The world of cross-border payments has evolved significantly throughout history, driven by innovations and shifts in market demands. Over time, various currencies have played pivotal roles in facilitating international trade.
However, recent developments and changing dynamics in the global economy are causing major shifts in how cross-border payments are managed. We are witnessing major changes on the horizon such as transitioning to T+1 for USD security settlement, for example, which has a knock-on impact for funding securities in the foreign exchange (FX) market. With the market’s gaze firmly set on enabling greater efficiency, all while navigating the increasing risks that have become well established across the globe, cross-border payments need a revolution, as we are seeing in the foreign exchange space with the likes of de-dollarisation.
A spot FX trade typically follows a standard settlement timeline of two days after the execution. Within this process lies a well-founded imposition known as Herstatt or settlement risk - the risk that the payment from one side won't be fulfilled while the matching payment from the other side is already made or irrevocably committed.
However, within the next year the process will undergo another major change. The US Securities and Exchange Commission (SEC) has taken steps to amend its rules, shortening the standard securities settlement cycle from T+2 to T+1, meaning that the settlement now occurs in one business day after the trade date.
This change is set to take effect in May 2024 and will impact market participants involved in US equities, corporate debt, and unit investment trusts. Canada is also poised to adopt this change. We are already seeing the world start to shift in this direction, as evidenced by India's phased transition to T+1 for its equity markets in January 2023.
While this development is a step in the right direction towards faster, more efficient cross-border payments, there is still a major threat from FX settlement risk and challenges around the practicality of T+1 settlement.
As the world changes, so do the dynamics of global trade and finance. Currency fluctuates and markets evolve, both of which have meant that trading with the US dollar is less cost-effective for some nations.
There are signs of de-dollarisation in APAC, for example. India made its first crude oil payment to the UAE in INR (Indian Rupees) in recent weeks. BRICS countries have also voiced de-dollarisation, and banks in Russia, Laos, Cambodia, and Myanmar, for example, have increased their holdings of Renminbi over the last decade. However, this shift has not been fast paced.
Currency pairs that do not involve the US dollar are also experiencing tighter spreads, making them more attractive for international trade.
Furthermore, the increasing number of market participants quoting prices in a broader range of currencies has contributed to the shift between tighter spreads in emerging economies. Trading between two less frequently traded currencies often requires the involvement of a more globally recognised currency as an intermediary, i.e., the USD.
However, this shift is not necessarily guaranteed, and it would be a long-term process. Many financial markets operate under the ’if it isn't broken, don't fix it’ principle. The US dollar’s liquidity and efficiency in facilitating cross-border transactions have worked well for decades.
A next-generation Financial Market Infrastructure (FMI) that makes PvP settlement possible for virtually any currency corridor, enabling instantaneous settlement between commercial and central banks, based on the real-time availability of liquidity, is something the market could potentially benefit from. PvP eliminates FX settlement risk because it creates simultaneous exchange of the currency ownership, which can only take place once both sets of funds have moved, providing the assurance that one party continues to own their funds until their counterparty has met their transfer obligations.
The long-term future of cross-border payments is uncertain, but the goals for all parties involved are greater efficiency and removing unnecessary friction.
The direct exchange between two emerging market currencies requires liquidity providers, market makers, as well as financial institutions that are willing to step into this market. The confidence vastly increases when the market infrastructures to support these currencies offer the equivalent (or improved) services only available to the larger established currencies under the existing arrangements.
The future of cross-border payments remains undetermined. Whatever the outcome, we should expect reduced friction and greater payment efficiency, while the USD remains the world’s reserve currency, at least in the short to medium term.
RTGS.global is the next-generation settlement service delivering real-time cross-border payments and liquidity management. Our service reimagines how settlement occurs in the interbank foreign exchange market, enabling counterparties to settle trades instantly, bilaterally, and without settlement risk, 24/7/365. The RTGS.global settlement service today offers fiat currency settlement and is designed for a future that includes CBDCs and other digital asset classes. We are built for now and designed for what’s next.
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