If a German company wants to buy an industrial robot from a Japanese manufacturer using U.S. dollars during a holiday or weekend, it will have to wait. The Fedwire Funds Service, typically used for such transactions, is open during regular business hours, Monday through Friday.
For an increasing number of businesses, this kind of wait is no longer acceptable.
“The recent Fourth of July holiday was a working day in most parts of the world, and people still want to make payments on U.S. bank holidays and on weekends,” said Tony McLaughlin, head of emerging payments and business development at Citi Treasury and Trade Solutions.
This is one key use case for the Regulated Liability Network, a blueprint for a proposed regulated financial market infrastructure that would operate a shared ledger with central bank, commercial bank and electronic money on the same chain, settling transactions instantly.
The ledger and network design was recently tested by several banks and other financial services players in a 12-week proof of concept that included Bank of New York Mellon, Citibank, HSBC, PNC Bank, Swift, TD Bank, Truist Bank, U.S. Bank, Wells Fargo, Mastercard and the Federal Reserve Bank of New York. The technology was provided by Digital Asset and SETL and hosted by Amazon Web Services. Sullivan & Cromwell provided legal services, and Deloitte provided advisory services.
“So many commercial entities outside of the U.S. trust the U.S. dollar for international settlement,” McLaughlin said. Improvements have been made in international payments, he said, citing Swift’s Global Payments Innovation product, which lets members track and trace payments in U.S. dollars. But gaps in the service window remain that create long delays, he said.
“The ability to move dollars in any amount on a 24-by-7 basis would be a game changer for global users of the dollar,” McLaughlin said. Such a system would help ensure that the U.S. dollar remains the international currency of choice.
The proof of concept tested an idea that has been floated for years: Why not use a blockchain-like distributed ledger to handle payments between companies instantly, even when banks and systems like Fedwire are closed? Many entities have come up with their own approaches to this idea, including Ripple, Tassat, Figure Technologies and its affiliated Provenance Foundation, Silvergate Capital and Signature Bank.
All of these attempts have wilted due largely to one factor: lack of support from regulators.
Though in many of these initiatives, regulators have been well informed and did not register any objection, none have had actual day-to-day participation of regulators. In the Regulated Liability Network, not only was the Federal Reserve an active participant in the recent trial, but if the network comes to fruition regulators would have their own nodes and have visibility into all that goes on in it.
Another related advantage of this project, at least in the eyes of the government, is its commitment to trying to uphold the U.S. dollar as the settlement currency of choice around the world. Some industry observers have argued that much of regulators’ recent Chokepoint 2.0 activity preventing banks from working with crypto companies, and even regulators’ shutdown of Signature Bank, have stemmed from the government wanting to keep the U.S. dollar supreme.
The Regulated Liability Network project has a number of things going for it, according to Monica Summerville, head of capital markets at Celent, including the fact that it started with clear business use cases, it involves large banks with strong digital expertise as well as Mastercard and Swift, it’s building a new system but not requiring a change in legal structure, and it may tackle the interoperability challenge if it does extend to multiple currencies and assets as planned.
“Currently there are a lot of walled gardens being built and if that continues we could just end up with a version of the correspondent network we have today,” Summerville said.
Some industry groups expressed support for the RLN test.
“The success of phase one of the RLN demonstrates the ability of the regulated financial system to innovate while maintaining stability and dollar supremacy as well as safeguarding against risks like illicit finance,” Paige Pidano Paridon, senior vice president and senior associate general counsel of the Bank Policy Institute, said in a statement. “Novel payment methods, like central bank digital currencies and unregulated stablecoin alternatives, remain costly distractions.”
What’s in the network
The Regulated Liability Network was designed by a group of bankers, including McLaughlin; Vivek Kohli, head of emerging technology and digital assets at BNY Mellon; Vincent Lau, head of international payments in the Asia-Pacific region for HSBC; Peter Left, head of prudential liquidity management at Lloyds Bank; Jon Prendergast, head of payment strategy at TD Bank; Matt Shepherd, lead for digital currency and asset tokenization product management at Wells Fargo; Chris Swanson, product innovation director at U.S. Bank; and J. Christopher Ward, head of wholesale payments at Truist; as well as Nick Kerigan, head of innovation at Swift.
McLaughlin said the Regulated Liability Network is “inspired” by shared-ledger technology, like the bitcoin blockchain.
“The traditional world of payments is made up of messages that flow between regulated banks, and the central bank provides settlement services,” McLaughlin said. “Each of these separate institutions operates their own data centers containing their books and records.” A shared ledger would connect all of these and create one immutable record.
In designing the Regulated Liability Network, the group discarded several blockchain features that do not readily apply to regulated financial services, such as anonymity, proof of work and the use of unregulated units of account. The group chose not to test the use of public, permissionless blockchains, thinking that the technology is not mature enough yet.
“When these features are put aside, we’re still left with intriguing attributes of blockchains that might be used to upgrade regulated financial services,” McLaughlin said. These include 24/7 operation, multi-asset representation and settlement and programmability.
Putting it to the test
The proof of concept that was completed last week tested the business applicability, technical feasibility and legal viability of the RLN concept. No real money was moved, but simulated liabilities were denominated in U.S. dollars.
It tested two use cases. One was domestic payments between commercial banks. Transactions were conducted in commercial bank deposit tokens and settled using a tokenized record of a central bank deposit liability. The other was cross-border payments in U.S. dollars, to improve the experience of global users of U.S. dollars as an international trade and settlement currency.
There did not seem to be any intent to replace Swift, the network on which most international payment messages run today.
“We started with the thesis of a better settlement mechanism that would complement rather than replace existing secure messaging solutions,” McLaughlin said. “Financial messages today between market participants already take place at near the speed of light, and formats like ISO 20022 can carry very large data payloads. The working group felt that the greatest benefit could be derived from the closer coordination of settlements with the payment messages.”
This objective was achieved, he said.
“We satisfied ourselves that the Regulated Liability Network is a viable payment system design,” he said, especially for cross-border payments in U.S. dollars.
Using RLN, that German company seeking to buy an industrial robot from a Japanese company could do so immediately. This could be done in full compliance with all rules and regulations “with no corners cut with respect to know-your-customer, anti-money laundering compliance and sanctions.”
The proof of concept did not conclude that RLN is the only path to building such a system, McLaughlin said.
“But it was through this public-private partnership that we demonstrated the possibility to construct a compliant global instant dollar payment system,” he said.
The group did not try to test throughput, scalability or cybersecurity resiliency.
The test demonstrated five critical functional capabilities of the RLN design, according to Raj Dhamodharan, head of crypto and blockchain at Mastercard.
The first one was availability — for instance, being able to execute a payment between two countries over a weekend. The second was efficient settlement — the ability to settle multiple transactions in near real time and provide finality of settlement.
The third was interoperability. “We live in a world of multiple networks and that’s not going to change tomorrow,” Dhamodharan said. “Therefore, interoperability using industry standards — including ISO 022 — is important. We demonstrated that the setup that we have can start to provide that kind of connectivity to back office systems and traditional payment trails.”
Privacy was another important consideration, he said.
“Sometimes people may say, it is a shared ledger, how are you having private transactions?” he said. “The technologies are available to have point-to-point private transactions between two parties that are not seen by others. So it was important for us to demonstrate this functionality as well.”
The last capability the RLN needed was the ability to assemble applications in the form of smart contracts to automate complex workflows and deliver settlement, Dhamodharan said.
Each of these was addressed successfully in the proof of concept, he said.
“Digital ledger technology, when designed right, can become a utility for storing and moving value and to be programmed on, we sincerely believe that,” Dhamodharan said.
Though the Federal Reserve Bank of New York participated in the proof of concept from the perspective of the U.S. central bank and as a payments system operator, it’s not committed to doing anything with it in real life, according to Per von Zelowitz, director of the New York Innovation Center at the New York Fed.
“This research effort is not intended to advance any specific policy outcomes, nor is it intended to signal that the Federal Reserve will make any imminent decisions about the appropriateness of issuing central bank digital currency or any other product or service, nor indicate how one would necessarily be designed,” he said.
But he noted that the Fed and regulated banks share a common interest in “aligning financial market infrastructures with the needs of a rapidly digitizing, always-on global economy. There was a real area of interest for us in understanding implications to operations for a central bank in a world where there’s a theoretical financial market infrastructure that includes regulated, tokenized commercial bank deposits and tokenized central bank money on a single ledger.”
Rebecca Simmons, partner at Sullivan & Cromwell, led a team that studied the legal viability of the network, and concluded that it could operate under the financial market utility regulatory framework established by the Dodd-Frank Act, she said. State and federal laws would apply, as would Article 4A of the Uniform Commercial Code.
“Of course, regulatory input would be needed if an RLN is developed, in particular input from the [Federal Deposit Insurance Corp.] will be needed to ensure that the use of the proposed system remains consistent with the FDIC’s requirements and needs as the provider of federal deposit insurance,” Simmons said.
What’s next
One next step for the group could be to create a multi-asset version of the Regulated Liability Network that includes securities as well as central bank money and commercial bank money on the same platform, McLaughlin said.
“Such a system could enable more efficient liquidity operations, like repurchase agreements on an intraday basis,” he said. “The second interesting direction to explore would be a multicurrency regulated liability network that could provide some of the answers to questions posed by the G20 on their work on cross-border payments. There is a missing layer in global payments: We don’t have a multicurrency equivalent to Fedwire or Chips.”
More work could be done on smart contracts, interoperability and common settlement, according to von Zelowitz.
“This combination of capabilities may offer counterparties a level of efficiency, safety and security via programming and testing those features further under increasingly complex scenarios,” he said.
