The Operation of Transjurisdictional Value Transfer Systems in the Contemporary Global Order: a comparative perspective

1. Presented at the European Complex Systems Society Conference,Lisbon, September 16th, 2010 The Operation of Transjurisdictional Value Transfer Systems in the Contemporary Global Order: a comparative perspective Roger Ballard Centre for Applied South Asian Studies roger@casa.org.uk www.casas.org.uk

2. Value Transfer and Long-Distance Trade • Access to an effective system of transjurisdictional value transfer is a necessary prerequisite if long-distance trade is to be more than a matter of barter • value transfer/exchange systems are of ancient o rigin • long pre-dating the emergence of European banking systems • Nevertheless all such systems throw up a similar set of technical challenges: • Communication: how to move information from a → b → c • Logistics: how to move value from a → b → c • Trust: how to contain the risk of malfeasance when a, b and c are widely separated from one another • In the past communication was a much more challenging task • long distance data transfer took many months • in sharp contrast to the current availability of instant data transfers from anywhere to anywhere • Meanwhile the scale and complexity of transjurisdictional economic activity has grown exponentially • with the result that logistics and risk-control have become steadily more challenging issues • How, then, have these challenges been resolved?

3. The logistics of value transfer • Currency – whether in the form of cowrie shells, doubloons, banknotes or e-money – is a means of storing and exchangingvalue • but currency and value are not synonyms • cowrie shells have never been legal tender in New York • nor rupees in London • with the result that the relative value of local currencies are subject to constant renegotiation • In consequence the spatial transfer of currency (in whatever format) is an intrinsically counter-productive activity because • it is unlikely to be legal tender at the other end • at some point or other it has to be exchanged for local currency • moving it from a to b (in anything other than an e-format) is an operation which is as expensive as it is risky • Hence those involved in value transfer invariably seek to ensure that their operations are as close to zero-sum in character as possible • no less in the present than the past

4. A simple transjurisdictional example • Merchant P sails from A to B, • where he sells his cargo ₱ 10,000 • Just as he does so Merchant Q arranges to buy a cargo for ₱ 10,000 in B, • which he aims to sell at a profit in his home base A • But merchant P doesn’t plan to go home just yet, since he fancies he can pick up a profitable cargo further away in C • So P approaches a harbourside value transfer agent (VTAb) to deposit ₱ 10,000, who puts him in credit to the tune of ₡ 22,000 (his home base currency) • So when Q approaches the VTAb looking for ₱ 10,000 to complete the purchase of his cargo against the credit he had obtained from VTAb ‘s partner back, VTAa, back in his home base A • hands Q the local currency which he has just received from P • and promptly docks Q’s credit by ₡ 23,000 – giving himself profit of ₡ 1,000 on the deal • Whilst Q does even better when he sells his cargo for ₡ 50,000 when he gets back to A • Meanwhile Q sails on to C, where he approaches VTAc , who cashes in the letter of credit for ₡ 22,000 he received from VTAb in yet another local currency, so enabling Q to purchase yet another cargo ...... • A process as simple as using ATMs as far as the VTA’s customers are concerned • in processes which are readily scaleable, always provided that the VTAs can keep track of what is going on

5. The non-transparency of ‘Back Office’ processes • It follows that as far as customers are concerned, the processes whereby value transfers are achieved are both invisible and inaccessible • this does not cause for concern, so long as the delivery process is reliable • hence a reputation for absolute trustworthiness is a necessary prerequisite for operating a VT network • Likewise the issue of how delivery is achieved is of no concern to customers • VT operators invariably keep their cards very close to their chests • for the sake of operational security • to prevent members of rival VT networks poaching their business • Furthermore if VTA’s achieve their goal of zero-sum value flows at each node • their back-office processes will rarely give rise to physical currency transfers • Hence VT networks are essentially messaging systems deployed to facilitate the transjurisdictional transfer of value • and fulfil just the same role as the software which enables ATMs to dispense cash

6. On Banks and Banking • One of the most obvious features of banks is that they are institutions for the storage of value • so obviating the need to stash away wads of currency notes under our mattresses • Banks also provide value transfer services in several distinct ways. These include • Within-jurisdiction value transfers, by cheque, BACS etc • The issue of loans against the security of the security of the running sum of deposits – as in mortgages, for example • But whilst these processes are the bread-and-butter foundation of retail banking, there are two further aspects of contemporary banking operations which demand our attention • Transjurisdictional value transfers of the kind we have just been considering • Commercial inter-bank (and inter-financial institution) transfers, and most especially those massive swaps and transfers (of debt rather than credit) which ultimately gave rise to the recent credit crunch • But no matter how complex and arcane such operations may be, • the logistical principles deployed in implementing them remain closely congruent with those which we have just considered.

7. On the Containment of Risk • Whenever we temporarily place value in the hands of others we put it at risk • since banks don’t just store our savings: rather they loan out our deposits to other customers • so there is always a risk that we won’t get our money back when we want it • But thanks to the internet, contemporary value transfer operations do not give rise to risk of this kind • facilitated by the internet, next-day delivery is the name of the game • Moreover if VTAs don’t fulfil their promises, they are subject to swift negative feedback • recipients can likewise use electronic facilities to report failure back to the sender if the money does not arrive on time • And the resultant loss of reputation can readily put them out of business

8. The containment of Systemic Risk • It follows that the key challenge in transjurisdictional contexts lies elsewhere: • how can VTA’s contain the risk of malfeasance amongst themselves? • In contemporary Euro-American contexts transactional security is in principle maintained by means of legally enforceable contracts • the existence of which is routinely confirmed by the issue of formally prepared invoices and receipts • Such contractual relationships are by no means restricted to corporate transactions with retail customers • corporate bodies (from banks onwards) secure deals between each other on precisely the same basis • Hence at in contemporary Euro-American contexts • legally enforceable contracts are the principal backstop against the prospect of financial malfeasance

9. But how often do we go to court? • But whist we all assiduously keep records of our financial dealings • and hence we feel naked and exposed in the absence of the comfort of our receipt • Bur we very rarely go to court to enforce our contracts • at an everyday level we actually operate on a basis of mutual trust • not least because we have all got our own personal and/or corporate reputations to maintain • Hence going to court to enforce contracts is best identified as a remedy of last resort, and is very rarely used • but if trust is the de facto foundation of our financial dealings, what happens when trust itself evaporates?

10. The consequences of the evaporation of trust • The answer is obvious: no deal • Banks do not lend to customers they do not trust • Customers do not leave their funds in Banks which appear to be on the point of collapse • Banks do not lend to each other if they fear that potential borrowers are sitting on heaps of toxic debt • In other words in the absence of mutual trust, the whole financial system swiftly jams up • which is the principal reasons why Euro-American financial systems are subjected to tight regulation by the state • such that powerful regulators regarded as the ultimate backstop against systemic risk • But despite their efforts, the banks recently over-reached themselves yet again • and as a consequence of their excesses, had to be rescued by the lender of last resort: the state • So what went wrong?

11. The downside of contract • There is a strong sense in which the onrush of relationships of contract tend to swamp those of trust • since contracts are concluded on the basis of caveat emptor • there are no further obligations between the parties beyond those precisely specified in the terms of the contract • in other words the two parties are not bound together by any underlying relationships of reciprocity, or by concern for the stability of the system as a whole • In these circumstances financial actors have no intrinsic loyalty to the demands of regulators • regulations merely indicate the limits beyond which they may not go • unless they can find some carefully crafted loophole by means of which they can legitimately evade regulatory injunctions • by moving value offshore, for example • or by slicing and dicing risky sub-prime mortgages, repackaging them into nominally AAA CDO securities, and then selling them on to other financial institutions on a caveat emptor basis • in a curious mixture of trust and contract • So producing the ‘rationally constructed’ shadow economy based on the transfer of risk and debt, which recently collapsed like a pack of cards • as a result of comprehensive systemic failure

12. On the prerequisites for systemic stability in value transfer systems • With this in mind let’s go back to the issues with which I began, when I specified the three basic challenges which VT systems must of necessity resolve: • Communication: how to move information from a → b → c • Logistics: how to move value from a → b → c • Trust: how to contain the risk of malfeasance when a, b and c are widely separated • In the contemporary world communication has never been easier, and the logistic issues are pretty straightforward • instead it is the containment of risk which is proving to be the really challenging task • For despite huge investment in lawyers, contracts, regulatory initiatives and so forth • formally constituted Euro-American VT systems remain as sclerotic as they are expensive • especially when it comes to making transjurisdictional value transfers • and despite the emergence of instant global information transfer facilities • And worse still, formal methods remain acutely vulnerable to system failure • in the face of all this can we learn anything useful from the operation of contemporary ‘informal’ alternatives?

13. ‘Informal’ VT systems in the contemporary world • Informal VT systems have sprung to public attention during the past decade along two main vectors • As vehicles for the transfer of migrant workers’ remittances to their countries of origin • As potential vehicles for terrorist finance, laundering the profits drug smuggling and so forth • Migrant workers in all parts of the globe have developed informal VT networks as a swifter and cheaper and alternative to the VT services provided by formally constituted institutions (i.e. Banks) • current flows down such IVTS channels are in excess of USD 2.5 billion p.a. • Concrete evidence as to the extent to which terrorists and money launderers actually utilise these networks to facilitate their activities is extremely limited • but is the focus of intense debate on both sides of the Atlantic • Whilst migrants from Latin America, China, Africa and elsewhere have all developed their own distinctively organised IVTS networks • those serving migrants from South Asia have attracted the most intense public attention, especially since 9/11 • not least because their clients and organisers are largely, although by no means exclusively, Muslim

14. The roots of Hawala • Deployed by long distance traders of Muslim origin in the Indian for more than a millennium • the Hawala system is best understood as series of networks of mutual trust • or to be more precise, of coalitions of reciprocity • whose constituent members, although spatially distributed, are under an absolute obligation to fulfil the agreements which they negotiate with one another • in the course of facilitating the transfer of the tranches of value which they implement on behalf of their customers • As a result Hawala networks are best identifies as self-governing distributed systems of mutual reciprocity • operating on a transjurisdictional basis • and hence independently of any parochial legal jurisdiction • in which relationships of trust, rather than those of contract, provide the foundations of system security

15. Trust and reputation • From a Euro-American perspective, ideologically grounded in expectations of caveat emptor • reliance on such a windy and ephemeral concept as mutual trust as the foundation for system security looks extremely risky • Unless and until one inserts the concept of reputation into the equation • once this is in play, a coalition of reciprocity can also be understood as a coalition of mutually guaranteed reputations • Which is articulated at a range of different levels • in collective terms, any given VT network can only stay in business if all its members sustain a reputation for prompt and scrupulous value delivery • hence all network members have a collective interest reputation maintenance • and consequently have a collective interest in self-policing • so if any member should damage that reputation without good reason, he will be regarded as being in breach of trust to the coalition as whole • loss of trust as a result of malfeasance has disastrous consequences for the perpetrator • the malfeasant will be personally excluded from the coalition unless he makes good the losses (which the coalition itself may have done if retail customers require reimbursement) • exclusion will also extend into the familial sphere: all the malfeasant’s close relatives will also suffer a similar loss of social, no less than financial reputation • The power of these sanctions should be self-evident

16. The construction of coalitions of reciprocity • The coalitions which underpin such networks do not spring into life out of the blue • rather they emerge over time from foundations which as much more parochial character • most usually in the form of networks kinship reciprocity • most particularly in those communities which already support extended families, descent groups, clans and so forth • and failing that on the basis of pre-existing relationships of trust within religious and sectarian groups, common home-town residence and so forth • In other words IVT networks are invariably the outcome of entrepreneurial efforts to reinforce and extend pre-existing networks of reciprocity • the better to take advantage of commercial opportunities • It also follows, at least in the first instance, that transjurisdictional networks are strongly community specific • which yet further reinforces the power of exclusionary sanctions • since loss of community membership has such far reaching (and in this case trans-jurisdictional) consequences • But although initially constructed on a parochial basis • once such coalitions are in active business, cross-network alliances, constructed on exactly the same basis, regularly emerge

17. The context within which contemporary IVTS networks have emerged • In structural terms, contemporary Hawala networks are in no sense a novel phenomenon • they are built on foundations which long ante-date the emergence of the contemporary Euro-American financial system • Nevertheless they have emerged in a specific phase of globalisation in which • Several hundred million migrant workers from the global south have taken employment in more prosperous regions in the global north • precipitating an unprecedented demand for multi-billion dollar value transfer services in the reverse direction • Formally constituted banks were ill prepared to meet these demands • migrants typically sought to transfer penny packets of value (USD 100 - 500) to destinations located well beyond the spatial limits of the banking frontier • Many banks in the global South were even less prepared to cope with these demands than were their Euro-American counterparts • and were also subject to tight restrictions on access to foreign exchange by the state • With the result that there was a pent-up but unmet demand for access to foreign exchange within most southern jurisdictions • especially when South/South trade began to take off with a vengeance • Thereby giving rise to substantial opportunities for transjurisdictional arbitrage

18. The growth of remittance-driven Hawala networks • Within this context long-distance labour migrants were well placed to take advantage of the opportunities which have opened up in the current phase of globalisation, given that • as a result of their history of chain migration, migrants they were already entrenched in globally extended transjurisdictional networks • electronic communications were becoming steadily more accessible on a global scale • Dubai had emerged as node providing transjurisdictional value transfers for traders based in South Asia, the Middle East and East Africa, and the counterparts in Euro-America • Against that background all that South Asian settlers in the UK needed to do was construct a system of logistics by means of which to tap into existing facilities in Karachi and Dubai for a hawala-driven system of ‘informal’ value transfers to take off • thereby providing members of their community with an essential financial service • Which was cheaper, swifter, much more spatially extended and just as reliable • as that provided by more formally constituted financial institutions

19. The formal characteristics of Hawala networks • Hawala networks are best identified as distributed systems • whose features are closely parallel to those which underpin the operation of the internet: • The core function of Hawala networks is to facilitate the transmission of data and instructions with respect to the implementation of local value transfers to be implemented by hawaladars located in spatially separated nodes. • Their central objective is the efficient transmission and routing of traffic between end nodes; packets of data are transmitted between and stored at the edge of the network, i.e. in the end nodes. • Networks have no central registry; exchanged data is stored separately at each node by cooperating hawaladars. • Those located at any given point in the network only have a limited view of the system as a whole. • As in TCP/IP, the routing system is layered; Hawaladars operating as upper tier routers have a more comprehensive – but still far from complete – view of the network’s extent. • As in the internet, the system’s priority is accurate and speedy data transmission; systemically redundant forms of information storage is routinely avoided.

20. Providers of VT services find themselves confronted by two parallel challenges: A financial challenge: converting customer’s funds from one currency into another A logistical challenge: delivering those re-denominated funds into the hands of distant recipients Whilst currency-conversion is readily achieved on wholesale basis in forex markets the marginal cost of converting small sums is prohibitive as ever, economies of scale are a prerequisite for commercial efficiency The solution to that challenge is straightforward the consolidation of innumerable penny packets of value into large commercially negotiable tranches which can be traded in forex markets in London or New York or better still by negotiating back-to-back settlement swaps with interested counter-parties, thereby eliminating brokerage costs But having been consolidated for conversion into alternative currencies customers funds also need to be accurately disaggregated and swiftly delivered to recipients largely resident in obscure rural destinations How, then, do Hawaladars crack these logistic challenges? Remittance delivery: the financial and logistical challenges

21. The solution which contemporary hawaladars displays two key features: The routine separation of the messaging dimension of the process from both its settlement and its currency-transfer dimensions The construction of hierarchical pyramids of mutually cooperating Hawaladars within which to layer the various dimensions of the settlement process in the context of a constantly renegotiated distributed system which enabled them to execute an inter-related series of individually brokered transjurisdictional pas-des-deux between cooperating networks during the course of which large tranches of value are consolidated and deconsolidated mixed, matched and swapped on a global basis in such a way as to precipitate cross-currency transfers which meet host of globally distributed customers’ forex requirements all on a daily basis Several further distinctive features of this system are also worth noting since the system operates in real time, no-one holds customers’ assets for long enough to make extract investment benefits from them foreign exchange risks are minimised since all deals are contracted at spot rates given that this is a distributed system without a central registry, no-one has a comprehensive view of all elements of the global settlement The Hawala solution to the challenge of transjurisdictional VT

22. RH1, a retail sending hawaladar in Bradford has received orders to deliver a total of £30,000 to his customers’ relatives in Pakistan this made up of 35 individual transactions for sums of between £200 and £2,000, to be converted at the rate of £1 = Rs. 130 a rate agreed with his consolidating hawaladar CH1 in Birmingham that morning as well as to several more in others localities in Northern Pakistan with whom he does business At close of business he faxes a list of delivery instructions to his disbursing partners DH1, DH 2 and DH3 in Northern Pakistan which they set about implementing the following day At the same time makes arrangements to send £30,000 in cash to CH1 in Birmingham together with instructions to arrange appropriate cash deliveries in rupees to DH1, DH 2 and DH3 etc in Pakistan Fax messages Disbursing Hawaladar DH1 DH2 DH3 Retail Hawaladar RH1 Consolidating Hawaladar CH1 1. The initial stage in UK: receipt of funds, data transfer and disbursement £££ • Bradford • Bradford • Birmingham • London • Karachi

23. Meanwhile in Karachi three businessmen have invoices to settle to a total £100 K for goods imported from the UK (or perhaps elsewhere) Having checked the rates on offer at several Exchange Houses in Karachi they hand over a total of Rs 14 million to an agent of their selected Exchange house together with details of their suppliers’ bank accounts in the UK into which a total of £100 K is to be deposited Exchange House Disbursing Hawaladar DH1 DH2 DH3 Retail Hawaladar RH1 Consolidating Hawaladar CH1 2. The initial stage in Pakistan: a reverse transfer begins to crystallise • Bradford £££ • Birmingham Rs. Rs. Rs. • London • Karachi

24. The Exchange House in Karachi phones CH1 in Birmingham, indicating that he is seeking to place £100 K in Exchange for rupees, and they agree on a deal @ Rs 135 to the Pound, to be implemented later that day, whereupon: The Exchange House faxes its local agent in London to signal the impending arrival of £100k, along with details of the bank accounts into which the funds are to be deposited Hawaladar CH1 faxes delivery instructions to the Exchange House in Karachi, such the a total of Rs. 13.5 million are physically transferred to DH1, DH2, DH3, DH4 and DH5 since CH1 is providing transfers services for RH 2, RH 3, and RH 4 as well as RH1 CH1 then phones RH1, RH 2, RH 3, and RH 4 to inform that delivery is in train Later that day the settlement is implemented, and the deal is complete Exchange House Disbursing Hawaladar DH1 DH2 DH3 Retail Hawaladar RH1 Consolidating Hawaladar CH1 3. A back to back transjurisdictional value swap is brokered and implemented • Bradford Rs. Rs. Rs. • Birmingham Phone Calls ££££ • London • Karachi

25. Several key features in this system are worth noting All the elements of this complex deal are executed on the basis of reciprocities of mutual trust Information is transmitted on a need to know basis; CH1 will have no information about the precise identify of the ultimate retail beneficiaries of the transfers he has brokered But this is not a ‘system without records’: it could not work reliably without the accurate transfer of delivery information Rather it is a ‘lean and mean’ operation in which unnecessary (and hence redundant) information transfers are avoided The whole operation is vigorously competitive: all hawaladars are in competition with one another as they seek to secure better bargains The system can readily be scaled up both vertically and horizontally – and can readily include a plurality of jurisdictions Exchange House Disbursing Hawaladar DH1 DH2 DH3 Retail Hawaladar RH1 Consolidating Hawaladar CH1 4. Key features of the system • Bradford • Birmingham • London • Karachi

26. Customers’ domain Senders Recipients Valuetransfers Migrants in UK Pakistani importers Customers’ domain Exporters in Pakistan UK Migrants’ Kinsfolk Hawaladars’ domain Retail Hawaladar Retail Hawaladar Retail Hawaladar Delivery Hawaladar Delivery Hawaladar PKR Cash Transfers Delivery Hawaladar GBP Cash Transfers The spatial dynamics of a back to back Hawala swap Faxed instructions Regional Hawaladar Deconsolidating Hawaladar Consolidating Hawaladar Swap negotiated by phone Karachi -based Exchange House Faxed instructions Agent of Karachi Exchange House Local Brokers Delivery Hawaladar Delivery Hawaladar Retail Hawaladar Retail Hawaladar Hawaladars’ domain Remittances to Pakistani students in UK Pakistani exporters from UK Importers of goods and services in Karachi Remittances from parents to offspring studying in UK Customers’ domain Valuetransfers Recipients Senders

27. The Systemic logic of a back-to-back Hawala value-swap

28. delivery instructions Cash swap delivery instructions

29. Global Hawala • The model I have presented today is highly simplified • I have hugely shrunk the number of operators at each level • and have restricted my to settlements are straightforward GBP/PKR exchanges • In reality • Pakistani migrants are to be found in large numbers in the Gulf, throughout Western Europe and in North America • Hawaladars serve a wide range of communities of South Asian and Middle Eastern origin • whose members are currently employed in the US, Europe, the Middle East and prosperous parts of South East Asia • Meanwhile the counterparties who buy the forex dimension of their remittances are extremely varied • such the financial liquidity thereby generated by serves to facilitate transjurisdictional trade throughout the Indian Ocean region • Whilst the proportion of these transfers which is implemented through Banks, as opposed to IVTS networks, is unknown • in economic terms IVTS networks are undoubtedly the market leaders in non-corporate contexts • since the ‘lean and mean’ character of their logistic operations sharply reduces their overheads • Nevertheless the system has begun to ring alarm bells in Washington DC

30. The role of Dubai • Like the internet, Hawala is a distributed system with no central register • However it does have a number of hubs /routers: • such that at highest level most of these deals of the kind I have described are ultimately brokered as between the Exchange Houses of Dubai • in global back-to-back cross-currency settlements in which the units of account are stacked up in tranches of value in multiples of $100,000 • a significant proportion of which are brokered in parallel IVT hubs in Singapore and Hong-Kong • The central concern of the Euro-American authorities is that IVT transfers are untrackable • and hence provide a ready means whereby terrorists, drugs smugglers and the like can launder money on a global scale • As a result they are making a vigorous effort to criminalise Hawala operations • in the hope that all those engaged in legitimate financial activities will choose to use the formally constituted banking instead • Despite its higher overheads and sclerotic delivery capacity • on the grounds that the records in the banking system’s centralised data bases can readily monitored • which would in turn facilitate – or so it is suggested – the detection of terrorists’ and drug-smugglers’ financial activities

31. The impact of 9/11 • Since 9/11 all banks have been required to implement extensive (and expensive) AML precautions • on pain of being excluded from New York money markets • many local and regional Hawaladars have also found themselves subject to criminal prosecution on these ground • However the Hawala system is nothing if not adaptive • in the aftermath of these developments many of the leading Exchange Houses in Dubai and Karachi have • set up wholly-owned PLCs in London • between them recruited most local hawaladars as their agents • who now transfer their daily takings into the central bank account of the PLC with which they have signed up • so enabling them to shift the bulk of the back-office operation to Dubai • So whilst the system works on much the same principles as it ever did • the greater part of the logistic operation is now carried out within a jurisdiction into which the UK and US authorities have no immediate rights of access • and where many Exchange Houses are in the midst of establishing close ties with Wall Street Banks

32. The ultimate challenge • The wider context: • population of the globe is now 6 billion+, and expanding rapidly • Global mobility (or to put another way transjurisdictional activity of all sorts) is expanding exponentially • Inequalities on a global scale are becoming steadily more intense • The hegemonic position enjoyed by Euro-America for the past two centuries is subject to serious challenge from below, and cannot be expected to last long • and as this has occurred all manner of internecine conflict s have erupted in all corners of the globe • As states become more and more uncertain of their capacity to sustain the status quo • they are becoming ever more interested in systemic strategies by means of which to maintain their comfortable position of hegemony • But whilst the powerful are magnetically attracted to the data-mining capabilities of IT as a means of sustaining their position of advantage • the implications of the recent revolution in communications technology are far more even-handed • They regularly provide an equally effective means of undermining the interests and assumptions of the Euro-American socio-cultural order