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Tokenization is widely expected to be a key element of tomorrow’s financial markets. Fnality International (Fnality) is the result of a four-year research and development effort focused on understanding how market infrastructure must adapt to meet the challenge of tokenized markets.

Fnality is building a regulated network of distributed financial market infrastructures (dFMIs) by developing a payment foundation that incorporates legal, regulatory, operational, and technical components. It will have a digital settlement asset connected with each currency, the Utility Settlement Coin (USC), to settle tokenized value transactions with certainty. The initial scope includes five currencies: CAD, GBP, EUR, JPY, and USD, with other currencies to be added.

This article explores Fnality International’s role in using blockchain for securities settlement.

An Overview of Fnality International

Fnality Global Payments would consist of a variety of local payment systems, with balances backed up one-to-one by central bank deposits, with US dollars, Euros, British pounds, Canadian dollars, and Japanese yen slated as the initial digital currencies.

Fnality, being a financial market infrastructure, requires central bank authorization to begin operations. The Federal Reserve of the United States, the Bank of England, or the European Central Bank are most likely to grant preliminary approval.

Fnality focuses on at least four use cases. These include interbank payments, liquidity savings methods, margins for OTC derivatives, and potential connectivity with the HQLAX digital collateral platform.

Fnality’s goal is to offer central bank money in a digital tokenized form with a near-real-time 24/7 settlement capability, allowing banks to significantly reduce their intraday liquidity requirements while also unlocking the institutional potential of tokenized financial markets.

Fnality’s Solution

Market participants have recently shown a growing acceptance of DLT and its potential to significantly revolutionize global capital markets. Regulators, such as the EU DLT pilot regime, are beginning to provide the groundwork for its application in securities markets. As DLT progresses from experimentation to commercialization, industry-supported and central bank-supervised solutions for digital cash on DLT, such as Fnality, will become increasingly important.

The Bank of England (BoE) recently announced the launch of a new omnibus account model that will enable its real-time gross settlement (RTGS) service to connect with a broader range of innovative payment systems, including those that use DLT.

In practice, the operator of a payment system can hold funds in the omnibus account with the aim of filling its members’ balances with central bank money while also supporting different high-value payments, such as a commercial bank purchasing government bonds.

Fnality International has applied for the Bank of England’s omnibus account and plans to launch its Pound Sterling Fnality Payment System in October 2022.

How Does Fnality Work?

Fnality is a corporation that exists at the intersection between finance and technology. Its roots are firmly planted in the wholesale banking side of finance; the original owners are all major financial institutions with the common goal of developing a payment infrastructure solution for today’s and tomorrow’s financial markets. In a constantly evolving industry, collaboration execution, both within Fnality and with Fnality partners, is critical to achieving this result.

Fnality is a systems integrator on the technology side. The Ethereum Protocol serves as the foundation for the underlying software. Fnality International is collaborating with best-in-class partners to supply critical components of the tech stack in an open-source environment, including blockchain protocols, software development and testing, SWIFT Bureau capabilities, and technical assurance.

The organization has adopted a fully Agile outcomes-driven strategy to aid delivery, ensuring the organization can execute in an agile and responsive manner through rapid iteration. All activities are carried out in a decentralized manner but with a clear vision in mind. The teams are cross-functional, multi-skilled, and diverse in every way.

More importantly, flexibility remains at the heart of the company; a lean and efficient organization closely linked to the market’s dispersed, effective, and low-cost solutions. Collaboration is and will continue to be at the heart of everything Fnality does.

Fnality’s Focus

FnGP (i.e., Finality Global Payments) requires a central bank account for each currency to facilitate payment-on-chain within and between markets.

Participants in each Fnality Payment System (FnPS) will fund and defund this central bank account to use FnPS’s payment functionality. Fnality continues to advance account opening applications at the five founding currencies’ central banks.

Progress has been slow but steady. The organization is working closely with these institutions to negotiate novel policies and processes. Hello World; the first product release allowing participant access is now live.

Use Cases

Participants are currently testing the technology and its capabilities. This key initial phase was completed on time and is an important step toward the overall system rollout. The next step will be to begin testing payments between bank participants across the distributed architecture.

Fnality is focusing on five currency-independent use cases. The first two allow for single-currency payments within a single-jurisdiction payment system. These will serve as building blocks for demonstrating the system’s ability to make wholesale payments 24 hours a day, 365 days a year. The first covers inter-bank payments, while the second covers inter-company payments.

Every year, approximately 196 million domestic wholesale payments are made between market participants in the five jurisdictions that were initially targeted. Fnality is assisting its member banks in determining all of their inter-bank payments and understanding how real-time, 24-hour processing can help them save money and time.

Testing of identified flows will begin soon, allowing for a controlled ramp-up of live transactions once central bank approval is secured.

Assuming timely central bank clearance, Fnality anticipates a market share of around 35% across the five markets by the end of 2024.

When a financial institution has multiple subsidiaries and branches within its overall business structure, it must finance the required currencies for each, manage overdrafts properly, and comply with prudential regulations such as the Large Exposures Regime.

Each entity will frequently engage external correspondent banks to manage its obligations, incurring additional expenditures and exposing itself to counter-party dangers. A financial institution’s cash management team can use FnPS to shift funds bi-laterally in real time to entities that require them. Several Fnality shareholder banks are actively analyzing intercompany flows in anticipation of the upcoming testing.

The third, PvP (payment vs. payment) settlement, will allow participants of interoperating pairs of FnPSs to settle foreign currency tractions. This, according to Fnality, is a critical use case showcasing the benefits of peer-to-peer real-time cross-border payments, such as eliminating settlement and counter-party risks and significantly lowering costs by eliminating middlemen.

There are about 190 million wholesale FX transactions across the five target currency pairs annually. Fnality expects a 20% market share by the end of 2024, assuming imminent central bank approval.

The fourth, DvP (delivery vs. payment) settlement, will demonstrate atomic settlement between blockchains, which will be critical for future tokenized marketplaces. Although there is still uncertainty about how and when tokenized markets will become mainstream, financial services professionals largely believe that it is a matter of when, not if.

According to a World Economic Forum survey conducted in 2015, 10% of global GDP could be tokenized by 2027, with a tipping point occurring by 2025. Fnality will be in a great position to support this anticipated growth in a new but important sector by providing the payment leg of a tokenized security settlement transaction. This is because it has already been tested and used with business platforms offering tokenized asset capabilities.

The final use case investigates the prospect of employing the Fnality digital cash asset as a margin for cleared and uncleared derivatives, an area of interest for both banks and regulators. Assuming a Level 1 HQLA classification, the Fnality cash asset could be an important part of the future financial services collateral pool. It has the potential to be settled in real-time, cross-border, and as part of a derivatives smart contract.

In Conclusion,

Some consider Fnality International’s project to be a wholesale stablecoin, similar to JPM Coin. However, Fnality describes itself as a financial market infrastructure developed for on-chain payments backed by 15 financial institutions.
With tokenization in full gear, traditional payment processing slows things down, increases settlement risk, and negates blockchain’s benefits. The blockchain-based digital currency solution offered by Fnality provides rapid settlement or delivery vs. payment.

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