Updated: Sep 23, 2021
By Dirk A. Zetzsche (Universite du Luxembourg - Faculty of Law, Economics and Finance; Heinrich Heine University Dusseldorf - Center for Business & Corporate Law (CBC); European Banking Institute), Ross P. Buckley (University of New South Wales (UNSW) - Faculty of Law), Douglas W. Arner (The University of Hong Kong - Faculty of Law), and Maria Lucia Passador (Harvard University - Harvard Law School; Bocconi University - Department of Law; Universite du Luxembourg - Faculty of Law, Economics and Finance) :: SSRN | (Date written) April 26, 2021 | (Last revised) 10 September 2021
Cross-border payments suffer from a lack of speed and transparency and limited access, resulting in higher overall costs than domestic payments. This paper analyses how the best execution principle developed in the context of securities and derivatives could be applied to cross-border payments. Under that principle, financial institutions are legally required to provide the most advantageous order execution in terms of speed, risks and costs for their customers given the prevailing market environment. We argue that introducing best execution could alter the current set-up of cross-border payments which rests, for the most part, on a system of large, globally connected correspondent banks. The current system is best understood as one of “best friends”, in that the relationship among payment institutions determines through which institutions orders are routed. In turn, payment institutions charge their clients on a “cost plus profit” basis. Some of the payment institutions even benefit from rebates based on liquidity volume (kick-backs) and from reduced rates and soft commissions elsewhere in the payment chain. Overall, there is little incentive for payment institutions to truly put their clients first in terms of speed, costs and risks in the current “best friends” environment. Introducing “best execution” is potentially a game changer: it would require payment institutions to focus on their clients’ interests (i.e., when choosing the route the order is to take).
Based on experience with the best execution principle enshrined in securities law, we would expect the large-scale introduction of digital routing systems to identify the offer that constitutes best execution. Furthermore, we expect that more links between correspondent banks, new service providers from the FinTech space, and public payment networks (including regional integration systems) would be established and would assist in identifying excess liquidity in infrequently traded currency pairs. While none of this requires distributed ledger technology, strictu sensu, one convenient way, technically, to achieve that purpose is by implementing a distributed ledger that functions, initially, as a digital liquidity marketplace (a pure information sharing device) and, which in time, could be further developed into a “best execution platform”.