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Infrastructure and systems are undergoing a once-in-a-generation transformation.
Warning: This story includes discussion of changes to payments infrastructure and acronyms including LVTS, AFT, EFT, RTR and CBDC. Side-effects can include drowsiness, confusion and loss of attention. Reader discretion is advised.
Just kidding, but not really. For several years, one of the challenges to modernizing the Canadian payments landscape has been the difficulty of getting the leaders of financial institutions—banks and credit unions alike—to focus on the issue.
For some time, Canadian credit union leaders have known their payments system was an aging clunker held together by the computer equivalent of duct tape and baling wire. They agreed on the need for a new vehicle, but couldn’t reach a consensus on what model they needed, where it was headed or who would drive.
In fact, four years ago, the inability to reach an agreement on payments helped sidetrack efforts by $23 billion Central 1 Credit Union to lead consolidation among other centrals that would have centralized many services.
But now the payments clunker is finally on its way to the wreckers’ yard, driven by Payments Canada with the Bank of Canada riding shotgun and pointing the way.
The requirement to rethink payments has become undeniable. This is, in part, because the need to update the entire Canadian payments system has become critical as other nations—including the U.S., Australia, the U.K., and Germany—have improved their systems over the last decade. A survey by Mastercard subsidiary Vocalink found 58 countries, representing 89% of global gross domestic product, already have real-time payments. Canada currently hopes to join that group in 2022.
In 2015, Payments Canada was charged by the federal government with getting Canadian financial institutions back into the game and moving the system to one based on ISO 20022, the standard for data interchange between financial institutions.
“What we had realized as a country and as an industry is that we were at risk of falling behind other jurisdictions,” says Robyn King, lead/industry relations at Payments Canada. She says an advantage of making the changes now is that Canada has been able to learn from what’s happened in other countries as they rolled out new systems, particularly real-time payments.
“Since 2016, there has been noise that change is coming, but no details,” says Sue Whitney, VP/payments strategy and relationships at Central 1, Toronto. “My message is that it’s not just coming—it is here.”
Whitney says CEOs and boards need to turn their attention to payments so that they understand the decisions and the costs they face and can determine how payments fit into their strategic plans.
“It is a once-in-a-generation transformational change because the core payments infrastructure of the country is being rewritten,” she says.
The overhaul is necessary because no one has invested significantly in payments architecture for the past 30 to 40 years. Instead, they made minor changes to keep it working, she says. The result was a siloed system that no longer works efficiently and doesn't take advantage of new technology.
“Nobody has wanted to open the hood and restructure and reorganize it using more modern technology,” Whitney says. “You only do that when a government mandates you to. In the past 10 years, governments around the world have been mandating modernization, partly because technology makes it easier and better than it has been in the past and partly because it was time to replace the legacy systems.”
The impetus for Canada to finally make the change was the fallout from the 2008 financial crisis and the realization that the world financial system needed to have tighter tools in place to reduce the risk to the system in the event of a major financial institution’s failure.
Digital Payments Pave the Way
Consumers have also been switching from cash to digital and mobile payments, a move that has dramatically gained speed with the pandemic.
Since joining Central 1 CU almost two years ago after working at Payments Canada, Whitney has been meeting with credit union boards and executives to share her core message about payments change: “It is a big deal, it is a lot of money, and it’s not optional.”
The first stage in the transformation is replacing the Large Value Transfer System (the “LVTS” from the introduction to this article) with a system called Lynx later this summer. The dollar values processed are huge, but the direct meaning for credit unions and their members will be minor.
“Lynx is less impactful to credit unions because it is essentially a technology swap out of core infrastructure,” Whitney says. Central 1 CU, as the central group clearer for all credit unions except the Desjardins Group, is guarding credit unions’ interests during the change. She says an upgrade to the new Lynx platform in 2022 will have more direct impact since it will add a new message format to wire payments that is consistent with global standards. This should ease cross-border large-value payments and improve transparency about the context of the payment, for example by including an invoice with the payment itself.
The bigger factor for credit unions and their members will be the shift to real-time payments in late 2022. In the industry, it’s known as real-time rail (the “RTR” from the introduction to this article), but it’s not clear why, since there is no rail. When asked about the name, most insiders just shrug and say the jargon is understood by everyone who uses it. In the U.K., the similar shift was called Faster Payments; in the U.S. it was Real-Time Payments; and in Australia it was the New Payments Platform. No matter the name, it means instant, irrevocable transactions in seconds, any day, any time.
Whitney says that in the past, the success of Interac e-Transfer, which has boomed during the pandemic as consumers turned from cash and cheques to digital payments, helped relieve the pressure for changes to the Canadian system. An upgrade to e-Transfer this summer will increase its transfer limits, another much needed improvement.
In addition to the increase in Electronic Funds Transfers (EFTs), there has been a significant shift to Automated Funds Transfer (AFT), or batch payments, which are a staple of modern payments systems because they are a convenient and efficient option for important transactions like payroll and bill payments.
“Canada may be later than other countries in making some of these changes, so it is important to get on with it, because we want Canada to be competitive and Canadian businesses to have the same tools that businesses from around the world have,” Whitney says. “The technology should be triggering deep conversations about how you deliver services to your customer. How will payments change help you deliver on your strategy for improving services to your community and your members?”
First, as credit unions look ahead, they need to consider what payments services mean for their organizations and how they fit into their plans.
Dean Michaels, chief strategy officer at CUES Supplier member CO-OP Financial Services, Rancho Cucamunga, California, suggests credit unions need a new perspective to understand the importance of payments. He says credit unions need to change the way they think about the needs of their members and the services they provide. In the past, credit unions have looked at consumer life stages, such major inflection points as purchases of a home or car or retirement planning, and tried to position themselves to meet the associated needs.
The problem with this approach, he says, is that those events don’t happen often, and if a credit union misses an opportunity, it will be left, at best, as a secondary services provider.
“We’ve looked at shifting from life stages to lifestyles: What are people looking for in terms of how they want to interact with technology?” Michaels says. “To us, the important thing is how can credit unions meet members around how they want to manage their lifestyle. Those are the interaction points that members recall when they think about who their prime financial services provider is. It’s often, ‘Who am I pulling out of my wallet?’ or ‘Who am I interacting with on a day-to-day basis?’”
Echoing Michaels, Whitney says payments changes “should be looked at as strategy, not compliance—that’s been our messaging.”
Whitney predicts the big banks will focus first on their highest-margin customers in the large commercial payments space, leaving the opportunity for credit unions to serve the needs of individuals and small businesses.
She suggests credit unions should leverage their relationships with small business customers and reach out to them to ask about their payments needs. Real-time payments will allow businesses to be paid more quickly, which will improve their cash flow, and provide the opportunity to negotiate discounts when they pay instantly.
Focus on Fraud
As the real-time system removes the need to wait for payments and makes the transaction irrevocable, it increases the need for vigilance on the fraud front to ensure safety. The new system will also use ISO 20022 capability to send data along with the payments.
Some large credit unions hope to take advantage of Payments Canada’s plans to open access by connecting directly to the real-time system.
“Definitely one of our key public policy objectives is to increase access to Payments Canada’s infrastructure, specifically on the real-time rail,” says King.
The changes will allow credit unions and fintechs to participate in the system. Current legislation doesn’t permit credit unions to join Payments Canada directly, and updating that will require amendments that may take years.
King notes that in 2019, Ottawa announced plans for a retail payments framework that would enable some non-financial institutions or payments service providers to join Payments Canada. But “how that is going to work or how it is going to be structured is still in discussion.
“We are seeking to prioritize the changes for credit union membership over any others because we do see the credit union industry as a critical one to modernization, to reach all Canadians,” King says.
“The credit union industry is extremely important to us,” she continues. “It’s proven to be an important driver of competition and innovation in the banking sector. One of our public policy objectives is to benefit all Canadians, so the credit union industry is crucial to that.”
Canadian Credit Union Association is also involved in the discussion around changes, even though Central 1 CU is the leader in payments clearing.
“We have said that whatever changes are made at Payments Canada, we don’t want them to disrupt the group clearing structure, because that is important for credit unions, but we do want more flexibility for those credit unions that want more direct participation in the new products and services that will come out of modernization,” says Brenda O’Connor, VP/governance and strategy.
When credit union leaders look at the new environment, they need to ensure their core banking systems are ready to take advantage of the upgrades and be ready to choose between two options for some services in the future, one offered by Central 1 and the other by the Prairie Payments Joint Venture, which was encouraged and developed by the largest credit unions on the Prairies and is owned by the centrals in Manitoba, Saskatchewan and Alberta.
Whitney describes the Central 1 CU platform as a marketplace that will have virtual stalls for a wide variety of payments applications developed by fintechs and others. Credit unions will be able to pick and choose which elements they want.
The Prairie organization plans to fulfill a similar vision but on a different platform. It is built as part of an eight-year contract with IBM to use its Payments-as-a-Service cloud platform and payments connections.
The venture is currently owned by the three Prairie centrals but may be spun off in the future if legal changes permit credit unions to directly own an organization that connects to the payment system.
Creation of the venture was spearheaded by credit unions that wanted a more modernized option that would allow them to influence their future, while maximizing individual flexibility to develop and integrate innovative technology solutions and pursue collaboration. That ethos will continue to be a part of its approach as it rolls out new features.
The venture will also offer its services to credit unions and other financial institutions outside the Prairies.
No matter which route they take, credit unions will need to ensure their core banking system can meet the needs for speed and security. Transfers will happen quickly and in most cases are final. For example, the ISO messaging capacity will allow a biller to send a request for real-time payment to a customer. Once the customer initiates the payment, the money will move from the customer to the biller in seconds rather than hours. Also, the system will also allow for new payment options, such as real-time payroll, where the employee can request to be paid by the hour, by the day—basically on-demand.
The real-time system will consist of two components: a clearing and settlement component provided by Mastercard’s Vocalink and an exchange component that Payments Canada recently announced will be provided by Interac Corp., which already handles e-Transfers.
Is a Central Bank Digital Currency in the Works?
Lurking just the other side of the Payments Canada modernization program is another potential payments game-changer: the introduction of a Bank of Canada-backed digital currency—a “central bank digital currency” in the jargon (the “CBDC” mentioned in the introduction to this article).
A year ago, the bank said it was looking at digital currencies, but was in no hurry to test one. The pandemic has led to a change in plans as the growing shift away from cash toward digital payments has caught its attention.
“I think with COVID-19 we’ve seen an acceleration of the shift of activities online, and that suggests that if we want to be ready to develop any kind of digital central bank product, we need to move faster than we thought was going to be necessary,” Bank of Canada Deputy Governor Tim Lane said in October.
Other central banks around the world such as China, Sweden, Uruguay and the Bahamas are introducing or testing such currency. The digital cash is unlikely to replace physical cash entirely, but might instead be accepted alongside it as another form of payment backed by the government.
In a speech on the topic in early February, Lane discussed how much the pandemic had sped up the move toward a digital currency, but said no decision had been made to go ahead.
"The Bank will continue to explore the possibilities of a digital currency that would be an electronic version of the bank notes that Canadians trust and rely on. We will issue such a currency only if and when the time is right, with the support of Canadians and the federal government, and with the best evidence in hand."
So, not long after credit union leaders make their decisions about the payments framework and features their credit union will use over the next few years, they’ll need to set aside some time to think about the impact digital currency may have on the whole environment—just to be ready for the next phase in payments modernization. cues icon
Art Chamberlain is a writer based in Campbellford, Ontario, with almost 15 years of experience working with and writing about credit unions.
