Posted August 25, 2012
The SEPA Story: How Will The Drama?
“The end- date is looming”; “Massive bank failures are possible”; “Fewer than six months left until the end- date”; “IBAN the terrible” … These are some of the headlines one finds in the European media these days. And they all refer to the initiative harmonizing low-value euro payments, or what is called the Single Euro Payments Area (“SEPA”).
Doom and gloom in payments? Are not payments meant to be a stable part of the financial services industry with relatively few shifts and changes? In other words, a sector without much drama? However, much drama is indeed taking place in Europe these days. What is the plot of this three-act drama? What is happening in each act? How will it end?
The final act of the drama: the end-date of February 2014
As a result of recent regulation, European ACH-type payments will change dramatically from February 1st, 2014 onwards. From this “end-date,” SEPA will be reality. Low-value euro payments—credit transfers and direct debits—must shift to using new uniform bank account and business identifiers, new standards, new formats and common rules. The February 2014 end-date is mandatory for the 17 euro zone countries where only the euro is used as national currency. On a somewhat later time line—October 2016—is the regulatory end-date for the non-euro zone countries in Europe. In sum, from 2016, there will be 32 countries in Europe that would have harmonized their low-value euro payments traffic.
These mandatory changes impact everyone making or receiving low-value euro payments in Europe. Whether you pay your electricity bill or receive your salary, pay your insurance premium or receive a pension—banks, corporates and consumers alike will feel the impact. Banks and corporates must use the new standards and formats; consumers will need to give up their current national account numbers and become accustomed to using the much longer IBAN, a new 22-digit International Bank Account Identifier (“IBAN the Terrible”). Clearing houses that do not comply with the SEPA standards must shut down. The burden of implementing the changes falls on them as well as banks and corporates. Many have worked on their SEPA changes for quite some time while others have barely started. Thus it is not surprising that there is much last-minute effort, but also concern, hype and yes, drama, around this topic.
Act I: European payments before SEPA
Let us recap what the payments environment in Europe looked like in Act I of the drama, before SEPA.
Europe developed its payment systems and payment instruments over many years within national borders, catering to the needs and requirements of local banks, customers and corporates. Thus usage of payment instruments (e.g. credit transfers, direct debits, checks and cards) differs widely within Europe. Each country developed its own formats for payment instructions, market practices for clearing and settling payments, processes for payment infrastructures, its own national banking law and of course, pricing practices. While each national market functioned well within its own national boundaries, this could not be said about cross-border payments. Payment users— whether they be banks, corporates or consumers—could never be certain when a payment would be effected, what the fee would be and whether they might be faced with a deduction from the original payment amount. Working in one country but living across the border in another one, ordering merchandise or using services from another country was cumbersome and costly. A French citizen owning a summer home in Spain and wishing to have his electricity bill debited from his French bank account could not do so. A local account in Spain was needed. Different schemes, practices, standards, consumer protection laws and lack of interoperability of national schemes meant cross-border complexity, risk and cost—and hindering trade within Europe. Thus a truly harmonized internal market simply could not be achieved as long as the payments market was not harmonized either.
Act II: harmonization efforts start
Did the introduction of the euro in 1999/2002 not fix these problems, one might ask. Not really. While the euro certainly introduced a certain amount of harmonization and furthered the move towards a single internal market, payment fragmentation continued unabated. This fragmentation is particularly worrisome in view of the size of the European payments market. In the euro zone alone—the 17 countries where only the euro is used as legal tender—there are more than 330 million people, 16 to 18 million registered businesses and approximately 8,000 banks. This market generates more than 55 billion cashless transactions per year. So, size does matter!
It is not surprising, therefore, that as early as 1999, the European Commission started to draw attention to this fragmentation and the potential benefits to be achieved if harmonization of payments were to occur. In response, the European banking industry created the European Payments Council (“EPC”) in 2002, a decision-making body which started a self-regulatory initiative to make harmonization happen; SEPA, the Single Euro Payments Area project was born. Much effort followed, prodigious output was published, paper upon paper was prepared, multiple committees, working groups, task forces and industry forums swung into action, argued, discussed and negotiated common standards. In multiple consultations the payments industry commented, requested, demanded and reviewed.
Much progress was achieved
Act II of the SEPA drama took a long time—12 years! The results are indeed impressive and should not be underestimated; since 2002, common payment instruments were defined, data models and standards were agreed upon and spelt out in rulebooks, requirement papers, implementation guidelines and practical guidance documents. This was truly a first for the industry. Never before had a payments market participant been able to take such a document and find definitions and requirements on a pan-European basis.
The first new common payment instrument, the SEPA Credit Transfer, became available in 2008, to be followed by two new types of SEPA Direct Debit in 2009: one for consumers and one for corporates. The idea was that these new common payment instruments would replace the “old” national instruments over time. However, the optimistic view that “over time” would be synonymous with “in a relatively short time” proved to be false. The year 2010, when the majority of payments were supposed to be made in SEPA format, came… and went, it became clear that the vision of a harmonized European payments environment would not become reality as quickly as hoped—unless more drastic steps were taken.
Again many intense discussions, consultations and lobbying efforts followed and another first—the banking industry started to call for regulation to 'help' along with the implementation process. The argument was that no country would voluntarily give up its national formats and standards unless it were forced to do so. Thus, in December 2010, the European Commission proposed to set a mandatory deadline for migrating away from the “old” to the “new,” In March 2012, Regulation (EU) 260/212 (commonly called “SEPA End-Date Regulation”) became effective for 32 countries in Europe. The SEPA End-Date Regulation thus includes not only the euro zone countries where the euro is the only legal tender but also covers countries with other national currencies—such as the UK, Denmark, Sweden and others—to where euro payments are being made or received from.
What does the SEPA End-Date Regulation aim to achieve?
The SEPA End-Date Regulation sets a date after which only SEPA payment instruments may be used. Old national formats are no longer legally permissible, and clearing and settlement systems which are not SEPA-compliant must be shut down. In other words, migrating to SEPA is no longer a voluntary project of the banking industry, but a regulatory project whose implementation is mandatory. In addition, the Regulation contains detailed provisions on technical standardization such as the use of IBAN (International Bank Account Number) and BIC (Business Identifier Codes) by payers and payees. These will allow the identification of any account in the 32 SEPA countries. For the exchange of payments, a common data format (ISO20022 message standards) must be used, not only for interbank traffic but also for corporate-to-bank communication. Consumer protection measures are specified, such as the ability for a user to block his or her account for direct debit in terms of amount, periodicity and beneficiary.
While the SEPA End-Date Regulation is simple in concept, it is complicated to implement, due to its breadth and depth. Although many in the banking industry had been calling loudly for an end-date, the actual end-date (February 1st, 2014) was deemed to be “too soon”, “not feasible”, “not practical." No wonder the end-date created, doom and gloom in the headlines in the media.
To be clear: an EU Regulation is a legislative act of the European Union that is directly applicable and becomes immediately enforceable as law simultaneously in all EU member states. Simply put, there is no grace period after it has come into force. Since March 31st, 2012, the SEPA Regulation has binding legal force throughout every EU member state, on par with national laws.
Not complying with an EU-Regulation means breaching EU law. What happens in such a case? The SEPA End-Date Regulation left the supervision of compliance and potential sanctions in case of non-compliance to each individual member state. In other words, each country was free to name the authority which would supervise the banks' compliance with the SEPA End-Date Regulation and levy potential penalties. As country after country now starts publishing these, it is clear that applicable penalties can be quite hefty.
It is quite obvious then that the SEPA End-Date Regulation needs to be taken seriously, implemented by the prescribed date and fully complied with.
Act III: the current state of play
We are now in Act III moving towards the conclusion, a few months away from the deadline. What will happen when the curtain falls? Will there be a happy end? And is that the end of the SEPA story?
Simply put, it is quite unclear how many banks and corporates will indeed be able to achieve SEPA compliance by February 2014. There is a host of reasons for this last act of the drama:
· First, perhaps as a result of the long period leading up to the passing of the SEPA End-Date Regulation, SEPA stakeholders did not quite realize that the deadline would not be pushed back and that there was no legal grace period. In other words, the urgency of springing into action was not grasped.
· Second, the complexity of implementing SEPA standards and rules was underappreciated. Many banks considered SEPA as a simple IT-project that could be managed successfully by making a few changes on their payments platform within a couple of months. The scale and breadth of the Regulation provisions and their impact on a bank's business model had not been analyzed sufficiently.
· Third, banks were reluctant to make funds and resources available for a project whose revenue implications are mostly negative for them. SEPA does not introduce a new product or service per se, and it was not explicitly demanded by banks' customers. Quantifying the benefits of pan-European harmonization was difficult.
· Fourth, the SEPA initiative was driven by banks for a long time, without involving corporates. However, as has become painfully clear, payments do not just take place between banks—the corporate user is part of the payments chain, either as ordering party or beneficiary. However, corporates were unaware of the SEPA project for a long time and consequently had not started to even consider starting a SEPA project.
All of these, and several other reasons have slowed down the migration to SEPA. Nearly on a monthly basis, surveys and benchmarking analyses are published in an attempt to gauge the SEPA readiness of banks and corporates, country by country. And it is the disappointing lack of SEPA-readiness which leads to the dramatic headlines in the media.
Banks are in good shape
Of course there are large variations by size of bank, business model of bank and country of operation. As highlighted above, while banks in the euro zone have to meet a deadline of February 2014, banks outside the euro zone where the euro is not the national currency (e.g. UK, Denmark, Sweden) have a later deadline, namely October 2016. The fact that there are two different deadlines introduces another level of complexity, at least for the next two years.
Nevertheless, in general terms one can assert that the major banks in the 32 SEPA countries have made considerable progress in achieving SEPA. Some have been “SEPA-ready” for a while and are waiting to test SEPA payment instruments with other SEPA-banks and corporates. Some smaller banks are lagging behind. Their considerations about “build, buy or outsource” have led many to outsource their SEPA project to larger banks. This outsourcing does not come without risks.
Large corporates are on their way
From February 1st, 2014 corporates will need to use IBAN and BIC. This in turns requires that they will have reviewed their invoicing and accounting procedures, identified all systems that operate on the basis of account numbers, and have provided IBAN and BIC information to their business partners. Included in such a project is updating invoices, stationery and other documents. In the communication with banks, the XML message format must be used. As mentioned above, there is still confusion as to how banks will react should a corporate send a payment instruction in non-XML (i.e. in the “old”) format.
The good news is that many large companies have also discovered some of the benefits of SEPA. They have used this mandatory deadline to streamline and sometimes centralize their payments processes, reduced the number of banking partners and accounts, and introduced efficiency-enhancing measures. Payment factories and shared service centers have become popular again.
Small and medium-sized companies are lagging behind
Among smaller companies, however, there is a concerning level of uncertainty about what is actually required in order to become SEPA-compliant. Typically, communication between banks and their smaller corporate customers is less frequent. Smaller businesses are also less active in associations, have less time to attend conferences, and thus do not benefit from communication around financial services to the extent which larger corporates do.
Of particular concern are the thousands of associations existing in each EU member state, from football clubs to choirs to knitting circles to charities. Typically they collect contributions from their sponsors and members by national direct debit. And it is exactly this type of payment instrument which will be phased out in February, to be replaced by the new SEPA Direct Debit. How will the treasurers of small associations (who are often pensioners performing this function on a good-will and unpaid basis) deal with this situation?
The pressure from political authorities is increasing
All this raises the obvious question as to who is ultimately responsible for driving the SEPA migration to a successful conclusion—and there is no agreement about the answer. The banks argue that the political authorities have written the plot, but have done little to help the actors along. Banks claim they have shouldered the burden of designing SEPA for a long time and should and could not be made responsible for communicating a payments harmonization project to everyone in the market. And the corporates counter that payments is the bread and butter business of banks, certainly not of corporates.
To bring Act III of the SEPA drama to a successful conclusion, national supervisory and EU authorities have now stepped in to a greater degree than ever before, pushing banks to action. No country wants to be caught in a potential gridlock situation where corporates send payment instructions in the “old” way while banks expect payment instructions in the “new” way. In Germany, for example, the banking supervisory authority (BaFin) warned banks in a recent open letter that a delayed SEPA implementation by corporates could lead to massive liquidity problems for banks, possibly insolvency, and requested that banks provide information on their communication efforts vis-à-vis their customers. In the UK, irrespective of the less imminent deadline of 2016, HM Treasury requested a similar “proof of SEPA communication provided to your customers” from UK banks.
After the curtain falls
After the curtain has fallen and SEPA will have become reality in February 2014, the critics will start their review. It is not likely that the SEPA drama will delight everyone with a full happy end. Certainly stock needs to be taken. Has everyone been able to follow the storyline? Have the actors played according to the script? Have the benefits of payments harmonization been achieved? Are further adjustments necessary?
It is certain that not all SEPA countries will have achieved the same level of SEPA-compliance. In fact, a North-South divide in Europe is already apparent. How do we deal with that? When will lagging countries be able to catch up? And how do banks and corporates deal with such a situation? Moreover, in contrast to a play where the author is free to control the plot, the payments market is constantly evolving. New business requirements evolve, security concerns around e-and mobile payments need to be addressed, and payment instruments catering to a particular type of industry may be required.
In other words, we may well expect a sequel to the SEPA story. However, despite certain setbacks and deficiencies, a major step towards harmonization will have been achieved. And further payment opportunities—ranging from e-invoicing to new practices around liquidity management and other products—will be able to build upon it.
In the next issue of Global Insights: “American banks in Europe: how are they dealing with SEPA?”