In this series, we are taking a close look at the current state of cross-border payments. In the first installment, we considered how the growth of cross-border commerce and globalization has changed payments forever, and then we looked at what’s happening in the United Kingdom. In this, the third part, we are going to be looking at some of the biggest challenges that hinder cross-border payments, and how these effect businesses, the global economy, and growth.
Cross-Border Payment Challenges
One of the biggest cross-border payment challenges – especially for SMEs making and receiving payments of less than $10,000 (and in particular, those in the $500-$2,000 range) – is the time that needs to be allocated for funds to clear. This is a frustrating enough problem even for domestic payments, but when it comes to overseas transactions, the complexity of the issue – i.e., when businesses find themselves trying to navigate their way through the correspondent banking model – completion of payments (even low value payments) can often take months, and incur a substantial amount of charges along the way.
Figure 1: The Correspondent Banking Model (Source: http://aitegroup.com/report/cross-border-payments-challenges-and-trends)
Cross-border payments are more expensive than domestic payments, simply because more banks are normally required in the correspondent banking model to complete the transaction, and each bank takes a fee. What is more, it is often difficult to assess the particular charges incurred as a payment makes its way through multiple correspondent banks, which inevitably leads to loss of value and a severe lack of auditability and visibility.
There is also a high risk of critical information being lost about the payment, as payment messages are transferred across banks and across borders – certain details and data often gets truncated or goes missing. And, if companies are dealing with many different suppliers from around the world, there is no end to the proliferation of these administrative and control challenges. Other challenges include the difficulty in tracking payment progress when dealing with foreign businesses, in-payment reconciliation, and lack of foreign exchange fee transparency.
But, by far, it is the following three challenges that hinder the streamlined completion of cross-border payments.
- Regulation and Compliance Standards
It goes without saying that the second a business begins to transact in other countries, payments – for suppliers, employees, audits, etc. – become far more complex. A business will come up against at least two varying sets of regulation and compliance standards every time it seeks to do business abroad – those of the business’s home country, and those of the foreign country. In order to mitigate any potential problems that may arise as a result of this, businesses must do their research into each country to determine precisely how it implements its directives and any other applicable regulations – in some cases this might even mean setting up a physical presence in that country. A multi-country payments program should account for different jurisdictions, and address cross-border ‘area of use’ licenses as needed.
When dealing with businesses in China, for instance, it has been the case over the past few years that the country’s foreign exchange control regime has been constantly changing. The newest regulations, as issued by The State Administration of Foreign Exchange (SAFE), have been devised to simplify regulatory procedures and improve administrative efficiency. However, there are still plenty of issues regarding cross-border security that are not addressed in the changes, meaning that prior to any dealings in the region, a business will have to do its homework and take precautions to ensure that its interests are protected.
- Tax and Accounting Considerations
Tax considerations can significantly influence the manner in which payments products are structured. To work through this often involves contracting intercompany agreements between an organization’s various global operating subsidiaries, on top of always ensuring that the business (or its payments partner) has all the correct and proper issuer licenses in each country.
To use China as an example again. A Non-Resident Company (NRC) that is not registered as a tax resident or legal entity in China may provide services to Chinese clients that may be carried out both inside and outside China. However, no matter where in the world the NRC performs these services for a client that is located in China, there are certain tax implications that must be taken into careful consideration.
For example, if the service at hand that the NRC is providing inside China covers a time period exceeding 183 days, the NRC may be considered a Permanent Establishment (PE) in China, and will find itself entitled to pay an Enterprise Income Tax (EIT) at a standard rate of 25%. Further to this, the NRC may also find itself unaware that the Chinese tax authorities must collect tax from an invoice before the client can pay it.
All NRCs are subject to taxation on their earnings for services to clients in China. The most common forms of tax – aside from EIT – are withholding tax (WT), business tax (BT), and value-added tax (VAT), which now even applies to service transactions that are provided in numerous locations in China.
- Cultural and Practical Difficulties
While a business may get bogged down in working its way through all the legal, regulatory, and tax considerations that stand in the way of making cross-border payments a streamlined success, there are often other day-to-day operational factors that can be easily overlooked, and which also make success elusive. Finding the right financial and cultural balance between, say, the value of personal connections and the hard costs (such as international travel for company executives), can be a real challenge for organizations. When dealing with operations and meetings that are taking place across many different time zones, communications must always be customized to resonate with all of a business’s various target audiences. Each host country naturally has its own priorities, which, if not addressed correctly, will add additional challenges when it comes to cross-border transactions.
Take the inevitable language barrier, for instance. The B2B market inevitably runs a lot more smoothly when everyone involved speaks the same language, are in the same country, and does business using the same currency. The marketplace works efficiently because everyone understands each other, and the companies are essentially compatible.
But when a company expands and begins to do more and more business overseas, it suddenly becomes forced to deal in foreign exchange and finds itself having to work with multiple currencies and people who speak multiple languages. Here at Traxpay we call this the Ronaldo problem. Cristiano Ronaldo, the superstar Portuguese soccer player, was unstoppable in his home country, and so naturally he was headhunted by clubs all over the world. When he arrived at Manchester United in the United Kingdom, although his soccer skills could not be called into question, he had another barrier to overcome – he didn’t speak a single word of English, which all of his teammates spoke.
Ronaldo did of course overcome this difficulty, and ended up eventually performing on a par with his best back in his homeland, and is now indeed one of the most celebrated players in Manchester United’s star-spangled history (and has just gone on to pick up his third FIFA Player Of The Year Award).
And the same can happen to any business which is experiencing the Ronaldo problem, and needs to find a way to continually perform at their very best, even when dealing with foreign languages, currencies, and cultures that they don’t initially understand.
The challenges to cross-border payments are many and complex. But solutions are slowly beginning to be formed. For example, rather than attempting to manage payments within each local financial system, businesses would do well to enter into a global payments program, where financial transactions can be made faster, safer, and smarter.
As small as the world has become as we ride the wave of e-commerce, the global market is nonetheless dynamic, and we will be addressing this over the next four parts of our Cross-Border Payments series, where we will be taking a closer look at e-commerce in the United Kingdom, China, the United States, and Germany.