The Case for a Best Execution Principle in Cross-Border Payments

Douglas W. Arner is Kerry Holdings Professor of Law at the University of Hong Kong; Ross Buckley is Scientia Professor and King & Wood Mallesons Chair of International Finance Law at the University of New South Wales; and Dirk A. Zetzsche is Professor and ADA Chair in Financial Law at the University of Luxembourg and Director of the Center for Business & Corporate Law at Heinrich Heine University in Duesseldorf. This post is based on a recent paper by Mr. Arner, Mr. Buckley, Mr. Zetzsche, and Maria Lucia Passador.

Cross-border payments are typically slow, with poor transparency, limited access, and much higher overall costs than domestic payments. Our new paper analyzes how the best execution principle, developed in the context of securities and derivatives regulation, should be applied to cross-border payments. Under this principle, financial institutions would be legally required to provide the most advantageous order execution in terms of speed, risks and costs for their customers given the prevailing market environment.

Cross-border payments currently rest on a system of large, globally connected correspondent banks. The relationship among payment institutions determines how orders are routed. Payment institutions charge their clients on a “cost plus profit” basis and some institutions benefit from rebates based on liquidity volume (kick-backs) and from reduced rates and soft commissions elsewhere in the payment chain. Overall, there is little incentive for payment institutions to put their clients first in terms of speed, costs and risks in this environment of “best friends”. Applying a “best execution” requirement for cross-border payments would be transformative in the same way as its application in the US, EU and UK in the context of securities transactions.

In drafting a best execution rule for cross-border payments we suggest six issues be considered.

1. Coverage

Given the purpose of best execution is to spur competition between the system of correspondent banks, closed-loop systems and potential new tech-driven payment solutions (including digital currencies), any rule should optimally cover:

  1. all banks engaged in cross-border payments,
  2. all payment and e-money service providers,
  3. all closed-loop cross-border systems, and
  4. all functional payment substitutes, including payment-oriented crypto asset systems.

2. Rule design

Effective best execution rules rest on: (1) the fiduciary status of the service provider, (2) disclosure rules on the terms of, and priorities applied for, individual transactions, (3) market intelligence for regulators involving large scale data transfer from financial institutions, and (4) robust public and private enforcement. Items (2) to (4) are required for efficient enforcement in an environment where the fiduciary principle (1) necessarily entails discretions.

Drafting the principle is inexpensive. Reporting on execution terms, so far, is mostly a matter of reporting costs, plus explanations as to why transactions were executed as they were. Market intelligence on payments is in its infancy, yet is improving, with more central banks seeking transaction data by introducing transaction reporting requirements. A robust enforcement environment rests, one the one hand, on sophisticated clients negotiating execution terms, which is already happening, and on the other hand, on supervision, sector-wide inquiries and sanctions, to ensure that retail and SME clients benefit from advanced order routing systems.

3. Allocating volume-based commissions?

A best execution principle must accommodate the practice of commissions for routed volume. These commissions incentivize banks to bundle liquidity and to that extent are efficiency enhancing, yet the liquidity used is that of their clients, and commission could well be a disincentive to look for the best route for individual payments.

In response we would suggest mandating disclosure of commissions received and paid by the payment institutions to both regulators and the public. This disclosure could then allow new entrants to provide better offers if they can.

Secondly, we would recommend requiring the allocation of a portion of volume-based commissions to clients, based on transaction volume, with a fair share (perhaps 25-50% of commission received) to go to the payment institution for its efforts in bundling liquidity, as this bundling requires effort and technological investment. Sophisticated clients could possibly negotiate a different rate, but for retail clients only a greater share to clients would be allowed.

4. Openness to innovation

Payment institutions should consider costs, risks and speed when deciding upon an order route. As to risks, payment institutions should be free to choose the best route after considering at least three different routes. Their correspondent networks may or may not represent “best execution” in this sense. Further, standards should be implemented in a way that ensures openness to innovation, so that no new routes are disqualified as “too risky” provided all participants have received regulatory approval to operate.

5. Minimum number of order routes to be considered

In one important respect (in addition to the rule itself which would not allowing contractual avoidance), we would argue for limiting freedom of contract: payment institutions would have to look for, and compare, at least three different offers in terms of costs, speed, and risks. For that purpose, separate offers received through one distributed ledger system would count as multiple offers. An exemption from this requirement may be appropriate for scarcely traded currencies, subject to regulatory approval.

6. Facilitating enforcement: The RegTech approach

As with any fiduciary principle, enforcement will be key. Among clients, only institutions will be able to enforce best execution. Payment regulators and central banks will be able to do so if they are equipped with the same means as securities regulators: strong disclosure obligations that require the automated standardized transfer of market data, and algorithmic analytical tools. This RegTech approach will enable regulators to restrain pay-for-volume “best friend” arrangements.


Multilateral policy changes are not required. Countries can implement a best execution principle unilaterally, though of course it would have the greatest impact if done by the largest jurisdictions for both incoming and outgoing payments. Each country can require their own institutions to use the best, rather than the friendliest, payment route for clients. Implementation of best execution neither requires large-scale international standard setting nor technical implementation projects.

Introducing a “best execution” obligation could well be game changing as it would require the payment institution to prioritise their clients’ interests when choosing the route an order is to take. Based on experience with the best execution principle as enshrined in securities law, we expect it would lead to the large-scale introduction of digital routing systems to identify the offer that constitutes best execution. Furthermore, we would expect that more links between correspondent banks, new FinTech service providers, and public payment networks (including regionally integrated systems) would be established and assist in identifying excess liquidity in infrequently traded currency pairs. While none of this strictly requires distributed ledger technology and/or blockchain, one convenient way, technically, to achieve this purpose would be by implementing a distributed ledger to function, initially, as a digital liquidity marketplace (a pure information sharing device) and which, in time, could be further developed into a “best execution platform”.

The complete paper is available for download here.

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