How to Transform the $40T Cross-border Payments Industry to Make It x10 More Effective

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INTRODUCTION

The cross-border payments is a $40T/year global industry growing at 5% annually . Despite its massive size and consistent growth, it remains plagued by a number of inefficiencies and challenges.The main issues are:

 

1. Long processing times: SWIFT payments may take up to two weeks because of manual processing, time zones, and different compliance rules across countries.
2. Opaque wire statuses: users have to track payments with a sending bank,a  receiving bank, and sometimes with a correspondent bank. And most banks don’t provide detailed tracking status options online.
3. High fees: US banks rarely provide multi-currency accounts. This feature is only accessible for large corporate clients or ultra-high net worth individuals via JP Morgan Chase, Morgan Stanley, HSBC, or Citi. Mainstream banks offer 5% currency conversion fees for small and medium businesses.

An independent research of SWIFT funds delivery shows how many hours does it take to deliver a payment on average:

We can comment that GBP and CAD wires are faster because those currencies are used mostly within their timezones and between friendly countries. JPY and AUD take too long because they’re used between countries located in timezones with 12-14 hours gaps. USD takes too long because it’s been used by most of the countries, so it has negative effects of both different timezones and active entities from non-friendly countries.

HOW CROSS-BORDER WIRES ARE BEING PROCESSED TODAY

Let’s take an example CNY 100,000 wire from the US to China:

1. U.S. banks don’t open CNY accounts for U.S. companies, because they only have direct connections to The Fed, which operates only in USD. So, the point A is a USD account in an American bank.
2. When a customer instructs the American bank to wire CNY 100,000 to a Chinese vendor, the bank doesn’t provide the exact amount of USD needed for the operation. The customer only gets the preliminary amount that could be changed by the end of the transaction.
3. Plus, the customer also signs a consent that he will be charged some transactional fees of an unknown size.
4. The wire passes through the manual compliance process of the American bank. It could slip into the next business day if the customer instructed the wire after 3pm Eastern Time. So, we already have a probability of adding an extra business day.
5. The American bank goes to a foreign exchange (FX) partner to book an FX contract to buy CNY 100,000. To settle this transaction, the Asian bank with CNY has to be online. The 12-14 hour difference between the U.S. and Hong Kong (where most foreign CNY deals are being cleared) adds one more business day to our transaction.
6. More complications on top of that: there are two versions of Chinese yuan. Onshore CNY and offshore CNH. Foreign payments are settled in CNH in Hong Kong, and then CNH has to be converted to CNY.

 

1. When the CNH is at the Hong Kong account of the American bank or their Asian partner, they need to perform their compliance for the outgoing wire. It might take one more day.
2. If all is good — the Hong Kong bank has to flip CNH to CNY and send the CNY wire through the local Chinese payment rails.
3. The last step: the receiving Chinese bank has its manual incoming compliance process for cross-border transactions, which can add up a few days more. And there are multiple issues that can slower it down or lead to a bounced wire:
   1. Chinese vendors often have long names which don’t fit into most inputs in non-Chinese online banks. At the same time, Chinese banks are very cautious and hold or bounce wires even if there’s a single character missing in the beneficiary’s name.
      
      In the best case scenario,they will send a SWIFT request for amendment to the American sender bank. The American bank will redirect this to the customer, they have to sign the amendment, and deliver it back. The whole route takes 2-3 more days.
   2. Recieving banks are also sensitive to the sender’s name. They often ask the vendor to provide an invoice or a contract to match the sender’s name. In many cases the sender’s name in the SWIFT message might differ from the real name: sometimes it’s the name of the fintech payment provider or an intermediary bank, sometimes the name is cut and missing some characters. It can also lead to an amendment or a bounced wire.
   3. Then Chinese banks check whether the items in the invoice are legal to be sold to the buyer. If it’s a sensitive area (microchips, dual use, aircraft spare parts, etc.) — the compliance check can take a few more days.
4. If the wire has been bounced — the customer will get back an unknown amount of USD because they will lose money on two-way back-and-forth USD-CNH + CNH-USD FX and wire fees of all intermediary banks.
5. If the wire has been settled — the customer will also be charred an unknown amount of USD because they initially don’t know when the USD to CNH FX will occur in the future and how much money will intermediary banks charge. Typical small-busines FX fees for USD to CNY are 5% and the USD/CNY rates might fluctuate 0.2-0.5% a day. So, the total fees might reach 7% or more, depending on the settlement time.
6. The overal settlement time varies from 2-3 days to 2 weeks.

Here’s a graphic representation of the process:

 

Side note:

Large multi-national banks (JP Morgan, Citi, HSBC) have banking licenses and local currency deposits in dozens of countries. So, they settle such USD-CNY transactions internally as book transfers within a day, and can offer wholesale FX fees to the customers.

While, in fact, they only onboard enterprise clients wirth $1B+ in annual volumes into such programs. So, the 99% of the businesses have no access to this process.

HOW TO MAKE THE PROCESS 10 TIMES MORE EFFECTIVE

On-ramp to stablecoins in the U.S., off-ramp to CNH in Hong Kong, and wire the funds using local payment rails.

1. The client sells USD for stablecoins (USDT or USDC) in the U.S. There are hundreds of FinCEN-registered and State-licensed operators that can settle this almost instantly at a 0.1-0.2% retail rate.
   
   As long as the client exchanges from their own account to their own wallet — it’s considered a first-party transaction, and requires no extra compliance checks.
2. The client sells stablecoins for CNH using a Hong Kong licensed operator and settles it instantly to its CNH account, because it’s a first-party transaction too.
   
   So, the customer can fix the USD-CNH rate almost in real time, and has no excessive compliance on the road.
3. The client instructs a CNY wire to the vendor using the Hong Kong financial operator, which is familiar with local regulations, proper names of beneficiary and sender, etc. So, in most cases, it significantly brings down the probability of having compliance issues or mismatches.
4. The best option for the customer is to have a Non-Resident CNY Account (NRA) in a Mainland Chinese bank, but it’s very hard to get because of the local bank not being used to open accounts for foreigners.
   

OVERALL x10 BENEFITS OF THE NEW PROCESS:

• Increased transaction speed: from 2-20 days to 3 mins – 2 days.
• Multiple times less fees: from 5-7% to 0.6-1.2%.

The main source of those advantages is the shift: 

• From using fiat currencies for moving funds cross-border, which:
  • Slows the process because most fiat payment rails work only 8-5 local time.
  • Adds additional friction for non-relevant intermediary compliance.
  • Increases the fees because of the incumbent moat.
• To using stablecoins for transferring funds between two local ecosystems, which:
  • Enables 24/7 fast and cost-effective transfers.
  • Leaves a single step of local compliance at the final destination instead of three.

FURTHER DEVELOPMENT

As governments will adopt digital assets and introduce Central Bank Digital Currencies (CBDC), the operation will become seamless. 

Customers will have access to smart-contract-based fully automated DeFi protocols to: 

1. Exchange USD stablecoins to CNY stablecoins in real time.
2. Send CNY stablecoins to Chinese vendors and settle transactions in a minute.

The major thing to be done for this scenario is a harmonized automated global compliance protocol. The existing banking compliance ecosystem is fragmented and opaque: 

• Every country has its own sanctions and AML requirements, which are described too broadly.
• Central banks put pressure on commercial banks and scare the industry with license revocations if banks will not obey the AML/compliance rules.
• As a result, every commercial bank has its own understanding of local and global regulations, which results in dozens of thousands of different compliance policies around the world.
• It slows down the wire processing because it makes every wire unique, depending on the country and exact banks that are involved in the transaction. So, the banking compliance costs grew from zero to $206B/year in 20 years while the effectiveness of the current compliance system is less than 10%.

So, the banking community has to collaborate with regulators to establish a united compliance repository with automated rules. It will:

1. Drastically reduce the compliance costs for banks, governments, and customers.
2. Increase the transaction speed: from days/weeks to minutes.
3. Enable 100% transparency of all transactions for government bodies.

By George Goognin