Strategic Review of Innovation in the Payments System: Summary of Consultation – February 2012 5. Payments System Architecture

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Along with governance, the critical decisions arising from this review are likely to relate to architecture, for a number of reasons. First, the Bank has observed that centralised systems appear to be better able to innovate than bilateral systems. This might in part reflect necessary differences in governance structure, but centralised systems also provide easier access for new entrants and can potentially provide additional services that may transform the nature of the payments and services that can be provided. Second, the efficiency gains from centralisation increase as the size of the network increases. Therefore, to the extent that a high level of participation is an objective of any new systems, there should be a presumption in favour of centralised architecture. Third, architecture is relevant in the context of real-time or near real-time settlement of retail payments, which may require the establishment of a new system interfacing with RITS. Finally, discussion of architecture is intrinsically linked with governance discussions. For instance, investment in architecture that offers a public benefit might not present a compelling business case for a sufficient number of financial institutions, particularly where it may cannibalise existing products. In such circumstances, the investment is unlikely to proceed under a range of governance arrangements. This potentially raises public intervention as a response.

The consultation paper asked for views on the benefits, costs and possible roles of hub architecture and also the benefits and costs of real-time or near real-time settlement architecture. Because it was not specific about the type and function of a hub that might be considered in the Australian context, comments on the paper were quite disparate and not necessarily focused on the same concepts. In general, submissions acknowledged the benefits of hubs and many supported their use for new systems, although one party argued that the standardisation involved in hub arrangements is inflexible and is therefore not best practice. A number of players also pointed to the risk entailed in creating a single point of failure.

A number of submissions focused on physical connections and argued that the Community of Interest Network (COIN) already provides sufficient centralisation. Others focused more on the cost of moving existing bilateral arrangements to a hub, which they argued would be difficult to justify commercially. Smaller players, on the other hand, tended to emphasise the difficulty they saw in accessing existing bilateral arrangements.

APCA has presented a useful framework for considering centralised versus decentralised payment arrangements. This comprises three levels of interaction between participants, namely:

• physical – the means by which messages are carried from one institution to another
• logical – the rules/protocols that govern how those messages are exchanged
• business – the business/contractual arrangements that govern the relationships between participants.

Any of these can be established bilaterally, or be centralised and hence be ‘hub-like’.

Steps have been taken towards greater centralisation in Australia in recent times. As several submissions pointed out, the COIN is effectively a virtual hub, allowing participants to communicate with all other participants by making only one physical connection. The establishment of ePAL and initiatives of APCA have also led to some greater standardisation or centralisation in relation to logical and business arrangements. Nonetheless, new entrants to a truly centralised system need largely to deal only with the central body to establish these arrangements, whereas bilateral negotiations of some form continue to be required in many cases.

The case for considering alternative architecture arrangements rests on those arrangements either improving efficiency or addressing one or more specific problems identified in respect of a payments system. In the Bank's view, there are three main types of function that hubs can perform that are relevant to the Strategic Review:

• Simplify connections. The greater the extent to which physical, logical and business arrangements are centralised, the simpler will be access for new participants and the better the environment for competition and innovation.
• Enable additional processing functions, to provide more sophisticated payment products or greater interoperability. A hub could perform functions as varied as: splitting and distributing bulk files; conversion between message formats; fraud detection; the association of identifiers with account details (to facilitate easier addressing of payments or account switching); or holding data centrally that can be referenced in payment messages.
• Facilitate real-time, or near real-time settlement of retail transactions. Real-time or near real-time settlement of retail transactions would likely require centralised architecture to process large volumes of payments for settlement in RITS.

In considering these possible roles, account needs to be taken of different types of retail payments, in particular whether payments are transmitted as bulk files or individual real-time messages.

The recently created Low Value Clearing Service (LVCS) is relevant to the case of bulk files. This is effectively a form of hub to facilitate the exchange of payment clearing files, allowing institutions to continue to exchange files where they have adopted different communication networks. While the current function of the LVCS is to achieve interoperability between networks, it could be adapted to perform other roles in relation to bulk files, given that all institutions exchanging files must be capable of sending files to, and receiving files from, the LVCS. For instance, a new entrant could establish a physical and logical connection to all other participants simply by connecting to the LVCS. The LVCS could also be used to provide add-on services for bulk files, for instance, breaking bulk files apart for distribution to individual receiving institutions, or potentially more advanced functions. The LVCS is not, however, designed to provide services for individual real-time messages. Performing similar functions for these payments would require separate infrastructure.

The consultation document asked for views on ownership/governance arrangements for any new centralised infrastructure. One bank argued that private ownership would provide for commercially based decisions, but risked monopoly pricing, while a public utility might tend to be inefficient. It suggested a public-private model, which could take advantage of the benefits of each. Other submissions suggested that if a hub were created to process real-time individual transactions, it should initially be developed/managed by the Bank, but allowed to run as a commercial or semi-commercial venture at a later stage. One submission argued strongly that it would be inefficient for payments infrastructure to be in public hands.