Saturday, 20 July 2019

Russian SPFS – Not a Serious Sanctions “Buster”

AA Explains SPFS and Venezuela : "Много шума из ничего"

Regular readers of this blog, by all evidence a select group of a handful of individuals or perhaps even more sadly bots, will recall the “great hysteria” (or in some quarters joy) of 2016 that CIPS, the China International Payment System, was poised to be the final nail in the coffin of the primacy of the dollar.

AA dispatched that canard in short order with two posts here and here.
Recently the good folks at Bloomberg reported that Weary of Sanctions, Venezuela Mulls Using Russian Payment System.
Fair enough.  When in a desperate situation, one is likely to consider all sorts of things, including those not likely to be of much utility.
Venezuela has issued its own crypto currency el Petro as a way of countering sanctions. It has also discussed using the Russian ruble in bi-lateral trade with the Russian Federation.
So why not consider the SPFS?
The question is whether the SPFS is a solution. Or like el Petro not much of a solution.
At this point the Система передачи финансовых сообщений (the Financial Messaging System – clearly more sinister in the Cyrillic than English) has not yet risen to the level of a new imaginary threat.
What is missing so far is an assessment of whether joining SPFS will give Venezuela a significant way around US sanctions, especially if Venezuela is de-SWIFT-ed.
Before SPFS becomes a source of unwarranted hysteria or joy, AA will “put the spike in that optic” with a hopefully timely prophylactic post making "the call".
Summary: SPFS is not a significant work-around to sanctions and does not herald the end of the role of the US dollar in the global economy.
Some basics about international cross-border payments to set the stage.
Payments versus Payment Instructions
Both the SPFS and SWIFT are systems for the exchange of messages relating to financial transactions. Neither SPFS nor SWIFT hold bank accounts. Neither makes payments.
They simply relay messages containing financial information, including payment orders, between the institutional holder of an account and the bank where the account is held and vice versa.  Note that individuals may not be members of either system.
How messages are sent to one’s bank is only one part of the issue.  More important is the willingness of the bank to make the requested payment.  
The bank that is asked to make the payment will make the payment or not depending on a variety of factors.  These include the balance in the customer’s account, whether the bank grants an overdraft facility to that specific customer and for what amount, and any legal constraints.
Sanctions are a possible legal constraint. The branch or affiliate of a bank located in a foreign country will generally have two laws to consider: that of its home (parent) jurisdiction and that of the jurisdiction of its location, though the US “doctrine” of “secondary sanctions” or as Europeans both “old” and “new” like to put it “extraterritoriality” also comes into play.
The payment will be either in (a) the national currency of the country where the bank holding the account is located or (b) the national currency of another country.
Payments in the national currency of the paying bank’s location are fairly straightforward.  They are made through the payment systems in that country or as “book transfers”.
A book transfer takes place when the recipient of a payment (the beneficiary) has an account with the bank that has been instructed to make the payment by its customer.  That is, both parties have an account with the paying bank in the same currency.

Unless the party instructing the payment states otherwise, the paying bank will debit the account of the instructing party and credit the account of the beneficiary on its books.  No money will leave the paying bank. A book transfer is simply an accounting entry.
Generally beneficiaries like to get their payments credited to the accounts they use most often.  They may have an account with the paying bank, but really don’t use it as their primary account.

They could receive the book transfer there and then send the money to their main account at another bank.  But that is not costless both in terms of time and bank payment charges.

Or they can tell their counterparty to send the payment directly to the main account at that other bank.
Of course, there could be non-commercial reasons for favoring a book transfer, e.g., desire for confidentiality, desire to avoid exposure to a certain juridiction's laws, etc.
Payments in another national currency are more complicated.
By luck it may be that the bank that has to make the payment holds an account for the beneficiary in the foreign currency of the payment.  Then unless instructed otherwise by its customer (who has been told by the beneficiary where it wants the money sent) the bank will make a book transfer. As above, the money never leaves the paying bank until the beneficiary issues a subsequent payment order that itself is not a book transfer at that bank.
In some rare cases, there is a local payment “utility” for making foreign currency payments.  For example, CHATS in Hong Kong. There are few of these.  They offer fewer options for making payments in terms of number of participating banks and ultimately number of customers (potential beneficiaries). If the money is to be used outside the local system, it will almost certainly need to transit a payment system in the country of the currency of the payment.
In most cases, neither of these alternatives apply—book transfers or CHATS-like systems. So, a bank in Russia, France, or Germany seeking to make a payment in US dollars will likely route that payment through a bank in the USA.

While that payment transits the US payment system, it is subject to US law. Authorities in the USA may block the payment.  Thereafter a subsequent review of completed transactions can result in fines and other penalties.
As mentioned above, the USA applies a doctrine of “secondary” sanctions for actions by non US parties outside the USA.  So a bank in Moscow or Minsk could fall afoul of US sanctions.
The method for transmitting payment instructions is only part of the “problem”.  Substituting one messaging system for another by itself is not a workaround for sanctions.

One has to have a willing bank.

This is the critical factor because there are many ways--not all of them as convenient or quick or secure as others-- to get a message to one's bankers.
Messaging System Coverage
When considering an alternative to SWIFT, one has to look closely on the relative geographic and institutional coverage.  Will the alternative meet the needs of party seeking or being forced to switch?  Or in other words can it use the alternative to communicate with all or a large percentage of those banks and countries it wants to communicate with?
  1. Was connected to participants in more than 200 countries.
  2. Had 11,367 live users.
  3. Handled some 2.7 billion messages relating to financial transactions during the month of April.  This includes more than just payment orders, though these were the bulk.
Statistics on SFPS are not as detailed.
  1. What we do know from the Central Bank of Russia is that as of 1 July 2019, there were 397 live participants in the SPFS, almost all from the Russian Federation.
  2. According to Bloomberg article cited above, a financial institution in Belarus (a subsidiary of Gazprom as identified elsewhere) was a member.  And reportedly the central banks of Southern Ossetia and Abkhazia.
  3. Let’s call that 4 “countries”.  AA suspects that Venezuela has little current business with 3 of them.  And prospects for significant business with them are limited. (To use a “charitable” term).
  4. AA couldn’t find any statistics regarding number of transactions processed but recalls reading somewhere that some 10% to 16% of domestic Russian payments were made using SFPS.
  5. This is a red flag of sorts.  It seems that SFPS is more of a "fire extinguisher" than a replacement for SWIFT.  It’s there in case Russia is de-SWIFT-ed.  Not to replace SWIFT today.
  6. There’s more that confirms that assessment. According to a Russian news source, Alma Obaeva, Management Board Chairman of the National Payments Council in Russia said this April that if Russian banks are obliged to join SFPS (currently they are not), they only need connect to the system.  Usage is optional.
What can we conclude from this comparison?
  1. SPFS lacks the coverage to give Venezuela a workable alternative to dealing with its correspondents outside of Russia and three rather small countries.  
  2. Remember: if a foreign bank isn’t a member, it can’t get a message through SPFS. So SPFS offers no way for Venezuela to communicate with Mexico, China, Brazil, India, Cuba, etc.  to name just a few of its major trading partners.  Its current major trading partner the US is another kettle of fish.
  3. SPFS doesn’t seem to be widely used by Russian banks, though AA supposes one could argue that if all Russian banks are connected, they would get a message from Caracas.  
  4. But Venezuela almost certainly doesn’t need to deal with 397 or more banks in Russia.  It would probably deal with just a handful, if that many.
  5. In such a case, Venezuela would be better served establishing a bi-lateral system for sending and receiving messages with Russian banks. This would be cheaper and quicker.
  6. Most banks these days offer customers a PC-based SWIFT like system (meaning it uses the same message formats that SWIFT does).  Such systems can be modified to accommodate a large number of transactions per day and to be linked to the customer's accounting system for Straight Through Processing.
  7. There are press reports of discussions to connect with the Chinese, Iranian, Indian and other systems.  These seem mostly aspirational.  
  8. SPFS may indeed grow and link to these other centers.  New currencies may supplant the dollar sometime in the future.
  9. Pero el presidente Maduro no tiene tiempo para esperar.  His problem is today not in the future.
  10. In the future when these alternatives have fully blossomed, surely the world proletarian revolution will have occured, transforming the US Government from an adversary of the Bolivarian Revolution to a supporter.  
Why Did the Russian Federation Create SPFS and NSPK?
The answer to this question is important in understanding what these systems are designed to do.
Prior to sanctions being imposed on the RF related to Ukraine, Russian banks almost exclusively used (and thus relied) on SWIFT to send instructions for domestic ruble payments.

Russian banks similarly relied on Visa and MasterCard to provide processing services for domestic credit and ATM cards. Both these firms conducted these processing services from outside the RF, outside the jurisdiction of the RF.  Russian banks also issued primarily domestic Visa and MasterCard cards.
A 2014 shutdown of credit card processing for sanctioned banks rang the first alarm bells in Moscow.  Calls by the British PM and some other politicians around the same time to de-SWIFT the RF led Moscow to realize that its domestic financial system was vulnerable to disruption by foreign powers and companies. You can read more about it here.
So the RF began building these alternative systems to protect itself, including issuance of a Russian card “Mir” and expansion of business relations with other card providers, China’s Union Pay, etc.
A Few Words on the “De-Dollarization”
The main cause of de-dollarization is and will remain policies of the US Government.  Fiscal policies and trade policies.  And overuse of sanctions.
While these trends were present in prior US Administrations, the current Administration seems to be doing its “best” to undermine the US dollar and international institutions which by and large have supported the US’s dominance of the global economy.  
Acting a brake on de-dollarization will be the absence of credible alternatives.  A credible alternative currency would have to have a market of size that was liquid. With an abundance of good investment opportunities. Good regulation.  Transparency. A market where one could rely on a reasonably fair legal system to protect one’s interests.
Would you want to put substantially all your reserves into securities issued by the Government of China?  The Government of Russia?  Or invest in those markets in non-government securities?
Or would you prefer to dabble in the DFM or other GCC markets?  Should we put our reserves into Dana Gas Sukuk or GFH shares? The Goldilocks Fund?  Or invest in a state-owned company with a free float of 10% of its shares?  That like many state-owned firms has non-commercial motives for at least some of its decisions. Subject yourself to the jurisdiction of the eminent courts of Sharjah?
Currently the EU is the most credible alternative. But only to a point as evidenced by the fact that it has not (yet) supplanted the US.  If the EU splinters, it and the Euro will lose the position they currently hold vis-à-vis the US dollar.
Another brake is the size of the US commercial and financial market.  If you’re a company contemplating whether to deal with Iran or Venezuela, you have to weigh the relative size of the US and Iranian or Venezuelan markets, the ability to place debt or equity in the USA versus the Iranian or Venezuelan markets. If you can only be in one of these markets, which would you chose?  

Seems to AA that this is a relatively easy choice to make.

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