01 April 2005 Features

 

Face off

Halfway through the roadmap to the creation of a Single European Payments Area and the signs are that the deadline will be extended. As regulators and banks point fingers at each other, Sherree DeCovny reports on the state of play

Five years ago, the European Union put in place a roadmap to become the most competitive economy in the world by 2010. Part of that plan was to create a Single European Payments Area (SEPA), which would lower the cost and increase the transparency of cross-border payments. The European Commission delegated that responsibility to the banking industry, along with a warning that failure to complete the task would result in forced regulation.

Speaking at a conference in Luxembourg last month, European Commissioner for Internal Market and Services Charlie McCreevy said that the 2010 target for achieving a SEPA would not, at the present pace of change, be met. Again, he rattled the same sabre, declaring the Commission will make some agreed industry standards mandatory if necessary, and include the roadmap for the SEPA in the draft legal text.

Meanwhile, the regulators and the banks stand pointing fingers at each other. According to TowerGroup, cross-border traffic accounts for only about 2.5 per cent of the volume going through euro ACHs. The European Commission argues the percentage is so low because cross-border payments are prohibitively expensive and difficult to execute in part because the national infrastructures are incompatible. And if the banks do not make payments cheaper and simpler, they are hindering the free flow of goods and services across the single market.

The SEPA is a very broad concept, which encompasses electronic debit and credit cards, the use of ATMs, bank accounts, direct debits as well as payments. Few banks would argue against the benefits it will bring to the European community, but they say the enormous scope of the project — not to mention the politics — has kept a lid on progress.

SEPA means bringing together 27 countries into a single euro zone. Some of them, like the UK and Sweden, do not use the euro. “If there’s only 12 countries using the euro at this stage, what happens to the other ones?” questions Chris Skinner, director of TowerGroup Europe. In addition, the largest payment processors — France, Germany and the UK — do not believe it is fair that they are entitled to only one vote when they have the largest exposure to change.

The European Payments Council (EPC), which was established by the banks, has acknowledged the progress banks have made in implementing SEPA credit transfers, especially with the introduction of European Banking Association (EBA) Step 2 pan-European ACH. But it is concerned at the delays in the introduction of a Pan European Direct Debit Scheme (PEDD).

“It isn’t surprising that the definition of the PEDD has taken a long time, as this needs to take account of the widely differing schemes that exist across Europe,” notes Tim Decker, product manager at JPMorgan Treasury Services. “From a customer perspective the cost of making SEPA-compliant payments has already come down to domestic levels provided the payments are appropriately formatted.”

Decker also points out that there has been progress on the definition of the PEDD. The EPC’s Electronic Direct Debit Working Group is expected to present a PEDD rulebook to the EPC Plenary in September 2005. Also, the use of International Bank Account Numbers (IBANs) for cross-border payments has increased considerably even though there is still limited take up of this as a domestic format.

Yet some banks maintain the 2010 target will not be met because regulators, governments, and industry officials have spent too much time wrapped in red tape. The European Commission relies largely on Napoleonic Law, which means that if it is not written down, you can do it. Therefore, everything is written down to the nth degree. For instance, the Financial Services Action Plan comprises 42 pieces of regulation; only one of those pertains to payments.

“It’s taken five years to get all these guys around the table to agree the principles and define the standards of regulation that they want to put into place, and they discovered it’s not a simple thing,” says TowerGroup’s Skinner. “You’re looking at trying to harmonise the legal structures as well as payments and financial structures.” Harmonisation is critical, he adds, because if two countries have different legal entities and structures, then a payment made between them may be recognised in one and not the other.

There was another setback recently. The New Legal Framework for Internal Markets, also known as the Payments Directive, was scheduled for publication in its final form in the first quarter 2005. It has been sent back for a total re-write, and will not be published until 2006.

The banks have agreed in principle with the European Central Bank to have a SEPA in place by 2008, and they will switch off the old ACHs in 2010 after two years of running in parallel. If the legal structure is not agreed until 2006, there is no legal impetus for the banking industry to act now.

Having said that, banks in some countries are taking the initiative to move forward with the plan. In order to facilitate processing of cross-border euro payments, the German Bundesbank decided to become a direct Step 2 participant. It connected its Retail Payment System (RPS) to the Step 2 system in November 2003. “The Bundesbank considers its active participation in Step 2 as a contribution to promoting European retail payments,” a Bundesbank spokesperson comments.

RPS serves as a Step 2 access portal for all credit institutions in Germany. The Bundesbank, along with other institutions, acts as an entry point to Germany for incoming Step 2 payments. The Bundesbank has already provided Bank Identifier Codes (BICs) and IBANs to government entities that need to make cross-border retail payments quickly and efficiently.

While the bank representatives on the various councils and committees nod their heads in acquiescence, a lot of folks on the ground have some nagging questions in the back of their minds. For a start, many doubt the logic behind using SEPA, which is intended for cross-border payments, for domestic payments.

There are about 36 ACHs processing low value payments. Admittedly, a few are creaking at the seams, but many work quite well. A few of the larger ones, the French SIT among them, are investing in technology to replenish their infrastructure to be more competitive in the euro zone. These ACHs see a good case for leveraging multiple Pan-European infrastructures, including Step 2, for transmitting specific types of payments.

Others see good sense in going down the Target 2 route, says TowerGroup’s Skinner. “Target 2 has come into play as a virtual entity to allow one interface from a national central bank’s RTGS into a pan-European RTGS,” he points out.

The revenue equation speaks for itself. The banks used to make about $12 on a cross-border transaction; now they make about $5.50. They will resist taking out legacy systems and investing in a new technology infrastructure, which they perceive is unnecessary, when their margins are falling. The allocation of limited resources also comes into play. Banks have an array of regulations they have to comply with — from Basel II to Sarbanes-Oxley — and they have to prioritise.

According to JPMorgan’s Decker, considerable systems development will be needed to meet the requirements for SEPA. By 2010 every EU account number must be an IBAN, which will be used in place of domestic account formats. That means the formats for the delivery of payments across the EU must be standardised. He also points out that consolidation among ACHs and clearing systems across Europe is likely as a consequence of SEPA. Banks will have to support these changes in addition to the introduction of PriEuro (priority cross-border payments), PEDD, customer migration away from existing national direct debit schemes, and the harmonisation of ATM, credit and debit cards.

But technology is not the problem, says Cristina Astore, payment system director at Società Interbancaria per l’Automazione (SIA), whose XML-based technology was used to create Step 2 as well as a payments platform for Italy. She agrees that if the banks do not meet their target, then rules should be forced upon the industry. “Five years is an achievable goal. If there is not the will behind that, it is not achievable in 15 years,” she says.

So is this just a game of chicken in which one of the parties will have to back down? If the deadline comes and the banks are not ready to switch to a SEPA, what will the regulators really do? Perhaps the regulators will have to give the industry some breathing space, just as they did with Sarbanes-Oxley compliance for non US-based institutions and T+1. On the other hand, the EU is unlikely to allow the banking industry to derail the plans for economic and monetary union. “This was certainly demonstrated in 2001 when the EU introduced Regulation 2560/2001,” Decker points out. This law establishes equal charges for domestic and cross-border payments.

Yet in some respects banks may welcome regulation. In such a competitive, price-driven industry as banking, there is always considerable demand for investment funds. Any development that is not profitable is unlikely to be approved, whereas regulatory requirements will always receive the highest priority.

For example, every aspect of EU Regulation 2560 appears to have been met in full, and this is probably the reason why the credit transfer aspect of SEPA has been relatively successful. There has been no similar regulation forcing the implementation of PEDD, which is perceived by the ECB as having been delayed.

Perhaps the banks are sitting and waiting for the mandate. “No-one’s waving that stick yet, because they’re still discussing the standards, the structures, the frameworks and the definitions,” says Skinner. He believes that the Commission and the banks will meet their deadlines, but in practice banks will not make the changes for about another three or four years later.