Sepa, the European Commission’s plan to create a domestic environment for euro payments, has launched. However, as Frances Maguire reports, the process has just begun on what will be a very long journey.

There is no doubt that the single euro payment area (Sepa) will transform cash management and greatly impact upon the banking industry. The establishment of a truly integrated European payments landscape, where euro transactions are subject to a uniform set of standards, rules and conditions was achieved through unprecedented co-operation from Europe’s banks. On January 28, 2008, Sepa became reality for 31 countries, and the Euro Banking Association (EBA) clearing saw the successful launch of the Step2 Sepa credit transfer (SCT) service.

The engineers of Sepa are heartened by the Polish clearing system’s connection to EBA clearing for euro payments ahead of the country’s migration to the euro. Yet consolidation among Europe’s automated clearing houses (ACHs) has not occurred, direct debits in the EU must still be processed according to national law, the cost of making a euro payment has not reduced and the decommissioning of national legacy payment instruments is slipping back to 2012.

In the beginning

Alan Koenigsberg, JPMorgan treasury services’ core cash product company executive for EMEA, says nobody expected January 28 to be a ‘big bang’, but the beginning of a transformation. Although initial Sepa payment volumes were higher than expected, the launch is just a first step.

On day one of Sepa, JPMorgan had corporate clients originating Sepa payments and it was one of the first banks to originate payments on behalf of corporates. It also handled one of the highest value payments on the first day – a single payment of €50,000 ($78,802) which went through faster than any non-urgent payment in the past.

Mr Koenigsberg says that corporates are waking up to the transformation that Sepa will bring and are talking to enterprise resource planning providers, despite the fact that some are waiting for the Sepa direct debit, not expected until the end of 2009, to become available so that they can fully migrate in one move.

Mr Koenigsberg says: “There are still some tax harmonisation issues and central bank reporting issues to be resolved, but there is an opportunity to consolidate account structures.” One corporate customer is looking to consolidate 11 banks into two maximum, which will vastly improve their liquidity structure.

He adds: “JPMorgan has corporate clients that are using Sepa products but we are not seeing enormous volumes yet, just steady growth. What corporate will not want to use a harmonised European credit transfer product, which will continue to grow with the inclusion of payroll capabilities.”

JPMorgan’s clients will need no investment to switch to Sepa payment instruments as the bank will process their files according to the Sepa rules. “The only reason some corporates are sitting on the fence is that they are waiting for the collection component to go live next year, and then there will be acceleration and growth towards a critical mass in about 2011 or 2012. Any good payment system has got to have a payable and receivable component and the direct debit instrument will complete Sepa,” says Mr Koenigsberg.

Sepa will lower costs only after the legacy clearing systems are closed down, when there is full migration, which must be maintained currently. “When full migration occurs, the true cost benefits of Sepa will be realised,” he says. “The next key step is direct debit. If that happens on time, in accordance of the adoption of the payments services directive, we will see accelerated adoption in 2009 and a move towards critical mass – which is above 70% of traffic.”

He considers that Sepa will divide banks into those which continue to handle payments for their customers and those which will focus on becoming leaders in the payments industry, creating a significant outsourcing opportunity. As a large correspondent bank, JPMorgan aims to capitalise on this and is packaging Sepa with its urgent euro services such as Target2 and Euro1 for other banks. Mr Koenigsberg believes this will accelerate towards the end of 2008. Many banks have already outsourced to JPMorgan for hosting Target2 services and these will follow shortly with their Sepa services.

Mr Koenigsberg considers that the debate over which clearing house will win is a false one: “There are two clearing houses out there which have proven that they have got scale, in terms of reach and leadership – EBA Clearing and Equens.” There are other domestic Sepa-compliant clearing houses in operation, he adds, but they have simply connected their domestic SEPA capabilities to EBA clearing.

However, Daniel Szmuckler, head of communications and corporate governance at the EBA Group, says a pan-European automated clearing house (Peach), as defined by the European Payments Council (EPC), must have full pan-European reach across the 31 countries in Sepa in terms of distribution capability of payments together with a country-neutral governance structure – and that there is only one Peach which is accredited by the EPC to date.

Clearing difference

Mr Szmukler adds that the EPC differentiates between a Peach-compliant clearing and settlement mechanism (CSM) and a Sepa-compliant CSM. The latter can process at least one Sepa payment instrument with a regional focus.

“There was an assumption that those CSMs that have enough critical mass to sustain their business model by way of their national traffic will mostly stay in place as they have no need to leverage out their Sepa investment across Europe to survive in the Sepa domestic market.”

There are still more than 30 ACHs in Europe. Many in the Sepa area have decided not to create reach across Sepa alone but to connect to Step2/Peach so that a de facto hub and spokes model has developed, with Step2/Peach as the hub.

Having first-mover advantage has allowed EBA clearing to win those banks’ business whose payments operations are across multiple Sepa countries. Mr Szmuckler says: “We have identified 120 banks, which are the major players and represent 85% of total payment volumes in Europe. They will opt, over time, for Step2, which is why our volumes are so high. We did not predict the enormous growth that we have seen.

“We have processed more than 2.5 million SCT payments – a strong signal to the market that we have a significant lead over the other ACHs in processing Sepa instruments. We are now seeing banks putting their domestic payments through the SCT service and this will significantly inflate volumes further.”

ACH consolidation

According to Mr Szmukler, consolidation among the ACHs will be a natural consequence of migration to the Sepa instruments. However, this consolidation of the ACHs is not likely to occur until 2011 at the earliest. He says: “The hub and spokes model is only the interim model – it may not last after full migration as it is just adding an extra layer of cost in Sepa.”

But the cost of payments in Europe has not lowered significantly with the launch of the SCT. Mr Szmukler says there has not been any real impact yet because the cost of the interbank-leg of a payment constitutes only 12% to 15% of the total cost of a payment. He adds: “The real cost today of a payment transfer is in the back, middle, and front office of a bank, not in the ACH infrastructure. A consolidation of the internal processes and departments within the banks is needed before the cost of a payment is brought down. This process has begun slowly. Another process needed is communication to customers.

“Sepa becomes fully efficient only once payments are fully automated. As long as banks need to do conversion from old to new, they may require manual intervention, but once the customers can directly feed Sepa information into the banks’ payment channels full automation is achieved and a huge cost can be taken out of the banks. This is why Sepa will take years until all payment departments of all banks in Europe have fully migrated to the new instruments and practices.”

Long-term benefits

Christian Westerhaus, head of payments strategy and infrastructures, cash management at Deutsche Bank, says that the formats and business rules that have been successfully established for the Sepa launch are the pre-requisite to reaping the benefits once domestic volumes kick in. “Through these standards, we have been able to establish a single mass payments processing platform for the entire region. The initial volumes have mainly come from what would have been cross-border traffic – and the direct debit product for Sepa is crucial to migrate real domestic volumes,” he says.

Yet while Deutsche Bank is already seeing more demand for account consolidation from its corporate customers, the real cost reductions will come only when legacy platforms can be decommissioned, and the pre-requisite for this is to replace legacy file formats and schemes.

“In the past few weeks of processing Sepa payments on our Deutsche Bank platform,” says Mr Westerhaus, “we have analysed and classified the non-STP (straight-through processing) cases that have occurred and defined measures to bring the STP-rate for Sepa on a par with the legacy domestic rates of the best performing countries. We are optimistic that during the ramp-up phase of this year, we will achieve a level close to those rates.”

While Mr Westerhaus says that EBA clearing has been successful in obtaining the critical mass and the vast majority of banks connected either directly or indirectly to Step2, he considers that in addition to Step2, Deutsche Bank considers bilateral clearing to be an economically and technically attractive clearing channel for Sepa, which should be used once volumes grow. “We will look at other clearing mechanisms from the aspect of costs and feature functionality,” he says.

Full migration

Unlike some, Mr Westerhaus says that the sooner that full migration to the new instruments is set, the better: “Our Sepa set-up at Deutsche Bank enables us to complete the migration process at an early stage. Setting an end date for migration will accelerate stakeholders’ preparation and implementation.”

Last month, the EBA published a reference guide on electronic invoicing at a pan-European level in a bid to begin the debate about the next step needed towards achieving an integrated and dematerialised European payment infrastructure. The release of the report coincided with the launch of the European Commission Expert Group, whose aim is the delivery of a European Electronic Invoicing Framework by the end of 2009.

E-invoicing would replace paper-based routines with fully automated and integrated billing systems within the EU and take out a layer of cost related to processing complaints and repairing invoicing errors. Will e-invoicing be the next step towards e-Sepa? “We have laid the foundations, and in the next phase the new elements can be discussed – this is where the additional optional services and ‘e-Sepa’ comes in. Banks need to decide what they want to have in the future for their customers,” says Mr Szmukler.

Infrastructure modernisation

Eric Sepkes, former vice-president and director at Citibank, says the debate is whether Sepa should stick to what is described in the EPC blueprint as “core payment services” or go further in modernising Europe’s payments infrastructure.

He says: “Many are using ‘core payment services’ as a euphemism for the term ‘legacy payment systems’ to try and keep the incremental functions of e-invoicing, mobile payments and internet payments out of the EPC debate. This is the Luddites trying to slow progress.

“How can you have a payments council that is not allowed to look at the future? The EPC has a role to play in building the infrastructure for e-invoicing, mobile payment and internet settlement capabilities. As a consequence of whatever is discussed and decided, the banks have to accept it in the responsibility of the EPC – there is no other place.”

He adds that while the thinkers and shakers in the industry see e-invoicing as the inevitable next step of Sepa, there is a significant power lobby in the predominately retail banking sector that is reluctant to give up power over the payments process, and this is slowing down modernisation. “A process with the necessary standards and rules to enable e-invoicing is needed. There will always be different domestic taxation processes but there needs to be a harmonisation of the way tax is collected and what the tax authorities will accept, to enable e-invoicing.”

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