Payments: the final push
There is something like a Kübler-Ross model operating among banks and corporates when it comes to the single euro payments area (Sepa). Elisabeth Kübler-Ross’ hypothesis, introduced in 1969, outlined five stages of grief when a person is faced with the reality of impending death or other extreme, awful fates: denial, anger, bargaining, depression and acceptance.
So it is with Sepa: with only five months until the final migration deadline of 1 February 2014, most organisations that will be affected by the European payments harmonisation project have accepted it will become a reality. Since the formulation of the Financial Services Action Plan in 2000, Europe has edged slowly and painfully towards Sepa. Along the way there has been denial (“it will never happen”), anger (“why us?”), bargaining (in the form of derogations and additional optional services) and depression (“we have so much else on our agendas”).
The acceptance hasn’t been a spontaneous move on the part of those involved, but more driven by the European Commission’s insistence that there is no “plan B” when it comes to Sepa. The deadline has been set and it is final. In May, the Council of the European Union reiterated its support for Sepa’s aim to achieve an integrated, competitive and innovative internal market for retail payment services in euro in the European Union.
It pointed up, however, that the rate of Sepa migration in member states “with few exceptions” was far from being complete and also warned that SMEs, small public administrations and local authorities were least prepared for migration. Those Sepa participants that were planning for late migration were exposing themselves to undue operational risks that could affect the smooth handling of payments, it added.
The European Payments Council (EPC) launched the Sepa credit transfer (SCT) scheme in January 2008 and Sepa direct debits (SDDs) in November 2009. To date the uptake of these instruments has been disappointing – around 42 per cent of credit transfers in euros are transacted via SCTs and a mere 2.5 per cent of direct debits are made using SDDs. Given the last minute approach of many organisations, optimists believe those percentages will greatly increase in the final months of the year as testing is completed.
But the mad dash for compliance has largely stifled the innovation that Sepa’s proponents have championed. The promise of electronic invoicing, reduced costs through greater efficiency and the ability to centralise accounts and reduce the number of payments services providers are seemingly distant prospects. Instead, there is intense competition for Sepa resources in the market; one observer told Daily News at Sibos that the cost of experienced Sepa XML staff had quadrupled in less than six months. The same happened in the lead-up to the new millennium, when programmers brought in to fix the Y2K software problems could command very high salaries.
“Budget and capacity constraints have steered many banks towards delivering the minimum requirements to be Sepa compliant by the February 2014 deadline,” says Bernd Richter, partner at Capco. “There are many initiatives happening in parallel and innovation is on the back burner. But if banks don’t look at innovating for Sepa, their cost of business will increase and nothing more. They will not be able to get the top line growth from new products and the demand that will come for those new products.”
A backdrop of late convergence, allied to ad hoc decisions to facilitate local compliance by February 2014, risks moving the market infrastructure further away from Sepa’s standardisation and harmonisation objectives, says Nick Diamond, head of cash management and payment sales, Lloyds Bank Commercial Banking. To mitigate this, banks need to inform clients clearly of the changes coming with Sepa and provide solutions that enable them to take full advantage of it.
The approach banks have taken towards SEPA has differed, says Paul Taylor, head of banks, Emea at Bank of America Merrill Lynch (BAML). “Some banks have opted for straight compliance, facilitating SCT and SDD transactions. But other banks, such as BAML, have gone deeper into Sepa and are using it as a basis for end to end solutions. We regard Sepa services as part of the wider eurozone cash management services that we offer.”
Rajesh Mehta, regional head, Europe Middle East and Africa, Citi Transaction Services says across the eurozone, financial institution readiness for SCTs is high, but SDD readiness is viewed to be much lower, with many market participants operating non-STP processes to facilitate the requirements of SDD processing. “As such many banks are upgrading their infrastructures to become fully Sepa compliant with the ISO 20022 XML, Sepa Rulebook and wider Sepa requirements. Bank infrastructure adjustments for SDDs are especially complex; particularly regarding the SDD B2B scheme. Therefore we expect B2B adoption to remain lower in the short term,” he says.
In recent years, pan-European banks have been at the forefront of Sepa readiness, driven by the needs to service their own multinational client bases, says Mehta. On the other hand, many smaller purely domestic or highly decentralised players have focused their efforts only on Sepa readiness since the regulatory deadlines were introduced.
Approaches also vary in the corporate space, with many of the larger multinational companies well ahead in terms of preparation. But when it comes to the smaller and medium sized enterprises (SMEs) there are real fears they will miss the deadline.
“There will be an overhang from the deadline in February of corporates who were not ready and are using banks to provide enrichment services,” says Steve Everett, global head of cash management at Royal Bank of Scotland. “These corporates will then have to migrate from these services to make sure they are fully compliant as soon after the deadline but at least by 2016.”
Pascal Augé, head of global transaction and payment services, Société Générale, says while French banking institutions will be ready for Sepa the picture is different on the corporate side. “They have been slow to move and there will be very intense activity in the lead up to the deadline as corporates get ready,” he says. “Large remitters have been migrating on to Sepa instruments, but the SME sector has been very slow. It has been difficult to convince these organisations that even though their business might be domestic, they still have to move on to Sepa instruments.”
There is a danger that some smaller organisations that do not make many remittances or do them on a quarterly or annual basis may move away from existing direct debit instruments and back to cash or cheques, he adds.
In July this year, Ireland’s Minister for Small Business, John Perry, advised SMEs to start their Sepa preparations. “A key benefit for businesses will be faster settlement and simplified processes that will help to improve their cash-flow and potentially help to reduce their costs. The last thing that a business will want to face after the Sepa deadline is having difficulty paying their suppliers, or receiving payments from their customers.”
The German Government, via the Finance Ministry, is also urging corporates to begin using SCTs and SDDs. In June, the Ministry released a survey that revealed corporates and other organisations were “simply not prepared for the changes and that there is therefore considerable need for urgent action”. Even large corporations, according to the Ministry, had underestimated the time involved in introducing Sepa. However, the SCT is in use in Germany’s public administration sector, where pension and child benefit payments are made via the instrument.
While many larger multinational corporations have already achieved considerable progress in their SCT migration plans, there is still a great deal of work to be done on SDDs, says Gerlach Jacobs, global head of transaction services, ING Commercial Banking. “Domestic businesses or smaller companies with operations in a limited number of countries often still have the bulk of the migration project ahead of them.” Such companies require guidance on formats and support for testing and onboarding.
Citi’s Mehta says centralised corporates, in addition to those involved in industries such as technology and pharmaceuticals, set the early pace on Sepa adoption. “These organisations continue to lead the way in terms of maximising the opportunities that Sepa offers by reengineering their processes and bank relationships. However, today Sepa is on every corporate agenda and for most organisations compliance is the key priority, with accounts payable/accounts receivable optimisation becoming a future opportunity; a “Sepa phase two” for this group.
BAML’s Taylor says some of the bank’s clients are already Sepa compliant, while others are working their way backwards from the deadline and will have the necessary testing completed by the end of the year. However, there are those who are concerned about their level of preparedness and are asking how long it will take to become compliant. “Getting ready for Sepa can be a rapid process.
“We can open the necessary accounts in a matter of days and provide services on a third party basis, almost at the flick of a switch. But that isn’t really the issue; it is more about the entire payments ecosystem – the suppliers corporates work with and the banks of their suppliers. The entire ecosystem that directs cash away from you and towards you needs to be taken into account when formulating Sepa strategies.”
This point is likely to be lost in the scramble towards Sepa compliance. As are the wider benefits the payments harmonisation initiatives across Europe are meant to deliver. Richter believes there will be a “second wave” of Sepa developments from 2014-2016 that will involve much more focus on efficiency of payments infrastructures at banks. “To date, banks haven’t really touched their core platforms in a way that will give them a future-proof, innovative platform that will enable them to compete in Sepa. After the deadline some banks will move to a target platform that will support a lower cost base and innovation by detangling much of the hard wiring that has been done to accommodate Sepa.”
The brave new world beyond Sepa is meant to be the dividend for the work and expense of introducing the initiative. Some of the more forward-looking banks and corporations are beginning to seek wider horizons through their Sepa projects.
Ray Fattell, global head of product, payments and cash management at HSBC, says a convergence is taking place between low and high value payments. Low value payments – which are typically batch, multi-format, next-day settlement – are moving into a similar scenario as the real time gross settlement/same day settlement world of high value payments. “By having a uniform format, Sepa allows treasurers at SMEs and large corporates as well as at banks to capitalise on this convergence to create efficiency related to the movement of funds within their payment and collection processes,” he says.
The convergence of high and low value payments is also occurring elsewhere in the world. The challenge will be solving multiple format related issues. Unless there is an approach to a single format similar to Sepa in these regions it will create challenges in managing convergence of payment operating flows.
Looking forward, once corporates move from a regulatory compliance mode they will find there are huge benefits in Sepa, says RBS’ Everett. “Corporates will be able to cut down on the number of accounts they hold and migrate payments and collections to just one, or a handful, of accounts. These corporates will rely on sophisticated services and networks from their banks to do this. They will be able to set up virtual accounts that can allow them to manage their payments and collections more efficiently. Off the back of this they will be able to implement solutions such as electronic invoicing.”
Smaller financial institutions that are more domestically focused may struggle to support their corporate clients in offering services across Europe. They need good Europe-wide networks, which they don’t necessarily have at present, so there may be many more partnerships as a result of Sepa with the regional transaction services banks, he adds.
Once the Sepa deadline has been met, it will be the time to “sit down with clients and talk to them about moving up to the next level in order to centralise the efficiencies and maximise the opportunities that Sepa provides”, says Sue Dean, head of transaction services, Emea at JP Morgan. In particular, there are a number of opportunities in liquidity and liquidity management, she says.
“The opportunities that Sepa brings haven’t been forgotten, but they haven’t been top priority as institutions have focused their efforts and energy on compliance by the end date. We are encouraging our clients to make that final push to be compliant. We believe Sepa will give us greater reach into the eurozone and will bring efficiency to our clients.”
Like others, Dean believes SCT and SDD volumes will ramp up significantly towards the end of the year as corporates put more volumes through these instruments. “But the really interesting part will start after the deadline as we all look to take advantage of what Sepa will bring.”
Jacobs says at present, Sepa migration “seems to be a lot of effort for all parties involved with sometimes seemingly few benefits”. But it ultimately brings substantial opportunities to simplify and harmonise cash management in Europe, to standardise formats and centralise and automate cash management, payments and collections. “We are convinced that for banks and corporates in the longer term these benefits lie in improved cash management throughout Europe, making it more efficient with standardised processes and the reduction of costs,” he says.
When Deutsche Bank talks to its corporate clients, says Andrew Reid, co-head cash management corporates, Emea global transaction banking, the conversation is about Sepa ‘musts’ and ‘coulds’. “They must have the basic requirements of migration for SCTs and SDDs in place,” he says. “They could, however, use Sepa as a catalyst for a broader range of efficiency and re-engineering processes that will accelerate centralisation and standardisation, such as the introduction of payment factories and/or simplified bank account and liquidity models. In short, corporates could use Sepa to fundamentally reorganise their treasury, cash management and liquidity strategies.”
Sepa will result in more commoditisation of the payments and cash management landscape, which in turn will inevitably lead to focus on remaining profitable as a business. Therefore, says Jacobs, the industry should expect an on-going push for innovation.
This innovation will occur in a number of ways. For example, banks can derive opportunities by making things easier for their customers; simplifying and harmonising international offerings and adding value by looking for integrated solutions in liquidity, trade and payments. “In that way we can focus on helping our clients to optimise the effectiveness of their working capital management,” he says.
Fatell says because Sepa delivers consistency of format, it will enable companies to expand into different areas for collections and payments, such as mobile. It will also enable banks and corporates to think differently about how they execute payments. “Sepa creates the opportunity for consolidation of treasury centres, which will lower operating costs and enable greater efficiencies in terms of receivables.”
There is also an opportunity to consolidate format structures for low value payments on to ISO 20022 or XML. “This approach has the potential to reduce infrastructure costs. However, it would mean close collaboration with regulators around the world. Singapore and Australia, for example, are moving towards convergence of high and low value payments,” says Fattell.
The key to taking advantage of the Sepa infrastructure depends more on how quickly corporates can move to implement the changes, rather than on innovative offerings from the banks, says Lloyds Bank’s Diamond. “The amount of value corporates derive from Sepa is conditioned by their appetite for change and their ability to implement change in the platforms (ERP and TMS systems) and processes.”
The type of offering that has been repeatedly discussed on Sepa is the ability to centralise the EUR account structure and to manage risk more effectively through a smaller set of transaction types. The risk and reward profile of centralisation opportunities will need to be calculated against the account structure that exists today given the corporate structure and culture, he adds. “Transformation of payables can be considered to be relatively straightforward. However, meeting Sepa compliance in receivables, given cross-border issues, is complex, and a transition to a fully centralised collections on-behalf-of structure is an even bigger challenge. It is therefore incumbent on key transaction banks to make this transition as easy as possible by giving clear guidance and providing strong implementation support to clients.”
Augé says it will possibly take four to six months after the deadline for the euro payments Iandscape to stabilise and banks in the meantime will be operating in a type of “crisis mode” to help their clients manage in Sepa. “By the end of 2014 and beyond I think we will begin to see the real benefits of Sepa coming through. Standardisation on ISO 20022 will enable us to do a lot, particularly for cash management services. We will be able to develop products that go beyond pure cash management and extend into new electronic invoicing techniques, for example. The ISO 20022 and XML it brings will be where most of the value from Sepa will come.”
Beyond Sepa, banks should be looking to develop real-time clearing on a 24×7, 365 basis because it enables the transformation of cash payments into electronic transactions, says Capco’s Richter. And these real-time payments should be interconnected to other payments markets across the world. “But developments such as this may be hampered because in most banks there is no position of head of payments – payments are too often seen as a facilitator for something else. Too few banks understand their payments P&L and are not considering whether to develop their core payments platform to enable more business.”