When a customer makes a cross-border credit transfer and ordering and beneficiary customers’ banks have no direct account relationship in the currency of the transfer, intermediary banks are used. There are two options: either an MT103 SWIFT payment instruction is sent down the chain of banks from one bank to the next, or the ordering customer’s bank sends its MT103 payment instruction directly to the beneficiary’s bank. The former is secure and fully transparent, but this serial form of payment can be time-consuming and is subject to levying of customer bank charges. The latter bypasses the intermediaries, and a “cover message” in the form of a SWIFT MT202 message is sent to the intermediary bank. Prior to the November 2009 change, this MT202 contained no information on the underlying customer credit transfer, i.e. on the originator or the beneficiary of the payment, or on other banks in the chain.
Frank Van Driessche, manager, Standards, banking and payments at SWIFT, explains: “The MT103 message contains the details of all the customers and banks involved and the remittance information. In the past, you would then send an MT202 message to clear the money at the interbank level, which came down to a four-line message. The regulator requested that originator and beneficiary details be made available to the intermediary banks. However, our standards working group tasked to find the technical solution decided to provide complete transparency on the end to end chain by including the details of all parties in a new-style MT202 COV, that is the customers, all the banks and the remittance information. So every intermediate bank tasked with the clearing of the interbank payment now has a view of the complete chain.”

“There was a need to increase transparency. That was the perception in the U.S., but also globally,” adds Günther Gall, executive vice president and division head of transaction services at Austria’s Raiffeisen Zentralbank, and co-chair of the Payments Market Practice Group (PMPG), which drafts business practice guidelines for the payments market. “The Wolfsberg Group and other industry bodies accepted there was a risk you could hide sanctioned beneficiaries or banks in the cover messages. They wanted to increase the information cover messages contained, by including details from the underlying MT103, allowing banks through which the cover is routed to check against a sanctions list and determine whether a payment should be stopped because of suspected money laundering, terrorist financing or sanctions busting.”

A smooth start
Everyone agrees that implementation was smooth and timely. “It was really exemplary,” says Van Driessche. “In 1996, we introduced the MT103 with a seven year migration. This time, we had little more than two years from receiving the request in 2007. If you consider that as of day one we saw 30 per cent of MT202 traffic migrate to the new message, that really was quite an achievement by the financial industry. No issues have been reported from our customer base, either technical or on the business side. I believe that is because the PMPG, the Wolfsberg Group, ourselves and other industry bodies had all been underlining the importance of being ready.”

While no-one, not even SWIFT, is able to say for sure what proportion of the old MT202s actually were cover payments, as no-one other than the MT103 originating and receiving banks had full information on the underlying transaction, the 30 per cent figure is in line with industry estimates, suggesting a (near) full migration of cover payments to the new standard, as was required. Old style MT202s continue to be used for other purposes, such as foreign exchange, trade or securities related payments.

While there were minor teething problems, industry feedback is overwhelmingly positive. Michael Knorr, managing director in Citi’s Treasury and Trade Solutions business, comments: “Implementation was very smooth. It shows that everybody in the market globally did a good job preparing for it. We ourselves had the right people in place, educated our service people and held education sessions for our customers.
“Logically, with more data elements in a payment order, your hits go up proportionally. Initially they increased due to new parties in the payments chain, and banks had to update their filters and ignore patterns to restore efficiencies. For the first half year, probably everybody had to over-compensate,” Knorr adds. Stephen Ley, partner in Deloitte’s payments team agrees: “Improving the efficiency of these solutions has been an active area of work for us. For most of the banks I speak to there was an increase in the volume of hits. But it doesn’t appear to be a disproportionate increase, and it’s not causing any significant issues.”

Knorr continues: “I’m a member of the PMPG, so we reached out to different banking communities around the globe as well, asking them to report any specific or systemic issues, and there has been nothing that pointed towards a larger issue. Some banks in certain markets hadn’t implemented the changes, so we did get some rejections, which had to be escalated so that they could accept the extended messages.”

Some institutions were late implementing and so switched to using serial MT103 messages, which is, of course, perfectly feasible. Reverting to serial MT103s was one of the options considered, but rejected as a general solution to the problem. However, some banks reverted to this as a stopgap to allow further preparation time, says Knorr, while others, whose cover volumes did not justify making the adjustments, reverted permanently. Another option is for banks to outsource cover payments to larger banks like Citi, by way of future advising services.

The PMPG reported delayed payments, partly due to inconsistency of sanctions globally. It monitors these and formulates guidelines to help the industry, as it does regularly on other (non-compliance) issues, such as charges or character formatting. It relies on receiving feedback from banks on their problems.

The implementation also uncovered some little-understood oddities, such as domestic dollar payment arrangements in certain countries – Turkey for example. “Banks sent MT103s for domestic payments to each other, clearing through New York. Initially some of these clearing arrangements didn’t want to or couldn’t handle the cover,” says Knorr. “They had assumed these were just domestic payments.”

He says these problems have now been resolved, but he believes some beneficiary banks still need to re-think risk assessment surrounding cover payments. “Banks need to be aware that they are taking a credit risk when they give their clients access to funds the bank has not yet received.”

Implementing the change
The smooth start was down to careful preparation. Deloitte’s Ley explains: “There was advice, there were joint groups, notifications, training, standards. People had time to gear up for this and they did. Overall this was a very successful implementation.”

Amanda Gilmour, product director, Temenos AML and STP, reports that her customers took the change seriously. “No surprise, considering the size of penalties we’ve seen handed down for sanctions breaches. We do a new SWIFT release every year, and this was one of the earliest we have been asked to do, to allow a good six/seven months’ testing.”

The actual changes in processing were not that complicated, says Barry Kislingbury, solutions manager for payments and messaging at Misys. “The problem was people had to change lots of systems. That sometimes meant running a big project for a relatively small change.” Just how big a headache this was depended on a bank’s IT architecture. Gilmour says: “It depended on the flexibility and configurability of the payment and transaction systems, and the STP products banks were using. One customer said it really was not a significant change: the configurability of their system was such that they simply altered the configuration file, choosing which fields in which formats of messages to screen, and it was business as usual. They ran an exercise confirming that they did not have duplicate hits, but that was just prudent. However, other banks didn’t have that configurability.

“It was not just changing the format of the MT202 COV and incorporating the additional data, it was making sure you understood what impact it would have downstream, in your other payment and transaction management systems,” notes Gilmour. Van Driessche adds that it went beyond technical changes for banks: “They also had to review their processes and workflows – where the PMPG assisted with defining market practice guidelines around the usage of this message – to foresee additional screening capacity as intermediate banks, and make sure the MT202 COV could be mapped into proprietary standards, for example in the U.S.”

Kislingbury contrasts two banks’ differing experiences – ANZ, a former Misys client, and National Australia Bank (NAB), a current one. ANZ’s well run, but older, technology required changes to numerous systems that had to generate the cover messages. “It took ANZ about six months to modify all of their applications. NAB, who run our messaging infrastructure, made the change centrally, in the messaging layer – something we also offer, but they built it themselves. There was additionally a minor change to the back-office systems, to identify a cover payment, but all the formatting and storage of messages was done in the messaging layer. It took
them just two weeks to build it and do the testing.”

Looking forward
The change may lead some banks to re-examine their payment architecture. “Since Sibos last year we’ve seen a marked increase in the number of people looking at upgrading their payments infrastructure, partly because of changes like this, partly because they just need to modernise. A modern centralised process is much easier to maintain and update, but upgrading a payments environment isn’t a five-minute job,” comments Misys’ Kislingbury. “You’ve got the larger banks that built their own payment engine, which tends to be central to operations and all the applications use it. To modernise that is just like open heart surgery.” But there are alternatives: “The payments hub has become more interesting and offers banks a different way to upgrade, without the enormous price tag and size of project that people traditionally associate with a payments engine replacement project.”

As to regulatory change, Citi’s Knorr believes the MT202 COV is just the tip of the iceberg. There are many other areas regulators are likely to address, from bulk file transfers to card transactions, where messages go across borders and settlements happen through a settlement bank that is not privy to the individual payment details. However, Knorr is upbeat about MT202 COV’s introduction: “I think it’s a very good story. The regulators identified the issue, they threw it out to the market, there was communication between regulators and industry groups, and the regulators allowed industry to come up with a solution, which was implemented. It was not somebody simply throwing a regulation at you. I think that’s an opportunity, and hopefully we can do more of that.”

Basel II and The Financial Action Task Force constitute a solid beginning, and the increasingly potent US Office of Foreign Assets Control (OFAC) list, which outlaws financial dealings with suspicious entities, is also going some way to prevent more scandals.

New technologies are now being called upon to help financial service organisations (FSOs) track deals, monitor trading activities and make business more efficient. To be beyond reproach, businesses need good working practises.

“Despite changing regulations and requirements, most IT systems are fixed,” says Shelagh McManus, managing director of operations at Moneo. “Financial services is one of the worst industries to work in, in terms of compliance.”

McManus points to consultation papers 121 and 124 as examples of industry initiatives that can prompt huge change in IT systems. CP121 involves reforms to the financial services market to make advice more impartial, and CP124 addresses what constitutes market abuse in bonds, equities and takeovers as well, as price stabilisation rules and compliance. “It’s one of the reasons our Exii Financial Services solution came about, to solve business problems in the financial market,” McManus explains.

The Teachers Provident Society (TPS) used Exii to deploy its Unit Trust products, then later reconfigured the system using business logic to provide a Stakeholder offering without incurring further costs.

In explaining why TPS chose to use the Exii system, Ellen Ritter, general manager of customer relations, points to its ability to provide better business adaptability. “In a year’s time we can easily change the organisation and change how the company operates again,” she says.

Move with the times
Managing risk and exposure to risk is very important for FSOs that want to stay competitive in a highly-regulated environment. Telephone trade recording systems are now used as standard procedure and are particularly useful when misunderstandings arise over a verbal deal. “You don’t get a vast number of requests for replay, but when you do, millions of pounds can be involved,” says Stephen Wright, product manager at Thales Contact Solutions.

“The key to improving capital and thereby share holder return is cost management and risk reduction,” adds Mark Robson, managing director for Treasury Services at Reuters. Its risk management product, Kondor Plus version 2.5, works in real-time so corporates can manage risk effectively. “It has extra enhancements around derivatives to create structured products, which can be sent out to customers,” explains Robson. “This allows users to build yield curves in a tailored fashion. Trades done on the trading platform Dealing 3000 are automatically captured. It creates an online deal ticket and automatically delivers output feeds of trade for risk management and settlement.”

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