Lessons from the U.K.'s Colossal Payments Overhaul

LONDON — Real-time payments arrived in the United Kingdom at the most inauspicious time imaginable.

It was May 2008, just as the U.S. mortgage crisis was morphing into a global financial crisis. Bear Stearns had already fallen; in less than six months, so would Lehman Brothers. Quantitative easing, the Eurozone crisis and the U.K. bailouts of HBOS, Lloyds Bank and the Royal Bank of Scotland were on the way.

The worldwide calamity overshadowed the commercial launch of the U.K.'s Faster Payments System, a set of rails to transfer funds from one bank account to another in seconds. The product of a decade's work, the platform would eventually process transactions at a rate of more than one billion per year, help businesses manage cash flow and allow consumers to send money 24/7, instantly, for free.

It didn't get the launch party it deserved.

"The banks didn't seem to push this service as they were dealing with being bailed out or taken over by the U.K. government," said Paul McMeekin, manager of business intelligence and market research for ACI Worldwide, a provider of electronic banking and payment solutions.

As the U.S. banking industry embarks on a similar journey to payment modernization, it may be able to learn some lessons from our cousins across the pond. Among those lessons: Stakeholders will first need to put aside their differences to work together. The U.S. can then create strong business cases, of which there are plenty, so there's a road map for building services atop a real-time payments platform. Creating a list of business cases might also help the system get the proper funding. And lastly, don't get distracted. It will be challenging in the U.S. to choose a technology and stick to it with a market full of payment startups leading the charge on faster access to funds.

In theory, the U.S. could even let the Brits manage the system from the Square Mile of London's financial district. They're already raising their hands and offering to help.

"The U.S. could chop three, four, five years of experimentation and expenditure on the base-build of software if they work with us," said David Yates, chief executive officer at VocaLink, the organization owned by U.K. banks and building societies that runs Faster Payments. (Building societies are mutually owned financial institutions similar to savings and loans.)

VocaLink has already exported its payments platform to Singapore and Sweden. Singapore's system, which is more advanced than the U.K.'s, was up and running in a year and a half, Yates boasted.

And recently, the operator has been providing its counsel, gratis, to the Federal Reserve and the Clearing House, two of the major players in the U.S. effort to modernize payments.

"We are doing our very best to convince all parties [in the U.S.]...that we have something really good to offer," said Yates.

But he recognizes that a trans-Atlantic contract is a long shot.

"Selling software to the United States and selling banking services to the U.S. is a little bit like selling sand to Saudi Arabia," he said. "The U.S. is full of talented software developers."

MANDATE FOR CHANGE

The faster payments concept first took hold in the U.K. in the late 1990s after the Treasury commissioned what came to be known as the Cruickshank Report. In 2000, the Treasury endorsed the report's recommendation for the establishment of an independent payment system in place of the existing, privately controlled interbank system.

The banks began work, or more accurately began discussing a system. In 2003 the U.K government, through a payments systems task force, stepped in and mandated the move to faster payments, leaving the tab with the banks.

Stakeholders came together in an industry forum to decide who should build the system. About five providers vied for the role. In 2005, the banks decided on a joint venture between Voca and LINK, and the following year, the companies had begun building. In 2007, Voca and LINK merged to form VocaLink, which launched Faster Payments in 2008.

But even then "there wasn't necessarily a clear view of the solution the industry wanted," said Stoddart.

To avoid such a situation, U.S. stakeholders need to come to the table and design an extensive set of requirements the real-time system should have, he said.

This will be one of the trickier matters in the U.S. More than 6,700 banks insured by the Federal Deposit Insurance Corp. operate in the country, not including the nearly 7,000 credit unions and a significant number of nonbank financial services and payments participants.

By contrast, "I think there were 10 U.K. financial institutions who originally signed up, which accounted for 95% of the transactions," ACI's McMeekin said.

The number of U.S. financial institutions with varying degrees of technological readiness could be particularly exhausting for scaling the real-time decision making capability the system must have, said Richard Martin, managing director of transaction services at Barclays.

"When faced in the U.S. with a larger number of banks and a mixture of large and small banks, some may struggle to keep up with the pace of ramping up," he said.

A CAUTIOUS START

When Faster Payments launched, the founding member banks proceeded cautiously. They had advanced technology running atop creaky legacy systems. At the beginning, banks allowed payments up to five pounds (about $8) to move over the rails. Banks then set their own values according to their risk appetite, but the goal was to allow up to 10,000 pounds for an individual payment. Barclays and RBS were the first banks to move 10,000 pound transactions across the system, Martin said.

Today the maximum amount a user can send over Faster Payments is 100,000 pounds. There isn't a technological limit, though. The government is contemplating raising that limit to one million pounds to enable big-ticket purchases like homes, Yates said.

While users of Faster Payments see cleared funds immediately in their account, settlement happens three times a day on the back end.

Early on, the banks in the U.K. wouldn't describe the system as "instant" in many cases, even though 99% of transactions went through in seconds, said Roy Vella, an expat independent consultant living in London.

"Banks usually under-promise and over-deliver...because they're so risk averse," Vella said.

Some payments can take a minute to clear and on large transactions the banks have two hours to deliberate, but that hasn't been a major complaint, he said. "The expectation of bank service provisioning is universally low," Vella laughed.

The U.K.'s Faster Payments system grows 20% per year, said Stoddart, and about 60% of that growth comes from transactions migrating from other systems. Faster Payments volumes increased 19% to 967 million transactions in 2013 from the previous year. Since it launched in 2008 to July 2014, Faster Payments has processed 3.75 billion transactions. In October 2014, the system for the first time processed transactions at an annual rate of 1 billion.

While the U.K. government ordered the system into existence, government mandates are likely to be a tougher sell in the U.S.

"The U.K. in general welcomes regulation to improve market conditions," said McMeekin, a Brit who's lived in the U.S. nearly a decade. Americans "have a distrust of the government and any market intervention is viewed with skepticism."

Not only will the U.S. government be in a tough spot to demand a faster payments system be built, but it will also have trouble making banks pay the tab like the U.K.

"It's going to require hundreds of millions of dollars of investment," Stoddart said. And who's to pay "isn't as straightforward anymore."

While the banks will be a big user of the system, he said, they need not foot the whole bill. Stoddart suggests public funding or listing the system on the stock exchange as options.

DISRUPTIONS AND DISTRACTIONS

All this is just the beginning. The real challenge is implementation. A system like this requires a massive amount of IT work, and discipline is key.

"During big change programs, lots of things happen; there might be an election, or you might get some sort of industry shock, or a bank goes bankrupt...so you must be very careful to not get distracted by those events," VocaLink's Stoddart said.

Not even new technology should sidetrack those involved, he said. For example, 12 months into the implementation, if a new version of Bitcoin comes out and it's a flawless payment system, Stoddart cautions, do not change course.

Partly because of the crisis, U.K. stakeholders didn't put as much effort into identifying business cases for the system early on, so many weren't realized in a sensible time frame, if at all, Stoddart said.

The U.S. is on the right track in that regard, he said.

"The natural start point for the banks to focus on is: Do I really need to replace the infrastructure? Can I not just simply paper over the cracks and build new functionality on top of the existing infrastructure and thereby reduce cost and time for delivery?" Stoddart said.

But when banks merely patch holes, the cost and complexity of change is only exacerbated, he said. This has proved extremely difficult as banks scramble to implement online and mobile banking platforms and enhance security through tokenization and biometrics.

Faster payment services "present an opportunity for the banks to deliver new sources of revenue but they require new infrastructure to work effectively and meet the requirements of businesses and consumers today," Stoddart said.

Business cases that might motivate banks to work together on a faster payments system include the ability to issue short-term, small-value credit to customers quickly.

"The real business case for real-time payments in the U.S., it isn't about making the things that currently move slowly...move faster," Yates said. "Just making that money move faster doesn't mean you can charge a customer more."

MESSAGING STANDARD

In building a faster payment system and the fraud management that goes behind it, the U.S. can reduce exception handling and manual intervention in transaction flows, Stoddart said.

These benefits come directly from the use of the ISO 20022 messaging standard, which the U.S. will most likely adopt as it builds its faster payments system. ISO 20022 allows banks and merchants to transport significantly more data with a payment — information like where the invoice should be sent, whether the transaction was for payroll or supply of goods, and what tax deductions should be withheld.

Transactions carrying bigger messages allow for increased confidence that the parties initiating payment are who they say they are. Plus, with more data attached to each transaction, it should be easier to reconcile payments and manage cash flow.

In exporting its product to Singapore, VocaLink built in the ISO 20022 standard. Singapore's "national real-time payment system is more advanced than ours in the U.K. in a couple ways," Yates said.

First is the data messaging standard. And second is the technology, which is more modern and allows for pull transactions, which are initiated by the recipient for things like monthly subscription payments. Pull payments will go live in Singapore in April.

INNOVATION AND MONOPOLY

To say that VocaLink has a monopoly on the back-end systems that enable payments in the U.K. would not be an understatement. And while London is currently a hotbed for fintech startups, few of them are developing payments technology — a fact that can be partially explained by this monopoly. "You just don't need it," said Vella.

However, the user interface that makes those real-time transactions happen might need a refresh. "It's great the back end will get these payments through in real-time, but it doesn't really help if I have to use my bank's mobile app which sucks," Vella said. "Payments innovation should be about the front end. The usability is on the front end."

For example, adding a new payee can be cumbersome. Consumers can't do this through the mobile application; they can add beneficiaries only through the Web app.

VocaLink allows third parties to develop applications on the Faster Payments rails, but these entities must be highly regulated, which creates barriers to entry for startups.

There has been some innovation, though, much of it by incumbents.

GoCardless, a four-year-old startup near Shoreditch, an area of London known for its grungy, hip tech startup scene, constructed a direct debit system for enterprises.

And Barclays, which is a member of VocaLink's board, built PingIt, a peer-to-peer mobile app, by leveraging the Faster Payments engine. More broadly, U.K. banks are building their mobile apps and electronic channels on top of the system.

Barclays has also launched a corporate disbursement service enabling its customers to issue files of Pingit payments, for example for insurance companies to send out claim settlements, said Martin.

VocaLink, owned by U.K. financial institutions, has itself built two applications on the Faster Payments rails, Paym and Zapp. Paym allows users to send payments in real time using only a recipient's mobile phone number.

Zapp provides a tokenized payment request from the merchant to the consumer. The consumer then authenticates the transaction with a simple yes or no, and the money is moved from the customer's bank account without giving the merchant their credentials.

Many say Zapp, which will launch in June, will revolutionize the market in the U.K. for mobile payments.

Zapp is different from a traditional e-commerce transaction today, where consumers must input substantial amounts of personal data. This process can be particularly aggravating and time-consuming on the small screen of a mobile device (not to mention the security risk of sharing sensitive information with strangers).

If you're feeling déjà vu reading that, it may be because Zapp is essentially addressing the same issue as Apple Pay, which more than 750 U.S. banks and credit unions committed to rolling out. U.S. banks' fear of being disrupted by the Cupertino colossus may be perhaps the ultimate business case for modernization.

"If you had a real-time payment system...banks would be solving the problem themselves, and wouldn't have to pay Apple Pay or other providers a piece because they're solving this card problem for e-commerce and m-commerce," Yates said.

While consumers have benefitted from Faster Payments, the biggest beneficiaries may be the small to midsize businesses that figuratively live paycheck-to-paycheck. With Faster Payments, these merchants are able to have funds for use in their bank accounts immediately, eliminating cash flow issues and generally helping the economy. A plumber, for instance, would have historically been paid with a check or cash and then made a trip to the bank to move funds into his account. Now he can receive funds directly. He'll be less likely to fall behind paying the bills or go without needed products and services.

The stakes will be higher for the U.S., a larger market than the U.K., and given the fragmented nature of the banking and regulatory systems, the challenges will be greater.

"The danger is that the U.S. spends two to three years debating what to do... as the rest of the world moves on and ... gets increasingly left behind in terms of payments infrastructure," Stoddart said. "It is the market that is most likely to benefit from providing this capability but also the most difficult market to provide" it in.