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The Bank for International Settlements (BIS) Innovation Hub has wrapped up its study of Project Mandala, a “compliance by design” system for cross-border transactions, with hopes that the technology can proceed to a production environment.
During Project Mandala, a proof of concept (PoC) led by the BIS, the central banks of Australia, Malaysia, Singapore and South Korea conducted joint testing of embedded compliance functions in cross-border transactions.
The project saw two use cases tested using Mandala’s purpose-built systems for performing, evidencing and approving compliance checks.
Bank Negara Malaysia (BNM) and the Monetary Authority of Singapore (MAS) tested embedded compliance procedures in cross-border lending transactions, where funds are transferred from an entity in Singapore to an entity in Malaysia.
The work focused on how Mandala can facilitate compliance checks by enabling provable sanctions screening and capital flow management measures during the pre-validation phase of a transaction.
Meanwhile, the Bank of South Korea (BOK) and the Reserve Bank of Australia (RBA) tested embedded compliance procedures for the cross-border financing of capital investments.
In this use case, an entity in South Korea financed a capital investment by an entity in Australia through the acquisition of the latter’s unlisted debt securities.
The payment for the securities involved a cross-border transfer and netting obligations. Netting is a method of reducing credit, settlement or other risks in financial contracts by aggregating two or more obligations to achieve a reduced net obligation.
As noted by the BIS, the transaction type studied in Use Case 2 could trigger capital capital flow management and netting notification requirements, subject to thresholds.
As such, in addition to the concepts tested in Use Case 1, Use Case 2 addresses the challenges associated with the manual verification process of capital flow management and netting reporting requirements.
How does Mandala work?
The goal of Project Mandala was to build a system that is compliant with regulatory measures from inception, to make cross-border payments compliance easier, faster, cheaper and more efficient.
Project Mandala seeks to ease the policy and regulatory compliance burden by automating compliance procedures, and by making the results of these procedures immediately verifiable by regulators.
Mandala uses an encrypted peer-to-peer (P2P) network design, where each node in the network hosts a “comprehensive library” of regulatory and policy measures of each participating jurisdiction.
Such measures include anti-money laundering and counter-terrorism financing (AML/CTF) controls, alongside controls on capital flow management.
When using Mandala, banks initiate transactions by sharing information about the purpose, amount and beneficiary of the transaction with the network. The network’s “rule engine” then uses these details to determine which regulatory measures apply.
Next, Mandala verifies compliance with those measures through a smart contract-based matching engine.
If successful, the protocol then generates a “proof of compliance”, which can be linked to any settlement, including central bank digital currency (CBDC), tokenised deposits or any other form of payment.
For a sanctions check, for example, the proof provides assurance that neither the sender nor the recipient is included in public and private sanction lists.
The transaction can then take place with both sender and recipient, and the regulators of each jurisdiction, knowing that the relevant compliance obligations have been fulfilled.
Source: Bank for International Settlements (BIS)
“We believe automation of regulatory compliance procedures could pay the way for international transactions becoming faster and less complex,” said the BIS.
“The Mandala Protocol allows for new policies to be included and new payment systems to be integrated.
“It can enhance transparency as stakeholders gain valuable information on applicable regulatory and policy measures before the payment is made, and this helps to increase the chances of straight-through processing.”
Further research and adoption potential
The BIS said that the scope of Project Mandala could be expanded in subsequent phases, and could be applied to other areas.
For example, the next iteration could include know your customer (KYC) requirements as part of the integration with external regulatory databases.
New jurisdictions could be added, and new integrations with other BIS tokenised or programmable systems, such as mBridge or Agora, could also be established.
In scaling up Project Mandala, the main risks identified by the BIS relate to legal liability and technical considerations.
An in-depth analysis is needed to determine legal liability associated with the provision, maintenance and operation of Mandala’s different components, said the BIS.
These would include the P2P messaging system, the rules engine and the proof of compliance engine.
Nonetheless, the BIS believes that Project Mandala has the potential to lower the costs of compliance procedures by removing redundancy, automating policy and regulatory checks, and minimising the need for manual processes.
“For successful integration in a production environment, future iterations should consider integration with commercial bank systems and full-fledged integration with existing systems, such as Swift’s messaging system,” said the BIS.
“After the technology solution has been established and firmed up, the legal liability aspects clarified and the usage of cryptographic proofs for compliance verification approved by regulators, the Mandala system could be applied more widely in the industry.”
