mindedness.)

By chef Simon Davies, via MyModernMet.