The European payments landscape is undergoing a period of dramatic transformation as regulatory, infrastructural and commercial pressures force Europe’s payment providers to invest colossal amounts of human and financial resources in new technological and compliance projects.Faced with SEPA, the PSD and UK Faster Payments, the transaction banking business has rarely been busier or more inflamed by competitive pressure.

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 THE PANEL

Otto BenzSenior executive, Accenture

Ian BryantSenior product manager, HSBC Global Payments and Cash Management

Ivan FernandezMarketing director, EMC

Stewart RoomPartner, Field Fisher Waterhouse

Ruth WandhoferVice-president, EMEA cash management, Citigroup

Brendan ReillyHead of northern European country product management, Deutsche Bank

THE ISSUES

  • PROJECTED BENEFITS OF THE EUROPEAN PAYMENTS PROJECTS
  • POLITICAL RESPONSE TO THE CURRENT FUNDING SHORTFALL
  • COMPLIANCE REQUIREMENTS
  • REAL-TIME BUSINESS
  • SECURITY SCARE
  • THE LANDSCAPE AHEAD
  • THE KEY ISSUE

A political response

 If the banking community’s will to forge ahead with investments in this area of the business is not yet waning, large pan-European payments projects may yet suffer at the hands of European politics. Among the most striking issues to arise from the global financial crisis is the extent to which many European finance ministers, faced with national banking failures, took unilateral action: the Irish government’s move to guarantee all deposits being the most controversial example at the time.

 The extent to which European fiscal integration, of which SEPA, along with other European projects designed to harmonise financial markets is a component, has been undermined by the political fallout of the crisis remains uncertain. “There is clearly a question mark about the entirety of the Financial Services Action Plan: whether it has been a failure or a success other people will judge further downstream,” said Stewart Room, partner at law firm Field Fisher Waterhouse. “But there is a question mark within national government about the willingness to continue along a harmonised path that might have been failing in recent times, and I think that’s going to have an impact on the downstream integration of the PSD.”

 Even though the PSD has some time before it must be transposed into national law by each member state, its implementation may be lost in the public and political clamour for more financial crisis-led regulation by member states. “For instance, the Financial Services Authority may well have bigger fish to fry over the course of the next twelve months,” added Mr Room. “I can see the commercial need, I can see the economic need and the advantages of SEPA and the PSD, but I think there are fundamental issues within banking and financial services that might delay this project substantially.”

 This is a worrying prognosis given how badly national politics has already dogged many of the payments projects. The ongoing lack of a SEPA end date for legacy payment schemes provides a case in point. Ensuring that the industry is set one is a “rare thing that everyone agrees on” said Mr Reilly, but the long-awaited date has still to materialise. “The banks agree we should have an end date, the corporate treasuries agree we should have an end date, and the European Central Bank agrees we should have an end date, but we don’t have an end date,” he added. The major problem, said Ms Wandhofer, is that the national governments do not agree. Some governments, she continued, have even stated explicitly that they do not want to use SEPA Direct Debits at all. “What do you do then? And that is the challenge at the moment.”

 For those countries on the edge of the eurozone, added Mr Benz, it may be tempting to scale back SEPA investment if it seems the question over when domestic Euro payment systems should be switched off remains unanswered. Enhanced engagement by the varying national authorities will be critical if both SEPA and the PSD are to be driven forward in the coming months. However, added Mr Room, the current crisis will not kill either project dead. “It is going to delay it, and I think will delay it substantially. But when you look at what this project is about in its broadest sense, you can find other successful European projects that have had the same difficult problems at birth,” he continued. “The same outcome will be achieved for payments because they are fundamentally critical to the economic health, not only of Europe, but the global economy.”

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Compliance requirements

 New payment infrastructures bring further compliance requirements. In the wake of 9/11, strong public and political fear regarding the extent of terrorist financing led to a number of legislative reforms – including the US Patriot Act and, more recently, the Know Your Customer requirements and the EU’s Third Money Laundering Directive – designed to tighten up the procedures surrounding the screening of payment instructions prior to execution, and for the prevention of money laundering.

 Well-intentioned though they might be, these sanctions are starting to prove extremely burdensome for the banking community, said Mr Benz: “The huge amount of effort that the banks are putting in to checking their payments, and the vast number of staff required to do the checking, threaten to overwhelm all the advantages that these new schemes provide.”

 Worryingly, however, the rise of globalisation has served only to multiply these requirements – in particular the government watch-lists – across a range of jurisdictions, while the “creativity” of regulators, as Ms Wandhofer put it, remains as strong as ever. Mr Bryant suggested that there might be scope for an industry-wide utility designed to take on some of this burden. But as Mr Fernandez added, the problematic legal implications of outsourcing such heavily regulated procedures have yet to be resolved.

 This leaves the banks in a difficult position, says Mr Reilly. “I like the idea of outsourcing it, but I think you have a massive problem because you will never get away from the fact that it will be the bank that will be fined if it doesn’t work.” The idea of creating a centralised industry facility, however, would likely throw up too many problems relating to the collectively agreed level of centralised oversight, he added.

 Faced with this intractable problem, there is a strong risk that the payment process itself – despite strenuous and co-ordinated pan-European efforts to improve the quality of the payments-wide market – could ultimately suffer. This point was vividly underlined by Mr Benz, who reported that some retail banks are now forced to put more effort into the sanctions checking than they are able to devote to the quality of the customer product. “I think this is really the wrong way round,” he added. This development seems highly counter-intuitive in a political climate largely characterised by the belief that, as Mr Room commented, the “consumer has been failed”.

 Underlying the entire problem, however, is a simple lack of resource: the extent to which the banking community can be expected to fund these requirements under current pricing models is a dynamic rarely addressed by the regulators, and one, added Mr Reilly, that is rarely discussed publicly. This may be because, particularly in countries such as the UK, it is largely taken for granted that the majority of retail banking services will be offered free of charge – a belief that has only been reinforced by the recent public debate on what have been perceived as unreasonable overdraft fees.

 Put quite simply, said Mr Reilly, “the pricing model is going to have to change”. In light of the historical revenue streams that have been obviated by the overarching payment developments, it seems only practical that the banks move to a completely transparent pricing scheme, he remarked. The customer may believe that the price of services are going up, but in fact they are receiving a fair and transparent fee directly associated with the rising cost of servicing payment transactions. “I think we need to be more open about that: I can see that free banking is going to disappear in the retail market sooner or later. In the commercial sector, where we’re serving corporate customers, those transaction prices are going to go up,” he added.

Real-time business

 For UK payment providers, the workload has been even heavier due to the roll-out of Faster Payments, the Office of Fair Trading (OFT)-mandated initiative, launched in late May 2008, designed to revolutionise the UK payments infrastructure. In the opinion of the OFT, Faster Payments is designed principally to benefit the average consumer, but for many, the true benefits of moving to a real-time settlement infrastructure are found at the commercial level, where the impact of freeing up working capital can be profound.

 “In huge businesses, where money moves through the system quickly, their working capital is going to increase massively and that’s going to the bottom line,” said Mr Room. These additional funds could, in turn, help to compensate for the rising costs of compliance, he added.

 Certainly, this potential benefit is driving demand among the corporate community to realise a more comprehensive real-time settlement infrastructure, said Mr Bryant. “Their business is real-time, and they want the payments business to act in real-time,” he added, as well as to have greater transparency surrounding movement of funds, and the improved ability to monitor intra-day liquidity.

 As Mr Reilly pointed out, however, the need for real-time settlement – perhaps somewhat ironically, given the ambitions of the Faster Payments scheme – is, in many respects, not as important for the consumer due to the relatively small amount of cash being transferred. Rather, added Mr Benz, the value of the service is found in the irrevocability of the payment, and the certainty that the fund transfer will take place. This point, he added, is key: “In the downturn, consumer focus will be on checking their balances, and doing their own mini-version of the large scale corporate cash managements.” To this extent, he added, “I hope that the investments that the banks made in the UK, in Faster Payments, will actually pay off to some extent.”

 In relation to its European peers behind whom it has historically lagged, the UK finds itself in a “fantastic position” as a result of the Faster Payments project, said Mr Room. For this reason, its appropriate to celebrate what has been a “very successful launch”, added Mr Reilly, in a time when banks are rarely, if ever, congratulated for their infrastructural efforts. Mr Bryant agreed: “It is incredible, but I do think it is just the start.” The next big battle, and one unlikely to be relished, is the long-anticipated elimination of the cheque, he added.

Security scare

 While the European and UK banking industry has been focusing its efforts on improving the UK payments infrastructure, the global cyber-criminal community has been equally as diligent in innovating new ways to subvert the payment transaction and defraud the consumer – a cost which is also borne by the banks. As Ms Price pointed out, it should be a matter of some concern, for example, that phishing attacks remain as prevalent as ever, while even the integrity of Chip and PIN, once touted as the final answer to customer-present card fraud, is now in doubt. As such, “there are a host of issues that need to be addressed”, said Mr Fernandez.

 Meanwhile, the ever-globalised nature of payment transactions and the increasing speed of their execution will make it more challenging for banks to detect and prevent certain types of payment fraud. Mr Room added that, notwithstanding the financial crisis, “one of the biggest challenges for the payments industry is security: the issue lies in fully automated systems and the quantities of data processing.” The very act of building a large, scalable and networked system designed to hold and transfer vast quantities of data, with multiple points of access, almost guarantees security failures, he continued.

 In particular, the parlous state of data security that has prevailed within both the public and private sectors in recent months indicates that further data losses are inevitable. “At that stage, the security dynamic will play out. And I actually think it poses one of the biggest single threats to these systems,” Mr Room added. The extent to which the banking community can be expected to bear the entire burden for ensuring the security of payment transactions in an ever-increasing variety of contexts is a critical question, however, especially since consumer acceptance of security mechanisms designed to protect their interests are generally quite low, said Mr Benz.

 Under the PSD, the liability for security breaches is shifted, by law, onto the payment provider. This liability, according to Ms Wandhofer, can even extend to the Chip and PIN payment transaction, meaning the consumer – even acting under the strongest authentication controls provided by the bank – takes no responsibility for unauthorised transactions. The cost of this blanket liability for electronic transactions, and the resulting price that would be passed on to the consumer, could result in the resurgence of cash. “It all comes back to rethinking business models and pricing structures,” she added.

 Unlike in other areas of the financial services industry, the payments industry does not charge in proportion to the risk it takes on, charging instead a fixed fee for both a small payment, and a much larger one carrying far more risk. “For me, that is actually quite strange,” said Mr Reilly. “The more we address these issues of fraud, charging a fee in proportion to the risk may become a possibility,” he added. The banking community’s predicament in this regard underlines what Mr Room dubbed a “fundamental” truth of banking: “That it is a social service rather than a purely capitalist offering.”

 For this reason, he demurred that it would be possible for banks to change their pricing structures in this way. Furthermore, as the fall-out of the crisis and its unprecedented large-scale bailouts are brought to bear on government policy, this social agenda will grow stronger. “If that comes, you wouldn’t be able to price by reference to pure risk in the way we would see in a truly competitive environment,” he remarked.

The landscape ahead

 Negotiating the growing cost of security and compliance will remain a key issue for the transaction banking industry in years to come, participants agreed. “It is the only issue that has the potential to floor these projects and bring them crashing down: it is a massive prize to attack these systems,” warned Mr Room, adding “this will extend much, much further than the political, economic and social issues.” Mr Fernandez said: “We talk about systemic risk in the marketplace but this is as bigger issue.”

 In line with these concerns, costs will continue to rise, and “this will continue to be a challenge”, said Mr Reilly. “If it is regulatory, or security, whatever it is, it is going to feed into our cost base.” If the the transaction banking business is to cope with this growing cost base, banks will have to continue to expand their volumes, and in-source business, he added. Mr Benz agreed that transaction banks will continue to scale in line with payment volumes, and expand their market share, matched by continued consolidation as smaller players bow out of the payments business.

 To this extent, the challenges of SEPA and the PSD are symptomatic of broader hurdles which the transaction banking business will be forced to overcome in future years: risk, pricing and the business models in a transformed infrastructural, regulatory and commercial environment.

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