The UK currently has one of the longest clearing cycles for electronic payments in Europe, but this is set to change. The UK Faster Payments service developed by payments processing organisation VocaLink is due to be launched in May 2008. We talk to Martin Wilson, Chief Commercial Officer of VocaLink, about the unique features of the new service.
Chief Commercial Officer
Martin is responsible for VocaLink’s commercial growth including sales, customer relationships and service line and territory development. Following the successful merger of Voca and LINK Network Interchange to create VocaLink in July 2007, Martin continues to drive the company’s expansion into new markets and territories.
Why was Faster Payments developed?
For a while there has been some regulatory oversight on the payments industry in the UK. The Cruickshank report is often cited as an example of that.
The Office of Fair Trading (OFT) became involved, and the market perception began to grow that there was a level of customer1 dissatisfaction with the clearing times for payments within the UK. When you look at other markets in Europe and around the world, our three day clearing cycle is slower than most. The industry was asked to look at speeding up this process.
It was also perceived that the three day process gave paying banks an opportunity to retain ‘float’ from approximately 6% of Bacs payments that are Standing Orders. In actual fact, most, if not all banks, had removed float from the process, but the perception remained. The OFT asked the industry to look at that as well.
May 2000 saw the publication of Don Cruickshank’s report Competition in UK Banking: A Report to the Chancellor of the Exchequer. The report was an independent review of the banking industry commissioned by the UK government. In the report, Cruickshank criticised the lack of competition in the UK banking sector and offered a number of recommendations, including the need to reduce the time taken to clear transactions.
The OFT was looking for a next day service to be created. The payments industry responded by taking the opportunity to rethink the way payments were processed and managed. This led to the voluntary decision to leapfrog the rest of the market and introduce a real time payments service instead.
So Faster Payments is both the industry’s response to regulatory influence and its collective initiative to develop payments for the future.
Who is involved in the initiative?
The UK payment industry body APACS has co-ordinated the process of gathering the banks’ requirements and agreeing the specification that defines the system and its central infrastructure. Thirteen banks in the UK have been involved and together with APACS and VocaLink have devised the system requirements, the scheme rules, and how the whole system will work.
Founding member banks of Faster Payments
Abbey, Alliance & Leicester, Barclays, Citi, Co-operative Bank, HBOS, Clydesdale and Yorkshire Banks (national Australian Group), HSBC, Lloyds TSB, Nationwide Building Society, Northern Bank (Danske Bank), Northern Rock and Royal Bank of Scotland Group (including NatWest and Ulster Bank).
The original bid involved two separate companies, Voca and LINK, who formed a joint venture called IPL (Immediate Payments Ltd) to deliver the service. But since winning the bid, Voca and LINK have merged, and therefore IPL has been subsumed into VocaLink and is a wholly owned subsidiary of VocaLink.
What types of payment can be processed using Faster Payments?
In the first phase, the service will be used for credit transfers. The initial volume will come from internet payments, telephone payments and standing orders. Going forward, Faster Payments creates opportunities for banks to differentiate themselves by offering new and targeted payments services on the back of this.
How does the clearing and settlement process work?
The basic principle is that when a payment is initiated, a check is made on the availability of funds in the sender’s account. Assuming the transaction is valid, meaning that all of the data is available and correct, and there are funds in the account, then the transfer is made and that payment is classed as irrevocable, so it cannot be recalled.
The settlement may take place a little while after that. It’s a multilateral net settlement service, so VocaLink nets out the monies owed by one financial institution to any other that is participating. Settlement is triggered by time or value. Both parameters are determined by the scheme.
So to summarise, once the transaction is complete, it becomes irrevocable. As a technicality, the settlement might not take place for an hour or so after that.
How will payments made outside of working hours be settled?
As far as consumers are concerned, there’s no difference. But clearly settlement is done through the Bank of England, and therefore is subject to the office hours of the settlement agent. Therefore in the dark hours and at the weekends settlement isn’t triggered until the start of business.
How does that work for the beneficiary?
The beneficiary is entirely secure throughout, irrespective of the time of day or whether it is a weekend or weekday. As far as the participants are concerned, the sender has funds deducted from their account and the receiver has funds allocated to their account, and that transaction is irrevocable.
The settlement is the business of the financial institutions that intermediate. Whilst inter-bank settlement does not occur at the weekend and outside working hours, the use of multilateral netting contains the net exposures between members. There are also a number of risk controls to protect the systems and the customer in unusual events. Thus, as far as the end user is concerned, payments can be made quickly and irrevocably at any time.
The joy of this is the certainty it gives to all parties that it’s either done or not done. It’s real straight through processing. You know when you’ve made a transaction successfully because the funds will have been removed from your account. If it’s unsuccessful in some way you’ll quickly know.
Clearing systems in the UK
Until now the UK has had two clearing systems for electronic payments:
Bacs operates two main payment schemes: Direct Debit and Bacs Direct Credit. Together these schemes process around 5.5 billion transactions worth £3.7 trillion each year. Direct Debit enables banks to collect money from customers’ bank accounts. Direct Credit is used for electronic transfers. Bacs payments generally take three days to clear.
CHAPS is a real time gross settlement (RTGS) system for same-day payments made in sterling or euro within the UK. CHAPS is used for business-to-business payments and for high-value consumer payments. There is no lower limit on the value of transactions processed through CHAPS, but as payments made by CHAPS are relatively expensive it is best suited to high value payments. CHAPS processes around 130,000 payments worth £300 billion every year.
How does Faster Payments differ from the existing payment systems?
It doesn’t depend on payments being batched up for submission or for processing. Payments made through Faster Payments are single immediate payments. Like card transactions at the point of sale or at ATMs, payments are generally initiated on demand. Unlike card transactions, they are irrevocable and they can be anything up to the value set by the bank, so they can be low value or relatively high value.
In the early stages, the industry is setting a limit. That is obviously the right approach to ensure that the system works well and beds in correctly. In the future, as usage increases, the limit may be raised to anticipate rising demand. The limit is currently set at £10,000 for one-off payments.
That’s different from something like RTGS, which is typically used for high value payments. RTGS systems also provide single settlement, meaning that payments must be settled individually at the Bank of England, before value can be delivered to the beneficiary. Through the Faster Payments scheme, individual payments are irrevocable and the arrangements between the financial institutions mean that settlement can take place at a later point.
In terms of other payment types, I like to use credit cards as an example. Faster Payments sounds a bit like a credit card in some ways but payments can be made from account to account, which you can’t do on a credit card. The other thing that is really attractive relates to internet payments. When you make a purchase on the internet at the moment you have a couple of options:
You can either use your debit or credit card, in which case you have to reveal your identity details, and of course some consumers can be worried about identity theft.
Or you pay through another method not sponsored by financial institutions such as PayPal, which effectively leaves you with the problem of funding your PayPal account via another payment instrument – an extra step in the process.
Faster Payments means that you can make a purchase over the internet and there could feasibly be a facility to make the payment through your online bank account, using the security that your online bank account offers. Therefore you don’t have to reveal your identity details and the payment goes straight from your account into the merchant’s account. That’s good for you because you’ve got that security and the surety of delivery. It’s good for the merchant because they know immediately that they have received your payment. It’s also good for the banks as it enhances their customer proposition and is entirely self service.
The best way I can describe Faster Payments is like electronic cash. If you hand over cash at a counter, the merchant knows he’s received the money and you know you’ve handed it over. Faster Payments is the electronic version of that.
On the other hand, merchants using credit cards are charged higher fees for processing credit card transactions. There is also a level of uncertainty around the transaction. Some credit card transactions fail; the merchant doesn’t get their funds but they’ve already released the goods. It’s a genuine headache for online merchants and this service could eradicate that.
Presumably merchants would also receive funds a lot earlier for transactions made over the weekend?
Indeed. It’s a 24/7 service. For the consumer and the merchant it doesn’t matter what time of day or night it is.
How will corporates benefit from Faster Payments?
This first phase is the account-to-account credit transfer service for single payments. Whilst this will be useful for exceptional, urgent payments (eg last minute salary adjustments), the industry is looking at the opportunity to open this out to provide a service that will allow businesses to submit batch files for fast processing. This is an opportunity under investigation at the moment. But it’s the same concept, just on a larger scale.
To illustrate what that might mean for corporates – if you take a salary file, using the service that we have in the UK today, you have to submit the file on a bank working day and it won’t be cleared for another two or three days after that. If the corporate wants to make changes to the file once it has been submitted, they have to go through a highly structured process to change the file, which can be quite time consuming. And of course they have to reserve funds for that submission.
This service might offer corporates the opportunity to hold their payment file until the time it needs to be processed. So it reduces the levels of liquidity that they might have to manage in their business.
Managing liquidity is not just a risk – it also represents a significant cost. Whether you’re a financial institution or a corporate, when you’re dealing with huge sums and you’ve got money tied up, it is costly to your business. So this could make the whole process much more efficient and cost effective.
In the future – well, VocaLink’s real-time infrastructure is inherently flexible, with much greater capability to enable payments integration with corporates’ integral business processes than today’s batch systems.
What are the limitations of this service?
We’re actually artificially putting in limitations to make sure that the system works securely and well at the outset. This is not a limitation of the system – it’s just a precaution that is in place for the time being. I can’t think of any physical or technical limitations of the service itself.
Why was the original launch date of November 2007 postponed?
This is the first genuinely new payments scheme to be introduced for many years. A level of complexity is involved in it because it requires all participant banks to integrate with a central infrastructure. For new payment schemes and payment systems to take off, it is vital that they win and maintain the confidence of the market. So it is much more important to get it right than to get it in by a particular date.
The industry therefore took the decision to take extra time and care to test these systems and integrate them. If it were implemented and something went wrong it could be difficult to build up the market confidence, so making sure the system is secure, stable, and works very well from day one has always been the priority.
This is a service for sterling payments in the UK but what has been done to make Faster Payments SEPA-compliant?
The service has been developed with full knowledge of what the SEPA standards are. It is therefore easily convertible to take on ISO 20022 message formats, for example. We’ve already built SEPA compliance into the service, making sure that we adhere to the message formats and settlement and clearing standards that have been defined by the EPC.
Are there any comparable systems in Europe today?
No. This is quite unique. It is the first genuinely new payments scheme to be introduced for about 50 years. Some people will claim that they have fast payment systems, but these are either bulk payment systems or are dependent on the settlement agents being available. This, on the other hand, is an irrevocable single immediate payments service that’s available 24/7.