Dodd-Frank section 1073 has potential global impact

Dodd-Frank section 1073 generated much comment at both the International Payments Framework Association (IPFA) General Meeting and the NACHA Global Payments Forum (GPF) conferences in Munich this week. A straw poll of the GPF delegates revealed that two thirds of the attendees believed it has the potential to change the business model for consumer-originated payments for the entire global payments industry, with the remainder seeing its consequence as changing the model merely for their bank or business.

The US Bureau of Consumer Financial Protection Bureau (CFPB) is publishing a final rule to implement section 1073 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, amending Regulation E, which implements the Electronic Fund Transfer Act, and the official interpretation to the regulation, which interprets the requirements of Regulation E.

Overshadowed by new rules around interchange imposed by Dodd-Frank, section 1073 has had little publicity to date. Its consequences – some perhaps unintended - are considerable. It may result in some banks electing to withdraw services and tilt the playing field in favour of non-banks – many of which are US-based.

The rule applies to US consumer-initiated transfers and payments. The U.S. Bureau of Economic Analysis estimates that in 2010, $37.1 billion in-cash and in-kind transfers were made from the United States to foreign households by foreign born individuals who had spent one or more years there. Globally, the World Bank estimates that the worldwide volume of certain cash, asset, and in-kind transfers made by migrants to developing countries reached $325 billion in 2010 ($440bn to all countries), and that the United States was the source of the greatest number of such transfers.

The scope of the regulation goes beyond remittances, and includes all consumer-initiated transfers; for example, payments to firms for goods being imported to the US are covered. Whilst the regulation is limited to consumer-initiated, US based corporates may also choose to use services which support it, if they become competitive with traditional cross-border payments services.

The main provisions are:

• Full fee disclosure at the point of, and time of, origination
• Guarantee of amount of final funds delivered, to be delivered at time of origination
• Guarantee on when funds will be received
• Right to cancel a transaction up to 30 minutes after its submission.

There are also stringent requirements regarding resolution of enquiries, complaints, returns, etc.

Delivering against such criteria is particularly challenging for ‘open loop’ service models such as correspondent banking. Such ‘fire and forget’ services rely on others in a chain to effect delivery, where the transaction routing may not be known at the start of the transaction, making end-to-end service levels unpredictable. Those other parties may impose fees, which they may take out of the principal of the transaction. In some cases, FX conversion may occur ‘downstream’, making it impossible to know, when sending a sum of money, how much will arrive at the far end. The advantage of ‘open loop’ is its reach; funds can be delivered to more or less any bank account anywhere.

In contrast ‘closed loop’ models, where the provider of the service to the sender also has control of the delivery to the beneficiary, are far more ‘transparent’. The amount, fees and the delivery date are known beforehand with a very high degree of certainty. Few banks operate closed loop services today.

However, the writing has been on the wall for the current correspondent banking model for some time. Indeed SWIFT says, ‘this model is still too bank product centric, based on inherently inefficient multiple agreements. The world has changed around us’, in its Correspondent Banking 3.0 paper.

Given the very short implementation period, and the usual shortage of internal project resource, collaboration may be the only realistic option for US banks. Services which have the fewest steps in the journey to the maximum number of beneficiaries, via established bank-owned intermediary services such as national ACHs, can provide consistently high and transparent service levels over a wide range of international routes.  Indeed, the IPFA, a global industry initiative, has been working to improve cross-border payments through providing rules, standards, operating procedures, and guidelines to standardise links between ACHs globally. Some IPFA-compliant services have been live for some time.

Payments services providers in Europe may also be an option. There are similarities between Section 1073 and the EC Payment Services Directive (PSD) implemented in 2009. The PSD was intended to support SEPA and required payments services providers to become regulated and thus protect consumer and business users.  Though typically referred to as non-bank providers, some services are white-labelled and are designed to help banks ‘own the customer’ and earn ‘adjacent ’ revenues such as FX. As of January 2012, there were 176 Authorised Payment Institutions in the UK alone; around 90% of such providers in the EC are UK based.

But that may not be enough. The regulation provides for recourse for the sender even in, for example, the event that the sender has input an incorrect, but nonetheless operational account number for the beneficiary. In many jurisdictions, such as the UK, the account number has primacy – once funds have been paid into an account, there is no automatic right of recourse. Consequently the service provider, who may have charged a fee of perhaps $5 for delivery of a $1000 transaction, may be liable for the full $1000. Transactions of that value and above are commonplace; a footnote in the rule states that more than 50% of total worldwide transfers made by one diaspora are in amounts of $1,100 and above, and of that category, 63% exceeded $2,200. The initiating service provider will need strong antifraud measures.

At the Meeting, several IPFA members asked whether the Association can help. Since such a requirement is a change to IPFA’s scope, a working group was tasked to review whether it would be feasible and appropriate to change IPFA scheme rules. According to the straw poll at the GPF conference, which followed the IPFA General Meeting, most of the delegates at GPF had already – or will have by now - begun impact analysis. There is not much time to do so. The regulations come into force in January 2013.

A short time window remains to offer suggestions. Until April 9, 2012, the CFPB is seeking comment on whether to make a few additional adjustments to the final rule. And there may be more to come. As reported in the Economist in Feb 2012, only 93 of the 400 rule-making requirements mandated by Dodd-Frank had been finalised by then.  Use of consumer regulations by EC and US regulators to drive change in the payments industry has no doubt been noted in other jurisdictions. Speakers at the GPF conference commented on significant payments industry governance and regulatory change underway in Canada and Brazil. The trend seems obvious.