SEPA: Time for Corporate CEOs to Get Involved!
This article is based on a panel discussion among corporate treasurers and financial controllers organised by Orchard Finance Consultants in October 2006 on the subject of ‘SEPA: What will it mean after it has become reality? 2008-2018: The consequences for corporates’. Over 30 financial professionals including treasurers from large corporates attended the discussion as well as government authorities, insurance companies and specialists from the payments industry. The panel consisted of representatives from the interest groups most affected by SEPA, while the banks were represented by the chairman of the European Payment Council (EPC), Gerard Hartsink. The banks’ corporate customers were represented by the president of the Dutch Association of Corporate Treasurers (DACT), Albert Hollema. Also present was chairman of TWIST, Tom Buschman and an independent consultant from Orchard Finance, Jaap Ringnalda. Roelof Hendriks, executive vice president of the risk management and insurance company, Aon, chaired the meeting.
According to the original plan for the single euro payments area (SEPA), European banks are expected to provide identical payment services throughout the EU by January 2008. European legislation is going to force banks to compete on a European scale – but is this too good to be true? Lack of clarity about SEPA legislation and implementation may provide banks with a shield against increased competition for another two years. In the meantime, the bill for SEPA investments has already been presented to the public. Now is the time for CEOs to get involved.
Corporates have been promised the luxury of one single bank fulfilling all their payment and collection requirements in every country within the EU. But there are some major hurdles in the way of this corporate cash management paradise. Legislators and senior corporate management have been sleeping on the job: no-one is ready for SEPA.
The impact of SEPA is considered to be larger than the introduction of the euro and yet very few view seem to be bothered about it. How are corporate executives dealing with their SEPA challenges (if they are at all)?
So far, SEPA has been the focus for technology providers, IT consultants and bankers who will gain or lose millions in constructing this new payment system. In the period after SEPA’s introduction, a landslide of moving banking relationships may change the map completely. Senior corporate executives have not been involved in this strategically important issue and legislators underestimated resistance to such a dramatic change in market relations.
It has become clear that local legislation in European countries was not ready for such a fundamental change in competitive forces in the traditionally highly protected banking industry. The brakes were activated, competition slowed down again and banks felt relieved.
But not all is lost. This is a great opportunity for corporate executive management to get involved in an issue they did not care about before. SEPA is not only about restructuring international banking systems; it is about corporate-to-client relationships in their home market and strategic choices for companies.
SEPA is not about banks trying to save their business by cutting the cost of redundant payment infrastructures; this is an opportunity for corporates to streamline their financial supply chain and re-arrange their relationships with customers while benefiting from the fierce competition among banks.
Roelof Hendriks, executive vice president at AON and chairman of the discussion panel, was shocked. “This is a C-level issue and I am sure very few of my colleagues are aware of it,” he said. A central bank representative who attended the meeting concluded that a lot of homework is to be re-done by banks and financial authorities and admitted that “while focusing on the consequences for the financial industry we forgot about the clients.”
As a representative of the corporate community Albert Hollema, president of the Dutch Association of Corporate Treasurers (DACT), has obviously thought about the consequences of SEPA before. He believes corporates should embrace the idea and opened the discussion with two statements.
The first statement placed a heavy burden on corporate shoulders. “For the European Central Bank to fulfil its vision of full harmonisation and standardisation across the eurozone, SEPA must be embraced by corporates. Corporations are the biggest users of euro payments and if they don’t use the new scheme, which will commence from 1 January 2008, it could quickly be rendered irrelevant.”
Of course, he is right, but ‘irrelevant’ is the least worrying of the potential consequences. Billions of euros would have been invested in the new infrastructure – who is going to pay for that? Not the banks; in the end, it is the consumer who will pay. Are we heading towards a double infrastructure even though the existing infrastructure is not effectively used and is suffering from huge overcapacity? Over the next three years, this is a likely scenario.
Hollema’s second statement revealed his realistic view on the state of affairs although his wording was prudent. “What SEPA is for payments throughout Europe, is what the euro was for currencies. The level of preparedness is substantially lower than for the introduction of the euro. Corporates are still at a very early stage,” he said.
Rens Koster at Orchard Finance has an explanation for this phenomenon. Having been a corporate treasury consultant for many years, he has experienced a relative lack of interest among corporate senior management to optimise the financial supply chain for commercial purposes. Corporate controllers tend to focus on accounting and operational cost control while treasurers focus on reducing interest costs and currency exposure. At best, the costs of payments are considered part of the banking relationship and it gets relatively little attention in comparison to the cost of financing and the fun of currency and derivatives dealing. Corporate commercial staff are not interested in payments at all. So who is the natural counterparty of bankers to discuss corporate requirements? In theory it should be the treasurer. But what practical knowledge do they have about the commercial aspects of the financial supply chain?
At the discussion panel, Albert Hollema pointed out how around 200 companies throughout Europe have a shared service centre or are in the process of constructing one. Most of these shared service centres are established because of the need for cost savings in administrative processes and some of them are driven by tax arguments. Fundamental discussions with commercial staff are related to the possible negative impact on commercial relations of centralising supplier payments and customer collections. The treasurers’ involvement in these processes focus on the actual pricing of payments as part of a bank’s relationship management, not as a part of commercial development. Payments and collections are considered necessary, but highly uninteresting financial, administrative functions. Who is interested in making the techniques work for commercial purposes? Certainly not senior management.
Still, that is exactly what SEPA is about to enable so senior management should be interested. But they won’t if the discussions don’t move from the first technical level first. A catch-22 situation.
So corporates are not ready for SEPA and they don’t seem interested at the moment. How about the banks? Are they ready – with just one year to go?
Gerard Hartsink, chairman of the EPC and a senior executive vice president at ABN AMRO, outlined the recent history of SEPA initiatives, their progress and remaining challenges. Mr Hartsink is one of the bankers who shares the Commission’s dream of ‘a euro area in which all payments are domestic, where the current differentiation between national and cross-border payments no longer exists’. This is certainly a daring vision for a member of the banking community who earns a lot of money from the mere inefficiencies of the European banking system.
The average corporate banking customer can hardly believe it. Domestic payments all over Europe? Same-day value and at virtually no cost? Doesn’t that sound further in the future than just one year away? But this is what the EPC has promised and Hartsink outlined the deliverables:
Anyone who knows a little about European banking might be convinced that this is impossible, yet Hartsink promises that the European banks will be ready to start from 1 January 2008. The EPC’s most significant contribution has been to change the mindset of many traditionally conservative European bankers who protect their current position knowing that every move towards European competition will cost them a lot of money initially. Only the best bankers will succeed in getting new business from add-on services, such as consumer behaviour profiling, electronic invoice presentment, real-time debtor solvency information or even online real-time receivables, finance and securitisation solutions.
Moreover, national central banks will facilitate the implementation. The industry has apparently taken on a one-sided obligation, demanding nothing in return. It would sound unbelievable – really a dream – if we did not know that legislation is forcing them to comply.
Now one year before the planned start, we understand why the bankers were not too afraid of the imminent fierce competition. They must have relied on the European paradigm – the moment you announce irreversible decisions is actually the moment you start understanding the problem – which gives everybody the right to opt out or delay somewhere down the road.
But even with a two-year delay in the actual implementation, SEPA is imminent. By the end of 2010, the objectives of SEPA must be implemented, meaning that anyone must be able to migrate to SEPA standards if they want to. But suppose that they don’t. Can companies keep using the old standards? Well, that may be too much to ask from a bank. Everybody will be switching to SEPA, like it or not.
The necessary piece of European legislation, the Payment Services Directive (PSD), has not yet been approved by the Economic and Finance Council (ECOFIN), which means that local legislation will not be changed on time. There is an obvious conflict between the rules-based approach of some European countries and the principle-based approach of others.
The PSD is not expected to return to the voting agenda before mid 2007. And even when it does, it normally takes at least 18 months before it can be incorporated into national legislation within all member states.
Corporates and (semi) government institutions with massive payments and collections should use the extra time to re-evaluate their strategic options. They must assess the possible impact of SEPA on every stage of the financial supply chain, both internationally and domestically:
Senior management should develop a vision on integrating payment and collection techniques into their core business and allocate responsibilities accordingly. Albert Hollema provided a SEPA checklist that will help corporates prepare technically for things to come:
Orchard Finance’s Jaap Ringnalda doubts whether big corporates will benefit from SEPA. First of all, current national standards may be more favourable to companies than the new European standards. Take, for instance, value-dating practice in the Netherlands. Every serious corporate banking client has negotiated same-day value settlement at their side of the clearing. The Dutch clearing system makes same-day value settlement possible and there is no reason to pay more; same-day settlement is best practice. “Everyone can calculate the value of same-day settlement. If you don’t get same-day value, your bank fees should be considerably lower, in order to cater for the same-day value effect. Shifting to SEPA standards would mean a three-day float as a standard. Who would be foolish enough to accept that without compensation?” he pointed out.
Moreover, Ringnalda thinks that European competition law does not guarantee a level playing field among European banks. He gave the example of the current Italian government banking contract, which requires the Italian government to bank with Italian banks until 2020: a difficult start for foreign banks.
His advice to corporates is to find out how customers will react to SEPA, perform an impact study and then decide how to proceed. He also suggests that corporates should not rely too much on bankers’ judgements in this respect. Ringnalda is convinced that every organisation should make their own policy decisions based on economic facts looking at the costs and benefits throughout the financial supply chain: from producer to customer not just bank to bank.
Tom Buschman, chairman of TWIST, focused on the financial supply chain at the discussion. From research, he knows that companies all over the world are willing to pay more banking fees if information services link with corporate needs more effectively. US corporate customers, for instance, expect US$65bn cost savings if they reduce the number of paper invoices by replacing them with electronic invoices through the banking channel.
“If banks are able to send the customer a daily electronic account statement, surely they must be able to send an electronic invoice as well. If they do, what would the additional cost of a payment be? Virtually negligible,” explained Buschman. The European Commission expects the savings of electronic invoicing to be over €100bn a year. Banks should therefore focus on these kind of value-added services, rather than just trying to reduce the costs within their own channels.
But why would banks co-operate in a process that could only lead to reducing their income? Clearly they wouldn’t if left to themselves. Banking law must allow other companies to enter the industry, thus forcing banks to innovate in their products and processes.
One attendee at the discussion, an experienced professional in restructuring payment processes, is currently working to create a European chain of automated clearing houses (ACHs). He is surprised about the relative lack of interest among corporate customers. He thinks payments, by nature, are not a bank product but a community product. By leaving the development to banks, corporates are missing the opportunity to have the systems geared to their needs. Wouldn’t it be more logical to develop payment and related information services among communities with identical interests and members of the same supply chain?
Jaap Ringnalda emphasises the fact that the major costs and benefits of payment techniques are not found within the banking link of the supply chain. The total costs of the payment/collection process may amount to around €30-60 per transaction, while the costs of the settlement may be limited to just a few euros or even cents. Talk to the ERP suppliers, talk to customers, material suppliers or authorities demanding all sorts of reporting. Integrate the physical and commercial supply chain and, of course, the financial side of it. But approach it from the core processes of the community, not from the final stage of these processes, the settlement.
Who would believe banks would invest heavily in new payment systems in order to reduce their income and see customer communities develop their own systems in the end? The truth is that banks have not invested in the greater part yet. Granted, they spent millions on investigating their systems. This research had to be performed anyway though. Many of the payment systems in Europe are obsolete and do not meet today’s requirements in terms of efficiency and flexibility.
Banks throughout Europe can save an estimated €50-100bn a year by switching to modern systems. The legacy systems of many banks are impossible to maintain and extremely expensive in their operation. On top of that, data centres have an average occupation rate of 50%, which is far too low to compete.
Banks have every reason to improve the European infrastructure. With these figures and an open payments market there is going to be a lot of interest from US banks keen to enter the EU with value-added payment services. Gerard Hartsink at the EPC was one of the first bankers to see this and accept the consequences: SEPA.
Payment services by nature are a fixed cost issue. Large investments in infrastructure generate huge incremental costs, while variable costs are virtually negligible. High occupation rates of the infrastructure are therefore of paramount importance. In the future, even more than today, there is no room for small payment services institutions. The smaller banks will have to hook onto the systems supplied by the bigger banks. Large-scale payers and collectors will have the negotiating power to move their financial flows to the cheaper suppliers, perhaps foreign banks. If a bank allows a few of their large customers to go to a competitor, they will have to recover the costs of the systems from the remaining customers. Those who stay behind will finally have to cover all the fixed costs of their banks. Very soon the price will get prohibitively high. All the more reason to join the frontrunners and act now.
The most likely scenario is that large corporates will choose the most cost-effective solution shortly after the start of SEPA. Local banks will then allocate their cost over the customers who cannot move, because of a credit dependency. It is going to be a hard life for the sitting ducks.
By the postponement of the necessary legislation we have more time to prepare for SEPA. We should use that time to our advantage. This is not a technical issue but a strategic one so CEOs should get involved in SEPA. The discussion about SEPA should be brought to the right level – away from bankers and technology providers – and into the corporate boardroom.