In a speech delivered at Mansion House on 21 June 2018, Mark Carney, the Governor of the Bank of England (BofE), made the case for a modernised financial services sector, which would be underpinned by a thriving FinTech sector, especially in the area of payments.
The remarks reinforce the BofE’s plan for FinTech in central banking, which started last year when it partnered with a range of firms to look into the functionality the BofE would need to offer to support the sector. The result came when the BofE announced that a new generation of non-bank payment service providers would be eligible to apply for a settlement account under its real-time gross settlement system (RTGS). Those proposed changes were also focused on widening access to UK payment systems, supporting financial stability through greater diversity and risk-reduction technologies, and creating a more level playing field for non-banks wishing to compete with banks.
Modernising UK banking system payments
Mr Carney explained, in his speech last month, how those plans will continue with an “ambitious rebuild” of the bank’s RTGS (described as the “backbone of every payment in the UK”).
This will include allowing private payment systems to connect to the BofE’s network, including those based on blockchain and other types of distributed ledger technologies (DLTs), as “no longer will access to central bank money be the exclusive preserve of banks.”
The RTGS will also be reconfigured to lower the costs of cross-border payments, with the hope that £600 million could be saved on these types of payments through modernised technology.
The BofE also aims to make it easier for the UK financial system to realise the promise of big data. The revamped system will capture richer data on payments in a “format that defines international best practice”. The BofE is currently consulting on how to achieve this.
Backdoor into the EU’s walled garden
Analysing the key points of Mr Carney’s speech described above, it would seem that, in light of Brexit, the UK’s financial system currently faces risks but also brings opportunities.
As the fantastic Izabella Kaminska wrote in FT Alphaville in 2016 when she compared the UK government’s decision to stay out of the Eurozone in the late 90s and the BofE’s decision not to join Target or Target2, to the issues we will encounter when leaving the EU next year: “What is less talked about…is Brexit’s impact on the European payments clearing system, Target2 – and how the passporting issue connects by way of Target2 to the realm of sovereign monetary policy.”
The message that came from those decisions by the UK government and BofE was that, instead of joining the European financial system, they wanted to capitalise on the City’s dominance in servicing European businesses in the eurodollar market by creating a parallel euro-clearing market that was essentially offshore from the Eurozone. It paid off as today the City stands as the largest euro-clearing market (up to US$900 billion a day, primarily in euro-denominated contracts), much to the annoyance of the European Commission and the financial centres on the Continent. This winning streak continued all the way to 2007 (and past it) when the BofE opted out of joining Target2 (the holistic platform successor to Target).
ESMA now wants the City’s dominance in this space to be dismantled, as it prepares to create its own form of “equivalence” by requiring clearing houses outside the EU to meet special conditions, such as compliance with EMIR, and by creating its own “recognition” scheme. This approach is unnecessarily protectionist as, for now at least, the City’s euro-clearing market needs to be kept on an even keel.
Any obstacles in the way of British banks’ participation in Target2 will end up encouraging the real opportunity here, which is for them to create a truly separate parallel euro-clearing system which is closed off from the clutches of the ECB. This will also be a great platform from which to draw participants away from the euro altogether to alternative currency frameworks.
As Izabella concluded almost two years ago to the day: “the real war won’t be over passporting rights, it will be over nationalistic attitudes towards currency and payment frameworks.”
This is where Mr Carney’s speech comes back into play. By opening the BofE’s payment and settlement system to non-banks; leveraging off technological developments in the system, such as through the adoption of DLTs; and exploiting the massive amounts of data passing through its pipes, the BofE’s payment and settlement system has the potential to become best in class. We will need to wait and see, however, whether this is enough to draw foreign banks and non-banks away from the Eurozone, thereby realising the opportunity first identified by the Brexiteers of their time.
The BofE’s FinTech plans may even attract attention from other European central banks that want to learn from it. In a twisted move of brilliance, this could be Mr Carney’s way of the BofE being re-invited to join Target2 and effectively creating a backdoor for the BofE into the European financial system – a timely move, not only because of the UK’s departure from the EU, but also because of the ECB’s current plans to harmonise European settlements into a newly proposed central liquidity management system.
Being connected into the European payment and settlement system would be an important business move for the BofE, not a political one that could be overturned by the hard-Brexiteers. By using big data analytics, its participation would allow the BofE to keep an eye on the volumes in Target2 in order to foresee any imbalances or (even) impending crashes.
Whatever his intentions, be it necessity, survival or just plain brilliance, it is almost ironic that Mr Carney’s lasting legacy might not be his monetary policy after the Great Recession, but as the great industrialist of FinTech.