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What is SWIFT and Why Traders and Investors Need to Know About It

justin freeman
Justin Freeman trader
Updated 23 Jun 2022

The international payments system SWIFT has suddenly become a mainstream news topic, and for those trading the financial markets, there are good reasons to understand why. How and why did an international money transfer system become the subject of high-level meetings between world leaders? And more importantly, what do recent news events mean for retail investors?

The idea that banks from some countries might be banned from using SWIFT, which is essentially a payments system, might not at first appear too big a deal. But even a cursory glance at the nickel market and the events of Tuesday 8th March highlight how geopolitical risk events can result in markets being closed suddenly and prices getting out of control in an instant. The surge in activity in meme stocks in April 2021 saw some brokers temporarily restrict retail traders from taking new positions in GameStop and AMC. It’s curveballs such as these that can leave traders stuck in positions or vulnerable to price moves on a scale that can wipe out accounts.

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What is SWIFT?

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is an international payments system set up in 1973. The aim was for global banks to have a secure way of transferring huge sums of money between them.

Part of the reason for the collaborative approach was that although the technology required to run the system was freely available, none of the central banks wanted one of their rivals to develop a scheme that would become the industry's ‘go to' payment system.

With the risk of one of the big banks becoming too powerful taken off the table, there was a dramatic uptake in the service. SWIFT is today still owned by its members and now links 11,000 banks worldwide and sends more than 40m messages each day. Any of those messages can transfer a single payment worth millions of dollars, and the use of standard templates and codes keeps transaction costs to a minimum.

How is SWIFT different?

A SWIFT payment instruction sent from one bank to another generates two confirmation messages, one that the money has been sent and another that it has arrived. This proof of delivery is the key to the system's success, and with SWIFT being able to boast that it has never lost a message, banks can transfer funds with complete confidence.

Another way of approaching the question is to note the similarities between SWIFT and the blockchain payments systems associated with cryptocurrencies. More than 30 years before Bitcoin was invented, the SWIFT payment system went some way toward solving one of the problems that cryptos now claim to have resolved.

However, the transparency of the SWIFT system, with parties being able to share proof of transactions, isn't quite at the same level of transparency as Bitcoin's blockchain system. Unlike Bitcoin, the banks don't declare their holdings in a particular currency or instrument, but the transaction codes relating to the payments can be shared and checked. That is enough to remove the risk of disputes between banks claiming they haven't received payment.

Why is SWIFT in the news?

SWIFT's headquarters are in Brussels, and regulatory oversight is provided by the National Bank of Belgium in partnership with other central banks worldwide, including the Bank of England and the US Federal Reserve.

The governance structure is designed to keep the system neutral, but it is so reliable and cost-effective that any banks restricted from using it would face immense difficulties. Not only would SWIFT members and banking clients be disincentivised from dealing with firms outside the SWIFT network but changing to plan B would be costly and time-consuming.

It's, therefore, a significant development that on February 26th, 2022, due to an escalation of the conflict between Russia and Ukraine and pressure from the EU, USA, UK and Canada, the decision was taken to ban a select number of Russian banks from using SWIFT. This was the first time such action was taken since Iranian banks were sanctioned in 2012. The sanctions caused significant economic hardship as Iran's means of carrying out international trade, particularly its oil sales, dried up.

As the SWIFT payment system begins to exclude certain banks, it's worth considering the knock-on effects on the global economy. Building in any kind of systemic inefficiencies is never a good idea, particularly not at a time when businesses are trying to recover from the Covid pandemic.

The ‘game analysis' gets even more complicated if geopolitical flashpoints such as China and Taiwan are factored in. Could raising tensions in that part of Asia result in more SWIFT members being denied access to the system?

Below are some of the risk factors that traders and investors should look out for when considering SWIFT's role in the international financial system.

Why Should Traders be Concerned About SWIFT?

The unprecedented events in the nickel market in March 2022 highlighted the potential consequences of markets becoming inefficient or requiring intervention from authorities.

On 8th March, the London Metal Exchange saw the price of nickel sky-rocket in the space of a few hours. With prices spiralling out of control and breaking intraday trading limits, the market authorities suspended trading. They controversially cancelled billions of dollars’ worth of trades that had already been booked that day.

Those who had booked winning and losing trades saw their trading P&L return to zero, which split the mood of the market; as importantly, some traders had been running ‘pairs' strategies and trading nickel in conjunction with other metals. That hedging of positions was intended to mitigate risk, but with the nickel leg of the trade cancelled, the other was turned into a completely unhedged ‘naked' position. Such events are hard to predict and can be catastrophic for traders.

The End of Petro-dollars

The world's commodity markets are priced in US dollars which is great news for the greenback and the US government. Anyone wanting to buy nickel, palladium, oil, or gas has historically been required to sell their base currency and buy dollars before buying their chosen commodity. That supports the price of the dollar and allows the US Federal Reserve to print money that the rest of the world is desperate to buy.

In March, Russia insisted that foreign buyers of its commodities, including Germany and the Netherlands, pay for its oil and gas using Russian rubles instead of USD. This move was rebuffed, but Russian exporters are now expected to convert any foreign currency proceeds from exports into rubles once they are credited to their account.

A parallel move by Russia has been a multi-year programme of readjusting its reserve assets away from USD and into other currencies. A previous round of sanctions in 2014 didn't include restricting access to SWIFT but acted as a catalyst for the Russian central bank to take measures. They had built up a $600bn stockpile of foreign currency weighted towards the euro and renminbi rather than USD.

A move away from the US dollar being the world's base currency has been talked about for many years and a long-time before the Russia-Ukraine conflict began. Recent moves towards commodities being traded in currencies other than dollars keep that topic at the top of the agenda for those following long-term macro strategies.

SWIFT and Crypto Prices

One left-field factor highlighted by the increased interest in how SWIFT works is a revisiting of the pros and cons of crypto. If Bitcoin, Ether, or any of the Altcoins could use their blockchain technology to become the global payments system of the future, their price would be exponentially higher than now.

The cryptos would have to become accepted as a form of payment to achieve that aim. To date, that has been hindered by the time it takes for blockchain transactions to complete and the high levels of energy used by crypto.

A closer analysis of SWIFT shows that a low-energy, low-cost, reliable payments system already exists and challenges the idea that the whole financial system needs to be reformed. The twin-message processing, which ensures every SWIFT transaction is confirmed, offers users confidence in the system and leaves fans of crypto falling back on anonymity and ‘socking it to the man' as reasons their system would work better. Those reasons might be enough for die-hard fans of crypto. Still, mainstream opinion might come down firmly on using existing technologies, especially considering their smaller carbon footprint, sending crypto prices scurrying down.

Final Thoughts

It's hard to gauge the impact on retail investors if the SWIFT payments network becomes less universally used. That is partly because SWIFT has operated effectively for many decades, so minimal consideration has been put into what' plan B' might look like. It is worth factoring in that the multi-year boom in asset prices has been supported by quantitative easing and ‘cheap money, and the SWIFT system, which ensured that money was circulated effectively.

This potential shock to the global financial system comes hot on the heels of the Covid pandemic and adds to the sense that political and economic networks are realigning. It's a situation to monitor and highlights why it is essential to consider a broker's operational and regulatory structure when choosing which platform to support your trading.

justin freeman
Justin is an active trader with more than 20-years of industry experience. He has worked at big banks and hedge funds including Citigroup, D. E. Shaw and Millennium Capital Management.