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The Federal Reserve has announced the adoption of ISO 20022 messaging standard as part of its payments modernization effort but mid-tier banks may be struggling with migration by the planned 2023 deadline.
Last week (October 6), the Federal Reserve announced plans to migrate Fedwire, its real-time gross settlement (RTGS) system, to the ISO 20022 message format in November 2023.
The global messaging standard, with its data-rich and future-proof structure, is intended to facilitate interoperability for high-value cross-border payments and improve compliance with anti-money laundering (AML) rules, sanctions screening, and fraud monitoring.
The adoption of the standard is accelerating around the world. SWIFT will begin migrating to the ISO 20022 standard in November 2022, with a subsequent three-year period allowing member banks to use the old messaging type alongside the new standard. Canada, the UK, and the eurozone’s TARGET2 system have also announced plans to migrate their respective RTGSs by 2022. A separate survey of 61 retail instant payments services around the world found two-thirds were based on ISO 20022 standards, according to VIXIO research.
The Fed's notice published in the Federal Register is now proposing the migration to take place in one run in November 2023.
It means that the Fed will mandate the use of ISO 20022 messaging for participating banks when they exchange wire payment messages with the Fedwire network, but banks will continue to be able to use other message formats when exchanging messages with their customers, and between bank internal systems, Vinay Prabhakar, vice president of Volante Technologies, explained.
This will be a challenge for many banks, particularly mid-tier banks, that are running older versions of core banking and payment systems, he told VIXIO.
Large banks, on the other hand, will be ready, Scott Talbott, senior vice president of government affairs at the Electronic Transactions Association (ETA) said, pointing out that many of the large banks are global correspondent banks that are already largely compliant with the ISO 20022 standards for the other applicable products and financial market infrastructures, such as The Clearing House's RTP network and international clearing systems that are already on ISO 20022.
Compliance, whether regulatory or operator driven, has become a significant factor in the drive towards ISO 20022. Although many modernised national and regional payments systems may be ISO 20022 ready, significant cost and logistical implications for financial institutions has held back practical use of the standard's benefits. The Fed announcement means those systems that are not ISO 20022 compatible will require major upgrades to handle the new message standards.
“In the long run, it is clear that legacy systems will hold banks back from tapping into the full power of ISO 20022 for data-rich wire payment experiences, and that intelligent payments modernization will be the key to competitiveness,” Prabhakar said.
Although the Fed originally planned to migrate in three phases between 2020 and 2023, it decided to switch to the new standard in one run to reduce operational risks with its privately-run counterpart, The Clearing House, which had announced the migration of its large-value payment system CHIPS will take place in November 2023.
To address potential cross-border interoperability frictions with SWIFT after November 2022, when it starts its three-year migration process, the reserve banks plan to expand their existing messaging field in Fedwire to provide sufficient space to include the full text of the ISO 20022 messages.
In addition to the RTGS systems, the Fed will adhere to the ISO standard in its new FedNow instant payment service, to be launched in 2023, while The Clearing House’s RTP system already uses the standard.
“Banks who have already adopted a strategy of separating their payments processing from their core will have a distinct advantage, as will those who have already implemented the modernization steps required to deploy real-time payments through The Clearing House’s RTP network,” Prabhakar noted.
