The Inefficiencies ofCross-Border Payments:

How Current Forces Are Shaping the Future

WrittenbyYoonS.Park,PHD&DBA,GeorgeWashingtonUniversity

Visa,asapaymentindustryleader,isfocusedonincreasingtheefficiencyandreducingthecostofcross-borderpaymentsforfinancialinstitutionsandtheirclients.

Cross-bordertradeisgrowingrapidlyasmorecompaniessourcegoodsandservicesoverseas.Mostcross-bordertradepaymentsarehandledthroughcorrespondentbankingrelationships.Asvolumecontinuestogrow,pressureisbeingexertedonfinancialinstitutionsandpaymentsystemstoimprovethecross-borderpaymentprocess.

VisacommissionedDr.YoonS.Park,anexpertonglobalfinancialmarketsandProfessorofInternationalFinanceattheSchoolofBusinessatGeorgeWashingtonUniversity,toexaminethecurrentchallengesofthecross-borderpaymentsprocessandhowacombinationofforcesareinfluencingthefutureofpaymentprocessing.

Wehopeyoufindthisreportusefulinunderstandingthecross-borderpaymentlandscape.Webelievethatimprovingthecross-borderpaymentprocesswillprovidequantifiablebenefitsforbothbanksandcorporates.

Sincerely,

AlizaKnoxSeniorVicePresidentVisaInternational,CommercialSolutions

TableofContents

Executive Summary 2

Overview of Cross-Border Payments 4 Scaleofcross-borderpaymentsandinternationaltrade 4 Howcross-borderpaymentsworktoday 5 Exampleofcross-borderpaymentflow 6

Cross-Border Payment Challenges 8 1. Domesticinfrastructuresarenotdesignedtohandlecross-borderpayments 8 2. Lackofcommonmessagestandards 9 3. Impactofregulatoryrequirements 9 Corporateperspectiveoncross-borderpaymentinefficiencies 10 Inefficienciesofcross-borderpaymentsdrivecosts 10

Payment Trends and Impact on Cross-Border Payments 12 Trend1: Transnationalpaymentsystemsaregrowing 13 Trend2: Government-ledinitiativesandmandatesareincreasing 14 Trend3: Riskandliquidityarebeingcloselymanaged 15 Trend4: Multinationalbanksandbusinessesareexpanding 17 Trend5: Operationalefficienciesarebeingsoughtthroughoutsourcing 18 Conclusion 18

Questions for Management 20

Appendix 22 Paymentsystemtypes 22 Asurveyofmajorsystemsfacilitatingcross-borderpayments 24 Selectedgovernmententitiesinfluencingcross-borderpayments 29 References 31

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Cross-bordertradeisgrowingrapidlyasmorecompaniessourcegoodsandservicesglobally.Internationaltradedoubledoverthepastdecadeto$10.5trillionin2005.1Mostcross-bordertradepaymentsarehandledthroughcorrespondentbankingrelationships,wherebyaseriesofbanksanddomesticpaymentsystemsaretypicallylinkedtogethertomovefunds.

Whilevolumecontinuestogrowandmigratetoopenaccountterms(suppliercreditextendedtobuyerattimeofsale),pressureisbeingexertedonbothbanksandpaymentsystemstoimprovethecross-borderpaymentprocess.Thepaper,“Theinefficienciesofcross-borderpayments:Howcurrentforcesareshapingthefuture,”looksatthechallengesofthecurrentcross-borderpaymentsprocessandhowacombinationofforcesareinfluencingitsfuture.

Cross-border payment challengesCross-borderpaymentsareintrinsicallyinefficientbecausethereisnotonesingleubiquitousglobalpaymentsystem.Therearethreechallengesthatmustbeovercomeinordertoimprovethecross-borderprocess:1. Mostpaymentsystemsarebasedonlocallawsandpracticeswithinexisting

domesticbankingandfinancialstructures.2. Lackofacommonglobalstandardandvariationsbetweensystemshavereduced

theabilityofbothbankandcorporatetreasury/enterprisesystemstoseamlesslypassdatabetweeneachother.

3. Governmentregulationsarechanginghowpaymentsaremade.Paymentsaresubjecttodomesticregulationswhichcompoundthechallengesofcross-borderpaymentsbecauseoftenrulesvarybetweenanoriginatingandreceivingcountry.

Trends shaping the futureAnumberofforcesareshapingthecross-borderpaymentlandscape:1. Transnationalpaymentsystems–Emergingtransnationalsystemsarereducingthe

relianceoncorrespondentnetworksforpaymentsandstandardizingdataformats.2. Government-ledinitiativesandmandates–Government-ledinitiativesare

influencinghowpaymentsaremadeandwhatfeescanbecharged.3. Riskandliquiditymanagement–Paymentsystemsarebecomingmoreefficientat

managingcreditrisk,liquidityneeds,andfundingcosts.4. Multinationalbanksandcorporations–Multinationalbanksareachieving

processingeconomiesofscalewhileunintentionallyconcentratingcreditriskduringsettlement.

5. Operationalefficienciesthroughoutsourcing–Banksarebundlingpaymentsandoutsourcingoperationstootherbanksandthird-partyprocessors.Thisisdrivingprocessefficiencies,butfurtherdisintermediatingfinancialinstitutionsfromthepaymentprocessandthefinancialsupplychain.

Today,cross-borderpaymentsareslow,inefficientandcostlyforbanksandbusinesses.Increaseinglobaltradeandimprovementsinphysicalsupplychainefficienciesarecreatingdemandforprocessimprovements.Improvementintheefficiencyandeffectivenessofcross-borderpaymentsislikely,butallstakeholdersarebeingrequiredtoincreaseinvestmentstochangetheprocessesandsystemsofcorporates,banksandpaymentsystems.

1 JackStephenson,“GrowingPains:OutlookfortheU.S.PaymentsIndustry,”McKinsey&Company,2005.

Executive Summary

Overview of Cross-Border Payments

Scale of cross-border payments and international trade

Paymentsarebigbusiness.RevenuesfromtheU.S.paymentsindustryalonehavegrownat6%peryearsince1994,topping$207billionin2004.Inaggregate,thepaymentsbusinessgeneratesmorerevenuesthandotheairline,personalcomputing,lodging,orentertainmentindustries.2

Intermsofvolume,cross-borderpaymentsareestimatedtorepresentapproximately8%oftotalpayments.3Althoughitisdifficulttosizeexactly,onecanindirectlyestimatetherelativemagnitudeofcross-borderpaymentflowsbyanalyzingthescopeofinternationaltrade.Duringthepasttenyears,theworldtradevolumeasmeasuredbytotalimportshasroughlydoubledindollarvaluefrom$5.5trillionin1996to$10.6trillionin2005.Correspondingly,onecansurmisethatthecross-borderpaymentsrelatedtointernationaltradehavedoubledinsize.

Table 1: World Trade as Measured by Imports (in trillions of U.S. dollars)

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

World 5.5 5.6 5.6 5.8 6.6 6.3 6.6 7.7 9.3 10.5

IndustrialCountries(23)1 3.6 3.6 3.7 3.9 4.3 4.2 4.3 4.9 5.8 6.4

DevelopingCountries(164) 1.9 2.0 1.9 1.9 2.3 2.1 2.3 2.8 3.5 4.1

TheBostonConsultingGroupestimatesthatthevolumeofcross-borderpaymentswillincreaseatacompoundannualrateof10.2%globallyand7.8%fortheNorthandLatinAmericasduringthedecadeof2000through2010.4

2 JackStephenson,“GrowingPains:OutlookfortheU.S.PaymentsIndustry,”McKinsey&Company,2005.3 CelentCommunications,Cross-BorderBusiness-to-BusinessPayments:TheNewFrontier,Boston,October 2004.4 BostonConsultingGroup,GlobalPayments2003:ThePaymentPuzzle,2003.

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How cross-border payments work today

Mostoftheworld’smajorbanksmaintaincorrespondentbankingrelationshipswithlocalbanksineachoftheimportantforeigncitiesoftheworld.Thistwo-waylinkbetweenbanksisoneofmanyinterbankrelationships,suchasnostro/vostroaccountsandthesellingofcashmanagementandtreasuryservicestootherfinancialinstitutions.Theinstitutionprovidingtheservicesisthecorrespondent bankorupstreamcorrespondent,whiletheinstitutionbuyingtheservicesistherespondent bankordownstreamcorrespondent.Atleast80%ofbank-to-bankcross-borderpaymentscurrentlytakeplacethroughtraditionalcorrespondentbankingarrangementsorviaintra-banktransactions.�

Oftenbanksdonotseparatedomesticandcross-borderpayments,blurringthelineofdemarcationinpaymentflows.Globalfinancialinstitutionsutilizetheirinternalnetworkstoclearandsettlebothdomesticandcross-borderpayments.Oftenmanypaymentsarebundledinasingletransfer,withbothdomesticandinternationaltransactionscommingledbycurrency.

Manycross-borderpaymentsareactuallysettledinaspecificcountry’sdomesticsettlementsystem.Forexample,aBritishcompanymakingaU.S.dollarpaymenttoaKoreancompanytransfersthenecessarydollaramountfromitsU.S.correspondentbanktotheKoreancompany’sU.S.bankaccountintheU.S.IftheKoreancompanydoesnotmaintainanaccountatabankintheU.S.,thefundsaretransferredtotheKoreancompanybank’scorrespondentbankintheU.S.

5 Retail Banking Research Ltd.,RetailBankingResearchLtd.,Regulation 2560/2001: Study of Competition for Cross-Border Payment Services,FinalReportpreparedfortheEuropeanCommission,London,September2005.

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Example of cross-border payment flow

CompanyXintheUnitedStatesneedstomakeapaymenttoCompanyYinJapan.CompanyXrequestsitsbankintheUnitedStates,BankA,tosendaU.S.dollarpaymenttoCompanyY.SinceBankAdoesnotbelongtoCHIPS,itrequestsitscorrespondentbank,BankB,whichisamemberofCHIPS,tofacilitatethetransfer.BankBsendsthefundstransferviaCHIPStoBankCwhichisalsoamember.BankCisthecorrespondentbankforBankDwhichiswhereCompanyYhasanaccounttoreceivefunds.�

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Company X (US)

Company Y (Japan)

Bank A (US) Bank B (US, CHIPS Member)

CHIPS

Bank C (US, CHIPS Member)

Bank D (Japan)

(1) Company(X)intheU.S.requestsitsU.S.bank(A)tosendadollarpaymenttoitsclient(Y)inJapan.(2) BankAasksitsU.S.correspondentbankintheU.S.(B)tofacilitatethistransfer.(3) Bank(B),amemberofCHIPS,sendsthefundstransfercommandtoCHIPS.(4) CHIPSexecutesthefundtransferbycreditingtheaccountofanotherU.S.CHIPSmemberbankC.(5) Bank(D)inJapanisbankC’scorrespondentbank.(6) CompanyYhasanaccountwithBankD.

6 Notshowninthediagram,SWIFT (Society for Worldwide Interbank Financial Telecommunications) is anSWIFT(SocietyforWorldwideInterbankFinancialTelecommunications)isanindustry-ownedlimitedliabilitycooperativethatsuppliessecuremessagingservicesandinterfacesoftwareforfinancialtransactionstomorethan7,650banks,securitiesbrokersandinvestmentmanagersinmorethan200countries.SWIFT provides the messaging infrastructure for most electronic cross-border payments today.SWIFTprovidesthemessaginginfrastructureformostelectroniccross-borderpaymentstoday.

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Cross-Border Payment Challenges

Cross-borderpaymentsamounttotrillionsofdollarseachyear.AstudybytheBoardofGovernorsoftheFederalReserveSystemfindsthatendusersandfinancialserviceprovidersconsidercross-borderpaymentstobecostlyandcumbersome,butthattheincentivestodevelopfasterandlowercostsystemsdonotexist.7

1. Domestic infrastructures are not designed to handle cross-border payments

Overthepastfewdecades,manycountrieshaveestablishedbothhighandlowvaluepaymentsystemsthatarebasedonproprietarycommunicationandsecuritystandards.Asaresultoflargelyindependentdevelopment,thereisalackofstandardizationandautomationininter-bankandintra-banknetworks.Thisadverselyaffectsbanksandbusinessesalikeandresultsofteninmanualinterventiontocollectandrepairdata.

Majorbankswithsubsidiaries,branchesandassociatedbanksinmanycountriesmaymovefundstoadestinationcountrybyanintra-banktransaction.Thebeneficiaryiseithercrediteddirectlywhereithasanaccountwiththeforeignoperationorthepaymentissenttothebeneficiary’sbankviaabilateraltransfer,oranationalclearingandsettlementsystem.AreportbytheEuropeanCentralBank,however,findsthismethodtobethemostcostlyandinefficientduetotheuseofnon-standardcustomerinterfaces,incompatibleformatsbetweendomesticandforeignbanks,andthelowdegreeofautomationinbanks’internalsystems.8

Forexample,theUnitedStateshasdozensofsiloedandunderutilizedpaymentinfrastructures,oftencompetingwithoneanotherforvolumes.Withmorethan60distinctclearingandsettlemententities(downfromseveralhundred),amajorU.S.bankmayoperatedozensoflargelyredundantpaymentsoperationsandtechnologyplatforms,eachwithitsowndedicatedapplications,staffs,rules,andbusinessprocesses.

7 The Future of Retail Electronic Payments Systems: Industry Interviews and Analysis,byFederalReserveStaffforthePaymentsDevelopmentCommittee,FederalReserveSystem,December2002.

8 European Central BankEuropeanCentralBank, Improving Cross-Border Retail Payment Services: The Eurosystem�s �iew,�s �iew,s �iew,September1999,p.10.

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2. Lack of common message standards

Businessesalsofacethechallengeofremovingpaperandmanualprocessesbyintroducingstraight-throughprocessing(STP)asmuchaspossible.Thisrequirespaymentinstructionstobegeneratedelectronicallyaspartofthebusinessprocess,passedsecurely,efficientlyandcost-effectivelytotheirbanks,andmatchedandreconciledautomaticallyviaauniversalreferencenumberwithininvoicing,accountspayable,accountsreceivableandothersystems.However,accordingtoarecentwiretransfersurveyonly15percentofrespondentsreportthattheirwiresalwayscomewithsufficientremittanceinformation(forexample,customeraccountnumberandinvoicenumber,toapplythepaymentcorrectly).Thetypicalbusinessmustresearch17percentofthewiresthatitreceivesattheaveragecostof$35perwireand30minutesoftime.9Resistancetotheadoptionofstandardsarisesfromthelargecostsassociatedwithenhancinginternalsystemsandproceduresrelativetothesmallvolumeofinternationalpayments.Unlikedomesticstandards,cross-bordermessagestandardshavetosupportmultipledomesticrulesandregulationsbeforetheycanbeadoptedwithinamarket.Inadditionthevalueofastandardisrealizedonlywhenthespecificationiswidelyaccepted.Asaresult,banksmaybereluctanttomakesizableinvestmentstosupportsuchstandardsiftheyareuncertainthatotherbanksaremakingsimilarinvestmentstoupgradetheirsystems.

3. Impact of regulatory requirements

Thecomplexgovernancestructuresofthesedisparatepaymentsystems–somepublic,someprivate,someoperatedasindustryassociations–onlyaddtothechallenge.Achievingcoordinatedchangeatanindustrylevelisnearlyimpossiblewithoutgovernmentmandates.However,whengovernmentmandatesoccur,theytendtofocusmoreonrespondingtocrises(orpreventingcrises)thanonpromotingefficiency.ThePatriotAct,KnowYourCustomer(KYC),BaselII,Sarbanes-Oxley,andFederalFinancialInstitutionsExaminationCouncil(FFIEC)rulesgoverningcreditcardbusinesspractices–tonamejustafewrecentregulations–havecostbillionsofdollarsforbanks,butproducelittle,ifany,incrementalrevenues.

“We strive to adopt the most efficient and cost-effective practices in cross-border payments, but sometimes government regulations tend to stifle initiatives over safety and other regulatory issues.” Senior Manager, Treasury Team, Samsung Corporation

9AssociationforFinancialProfessionals,AFPWireTransferSurvey:ReceiptofRemittanceInformation,October2005.

Corporate perspective on cross-border payment inefficiencies

Theinefficienciesthatabankexperiencestrickledowntocorporates,resultinginhigherdirectandindirectcosts.Oftentheindirectcostsresultingfromoverallprocessinefficienciescanbemoresignificantthanthedirectcostassociatedwiththepayment.In2003and2004,theFederalReserveBankofNewYorkconductedasurveyoflargenon-financialU.S.businessesinordertoidentifythe most important andthe least well-met areasofpaymentsprocessing.10

About40percentofthesurveyrespondentsnotedthatreducingthetimeneededtodetectandresolveunauthorizeddebits,aswellasreducingtheirfrequencyandassociatedfinanciallosses,wereveryimportantorcriticallyimportanttotheirfirmsandthatcurrentserviceswerelessthansatisfactory.Inaddition,therespondentsputhighpriorityonreducingthetimerequiredtoidentifyinsufficientlyfundeddebittransactions,receivingcreditforoverseaspayments,andobtainingsufficientinformationtoprocessanincomingpayment.Companiesalsosawastrongneedtoimprovetheirabilitiestoreconcileinformationreceivedfrombanksonuseofpaymentservicesandreducebankfeesforpaymentservices.11

The Federal Reserve study “Opportunities to Improve Payments Services” identifies the following five areas as very or critically urgent but still largely unmet by the existing payments systems:• Risk reduction: decrease or eliminate losses due to fraud, security lapses, or

unrecoverable misdirected payments;• Liquidity: collect revenues faster or time payments more precisely to increase access

to funds and the amount of time a firm can use the funds;• Processing efficiency: develop improvements to reduce the amount of time required

to finish a task or the number of steps needed to complete a process, such as obtaining information or responding to inquiries;

• Explicit costs: minimize the out-of-pocket fees or investment expenses associated with a process; and

• Governance and infrastructure: establish fundamental building blocks of a well-functioning payments system, such as legal basis and operation by trusted parties.

Inefficiencies of cross-border payments drive costs

Costsassociatedwithcross-bordertransactionsarerelatedtovariousfactors.Businessestendtopayfeesnotonlyforinternationalpaymentsbutalsootherexplicitorimplicitfeessuchasforeignexchangeconversion.Moreover,variousintermediariesareinvolvedinthepaymentprocess,particularlythroughthewidespreaduseofcorrespondentrelationships.Consequently,theexecutiontimeforcross-borderpaymentsissubstantiallylongerthanfordomesticpayments,whichincreasesthefloatcost(intheabsenceofvaluedating).

10 SandyKriegerandMicheleBraun,OpportunitiestoImprovePaymentsServices:ResultsfromaSurveyofLargeCorporations,FederalReserveBankofNewYork,July2004.Thestudyaskedbusinesseswhattheyseektoachieveineachstepoftheprocessofmakingandreceivingpayments.Thequestionswereintendedtohelpcorporatesidentifytheirprioritiesforimprovements.Thesurveyencompassed733U.S.nonfinancialfirmswithatleast10,000employees,selectedfromaDunnandBradstreetdatabase.Theresearchersthensentletterstoarandomlyselectedsampleof200corporatetreasurersandchieffinancialofficersfromthispopulation,requestingthatthepersonmostknowledgeableaboutthefirm’spaymentsneedsrespondtotheFederalReserveBank’sonlinesurvey.

11 SandyKriegerandMicheleBraun,“ImprovingBusinessPaymentsbyAskingWhatCorporationsReallyWant,“CurrentIssuesinEconomicsandFinance,FederalReserveBankofNewYork,May2005. 10

Payment Trends and Impact on Cross-Border Payments

Thecross-borderpaymentsprocessisundergoingaperiodofprofoundchange.Wheretransactionservicesprovidedbybankswerevalue-added,theyarenowincreasinglycommoditized.Third-partyservices,suchasSharedServiceCenters(SSC),ERPsystems,etc.,arenowprovidingvalue-addeddatathatwasprovidedbybanksinthepast.12

Withincompanies,thetreasury,liquiditymanagementandriskmanagementfunctionsareintegratedmorecloselytotakeadvantageofnewknowledgemanagementtechnologyaspartoftheirdriveforgreaterefficiencyinanincreasinglyglobalenvironment.

Key trends impacting cross-border payments are:1. Transnational payment systems are growing2. Government-led initiatives and mandates are increasing3. Risk and liquidity usage are being closely managed4. Multinational banks and corporations are expanding 5. Operational efficiencies are being sought through outsourcing

12CurrentIssuesinEconomicsandFinance,FederalReserveBankofNewYork,May2005.

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Trend 1: Transnational payment systems are growing

Whileoncetherewereonlydomesticpaymentchannelsineachcountry,wehavewitnessedtheemergenceoftransnationalsystemssuchasTARGET,CLS(ContinuousLinkedSettlement),theFederalReserve’sInternationalACHProject,knownasFedACHInternationalandtheproposedpan-EuropeanautomatedclearinghouseknownasPE-ACH.Ontheotherendofthespectrum,cardsystemssuchasthoseoperatedbyVisaandMasterCardaretrulyglobalinscopeandhavebeenexpandingfromconsumerbasedtransactionsintocommercialpaymentsformorethanadecade.

Transnationalsystemshavetraditionallyfocusedonprovidingpaymentswithinaregionortoasmallnumberofcountriesandusuallysupportasinglecurrency.Althoughnoneofthesesystemsareyetglobalinscope,itislikelytheywillcontinuetoexpandtheircoveragetoadditionalcountriesandcurrencies.NetworkssuchasVisaandMasterCardareexamplesofglobalpaymentsystemsthatalsosupportmultiplecurrencies,thoughtheyareprimarilyusedforretailpaymentsandadhoc/T&Ecommercialtransactions.

Recently,incountrieslikeSwitzerlandandHongKong13,newarrangementshavebeendevelopedforthesettlementoflocalpaymentsinforeigncurrency.Thesearrangementsneitherfitperfectlyinthetraditionalcategoryof“correspondentbanking”orinthatof“paymentsystems”.Themaincommoncharacteristicofthesearrangementsorsystemsisthattheydonotsettleincentralbankmoneybutacrossaccountsheldwithacommercialbankandthattheyarebasedonclearlydefinedandtransparentrulesforpaymentactivities.Comparedtotraditionalcorrespondentbanking,thesenewsolutionsarestandardizedandsettlepaymentsinrealtimewithcontinuousfinality.

In1999,Swissfinancialinstitutionsestablishedacross-bordersolutioninordertofacilitatetheircashmanagementineuros.ThissolutioninvolvesafullylicensedbankinGermany,SwissEuroClearingBank(SECB).Toprocesseurotransactions,SECBusestheeuroSICplatforminSwitzerland,whichisoftenreferredtoastheeuropaymentsystemofSwitzerland.EuroSICisareplicationoftheSwissfrancRTGSsystem,SwissInterbankClearing(SIC).SICandeuroSICareoperatedbySwissInterbankClearingAG.SECBisthesettlementinstitutionandsharestheroleofsettlementagentwiththeoperatorSICAG.SECBisalsotheliquidityproviderineuroSIC.ItextendsintradayandovernightcredittotheparticipantsofeuroSICagainstcollateral.SECBprovidesalinktotheeuroarea,asitisadirectparticipantinRTGSPLUSthroughwhichaccesstoTARGETisestablished.

InHongKong,theU.S.dollarandeuroclearingsystems,USDCHATS(ClearingHouseAutomatedTransferSystem)andEuroCHATS,wereintroducedin2000and2003,respectively.Theyenhancethesafetyandefficiencyofsettlingtheseforeigncurrenciesinthelocaltimezone.ThesesystemsarealmostexactreplicasoftheHongKongdollarRTGSsystem(HKDCHATS).ThekeyfunctionsofbothsystemsaretoenablesettlementofforeignexchangetransactionsbetweenHKdollars,USdollarsandeurosintheirrespectivecurrenciesthroughalinkagewiththeCentralMoneymarketsUnit(CMU)inHongKong.

13 SinceJuly1,1997,HongKonghasbeenaSpecialAdministrativeRegionofThePeoplesRepublicofChina.Underthe“OneCountry,TwoSystems”policy,HongKongretainsitsowncurrency.

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TheHongKongMonetaryAuthorityhasappointedtheHongKongandShanghaiBankingCorporationasthesettlementinstitutionforUSDCHATSandStandardCharteredBank(HongKong)LimitedasthesettlementinstitutionforEuroCHATS.Bothinstitutionsprovideintradayliquiditytothedirectparticipatingbanksbymeansofreposaswellasoverdraftfacilities.OneofthekeybenefitsofboththeUSdollarandeurosystemsisthesamedayclearingoftransactions.

Alsodrivingtransnationalsystemsistheimplementationof“straightthroughprocessing(STP)”standardsfortransfersbetweenbanksaswellasbetweenbanksandcustomers.Toensuresimultaneousanddependabledeliveries,payment-versus-payment(PVP),delivery-versus-payment(DVP),anddelivery-versus-delivery(DVD)processeshavealsobeenestablished.

Thegrowthintransnationalsystemscanimprovetheefficiencyofcross-borderpaymentsbyreducingclearingandsettlementtimes,minimizingfloat.Bettervisibilityoffundsflowssupportsimprovedcashforecasting.Finally,standardizedformatswillreducecostlyerrorsandrepairs.

Case Study:Continuous Linked SettlementA good example of a transnational system is Continuous Linked Settlement (CLS), created by a number of global banks for the simultaneous settlement of foreign exchange transactions. CLS eliminates the settlement risk in cross-currency payment instruction settlement through CLS Bank by linking central bank Real Time Gross Settlement (RTGS) systems. Settlement instructions for a particular date are exchanged and funds are requested to be transferred by CLS Bank during a five-hour window of overlapping business hours. Although CLS is a specialized system only for foreign exchange settlement and not corporate cross-border payments, it demonstrates the benefits of transnational systems.

Trend 2: Government-led initiatives and mandates are increasingCross-borderpaymentsarebeingsubjecttonewrequirements.Duetotherecentdrivetowardsanti-moneylaundering(AML)andcombatingfinancingofterrorism(CFT),theimportanceofcross-borderpaymentshasincreasedtheroleofsuchgovernmentalagenciesastheU.S.TreasuryDepartment’sOfficeofForeignAssetsControl(OFAC)aswellassuchmultilateraleffortsastheFinancialActionTaskForce(FATF),theEgmontGroupofnationalfinancialintelligenceunits(FIUs),andtheWolfsbergGroupformedbyprivatefinancialinstitutionstocombatmoneylaunderingandterroristfinancing.Theseinitiativesandmandatesareimpactingthewaypaymentsarebeingmade.Thecostsofcompliancecanbesignificantforbanks,especiallybecausetheremaynotbeanoffsettingrevenueopportunitywithcorporates.

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SEPAisagovernment-ledinitiativeasdefinedbytheEuropeanPaymentsCouncilthatishavingasignificantimpactonbothbanksandcorporationsthatmakeeuro-zonepayments.BanksinEuropenowhavetoinvestsignificantlytoadapttheirpaymentinfrastructuresinordertoachieveSEPA-compliancewhiledevelopingacogentstrategytotakeadvantageofthenewopportunitiesopentothemthroughanintegratedSEPAsystemthroughouttheeuroarea.

Government-ledinitiativesarefocusingonthereductionofcoststotheend-users,adoptionofcommonpaymentstandards,andreducingtheabilityofpaymentsystemstobeusedforillegalmeans.Ultimately,thiswilltranslateintohighercostsforbanksthatprovidecross-borderservices.However,thisleadstorevenueopportunitiesforthosebanksthatprovideservicestootherbanks.

Case Study:Single Euro Payments Area (SEPA)

SEPA supports the creation of a euro area where the differentiation between domestic and cross-border payments no longer exists. Today there are more than 15 retail payments systems in the euro area for the clearing and settlement of credit transfers and direct debits. Most of them have their own specific operating rules and technical standards. Industry estimates put the investment on the participating infrastructures at more than ¤8 billion over the next six years and revenue losses from falling fees for payment services at between ¤13 billion and ¤29 billion; however, market savings could range from ¤50 billion to ¤100 billion.14 Substantial investments coupled with plummeting revenues should encourage banks to look for the maximum economies of scale and scope that the SEPA can offer. They should particularly focus on payments highways and on leveraging any investment they have already made in open and global platforms and solutions. This will mean rationalizing infrastructure and consolidating clearing and settlement mechanisms.

Trend 3: Risk and liquidity usage are being closely managed

Paymentsystemsaresubjecttomanyrisks,themostimportantofwhicharecreditandsettlement.Creditriskisthepossibilitythatapartywithinthesystemwillbeunabletofullymeetitsfinancialobligations.Settlementriskisthatapartywillhaveinsufficientfundstomeetafinancialobligationasandwhenexpected,althoughitmaybeabletodosoatsometimeinthefuture.

14 Peter Norman, “European Banking Reform Comes under Fire: Both Industry and Regulators Are DissatisfiedPeterNorman,“European Banking Reform Comes under Fire: Both Industry and Regulators Are Dissatisfied“European Banking Reform Comes under Fire: Both Industry and Regulators Are DissatisfiedEuropeanBankingReformComesunderFire:BothIndustryandRegulatorsAreDissatisfiedwithPlanstoFacilitateCross-borderPayments,””The Financial Times, November28,2005.

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Inpaymentsystemswherepaymentsareprocessedinreal-timeorinbatchesduringtheday,liquiditynotonlyhasend-of-dayvaluebutalsointradayvalue.Inbothgrossandnetsettlementsystems,thereisaclearrelationshipbetweenliquidityusageandsettlementdelay.Typically,themoreliquiditythatisused,thespeedierfinalsettlementwillbe.Ifthecostsofliquidityanddelayareequal,thecost-optimallevelofliquidityislikelytobethatforwhichnopaymentsaredelayed.Adelayinsettlementreducesthesender’sliquiditycosts,butincreasesbothitsdelaycostsandthereceiver’sliquiditycosts.Therefore,paymentsystemshavetostrikeabalancebetweenminimizingtheliquiditycostandkeepingsettlementriskundercontrol.

Themechanismstobalanceriskandliquidityneedsvarybysystem.Variousstakeholdersexertongoingpressuretominimizesettlementdelaywithoutfullyimpactingliquidityneedsandviceversa.Improvementsinbothriskandliquiditymanagementhelpdrivedownoverallcostsbyreducinglossesandfreeingupexcesscapitalusedduringsettlement.

Case Study:Two approaches to managing risk and liquidityLiquidity usage and settlement risk management is significant to RTGS systems. The world’s two premier RTGS systems, Fedwire and TARGET, have addressed the issues quite differently. Despite their differences, each system provides a similar trade-off between liquidity and settlement risk.

Starting in the mid-1980s, the Federal Reserve instituted important reforms aimed at controlling the use of Federal Reserve intraday credit by depository institutions seeking an inexpensive source of liquidity. The Federal Reserve Board of Governors imposed quantitative limits – or caps - on account overdrafts at Federal Reserve Banks in 1986 and a small fee on intraday credit in 1994. As a general matter, the majority of account overdrafts at Federal Reserve Banks are uncollateralized. Caps protect the Federal Reserve by limiting the settlement risk posed by any given institution.

TARGET takes a different approach to controlling settlement risk. It is a decentralized RTGS system consisting of the “interlink” of 15 national payment systems, together with the European Central Bank. The solution that was adopted allows system participants to borrow intraday funds at a zero interest rate. In the TARGET system, liquidity is provided by the individual central banks within the European System of Central Banks (ESCB). To protect the central banks from settlement risk, all intraday credit must be collateralized. This requirement raised the fear that the system would be too demanding in terms of collateral. To remedy this potential, a wide range of assets is eligible for collateral. The design of TARGET appears to work well. Access to liquidity has turned out not to be an issue and the ESCB is protected by the required collateral.

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Trend 4: Multinational banks and corporations are expanding

Mergersandacquisitionshavebeenthesinglebiggestforcereshapingtheglobalpaymentslandscapeoverthepasttwodecades.Themostrecentroundofconsolidationhasleftadisparitybetweenlargeandsmallneverbeforeseen.Forexample,wehavewitnessedtheemergenceofmegabankssuchasthecombiningofBankofAmericaandNationsBank,aswellasJPMorganChasecombiningChaseManhattanBank,ManufacturersHanoverBank,MorganGuarantyTrustandBankOne.Inascale-driven,technology-intensivebusinesslikepayments,theemergenceoftruemega-playersmayleadtomarkedlydifferentcompetitivedynamics.

Actingastheirowntransnationalsystems,largeinternationalbankssuchasJPMorganChase,Citibank,BankofAmerica,andHongkongShanghaiBankingCorporationoperatetheirowninternalglobalpaymentsnetworks.Throughthese,theycanroutepaymentstodestinationsindifferentcountries.Suchinternalnetworksdonotnecessarilydifferentiatebetweendomesticandcross-borderpaymentsastheseflowsareallwithinthebank.

Thetrendtowardconsolidationinthebankingsector,bothgloballyandindomesticmarkets,exertsinfluenceonpaymentsystems.Increasedconcentrationofpaymentflowsmayhaveimportantcredit,liquidityandoperationalriskimplications.Forexample,thecreditexposuresthatarisewithinapaymentssystemthatdoesnotachieveintradayfinalityarelikelytobecomeconcentratedonasmallernumberofbanks.Operationalproblemsexperiencedbyasinglelargebankcouldhavesignificantrepercussionsforotherparticipantsinthesystem.Aconcentrationofpaymentflowsincommercialbankshasemergedtoreflecttheincreasingrolethatmoderncommercialbanks,especiallylargeglobalbanks,haveplayedinthepaymentsystemsaroundtheworld.Thevolumesandvaluessettlingacrosstheirbooksare,insomecountries,quitesubstantial.Suchtraffichasoftenbeenaccompaniedbyincreasedformalizationofthecorrespondentrelationswithin,aswellasacross,nationalboundaries.

Banksthatachieveglobaleconomiesofscalecanfurtherdrivedownpertransactioncostsandderivehigherrevenuesbykeepingpaymentswithintheirownnetworks.Forglobalcorporations,ithasallowedthemtomatchtheirglobalneedswithahandfulofbanksratherthanmanagingalargenumberoflocalrelationships.

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Trend �: Operational efficiencies are being sought through outsourcing

Traditionalfinancialinstitutions,suchasbanks,areincreasinglyexpectedtofocusonmarketingexistingandnewproductsthatareinlinewiththeircorecompetenciesratherthanexpendingeffortsonconqueringmorerepetitivebackofficetasks.Thesearchforoperationalefficiencyhasledtotheoutsourcingofpaymentservicesclearingtothirdparties,whichmaybebankornon-bankentities.Bankshaveincreasingrecoursetosuchentities,allowingbankstospecializeinthe“salesfunction”(coveringdirectrelationswithclients,includingaccountholding)whileoutsourcing“productionfunction”suchastheprocessingofpaymentsandsecurities.Someexpertsworryabouttheregulatoryvacuuminthisareaassomeoftheseservicefirmsarenotbanksandmaynotberegulatedorsupervisedbygovernmentagencies.

Internalconsolidationinpaymentfunctionswithinanindividualfinancialinstitutionalsoleadstotheconcentrationofpaymentservicestothirdparties.Thisevolutionisincontrastwiththetraditionalorganizationofmajorinternationalbanks,wherepaymentsbusinessisdistributedamongtheirbranchesandsubsidiariesabroad,eachofthemhavingresponsibilityforsettlementsinthelocalcurrencies.Largeinternationalbanksnowtendtoconcentratemostoftheirworldwidepaymentsactivitiesinoneorafewprocessingcenters.

Gainingoperationalefficienciesthroughoutsourcingofnon-coreactivitieswillimprovetheoverallpaymentsprocess.Outsourcingwillallowmanybankstoreduceoperationalcostsaswellasofferadditionalproductsthatcouldnototherwisebeprovided.Thedownsideofoutsourcingmaybethatabanklosestheabilitytorapidlychangeproductofferingsthattheydonotdevelopandmanage.

Conclusion:

Asmarketsbecomeincreasinglyglobal,pressuremountstofulfillthefundstransferrequirementsofcorporates,thefinancialinstitutionsthatservethem,andthepaymentsystemsthatenablethepayments.Thevolumeandvelocityofcross-borderpaymentsismadeallthemorecomplexbythedifferingstandardsofdomesticpaymentsystems,increaseofinternationalregulationsandthechanginglandscapeofemergingtransnationalandglobalsystems.Marketpressuresandtheexpansionofmultinationalbanksandbusinessesaredrivingthesearchforoperationalefficiencies.Improvementintheefficiencyandeffectivenessofcross-borderpaymentsislikely,butallstakeholdersarebeingrequiredtoincreaseinvestmentstochangetheprocessesandsystemsofcorporates,banksandpaymentsystems.

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Questions for Management

Ascross-borderpaymentvolumeincreases,andcorporationsandgovernmentsdemandprocessimprovements,bankswillfaceincreasingpressuretoaddresstheremaininginefficienciesofcross-borderpayments.Inordertobeginthisprocess,banksshouldconsiderthefollowing:

What is the size and scope of your cross-border payment operations?Thecostofestablishinganefficientcross-borderpaymentprocessfromthegroundupmaybecost-prohibitiveforallbutthelargestbanks.Banksneedtofullyunderstandthecostsassociatedwithcross-borderpayments.

Are you maximizing your investments in existing payment systems?Theremaybeanopportunitytoharnesswell-establishedinternationalpaymentsystemstoincreasetheefficiencyandreducethecostofcross-borderpaymentsforyouandyourcustomers.

Does your bank have a strategy for determining what products and services should be kept in-house and what should be outsourced?Whendecidinghowtosupportabreadthofproductsandservices,decisionsshouldbebasedonanumberoffactorsincludingstrategicimportance,revenueprojectionsandcostconsiderations.

Are there hidden costs in your bank’s payment process?Banksshouldconsideranalyzingallpaymentsacrossthevariousinstruments,withaspecialfocusonthecross-subsidiesthatcharacterizethecurrentpaymentslandscape.

Do revenues reflect the true market value of your products? Banksmaybenefitfromabetterunderstandingofwhattheirclientsneedandhowtheyvaluetheservicesprovidedtothem.

How can your bank integrate throughout the supply chain process to avoid commoditization of payment? Banksmaybenefitfromworkingmorecloselywithpaymentsystemsandkeyalliancesbyprovidingvalue-addedservicestoclientsthatarebeingdeliveredbynon-banksolutionproviderstoday.

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22

Appendix

Payment system types

Todateinternationalpaymentshavebeen,toalargeextent,basedoncorrespondentbankoperations.Thetraditionalapproachtoprocessingpaymentswasend-of-daynetbatchprocessing.Today,batchsystemsoperatewithsettlementcyclesasshortasevery30minutes,knownasdeferrednetsettlementsystems(DNS).Thankstoreal-timeprocessingcapabilities,however,paymentscannowbeprocessedindividuallyandimmediately,withsuchatrendexpandingfromlarge-valuetransferstoretailpaymentsinresponsetocustomerservicerequirementsandthegrowthofe-commerce.Real-timepaymentsystemsfallintotwogroups:thereal-timegrosssettlementsystems(RTGS)ofcentralbanksandcontinuousnetsettlementsystems(CNS).

RTGS:volumeisgrowingbutitisdifficulttoimplementforallcross-borderpayments.RTGShascertaincharacteristicsthatmadeitchallengingtoimplementforcross-borderpayments: • Runbycentralbanks • Highliquidityneeds

Value Transfer Funds Settlement Timing Liquidity Needs

RTGS Immediate Immediate High

CNS Immediate Endofday Variable

DNS Endofcycle Endofcycle Low

Hybrid Variesbysystem Variesbysystem Variesbysystem

RTGSsystemseliminatethecounterpartycreditriskpresentinDNSsystemsbyrequiringparticipantstosettleallindividualpaymentsinstantaneouslyonagrossbasisinreal-time.However,thiscreditriskreductioncomesatthecostofarequirementforpotentiallyexpensiveintradayliquidity.Centralbankshavesoughttoreduceliquiditycostsforsettlementbanks,forexamplebyprovidingcollateralizedintradayliquidityandgoodsystemdesign.Evenso,intradayliquidityinRTGSsystemsisnotfreeandunlimited.

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AnimportantdeterminantoftheliquidityefficiencyofanRTGSpaymentsystemistheextenttowhichthesystemdesigngivessettlementbanksanincentivetomanagetheirpaymentsinanefficientway.InanRTGSsystem,onebank’spaymentsareasourceofintradayliquidityfortherecipientbank,whichitmaythensubsequentlyusetomakeitsownpayments.Withpaymentssettledonareal-timegrossbasis,banks’liquidityneedsunderRTGSaregreaterthanthoseunderDNS.Ifbanksrecycleliquiditysufficientlyquickly,however,theaggregaterequirementforintradayliquidityunderRTGScanbesimilarlyreduced.

CNS: CNSsystemscanbeconsideredprivateRTGSsystemsthatnormallysettleatendofdayinRTGSsystems.However,thesesystemsoftenusevariouskindsofswaporliquidityinjectionmethodstoreducetheirinternalriskpositions.SometimesprivatesystemscanautonomouslysettleusingcentralbankRTGSsystems.Insuchcases,theprivatesystemtransferscentralbankliquidityintoaseparateaccountheldbythecentralbankorthesystemitselfonbehalfoftheclearingparties.Alltransactionsarethenbookedontheseaccounts.ExamplesofCNSsystemswithRTGSinterfacesaretheCLSusedforreal-timesettlementofforeignexchangetradesandCHIPSintheU.S.andFrance’sPNS(ParisNetSettlementSystem).

DNS:Inadeferrednetsettlementsystem,fundtransfersaresettledonanetbasisaccordingtotherulesandproceduresofthesystem.Aparticipatingbank’snetsettlementposition,whichiscalculatedoneitherabilateralormultilateralbasis,isthedifferencebetween(1)allthetransfersthatithasreceiveduptoaparticularpointintime,and(2)allthetransfersthatithassent.Thepositioncanbeeitheranetdebitoranetcredit.Mostnetsettlementsystemsarenowprimarilymultilateralinnature.Settlementoccursatoneormorepre-specifiedsettlementtimesduringtheday.ExamplesofDNSsystemsareBACSintheU.K.,ACHintheU.S.A.andVisa.

Hybrid Systems: Intruereal-timeprocessing,theliquidityneedisfixedbytheprocessedpaymentflowsoitcannotbeinfluenced.Infact,theliquidityneedcanbesmoothedbydeferringpaymentsthroughaqueuesystemandbynettingqueuedpaymentsbetweenbankswithopposingqueuedpaymentflows.Thissituationalsogivesthepossibilitytosaveinterbanksettlementliquiditywhenallpaymentsdonotrequireimmediateprocessing.Thishasresultedintheemergenceofathirdgroupofsystems,hybridsystems,whichcombinefeaturesfromreal-timeanddeferrednetsettlementsystems.Mostlarge-valuepaymentsystemscurrentlyoperatedbycentralbankssuchasFedwireandTARGETareRTGSsystems,buttheycontinuallyacquireanincreasingnumberofhybridfeaturesforpreservingliquidity,optimizingtheuseofliquidityandresolutionofgridlocksituations.

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A survey of major systems facilitating cross-border payments

American Express:isapubliclytradedcompanythatissueschargeandcreditcardproductsbothdirectlyandthroughnearly100financialinstitutionsaroundtheworld.AmericanExpresshad$484billioninglobalsalesin2005.15

CHAPS(ClearingHouseAutomatedPaymentSystem):CHAPS,establishedin1984,istheUnitedKingdom’shigh-valuepaymentsystem,consistingoftwosystems:CHAPS SterlingandCHAPS Euro,whichprovidesettlementfacilitiesforsterlingandeuropayments,respectively.Overadozenlargebanksandbuildingsocietiesare“direct”orsettlementmembers,whiletherearealsoover400“indirect”members–typicallysmallerbanksandbuildingsocieties–whohaveaccesstothesystemthroughasettlementmember.

CHIPS(ClearingHouseInterbankPaymentSystem):CHIPSisabank-owned,privatelyoperated,real-time,multilateralelectronicpaymentssystemthattransfersfundsandsettlestransactionsinU.S.dollars.CHIPSbeganoperationsin1970with9participatingbanksand,asofmid2006,itprocessesabout300,000paymentsadaywithanaveragedailyamountof$1.5trillion.Itcurrentlyhas46participantsfrom19countriesaroundtheworld,includinglargeU.S.banksandU.S.branchesofforeignbanks.ThepaymentstransferredoverCHIPSareoftenrelatedtointernationalinterbanktransactions,includingthepaymentsresultingfromforeigncurrencytransactions(suchasspotandcurrencyswapcontracts)andEuroplacementsandreturns.

CLS (ContinuousLinkedSettlement):TheCLSsystemistheprivatesectorresponsetoaG-10strategytoreduceforeignexchangesettlementrisk.CLSwasfoundedin1997tocreatethefirstglobalsettlementsystem,eliminatingsettlementriskintheforeignexchangemarket.Formedinresponsetoregulatoryconcernrelatedtothetemporalandsystemicrisks(Herstattrisk)associatedwithforeignexchangetransactions,CLSsimultaneouslysettlesbothsidesofforeignexchangetradesusingamulti-currencypayment-versus-payment(PVP)mechanism.CLSisauniquereal-timeprocessenablingsimultaneousforeignexchangesettlementacrosstheglobe,eliminatingthesettlementriskcausedbydelaysarisingfromtime-zonedifferences.CLSsettleswellover$1trillionperday,accountingforasubstantialmajorityofcross-currencytransactionsacrosstheglobe.

15http://ir.americanexpress.com/phoenix.zhtml?c=64467&p=irol-reportsAnnual

2�

Eurogiro:ownedby16banks/postalfinancialservicecompanies,isanelectronicpaymentnetworkforpostalandgiro(postbank)organizationsthatexchangecross-bordercredittransfersandcash-on-deliveryorders.Establishedin1989,Eurogirohasmorethan40participantsfrom37countriesinEurope,Asia,Africa,SouthAmericaandtheU.S.Membersactascorrespondentsforoneanotherandholdreciprocalaccountswitheachothertoexecutepayments.

EURO1:aprivatesector-ownedhigh-valuepaymentsystem,operatedbytheEBAClearingCompanyforcross-borderanddomestictransactionsineurobetweenbanksoperatingintheEuropeanUnion,anditisthelargestofEurope’sfourlarge-value,netsettlementsystems, processing on average 170,000 payments a day with a total value of about €170 billion.Launchedin1998,EURO1wasdevelopedtoprovideanefficient,secureandcost-effectiveinfrastructureforlarge-valuepaymentsinthenewsinglecurrencyenvironmentoftheEU.EURO1isbasedonstate-of-artmessaginginfrastructureandcomputingfacilitiessuppliedbySWIFT.

FedACH International Services:ThisinternationalgatewayarrangementserviceisownedandoperatedbytheFederalReserveSystem.Currently,theFederalReserveBanksofferasuiteofFedACHInternationalServicesaspartofFedACHServicesandprovideU.S.-originatingdepositoryfinancialinstitutionswiththeabilitytosendinternationalnon-time-criticalpaymentsviathesameprocessusedtosenddomestictransactionsformanydecades.FedACHInternationalServicesofferanintegrated,uncomplicatedmethodtoensurestraight-throughprocessing(STP)ofcross-bordertransactions,usingNACHAformatsthataresupportedbymostsoftwarevendors.

Fedwire(FederalReserveWireNetwork):Thisisahigh-speedelectronicnetworkthroughwhichtheU.S.FederalReserveprovidestheFedwireFundsService,theFedwireSecuritiesService,andtheNationalSettlementService.TheFedwireFundsServiceprovidesanRTGSsysteminwhichmorethan9,500participantsinitiatefundstransfersthatareimmediate,final,andirrevocablewhenprocessed.

2�

LVTS(LargeValueTransferSystem):ThefullyelectronicLVTS,Canada’sreal-timegrosssettlementsystem,becameoperationalinearly1999.AsCanada’swirepaymentmechanism,itfacilitatestheelectronictransferofCanadiandollarpaymentsacrossthecountryinreal-time.Canada’snationalpaymentssystemhasbeenoperatedbytheCanadianPaymentsAssociation(CPA)since1980.MasterCard:isapublicly-tradedcompanythatoperatesaglobalpaymentsystem.InadditiontotheMasterCardbrand,theMaestroandCirrusbrandsarealsopartofthecompany.MasterCardbrandedcardsgenerated$1.7trillioninglobalsalesin2005.16

RTGSPLUS:istheGermanBundesbank’snewliquidity-savingRTGS,whichbecameoperationalinNovember2001.Itcombinestherisk-reducingbenefitsofgrosssettlementoftheformerGermanRTGSsystemknownastheEuroLinkSystem(ELS)withtheadvantagesofliquidity-savingprocessingoftheformerhybridsystemknownasEuroAccessFrankfurt(EAF).

SWIFT(SocietyforWorldwideInterbankFinancialTelecommunications):SWIFTisanindustry-ownedlimitedliabilitycooperativethatsuppliessecuremessagingservicesandinterfacesoftwareforfinancialtransactionstomorethan7,650banks,securitiesbrokersandinvestmentmanagersinmorethan200countries.

SWIFTpaymentmessagesareprocessedbytheFinancialInformationNetwork(FIN),whichoperatesonasecureIPnetworkcalledSWIFTNet.SWIFTisintegratingintotheACHmarketsegmentasapaymentserviceproviderviaitsFileActmessagingservice.ACHnetworkssuchastheEBAClearingCompanyandtheSouthAfricanAutomatedClearingBureauarealreadyusingSWIFT’smessagingplatform.

16http://www.mastercard.com/us/company/en/docs/Corporate%20Overview.pdf

STEPS (StraightThroughEuroPaymentSystem): TheSTEPSprogramwaslaunchedbytheEuroBankingAssociation(EBA)toofferafullrangeofeuropaymentsacrossEurope.STEPShasevolvedintotwosystemsaimedataccommodatingabroadbaseofprocessingneedswithintheEuropeanUnion:STEP1(apan-Europeansystemdesignedtoprocesssinglecross-border,low-valueretailpayments)andSTEP2(apan-EuropeanACHforbulk/highvolume,low-value,cross-borderanddomesticinterbankpayments).

STEP2:apan-EuropeanACHsolution,isajointventurebetweentheEBAandItaly’sACHoperatorSIA.STEP2processeshigh-volume,commercialandretailpaymentorderssenttothesystemviafilesthroughasecurenetwork.CharacteristicsofpaymentordersthatareprocessedviaSTEP2arecommercialandretailtransfersineurothatareformattedtoagreedtechnicalstandards.AccessiblethroughSWIFTNet,STEP2offerspaymentprocessingandsettlementineuro.

TARGET (Trans-EuropeanAutomatedReal-timeGrossSettlementExpressTransfer): TheEurosystem,whichcomprisestheEuropeanCentralBank(ECB)andthenationalcentralbanks(NCBs)ofthe12EUmemberstateswhichhaveadoptedtheeuro,hascreatedTARGETforlarge-valuepaymentsineuro.TheTARGETsystemisa“systemofsystems”composedofthenationalpaymentsystemsof16of25countriesthatarecurrentlymembersoftheEU,theECBpaymentmechanism(EPM)andaninterlinkingmechanismthatenablestheprocessingofpaymentsbetweenthelinkedsystems.

TARGET2:ThecurrentstructureofTARGETwasdecidedonin1994andwasbasedontheprinciplesofminimumharmonizationandinterconnectionofexistinginfrastructures.ThiswasthebestwayofensuringthatthesystemwouldbeoperationalfromtheverystartoftheEuropeanEconomicandMonetaryUnion(EMU)in1999.TARGET2isanenhancedversionofthecurrentTARGETincorporatingtechnicalconsolidation,asinglesystem-widepricingstructurefordomesticandcross-borderpayments,aharmonizedservicelevel,andthesystem-widepoolingofavailableintradayliquidity.Thego-livedateforTARGET2issetforNovember19,2007,withgradualmigrationtothenewsystembythememberstatesinfourwaves.AllcentralbanksparticipatinginTARGET2,togetherwiththeirnationalbankingcommunities,areexpectedtobeusingthenewsystembyMay2008.

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Visa:isaprivate,membershipassociationjointlyownedbymorethan20,000memberfinancialinstitutionsaroundtheworld.Visadevelopscommonstandardsandspecificationstofacilitatecommerceandprovidememberfinancialinstitutionswiththeglobalpaymentplatformtosupporttransactionson1.46billioncardsthatgeneratemorethan$4.3trillioninglobaltransactionsinover160countries.17

Voca:wasformedin1968andwasknownasthe“BankersAutomatedClearingSystem”orBACSwhichissimilartoACHintheUS.BACSchangeditsnametoVocain2004.VocaisoneofanumberofdomesticACH-typesystemsinEuropeandownstheBACSinfrastructurethatprocessesthemajorityofnon-RTGS,non-card,electroniccreditanddebitpaymentsforB2C,C2BandB2BintheUK.VOCAperformed5billiontransactionsin2005.

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17www.visa.com

Selected government entities influencing cross-border payments

Bank for International Settlements:BasedinBasel,Switzerland,theBankforInternationalSettlementswasestablishedbytheHagueagreementof1930asaninternationalorganizationofcentralbanks.TheBankforInternationalSettlementsseekstomakemonetarypolicymorepredictableandtransparentamongits55membercentralbanks.Whilemonetarypolicyisdeterminedbyeachsovereignnation,itissubjecttocentralandprivatebankingscrutinyandpotentiallytospeculationthataffectsforeignexchangeratesandespeciallythefateofexporteconomies.Bankingservicesareprovided,butonlytocentralbanksortointernationalorganizationslikeitself.BaselIIwhichbeganin2001focusesonminimumcapitalrequirements,supervisoryreviewandmarketdisciplinetopromotegreaterstabilityinthefinancialsystem.

FATF(FinancialActionTaskForce):FATFonMoneyLaunderingisa33-memberorganizationestablishedbytheG-7SummitinParisin1989withprimaryresponsibilityfordevelopingworldwidestandardsforAMLandCFT.Itworksinclosecooperationwithotherkeyinternationalorganizations,includingtheIMF,theWorldBank,theUnitedNations,BankforInternationalSettlements,andFATF-styleregionalbodies(FSRBs),mostofwhichparticipateinitsmeetingsasobservers.FSRBsincludetheAsiaPacificGrouponMoneyLaundering(APG),theCaribbeanFinancialActionTaskForce,theOffshoreGroupofBankingSupervisors,andtheOrganizationofAmericanStates.

FinCEN(FinancialCrimesEnforcementNetwork):FinCEN’smissionistosafeguardthefinancialsystemfromtheabusesoffinancialcrime,includingterroristfinancing,moneylaundering,andotherillicitactivities.ItadministerstheBankSecrecyActof1970,whichauthorizesthereportingandrecordkeepingobligationswithrespecttofinancialtransactionsforlawenforcementpurposes.Sinceitscreationin1990,FinCENhasworkedtomaximizeinformationsharingamonglawenforcementagenciesanditsotherpartnersintheregulatoryandfinancialcommunitiestocombatillicitfinance.AstheUnitedStates’financialintelligenceunit(FIU),FinCENlinkstoanetworkofoverahundredsimilarFIUsaroundtheworld,sharinginformationtopursueinvestigations.

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OFAC(OfficeofForeignAsstsControl):ischargedwithadministeringandenforcingU.S.economicandtradesanctionsbasedonforeignpolicyandnationalsecuritygoals.OFACcurrentlyadministersroughly30programsthattargetterrorists,roguecountriesandregimes,narcoticstraffickers,WMDproliferators,andotherilliciteconomicandnationalsecuritythreats.OFACisthesuccessortotheOfficeofForeignFundsControl,whichwasestablishedattheadventofWorldWarII.OFAC’sexpertiseinadministeringsanctionshasmadeitamodelforothercountriesthroughouttheworld.

SEPA: TheEurosystemhasavisionfortheSEPA–aeuroareainwhichallpaymentsaredomestic,wherethecurrentdifferentiationbetweennationalandcross-borderpaymentsnolongerexists.ThismeansthattheSEPAprojectnotonlyaimstoimprovetheefficiencyofcross-borderpayments,butalsoaimstodevelopcommoninstruments,standards,proceduresandinfrastructuresinordertofostersubstantialeconomiesofscale.WithintheSEPA,customerswillbeabletomakepaymentsthroughoutthewholeeuroareaasefficientlyandsafelyasinthenationalcontexttoday.TheSEPAisanaturalconsequenceoftheintroductionoftheeuro.TheultimateobjectivewithregardtodirectdebitsisthatalleuroareadirectdebittransactionsbeprocessedinaccordancewiththeSEPAscheme.

TFFC(TerroristFinancingandFinancialCrime):actingasthepolicydevelopmentandoutreachofficeforTFI,TFFCcollaborateswiththeotherelementsofTFItodeveloppolicyandinitiativesforcombatingmoneylaundering,terroristfinancing,WMDproliferation,andothercriminalactivitiesbothathomeandabroad.TFFCworksacrossthelawenforcement,regulatoryandintelligencecommunitiesandwiththeprivatesectoranditscounterpartsabroadtoidentifyandaddressthethreatspresentedbyallformsofillicitfinancetotheinternationalfinancialsystem.TFFCadvancesthismissionbypromotingtransparencyinthefinancialsystemandtheglobalimplementationoftargetedfinancialauthorities.

TFI(OfficeofTerrorismandFinancialIntelligence):TheUnitedStatesestablishedTFIinApril2004aspartoftheU.S.TreasuryDepartmentinordertomarshaltheTreasuryDepartment’sintelligenceandenforcementfunctionswiththetwinaimsofsafeguardingthefinancialsystemagainstillicituseandcombatingroguenations,terroristfacilitators,WMD(weaponsofmassdestruction)proliferators,moneylaunderers,drugkingpins,andothernationalsecuritythreats.TFIcomprisestheOfficeofTerroristFinancingandFinancialCrimes(TFFC),OfficeofForeignAssetsControl(OFAC),andFinancialCrimesEnforcementNetwork(FinCEN),amongothers.

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WithVisaCommercial,youhaveaccesstopaymentsolutions

designedspecificallytofittheneedsofyourbusiness.Ourflexible

paymentsolutionsandinformationmanagementcapabilitieswork

togethertoimproveyourprocure-to-payprocessforvirtuallyany

sizepayment.Whetheryouareasmallbusiness,alargecorporate

multinational,oragovernmententity,VisaCommercialoffers

solutionsthatwillbenefityouroperations.

Together,VisaCommercialpaymentsolutionsandVisaInformation

Managementdeliveracompletepurchasingprogramthatwill

helpyouoptimizepaymentprocessesandmakebetterbusiness

decisions.VisaCommercialpaymentsolutionsofferyouandyour

employeestheconvenienceofsimplifiedpaymentandpurchasing

efficiencies.Andbycombiningthiswiththeinsightandaccessof

VisaInformationManagement,youhaveacomprehensivesolution

thatwilldrivesuperiorbusinessperformance.

For more information go to www.visa.com/visacommercial or

contact your Visa Financial Institution today.