The idea behind the single euro payments area (SEPA) is that businesses and individuals should be able to conduct financial transactions such as payments anywhere across Europe as quickly and as inexpensively as they could conduct those transactions within a single European country. That ambition requires infrastructure that does not exist in today’s current environment of multiple local clearing systems and payment instruments.
SEPA will probably result in the creation of a smaller number of pan-European clearing systems offering pan-European payment instruments. At one time it was assumed that there would be just one pan-European automated clearing house (PE-ACH), but this now seems unlikely.
These systems will provide a homogenous clearing environment that will ultimately be capable of supporting similar functionality to that provided by local clearing systems today but on a pan-European basis. The objective is to make the process of sending a payment from one end of Europe to the other just like sending one within the same town.
In the words of Gertrude Tumpel-Gugerell, European Central Bank (ECB) executive board member, in a 2004 speech: “SEPA is achieved when people can make payments throughout the whole euro area from one bank account, or by using one card, as easily and safely as a national payment is conducted today. For the customer in the euro area, the choice of bank or location of account should make no difference.”
Migration to SEPA
The final deadline for full completion of the migration to SEPA is 2010, with the implementation phase lasting until 2008 followed by a two-year migration phase. The European Commission (EC) and ECB have made it clear from the outset that they want SEPA to be something created by the payments industry with EC/ECB support. However, both organizations have also made it clear that if they feel that the industry is making inadequate progress in relation to the deadlines mentioned above, and then specific legislation mandating SEPA’s creation will be introduced.
Because there are numerous existing clearing systems in Europe owned by a variety of entities, creating SEPA obviously requires the co-operation of the entire banking industry. The industry’s response has been the creation of the European Payments Council (EPC), which has brought together the European banking industry with a commitment to creating SEPA. The EPC’s activities to date have included the development and approval of rulebooks for a SEPA Direct Debit program and SEPA Credit Transfers and the development of a framework for SEPA cards and for SEPA clearing. Some SEPA instruments are already available, such as the Credeuro, which offers three-day settlement for less urgent payments.
The New Legal Framework/Payment Services Directive
The creation of SEPA by the payments industry is one thing, but the legal framework required for it to operate effectively is quite another. Current regulatory differences across Europe create legal uncertainty for cross-border operations and act as barriers. This has been apparent for some time and the European Commission has undertaken extensive consultation with all concerned to harmonize the legal framework into a concept originally referred to as the New Legal Framework (NLF) for payments.
The NLF has now been replaced by the Payment Services Directive (PSD), for which the European Commission issued a proposal in December 2005. The PSD is intended to establish the same harmonized legal framework as the NLF by removing legal and technical obstacles for the creation of an integrated payments market in the EU. It also introduces the concept of licensing of non-credit institution payment service providers that do not take deposits or issue e-money (‘payment institutions’). The intention is that these new providers will help to increase competition.
The PSD does not require corporates to take any particular steps. Most SEPA instruments, including credit transfers and card transactions, can function without it. The PSD primarily affects those corporates with significant direct debit activity, as direct debits are the area where existing local clearing systems have the most diverse rules and practices in areas such as revocability. Therefore, the SEPA direct debit will not have legal certainty until the PSD is ratified by EU member countries.
The good news is that EU ministers have finally agreed on the final terms of the PSD, which was originally expected to have been passed by the end of 2006. Following this agreement, the European Banking Federation says the long delay in the decision will mean that the direct debit part of SEPA cannot be implemented before the end of 2009. The lack of legal certainty around SEPA direct debits is not a problem for end-users who wish to continue using local direct debit instruments in the interim; however, there will be an impact on those who wish to migrate to the SEPA direct debit from local direct debit instruments.
IBAN/BIC
Two important elements underlying SEPA are the international bank account number (IBAN) and the bank identifier code (BIC). These standardize the means of identifying bank accounts and banks when making/receiving payments, so that systems relating to SEPA will not be made more complex by having to process/understand multiple different local formats. Both IBANs and BICs are specifically mentioned in Regulation 2560 as being necessary for the automated processing of cross-border credit transfers. From 1 January 2007, beneficiary account holding banks can reject any incoming cross-border transaction instructions that do not contain an IBAN. Strictly speaking, this only applies to transactions below €50,000. However, some bank systems may not (for various reasons) be able to recognize this threshold and may levy charges on (or reject) all payments without an IBAN, irrespective of value.
IBANs are issued to account holders by their bank. While there are some general rules relating to IBAN formats (e.g. a maximum length of 34 alphanumeric characters) there are considerable variations from country to country in terms of IBAN length and regarding which characters can be letters or numbers. An IBAN does not replace a domestic bank account number and is primarily intended for cross-border payments. However, it should be observed that IBANs can also be used for domestic in-country payments and, in some cases; their use for domestic payments is mandatory.
Does SEPA Matter to Me and What Do I Need to Do?
Resident organizations
If an organization makes or receives any payments into/from a euro account held within the EU, then it will be affected by SEPA. The extent to which it is affected depends upon a number of factors, including the volume/type of payments involved and the capabilities of the banking partner used. Bank of America clients will find that SEPA does not necessarily mean that their treasury/ERP systems or current treasury procedures will be in need of major changes or overhaul because the bank already leverages its European network.
For example, Bank of America already has the tools in place to convert between the various local payment formats; clients do not need to change their systems in order to issue payment instructions in SEPA-compliant formats. For instance, if a client has German direct debits to process, it can continue to send Bank of America the file in the German direct debit format, and the bank will automatically translate this into a SEPA-compliant format.
The opposite also applies, so if a client wishes to send payments in SEPA-compliant formats before 2010, Bank of America will translate these into the appropriate local payment formats until SEPA goes live. Finally, clients can also send comma-separated payment files containing payments for multiple countries, and again, Bank of America will translate these into all the appropriate individual formats automatically.
Non-resident organizations
Officially, organizations with bank accounts held outside the EU making payments into the EU are not affected by SEPA and are not required to use IBANs on their payment instructions. For example, the holder of a USD account outside the EU who instructs his bank to translate USD to euro and use the proceeds to make a euro payment on his behalf to a beneficiary in the EU is theoretically unaffected.
Unfortunately theory and practice do not necessarily tally. The paying bank in the above transaction would probably route the payment via an in-country (intra-EU) euro account. The beneficiary bank therefore might not recognize the fact that the payment originated outside the EU and levy charges or reject payments if an IBAN was not quoted.
Preparing for Change
There are some changes that clients will need to make. The most obvious of these relate to IBANs and BICs – as mentioned earlier, beneficiary account holding banks can reject any incoming cross-border transaction instructions after 1 January 2007, that do not contain an IBAN. Payment instructions will have to include these, so resident clients will have to update vendor database bank account details. In view of the potential problems outlined above, non-resident organizations would be well advised to do this as well. This is not necessarily an insuperable task, as banking partners will have tools that can assist clients by allowing them to validate IBANs and BICs provided to them before use.
Clients may also wish to make some systems changes to take advantage of the additional remittance information that will be available under SEPA. Up to 140 characters of remittance information will be available from clearing, and clients wishing to use this to improve automated reconciliation rates will need to make some system changes in order to receive/process the data.
While the changes corporates need to make now to comply with SEPA are not necessarily exhaustive, corporate treasuries still need to be thinking of possible future SEPA effects. For example:
- If the corporate has a large IT group developing individual payment files for the European market, what consolidation/changes might be necessary post-SEPA?
- If a corporate is particularly dependent upon a particular local payment instrument, how will it be replaced?
- If a SEPA-compliant instrument is available now for less cost than this local instrument, is it worth the corporate trying to move its customers to the SEPA instrument?
- Will partner banks be changing their terms and conditions as a result of SEPA? If so, what impact will that have?
- Can the number of bank accounts held in Europe be rationalized to a single provider? What would need to happen within treasury to reach that goal? What effect might this rationalization have on existing arrangements such as pooling structures?
- If it is already a marginal decision whether or not a corporate operates its own European regional treasury, might SEPA actually tip the balance in favour of treasury outsourcing?
Conclusion
From a corporate perspective, SEPA is not necessarily a seismic event – but neither is it something that can be ignored. A capable banking partner should be able to insulate the corporate from much of the potential cost of SEPA-related changes, but there are some areas (such as IBANs and BICs) where action is necessary now. SEPA may also produce a number of strategic and tactical challenges in the future, so it is worthwhile considering the various ways in which it might affect the corporate going forward. Finally, given that SEPA is clearly not a static event, it also seems advisable that any corporate impact assessment is regularly revised in the light of any further SEPA developments.
Origins of SEPA
SEPA is linked with EC Regulation 2560/2001, dated 19 December 2001. The original regulation makes no specific mention of SEPA, instead focusing on the catalysts for its creation – namely the efficiency (low) and cost (high) of cross-border electronic payment transactions1 and credit transfers2 within Europe.
Regulation 2560/2001 came into effect in three phases:
- With effect from 1 July 2002, charges levied by an institution for cross-border card and ATM transactions in euro up to €12,500 had to be the same as the charges levied by the same institution for corresponding domestic euro payments.
- With effect from 1 July 2003, charges levied by an institution in respect of cross-border credit transfers in euro up to €12,500 had to be the same as the charges levied by the same institution for corresponding domestic euro credit transfers.
- With effect from 1 January 2006, the €12,500 – the threshold for cross-border credit transfers – was raised to €50,000.
Unfortunately, the potential impact of the regulation on bank profitability has resulted in some banks striving to find ways of disqualifying payments from falling under the regulation. The net effect has been something of a free-for-all, with some banks attempting to make charge backs to their peers. Bank of America has strenuously resisted these charges on behalf of clients and has also devoted considerable efforts to achieving a sensible consensus with other banks over what is/is not an acceptable reason for cross-border euro payment charge backs.
Regulation 2560 has not actually reduced the cost of cross-border payments; it has simply prohibited banks from directly transferring these excess costs to end-users. Nevertheless, Regulation 2560 has been useful in prompting banks to seek ways of lowering the cost of processing cross-border payments in general. Therefore, in the words of Jean-Michel Godeffroy, director of general payment systems and market infrastructure at the ECB, Regulation 2560 is, “…in fact indirectly behind SEPA, but in no way can it be a substitute for SEPA.”
Note: This article contains suggestions only, and is not meant to substitute for your own internal procedures that are appropriate for your company. This information is not legal or tax advice. You may wish to consult your own legal and/or tax advisors.
1The cross-border transfers of funds effected by means of an electronic payment instrument, other than those ordered and executed by institutions, cross-border cash withdrawals by means of an electronic payment instrument and the loading (and unloading) of an electronic money instrument at cash dispensing machines and automated teller machines at the premises of the issuer or an institution under contract to accept the payment instrument.
2 “Transactions carried out on the initiative of an originator via an institution or its branch in one member state, with a view to making an amount of money available to a beneficiary at an institution or its branch in another member state; the originator and the beneficiary may be one and the same person.”