Sanctions against Russia spark race for alternative cross-border payment channels

The recent cutoff of sanctioned Russian banks from the Belgium-based Society for Worldwide Interbank Financial Telecommunication, or SWIFT, system has raised many questions about the present global infrastructure for cross-border payments.

SWIFT was created in 1973 by US and European banks as a jointly-owned non-profit cooperative society to allow banks around the globe to securely and quickly communicate messages on cross-border payments.

International financial transactions were conducted via telex before the creation of SWIFT, which establishes common standards for transactions and reporting, and operates a shared data processing system and worldwide communications network. Messages sent over the SWIFT network are deemed secure so it helps banks to honour payment instructions quickly. This ensures that financial institutions can handle high volumes of transactions every day.

SWIFT itself is not a payment system. Transaction messages transmitted via SWIFT are settled by the payments systems for the currency involved. For example, the Clearing House Interbank Payments System (CHIPS) is for clearing US dollars, and the Trans-European Automated Real-time Gross Settlement Express Transfer System (TARGET2) is for euros.

After almost half a century in operation, SWIFT today boasts about 11,000 member banks in 200 countries and territories. The system processed US$400 trillion worth of transactions or 90% of the value of global payments in 2021, averaging 42 million payments and securities transactions per day. 

Most SWIFT transactions are for dollar, euro and sterling- denominated payments, which account for 40%, 37%, and 6% respectively, of the total traffic. As of January this year, the Chinese renminbi was the network’s fourth most used currency, accounting for 3.2% of payments.

A neutral utility

SWIFT as an organisation is co-owned by 3,500 financial institutions and governed by a board of 25 independent directors comprising global financial executives elected by the shareholder banks. It is overseen by the G-10 central banks of Belgium, Canada, France, Germany, Italy, Japan, Netherlands, UK, US, Switzerland and Sweden, as well as the European Central Bank. The National Bank of Belgium is the lead overseer.

SWIFT describes itself as a neutral utility with no authority to make decisions on sanctions. “All decisions on the legitimacy of financial transactions under applicable regulations, such as sanctions regulations, rest with the financial institutions handling them, and their competent international and national authorities,” its website states.

In 2012, the European Union passed a regulation prohibiting specialised financial messaging providers, including SWIFT, from providing services to EU-sanctioned Iranian banks. Since SWIFT is incorporated under Belgian laws, it had to comply with this decision. 

That same year, SWIFT broadened its oversight framework by establishing the SWIFT Oversight Forum to provide a setting for the G-10 central banks to share information on oversight activities with a wider group of central banks from major economies including Australia, China, Hong Kong, India, South Korea, Russia, Saudi Arabia, Singapore, South Africa and Turkey. Nevertheless, oversight of the utility remains in the hands of the G-10 central banks.

The sanctions on Russia banks in the wake of the invasion of Ukraine put SWIFT in the spotlight once again. “Diplomatic decisions taken by the European Union, in consultation with the United Kingdom, Canada and the United States, bring SWIFT into efforts to end this crisis by requiring us to disconnect selected banks from our financial messaging services. As previously stated, we will fully comply with applicable sanctions laws,” it says in a statement.

This means the sanctioned Russian banks will have to use other messaging services to effect payments. But these would be slow and many are not designed for high-value international trades. Their counterparties would also be unwilling to deal with them for fear of also being sanctioned.

The alternatives

As the de facto global cross-border financial messaging utility, the increasing use of SWIFT for geopolitical aims has raised concerns about financial security among some countries. Three alternative platforms have sprung up over the last decade.

The EU’s Instrument in Support of Trade Exchanges (INSTEX) was established by France, Germany and Britain in January 2019 to facilitate legitimate non-US dollar and non-SWIFT transactions between EU countries and Iran to avoid breaking US sanctions. The platform only saw its first transaction conducted more than a year later, in March 2020, for facilitating the export of medical goods from the EU to Iran. It has since been largely unused, with Tehran and Brussels blaming each other for its ineffectiveness. 

 Russia’s System for Transfer of Financial Messages (SPFS) has been in development by its central bank since 2014 when the US government threatened to disconnect Russia from the SWIFT network. The system currently only works within Russia. There are over 400 Russian banks in the network but only 23 foreign banks. Before the recent sanctions, Russia was in discussion with China, India, Turkey and Iran, as well as countries in the Eurasian Economic Union, to connect the SPFS to their payment systems for cross-border transactions.

China’s Cross-Border Interbank Payments System (CIPS) was launched in October 2015 by the People’s Bank of China (PBOC) to promote the use of renminbi for international trade settlement. It provides an international renminbi payment and clearing system connecting both onshore and offshore clearing markets and participating banks. 

The system’s importance was boosted after Beijing initiated the ambitious Belt and Road Initiative involving hundreds of billions of renminbi worth of Chinese investments overseas. It gained further prominence in 2019 amid US threats to decouple its economy from China’s. Many expect the China-US trade frictions and now the exclusion of Russian lenders to accelerate the system’s expansion and reduce China’s reliance on SWIFT.

CIPS had 1,259 users across 103 countries as of January 2022, including 649 Chinese domestic banks. It had 75 directly participating banks, mostly subsidiaries or branches of foreign lenders, and another 1,205 indirect participants, more than half of them foreign firms. The system processed 3.3 million transactions in 2021, 50% more than in 2020. The total transaction value jumped 75% to almost 80 trillion RMB (US$12.6 trillion), comprising 13.7 trillion RMB in cross-border renminbi and 65.8 trillion RMB in foreign currencies.

But CIPS wasn’t designed to replace SWIFT in the first place. It collaborates with SWIFT for high-value cross-border foreign currency payments by switching those messages to the latter’s network for completion, and uses SWIFT-compatible messages for cross-border renminbi transactions to allow easy mapping. Some 82% of the 80 trillion RMB worth of the transactions that CIPS processed last year were completed via SWIFT as they were in foreign currencies.

It will take time to attract more foreign banks to join and use CIPS, increasing volume of trades being invoiced and settled in renminbi, and the Chinese currency becoming more freely convertible. The system is not in a position to challenge SWIFT any time soon.

Central banks join the fray

Central Bank Digital Currency (CBDC) is a more hopeful alternative. Digital currencies issued by central banks, along with the blockchain technology, can provide the ability to transact securely on a point-to-point basis across borders in real-time with payment and settlement occurring simultaneously for cross-border payments, bypassing intermediaries including SWIFT.

There are now 89 countries in various stages of adopting CBDC, representing over 90% of global gross domestic product, according to US policy research organisation Atlantic Council’s CBDC Tracker. Nine countries have fully launched a CBDC and 15 others are in pilot mode.

Among the major economies, China is the most advanced in its CBDC pilot. The e-CNY is currently piloted in 11 Chinese cities. More than 261 million wallets have been opened since the pilot was launched by the PBOC in April 2020. The total transaction value to date is over 87 billion RMB ($13.75 billion). 

The e-CNY was also trialled by domestic and foreign athletes, coaches and media personnel covering the Beijing Winter Olympics in February, during which over $315,000 of digital yuan payments changed hands daily.

China, together with Hong Kong, Thailand and the United Arab Emirates, is also working with the Bank for International Settlement on the mBridge project to explore the use of digital currency in the international market. The project is explicitly designed to reduce reliance on correspondent banking channels.

Meanwhile, The European Central Bank published a digital euro research report in late 2020 and then launched a two-year digital-euro investigation project in July 2021.

The US has been the slowest among the major economies to explore CBDC, but is now getting into the game. This January, the Federal Reserve published its first-ever research paper on a potential US digital currency, titled “Money and Payments: The US Dollar in the Age of Digital Transformation”. 

One of the key benefits it lists is the potential support for the US dollar’s international role. “Some have suggested that, if these new CBDCs were more attractive than existing forms of the US dollar, global use of the dollar could decrease – and a US CBDC might help preserve the international role of the dollar,” the paper says. The Fed is soliciting public comments until May 20.

In February, The Federal Reserve Bank of Boston, in collaboration with the Massachusetts Institute of Technology’s Digital Currency Initiative, released a white paper on the findings of its technological research project, called “Project Hamilton”. The researchers created and examined two possible code bases, including one that was capable of handling 1.7 million transactions per second (TPS). By contrast, the current TPS rate of the e-CNY is 10,000, although transaction capability is set to reach 300,000 TPS in future.

In order to gain a major role in cross-border trasactions globally, a digital currency must be interoperable with the CBDCs of other countries. This means the CBDC payment system in one country must be able to communicate with that of another country. So the PBOC is supporting the development of global CBDC standards and working with other monetary authorities to launch a multi-CBDC arrangement.

This is exactly where the US is concerned about the geopolitical implications and wants to exert its leadership in standard setting, even though it’s years behind in its own CBDC development.

US President Joe Biden signed an executive order on March 9 directing the Treasury Department and other federal agencies to examine the impact of cryptocurrencies on financial security and national security. What is eye-catching is that the order specifically urged the Fed to conduct research on the case for a digital dollar to “ensure US financial leadership internationally”.

“My Administration places the highest urgency on research and development efforts into the potential design and deployment options of a United States CBDC,” Biden says in the order. 

It’s too early to predict what will happen in the use of CBDCs for cross-border transactions, but these digital currencies have now entered into a new phase of development overlaid with geopolitics.

*This article was published in Asia Asset Management’s April 2022 magazine titled “Race for SWIFT options”.