The new global transaction services landscape

Click here to view an edited video of the discussion

Once overshadowed by the glamour and enormous profits boasted by investment banking, the international capital flows of commercial banking, and core retail operations, global transaction services (GTS) has in recent years gained an increasingly important place in many a bank’s operations.

But the GTS landscape is changing rapidly, as a panel of senior bankers and treasury and technology experts explained in a recent Leadership Series round table discussion hosted by The Banker.

As the first in a four-part series, the discussion covered a wide range of topics affecting the GTS sector, including economic and regulatory challenges. But a shifting business environment presents opportunities as well as tribulations, and the panel was keen to stress that banks which recognised and prepared for these could reap significant rewards.

Economic concerns

The worst of the financial crisis may be at an end, but that does not mean that all is well. Sovereign risk in the euro area, worries about commodity prices and concerns about long-running low interest rates in the developed markets are keeping Western banking heads on edge. Meanwhile, their emerging market counterparts are facing quite different issues in the shape of rapid inflation, high currency values and potential asset bubbles.

Some of these issues have led to specific causes of unease for GTS bankers and their customers, said Brian Stevenson, chairman of global transaction services at the Royal Bank of Scotland (RBS). For RBS, Mr Stevenson explained, client concerns revolved chiefly around counterparty risk – which has been at the forefront of many minds since the crisis – as well as efficiency and connectivity.

He also cited broader economic factors, in particular low interest rates in developed markets which prolonged beyond the stage most of RBS’s clients and industry analysts expected. 

Interest rates also had a major impact on banks' ability to invest in the infrastructure required to comply with new post-crisis regulatory regimes, Mr Stevenson added. “Historically, transaction banks have made considerable investments at the point when interest rates are high, ie. when their profitability is at its peak,” he said. “We now have broader challenges affecting investment decisions, including the impact of cyclically low profitability, because of low interest rates.”

However, stubbornly low interest rates are very much a developed market issue. Standard Chartered’s group head of transaction banking, Karen Fawcett, who flew in from Singapore to take part in the discussion, said Asian markets were experiencing the “lull before the storm” in terms of interest rates. “I think we’re seeing in Asia, particularly with local currencies, interest rates starting to come up. And there’s occasional movement in some of the major currencies as well,” she said. “So we may be at the bottom of where the interest rate cycle is but we do seem to be bobbing along the bottom.” 

Didier Vandenhaute, the director of PricewaterhouseCooper's treasury team offered a corporate perspective, commenting that for the companies he works with, counterparty risk is a concern which did not exist two years ago. He also cited access to, and control over, liquidity as potential issues.

Meanwhile, Senthil Kumar, group vice-president of business development for financial services provider Oracle, who works with both corporates and banks, echoed Mr Stevenson’s view that from a banking perspective, compliance is one of the top priorities.

Operational risks

A recent RBS report and survey of finance executives entitled ‘Perspectives on Operating Risk’, mentioned by The Banker’s editor and round table chair Brian Caplen, cited currency fluctuation as the number one economic regulatory and market risk concern. Under political safety and security risks, the finance executives listed cyber attacks and information security breaches as the biggest worries, while loss of customers was the chief business and strategic fear.

Mr Stevenson says the report was particularly interesting because it demonstrated that operational risk was a key concern in the GTS arena, despite it being an area of banking that has not received as much attention as credit or market risk. “Operational risk is the bulk of the risk that transaction banks run, and therefore it becomes naturally an area of specialisation that [we] should adopt as our own,” he added.

Foreign exchange risk is, of course, not new, as Mr Stevenson pointed out. Any customer that operates across borders and across currencies encounters it. Cyber crime, however, is a much newer threat, and one which requires banks to reassure their customer that when transactions involving billions of pounds are being conducted via online portals, they are as secure as possible. Mr Kumar also recognised this as a key priority.

Price is likely to be an increasing concern for GTS customers, said Mr Vandenhaute. But Ms Fawcett added that it would not be the only concern: "I think what we’re finding is that the clients are actually very concerned about how they link in very solid relationships. The financial crisis really showed them that the relationships with their banks, and the relationship with their buyers and suppliers, is incredibly important to them."

Marc Terry, managing director of Vocalink’s transaction services division, said the banks' priority should be ensuring that their technology infrastructure was able to cope with the demands they will face. “I’ve often found, with the banks particularly, they tend to add another siloed solution, [then] add another, [and] not look at the core technology in order to create something that’s much more flexible. And so, when these new regulations appear, when new opportunities present themselves, they can be architecturally inhibited.” 

Staying competitive

As the GTS landscape becomes more popular, and therefore competitive, for banks, the need to stand out from other players is more important than ever. However, facing unavoidable expenditure in the form of compliance measures to deal with incoming regulation, banks could find themselves in a position where they are unable to stump up the investment needed to add value to their services.

An additional pressure will come from the fact that pricing for GTS services has dropped in recent years, says Mr Vandenhaute, partly due to increased inter-bank competition and partly due to regulatory developments such as the Single Euro Payments Area (SEPA).

The net result, he added, is that some firms find it hard to differentiate between different banks and their services. “Corporates take the shortcut and say ‘well, if there is no real differences then let’s go for the cheapest one’, which I don’t believe is the right choice,” he said. “I think the challenge for the bank is first to be able to differentiate, and second to be able to provide valued services, around reporting or seamless integration, for example.” 

Mr Stevenson conceded that “fundamental core” GTS services involved moving money from A to B, a service which has become a commoditised product. However, he stressed that the ways in which customers are handled provides a crucial chance to create additional value. Offering improved connectivity and reducing the all-important operational risk element, for example, would be welcomed by clients, he said, and could well allow banks to charge a higher price.  

Successfully achieving this will be crucial for banks contending with tough rivals, Mr Stevenson added. “That’s how you will create value, and that’s not the area for cooperation. That’s the area for red-blooded competition to make sure that you are successful against the other institutions that are bidding for a particular mandate.” 

Offering multi-market consistency and the ability to look after a transaction at both ends can also prove attractive to international corporates, as can advisory knowledge, said Ms Fawcett.

Mr Vandenhaute agreed that businesses would pay for these kinds of services. However, he added that finding a bank which could provide them globally might be harder. The solution, he said, was for banks to compete in certain markets and cooperate in others. 

Regulatory trials

Increased regulation, and the costs associated with it, have caused consternation across the banking landscape. GTS is no exception, said Mr Terry, noting that the costs involved with addressing new legislation may leave precious little funds elsewhere. “Everybody has to address the requirements of their regulators, so they’re limited,” he said. “That therefore means there’s less money to spend and banks have to be much more critical in terms of deciding where that money goes.”

And it is not just banks that stand to lose out, as demonstrated by the current debate over Basel III and its impact on trade finance. Specifically, the proposed third iteration of the Basel Committee on Banking Supervision's Basel Accords has raised fears among bankers that trade financing could become prohibitively expensive. Under the new rules, a leverage conversion factor of 100% is assumed, meaning banks would be required to hold capital against the entire value of a trade finance lending commitment, up from the current prerequisite of 20% under Basel II – itself an increase of 10% from Basel I.

This could make trade finance a far less attractive business proposition for banks. If implemented in its current form, Basel III could lead to a 6% reduction in global trade finance capacity, an increase in pricing of as much as 40% and as much as a $270bn (1.8%) reduction in international trade flows, according to estimates from Standard Chartered.

Ms Fawcett said these issues have still not been solved, although there was an appetite among regulatory bodies to do so. “I think there has been very constructive debate and there has been an enormous amount of information sharing, and willingness to listen.”

For trade finance providers, problems are caused by the principle that off-balance-sheet (OBS) instruments could be a significant source of leverage for banks, and should be considered in an institution's overall list of obligations and limited. But planned leverage ratios will not account for the risk profile of a loan, so lower risk trade obligations – such as bonding or letters of credit – may be caught up with other, riskier, OBS instruments.

Burden of proof

But proving that trade obligations are indeed lower risk is the responsibility of the banks themselves, said Mr Stevenson. “In fairness to the regulators, I think their stance has been that if you as an industry can give us the data to prove what you are saying is correct, we will listen to you,” he said. And indeed, the banking industry does appear to have pulled together on this issue. The International Chamber of Commerce (ICC), together with the Asian Development Bank, for example, has created a register of 5.22 million trade finance transactions conducted around the world by nine international banks over the past five years. For the first time, the industry has empirical data to present to regulators on the average duration (115 days) of a trade finance deal and on total default rates (which amounted to just 1140).

“On the trade subject, I think there is a willingness to listen. In part because the G-20 and other regulators see trade as a major area for kick-starting the world’s economy, post crisis,” added Mr Stevenson. “I think, from a political point of view, there is a desire to make trade easy to operate, make it more efficient and to ensure the flow of capital going into trade. That’s why I think the regulators, if we are good as an industry in giving them the data about the real loss activity around trade, will listen to it.”

The panel also discussed SEPA. While there was a universal acknowledgement that implementation is a certainty at some point at least, Mr Stevenson voiced concerns over the impact of a failure to agree on an actual implementation date. "It’s going to happen. I think everybody’s always known it’s going to happen, but the parties haven’t yet got agreement on precisely when it’s going to happen. And when you have doubt about when an event is going to happen, you have a lack of investment because there is a lack of motivation to do so."

Mr Vandenhaute added that, for banks, an additional difficulty was presented by the fact that different institutions have taken different approaches towards corporates. “You have a variety of approaches from the banks, and as long as there was no mandated end-date for the migration, I think there was little incentive for the banks to change nor to push for a solution.”

New opportunities

Despite, and in some cases because of, the issues and challenges that the global GTS landscape is facing, new opportunities are appearing too – from vibrant emerging markets to making more efficient use of working capital, the panel said. But to take advantage of these opportunities, banks have to meet customer demands.

The financial crisis led to an increased awareness among customers about where their liquidity was sitting in the system, said Mr Stevenson. As a result, transaction banks are investing in creating greater visibility – about where the clients’ money is at all times, whether it is somewhere in the settlement chain, or sitting on a current account within the system.

More opportunities are presented by a diversification away from the big three Western currencies to settle trade transactions. In particular, in the rise of the Chinese renminbi over the past 18 months, said Ms Fawcett. “We’ve seen the quantities rise tenfold in the past year, and we’re now up to Rmb1000bn a month in trade settlement. That’s a very substantial amount.” 

This can offer banks a real opportunity to differentiate themselves from the competition, said Mr Kumar, as can operations in less crowded markets. “When you talk about differentiation, it can be difficult for corporates to differentiate,” he said. “It’s much easier in these type of regions, because the differentiation between the banks and solutions are really there. Last year, for example, there was an opening – in terms of the ability of banks or corporates to use the cash which was locked in China as collateral.”

New rivals

Banks are not just facing increased competition from their peers, however. A new breed of alternative payment providers are threatening to muscle in on their territory too. Although PayPal and its ilk only account for a small proportion of total transactions at present, they are more dominant in some arenas than others and could prove dangerous in the long term. Mr Stevenson said: “While volumes are small today, I think they’re much larger in some sub-segments of the transaction banking industry, and some of the players are just targeting the cards part of the transaction banking industry, not trade and not cash management, for example.”

Of course, a large multinational corporation’s requirements for cash management are very much tied to current accounts and the banking industry, but Mr Stevenson expects increased rivalry elsewhere too. “I think [competition from external providers] will extend into mobile telephony, and the whole range of activity associated with making the buying experience online, or even in-store, an easier process for the customer."

Mr Terry agreed that competition was currently focused in the cards space, but that in the UK at least, non-bank payments providers are beginning to ask why they cannot take advantage of the country’s Faster Payments Service, for example.

But competition exists elsewhere too, said Ms Fawcett, highlighting PayPal once again – which estimates it processes 18% of global online payments – and Kenya’s M-Pesa mobile-phone based money transfer service, which now boasts several million customers. “A lot of these things are coming from areas of the population which may not have bank accounts at the moment. That may be the future bankable population... I think we have to take these very seriously, and really look at the creativity and adopt those into banking practices,” she added.

These services are not just confined to consumer usage either, said Mr Kumar, noting that payment services such as Square – which allows users to accept card payments on a mobile device – will allow merchants to set up a stall anywhere and process thousands of transactions per day. 

Co-operative spirit

While competition may be increasing, the panel also noted an increased appetite for mutual co-operation between banks and other financial services providers when it came to some services and obligations.

Mr Stevenson identified these as tackling cyber-crime, providing common infrastructure so that customers receive a universal standard of experience, enforcing agreements about standards (such as encryption methods) in information delivery as well as maintaining efficient common connectivity links.

As Mr Terry pointed out, this is not a new concept, as witnessed by the UK’s venerable BACS scheme which electronically processes financial transactions. The same approach can be noticed in the country’s Link national ATM scheme, he said.

Banks have been working together to tackle common goals for significantly longer than that, said Ms Fawcett. “I think we should go back to the very old principles of correspondent banking – banks have been working together for centuries. We’re now automating all that very effectively, but actually the whole world of trade and payments wouldn’t exist unless banks [co-operated].”

The panel agreed with Mr Caplen’s suggestion that the financial crisis has helped bring correspondent banking back into vogue, but Mr Stevenson suggested that this was a smaller part of a resurgence of transaction banking as a whole, which he described as something of a “neglected child” within the banking industry. “It has been recognised now as a solid part of the banking world, creating value. It has performed well through the crisis,” he said. “It didn’t create the crisis, it is of real economic value… and it is of relatively low risk from a credit and operational point of view, relative to some of the other activities that banks were engaging in during the run up to the crisis.”