Carta Financiera Forging a path to the future of payments The global payments business is being significantly and rapidly reshaped by a number of market forces and developments. Diego Ortellado, BNY Mellon Treasury Services’ Head of Sales and Relationship Management for South America, examines the factors at play, how they are impacting the transaction landscape in Latin America, and how local banks need to adopt a client-focused, partnership-based strategy if they are to grasp the opportunities on offer.

The global payments environment in the coming years will look considerably different from that which we know today. A number of key factors are responsible, and the speed and extent to which they are altering the payments business is expected to gather momentum. Firstly, post-global financial crisis regulations and compliance continue to dominate headlines, and their current and future impact on the payments space shows no sign of decreasing. Secondly, the payments market is becoming increasingly competitive, transformed by a variety of new players entering the market. Thirdly, economic growth in emerging markets is leading to a geographic shift in payment flows, and is driving cross-border transaction volumes to ever-greater heights. Finally, technological innovation is fuelling new payment possibilities – with regard to efficiency, accessibility, immediacy and reach – changing where, when and how payments can be initiated and processed. With the payments industry undergoing such significant developments, banks must be alert to these trends and their wider implications if they are to flourish in the future world of payments and grasp the opportunities that the evolving transactions market will present. Let’s examine these trends in further detail.

The impact of regulation Regulation will continue to impact the payments business in the foreseeable future in order to address changing industry and market trends and requirements. In addition to those developments that are

Carta Financiera already in progress (such as Basel III), the industry will also need to enhance oversight and control in line with growing cross-border payment flows. Having a thorough understanding of local and regional regulatory requirements is paramount for the facilitation of cross-border payments, and with global cross-border transaction volumes set to more than double from 9.9 billion in 2012 to 20.7 billion by 20221, providers need to successfully navigate the complexities of international and local regulatory environments, as well as differing currencies, practices and payment formats. For instance, as economic growth in emerging markets Asia continues, this presents significant trade opportunities for Colombian businesses in potentially unfamiliar corridors. The regulatory specifics of trading with such countries will need to be fully understood in order for transactions to be undertaken effectively and efficiently. Difficult as it may be to navigate, the regulatory environment provides the structure necessary to ensure the financial environment functions effectively and securely. Furthermore, regulatory changes can be a great driver of innovation – giving the opportunity to reassess both internal and industry-wide practices – and ultimately create more beneficial conditions for banks and corporates alike. The introduction of the Single European Payments Area (SEPA), for example, has been a huge forward stride towards achieving greater payment harmonization and standardization. Through SEPA, payment borders have effectively been eradicated, and electronic euro transfers throughout the European Union (EU) can now be made with the ease of a local transfer. Moreover, through rationalization of processes and relationships (theoretically, corporates can now use just the one bank account for the whole of the SEPA zone), costs can be reduced and cash management improved. SEPA, although a European regulatory initiative, may provide a catalyst for initiatives elsewhere and on a wider scale, such as the broader global usage of the messaging format ISO 20022.

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https://www.bcgperspectives.com/content/articles/financial_institutions_digital_economy_global_payments_2013/?chap ter=2

Carta Financiera Despite requiring significant implementation efforts, the transformational benefits created by SEPA could encourage other global regions, including countries in Latin America, to introduce similar integration initiatives. This would further facilitate cross-border payments and intraregional trade and increase convergence. Advantages aside, there is no denying that the recent barrage of new regulations has put a great deal of pressure on banks (with financial institutions' annual spend on regulatory compliance now estimated to be in excess of US$70 billion)2. This in turn has raised concerns that the strain on bank resources and cash reserves could result in all-important investment into the development of new payment solutions being delayed, thereby hindering banks’ ability to respond effectively to transformational changes in the market.

An increasingly competitive environment It can be argued that the compliance requirements placed on banks in the wake of the financial crisis (particularly increased capital requirements introduced as part of Basel III, for example) have helped to open the door to the second significant development: the emergence of a host of non-bank, fintech-focused providers. The role of such fintechs in the payments business has increased considerably in recent years and, with technology fuelling everincreasing capabilities, their presence across all client segments and geographic locations is expected to expand. These new market entrants – from online payments providers and virtual marketplaces, to large technology and social media companies – are venturing into the payments business and vying to offer choices based on client needs and expectations. Colombia has a thriving fintech ecosystem, and it is believed that approximately 70 Colombian fintech start-ups are currently active and looking to shake-up the finance industry. Non-bank providers in the payments and remittance sector are particularly prolific, and include

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http://marketintelligence.spglobal.com/blog/regulatory-harmonization-time-to-network

Carta Financiera companies such as instapago, pasa, ePayco, puntored, autopagos.co, PayU and PagaMovil3. The success that non-traditional payment providers can enjoy has been evidenced by online payments provider PayPal. Available in over 200 markets4 – and now entering the trade lending market – Paypal continues to experience huge growth in its global customer base. In the fourth quarter of 2016, its number of active accounts increased year-onyear by 10% to reach 197 million. For the year, the business processed 6.1 billion transactions: a massive 24% year-on-year growth5. If other big players in the technology and social media space currently seeking entry to the payments market (such as Amazon, Google and Apple) can capitalise on their substantial global customer bases and present attractive, secure payment propositions, the potential scale of their impact on the payments space would be immense. Customers across the retail, commercial and corporate spaces are becoming increasingly receptive to new payment methods due to their ability – unconstrained by bank-related regulation – to offer innovative, customer-convenient payment methods. Crowdfunding, for example, while an industry still in its nascency, is a growing trend in a number of regions around the world. South America saw an increase in the amount of funds raised of approximately 50% in 2015, with figures reaching US$85.7 million6. Platforms in Latin America include Vakita Capital, Kubo Financiero, Becual and Broota7. Such interest is particularly true for small and medium-sized enterprises (SMEs). Historically underserved, SMEs can now benefit from the fact that new non-bank providers are offering access to products previously only available to large corporates. New market participants are providing stiff competition to more established financial services providers, and there is concern that the regulatory pressures placed on banks may put them at an unfair disadvantage. However, as non-banks’ presence in the payments space 3

http://www.finnovista.com/fintech-radar-colombia/?lang=en https://www.paypal.com/uk/webapps/mpp/merchant 5 https://www.paypal.com/us/webapps/mpp/about 6 http://crowdexpert.com/crowdfunding-industry-statistics/ 7 http://idbdocs.iadb.org/wsdocs/getDocument.aspx?DOCNUM=39725763 4

Carta Financiera is increasingly felt, their risk potential will subsequently grow – in turn attracting greater focus from central banks and regulators (consider the new PSD2 regulation in Europe8). It is therefore likely that regulatory standards between banks and non-banks will become more aligned in the future.

Shifting economic influence The third major factor influencing payments is the ongoing recalibration of economies across the globe, with shifting global demographics playing a vital part in shaping future payment flows. The global middle class population is predicted to soar by over 150% between 2011 and 2030, rising from 1.8 billion to a staggering 4.9 billion9. In Latin America and the Caribbean (LAC) specifically, huge demographic change has occurred in recent years, with the middle class rising by 50% from 100 million to 150 million between 2000 and 201010. This emerging market growth is fuelling trade, capital and investmentrelated payment flows to and from these regions. For example, at the turn of the century, the US and Western Europe accounted for approximately 69% of global financial assets, but by 2020, this figure is expected to drop to just 46%. In contrast, China, which held only 3% of global financial assets in 2000, is likely to see its share rise dramatically to 17% by 202011. As developing countries become more prominent on the global stage, this will drive the volume of transactions – particularly crossborder payments. Facilitating effective and efficient cross-border transactions (and providing flexible solutions in terms of currencies, geographies and channels) will therefore be a huge priority in the coming years. Indeed, we have already begun to see international discussion regarding the creation of global standards for domestic realtime payments systems, in order to help facilitate real-time cross-border payments in the future. 8

https://www.saxopayments.com/how-will-psd2-change-the-payments-landscape-021402 http://www.ey.com/Publication/vwLUAssets/Innovating-for-the-next-threebillion/$FILE/Innovating_for_the_next_three_billion_FINAL.pdf 10 http://siteresources.worldbank.org/LACEXT/Resources/English_Report_midclass.pdf 11 https://globaltrends2030.files.wordpress.com/2012/11/global-trends-2030-november2012.pdf 9

Carta Financiera The ISO 20022 messaging standard should help drive interoperability between domestic payment systems, and the ISO Real Time Payments Group has recently been created to explore and help standardize the role of ISO 20022 in real-time cross-border payments. With Colombia currently the sole participant in Latin America, it is hoped that progress for cross-border payment initiatives elsewhere will encourage further Latin America buy-in.

Technology The fourth trend is the change wrought by the rapid pace of financial technology (“fintech”) innovation, a factor that has already transformed the way in which we conduct payments (real-time and multi-channel devices, for instance). Customer expectations for accessibility, immediacy and flexibility on the retail side are increasingly translating into client demand on the corporate side, as a tech savvy generation of business leaders starts to take over regions of global commerce. As technology and security capabilities, such as biometrics, develop and become more sophisticated, smartphones and tablets will likely continue to play a significant role in the evolution of payments. Currently, the pace of technological development differs between emerging and developing economies, although not in the way one might expect. Without the constraints of a legacy payments infrastructure, emerging markets are moving more quickly than their more developed counterparts, with cutting-edge electronic platforms progressing quickly to fill the gap. In the case of mobile payments, for instance, China leads the way, with 66% of its population reporting having recently used a mobile payment to settle a transaction (followed by India at 64%, and South Africa at 48%). Such figures are well ahead of more developed countries, France and Canada, where only 13% and 15% respectively reported doing so12. For Latin America, which has one of the fastest rates of smartphone adoption in the world, a population of 158 million

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http://www.innopay.com/system/files/private/Mobile%20payments%202013_Innopay_v1.0.pdf

Carta Financiera millennials, and where nearly half of all adults (49%) don’t have a bank account13, the potential for mobile banking and payments is huge14. With respect to real-time payments capabilities, worldwide demand is growing. With real-time, on demand services becoming commonplace across many aspect of our daily lives, it is hardly surprising that real-time payments – and real-time payment information – are becoming a key priority. This is becoming increasingly important in Latin America, with a recent survey of banks in the region revealing that the ability to track changes to payments in real-time is important to nearly all those surveyed (see Figure 1 below).

Important to Track Payments in Real Time 6% 16%

5% 11%

5% 4% 37%

34% 36%

42%

2012 Very important

50%

54%

2014

2016

Important

Not important

Not sure

Figure 1: Source, FImetrix, 2016

The extent of the impact of technology on the financial sector can be seen in the recent advances in the field of trade finance. This relatively traditional sector – somewhat renowned for its reluctance to change, and paper-based for hundreds of years – is being transformed across the world by recent technological advances such as electronic bills of lading and documentation examination, proving that even the 13

http://www.nbcnews.com/news/latino/fintech-americas-boosting-latin-american-financial-access-n445266 http://www.paymentssource.com/news/paythink/smartphone-adoption-makes-latin-america-a-wise-mobile-payoption-3021832-1.html 14

Carta Financiera most conservative of business lines can progress significantly with the help of technology and data-based transaction models.

Client-focused strategies The global payments evolution is already underway, presenting an array of challenges and opportunities for banks and corporates alike. If banks are to thrive in the new payments space, they must adopt a future-proof, client-centric strategy. With so many factors influencing payments – factors that are constantly in flux – implementing strategies and solutions that are flexible and able to adapt to the shifting environment can be a huge competitive advantage. For instance, as payments become increasingly global and clients of all kinds demand greater levels of convenience and speed, banks need to be able to provide an efficient, secure, multicurrency supporting platform that can be easily modified according to evolving market requirements and clients’ changing business needs. This will help to ensure that banks are positioned to support and enable the full extent of global transaction opportunities that are unfolding. This is particularly important for countries in emerging markets, where south-south trade has become a key component of economic growth. In the Latin American and Caribbean region, for example, many countries’ exports to southern-hemisphere destinations are increasing at a higher rate than those to the northern hemisphere15. For this reason, being able to facilitate payments in exotic currencies is likely to become increasingly important. For a number of local banks, substantial investment into such cutting-edge platforms can be a significant challenge, particularly when banks continue to have heightened regulatory- and compliance-related requirements to contend with. An ideal solution in such instances can be correspondent banking partnerships – an alliance between a local and a global bank – in which the skills, experience and capabilities of each party can be combined and leveraged to offer clients value-added, enriched service and an enhanced transaction experience. Through such

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http://www3.weforum.org/docs/GETR/2014/GETR_Chapter2_2014.pdf

Carta Financiera relationships, local banks can provide sophisticated technology capabilities, without the considerable investment requirement. With technology driving huge change in the transaction space, a strategic manoeuvre that some banks are beginning to explore is the formation of an entirely new type of relationship – partnering with fintech companies. Banks need to be very much involved in the world of rapidly-evolving fintech developments if they are to maintain their stronghold at the forefront of the payments industry; those who choose to remain mere spectators risk being overtaken by both existing and new non-bank competitors. Through bank-fintech partnerships – which can take a number of forms, including venture capital-style investment, and accelerator and sponsorship programmes – new ideas and concepts can be developed most effectively and efficiently. While fintechs certainly bring technological know-how to the table, banks bring unrivalled experience of the financial industry and what is required from a regulatory perspective to help ensure fintech visions can become a reality. Banks, without doubt, are becoming increasingly alert to the power of fintech, and investment into the sector is at an all-time high, reaching US$36 billion in 201616 (up from US$19 billion in 201517). With more than 1000 fintech start-ups in Latin America innovating across financial services (including payments, lending, crowdfunding and wealth management), the region is abuzz with fintech activity, and the opportunities for banks in the region to engage with fintech companies are many.

Payment transformation: a world of opportunity for Colombia The payments space in Latin America – and across the globe – is undergoing significant change, and banks need to ensure they are ready to adapt to the developments that are underway. This is particularly important due to the growing number of fintechs that are driving increased levels of competition and raising client expectations for faster, more transparent and more convenient solutions.

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https://letstalkpayments.com/global-fintech-funding-36-bn-2016/ https://home.kpmg.com/xx/en/home/media/press-releases/2016/03/kpmg-and-cb-insights.html

Carta Financiera For Colombia in particular, there is a great deal of opportunity on offer for local banks that embrace the shifting transaction landscape and the new digital era of payments. For example, the proportion of the population that owns smartphones is expected to exceed 70% by 2019 (and grow from 40% to 57% region-wide)18, helping to fuel mobile commerce. Appetite for digital solutions is very much evident in Colombia: it is the third largest market in the region for banking transactions made via smartphones, behind only Brazil and Mexico19. Local banks’ success in the transforming payments world hinges on implementing a strategy that has client needs and partnership at its core. And the burgeoning fintech landscape in Colombia is ripe with innovation and potential bank-fintech opportunities: the growth of fintech startups in Colombia has been rated “spectacular” by Finnovista, with at least 70 companies active20. The sector is gaining increasing investment and support, with events being held to promote fintech investment – including hackathons such as the Hackathon Fincluimos Reto Colombia, aimed at consolidating technological products focused on sustainable financial inclusion. Colombia, with a significant portion of its population unbanked, and with an increasing interest in fostering fintech companies and driving digital change, is well placed to leverage technology capabilities to enhance the payments space. And local banks – with their payments expertise and unrivalled industry experience – are ideally positioned to help lead transformational initiatives. By developing value-added propositions and establishing strategic alliances that enhance the overall payments experience, local banks can establish their position in the future of payments in this increasingly crowded payments space, and grasp the burgeoning opportunities on offer. The views expressed herein are those of the author only and do not reflect the views of BNY Mellon or any of its subsidiaries or affiliates. This

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https://static1.squarespace.com/static/557dd429e4b035c8591b78e0/t/5807dfdfbe6594bf4a4a3769/1476911083917/AMI +Latam+Payments+Digital+Transformation+Oct+2016.pdf 19 https://www.rfigroup.com/global-retail-banker/news/colombia-consistent-growth-led-financial-inclusion 20 http://www.centrodeinnovacionbbva.com/en/news/fintech-companies-are-making-inroads-latin-america

Carta Financiera does not constitute treasury services advice, or any other business or legal advice, and it should not be used or relied upon as such.