SEPACSMOutsourcing Payments – Building a Flexible Foundation Post-SEPA

Outsourcing Payments - Building a Flexible Foundation Post-SEPA

The financial sector faces the imminent creation of a borderless eurozone for payments processing, resulting from the creation of the Target2 system for high value payments and the single euro payments area (SEPA) for lower value payments. With deadlines for implementation of both fast approaching (later this year and January 2008 respectively), there is an urgent need for banks to assess their ability to handle the imminent changes to their operating environment.

One trend that appears likely to result from the current push to harmonise European financial services is the increased outsourcing of payments processing. At a series of industry events held last year, Sterling Commerce surveyed senior IT managers from European banks and found that Target2 compliance was the most common IT priority for the next 18 months. The survey also found that almost half – 44% of the banks represented – expect to outsource Target2 processing to other banks, while 49% of banks expect to host these payments for their partner institutions.

SEPA and Target2 aim to provide a ‘level playing field’ for payments services across the EU. For the banking sector, this is likely to lead to a scenario of payments outsourcing, alongside consolidation. The future implications of these regulatory changes for the banks are significant compared to current activity in the payments sector. SEPA removes protective borders around national automated clearing houses (ACHs) to provide a single European marketplace based on service and price rather than geography or politics. The payments sector has been noticeably quicker to prepare for the effects of SEPA than the banks, so what can the banking industry learn from the experiences of ACHs?


Over recent months the payments sector has seen a number of mergers, including Voca and Link to form VocaLink, Interpay and Transaktionsinstitut to form Equens and BBS and PBS merging their card payment processing systems to form Nets. All such mergers are a natural result of the disappearance of country-based clearing and settlement systems. In a single European payments zone, economically cheaper processing and pan-European interbank connectivity will be the key to post SEPA survival – essentially ACHs will strive to become pan-European clearing houses (PE-ACHs). Industry analysts predict that, as the smaller operators that fail to evolve and adapt to the pan-European environment are absorbed into their larger competitors, the end result of this period of consolidation could be as few as three separate PE-ACHs1.

ACH consolidation is already a reality; Tower Group Research estimates that nearly 70% of tier 1 European banks are fixed on a strategy of merger and acquisition (M&A) and joint venture (JV) for future growth.2 Competition between banks shorn of nationalist protection and regional advantages will lead to a shakeout in the banking sector where only the biggest and most efficient banks control the high-volume transaction markets. As with the ACH sector, smaller players, including the majority of country banks, will be unable to match the global players on cost, service provision and pan-European reach, forcing them to either carve a niche with different or specialised services or face the prospect of being acquired by a larger player. Signs that M&A activity is already ramping up in the banking sector can be seen in recent reports analysing the potential for a merger between ABN AMRO and Barclays, with other interested parties believed to be waiting in the wings.


The creation of PE-ACHs will have repercussions for the banking sector; with possibly as few as just three PEACHs offering considerably cheaper payments processing, banks may look to offload their payments processing to these mega-ACHs. In general, payments are a big revenue source for banks but do not present a huge opportunity for profit growth, so there is a strong motivation for banks to outsource payments and push a considerable cost base on to a partner ACH. Considering that most ACHs are owned or part-owned by the banks, the outsourcing of payments to ACHs can be seen as a means for banks to move their payments revenue to what is essentially a more profitable division of their business. Growth in outsourcing won’t just be confined to payments though; already we are seeing securities management outsourced to global custodians and other business areas, such as foreign exchange, may also be increasingly attractive candidates for outsourcing – all are functions which smaller players may be able to run more profitably through outsourcing. By removing the geographical constraints and opening up the eurozone, SEPA forces banks to outsource uncompetitive functions and instead focus on a strategy that will help them elevate scale as the principle competitive advantage (on those areas where they can grow profits in by offering attractively-priced, differentiated services).

So what does this move to outsource their payments processing mean for the banks? A likely consequence is a lack of float, i.e. less cash in transit at a given time. Even in short periods, cash within a bank’s systems can be a source of revenue and with outsourced payments; the opportunity to invest such ‘cash in transit’ is lost to the PE-ACHs. Also, there are also implications for the bank-client relationship. Removing cross-border charging leaves banks with a shortfall in revenue, which has been estimated by ABN AMRO as something in the region of €29bn3 to all banks across the eurozone. Banks will likely try to make up this shortfall in revenue by introducing charges elsewhere, for example by re-introducing costs for previously free services. It is entirely possible that SEPA will result in commercial banking clients experiencing lower costs which are then passed on to the private sector. Alternatively, new sources of revenue may be developed, for example in areas such as trade services, to enable banks to grow their profits even as they hand over their payments revenues to outsourcing partners.

Flexibility – The Key to Surviving SEPA Shakeout

So how can banks address the two key challenges of SEPA – consolidation and payments outsourcing? Banks must follow the lead of the ACH sector, which has placed its faith in flexible and adaptable IT infrastructures to help them support their strategies for future growth. Implementing such solutions gives banks a greater level of control through a common service-oriented architecture (SOA) platform. This helps enable interconnectivity with customers and partners via standards-based data movement or over the internet. Because SOA allows existing processes to be reused, banks can quickly configure business processes respond to changing business conditions and offer new services.

Many ACHs have already implemented such agile process integration solutions to bring down the cost of payments processing and enhance their ability to accept payments insourcing, regardless of a client’s own IT systems. By implementing these flexible, ‘edge of the enterprise’ solutions, ACHs have removed the IT barriers that previously existed, enabling them to offer ‘any to any’ payments processing across the eurozone and to become flexible and adaptable to the changing demands of the EU financial services marketplace.

Banks have a similar opportunity to capitalise on the new, post SEPA environment, but only if they too take a progressive stance on the adoption of flexible IT infrastructures. Tower Group also predicts that the banking sector will have to invest around €10bn in new technology just to handle the demands of SEPA4, but if spent wisely, these systems can actually help strengthen a bank’s service propositions and grow profits. The benefits of flexible, easily configurable, and scalable IT solutions in enabling banks to compete in the post SEPA landscape can be demonstrated in the two key areas previously discussed; consolidation and outsourcing.

Industry analysts expect the banking sector to undergo a period of consolidation just as ACHs have – by 2010, Tower Group expects 80% of financial sector volume to be handled by just 10 multinational European banks (the same volume is handled by around 300 banks at present)5, so there is a pressing need for banks to be able to handle M&A activity with minimum disruption to service provision. Flexible external data communications are essential to smoothly managing the integration of two merging banks in that they can provide a ‘bridge’ between the systems of the two merged companies. They integrate business processes and translate and sort data to enable seamless working across the multiple divisions of the newly merged entity. By providing the ability to port processing from one system to another without affecting the customer, process integration enables banks to consolidate onto a preferred existing system, or even migrate core processes from both banks onto a new system.

The same flexible IT architectures are also vital to enabling effective, agile business in an outsourcing environment. For banks looking to outsource their payments to offset costs and take advantage of the cheaper processing offered by the post-SEPA PE-ACHs, it is essential that IT systems provide the same any-to-any integration benefits with external partners as they do in the consolidation example given above – they enable banks to change outsourcing partners with a minimum of disruption and without the need for costly re-engineering of IT processes. In fact, without IT platforms that can be easily configured and adapted to meet changing needs, many of the benefits of outsourcing are lost – what is the point of selecting an outsourcing supplier and then hardwiring your payments processing into their systems? By doing so you would be unable to react to changes in market conditions and take advantage of short-term opportunities with other suppliers. Even worse, what if a competitor acquired your hardwired ACH when your business is locked into working with them? Such examples demonstrate the importance of not being constricted by technology.

Above all, the agility that flexible IT architecture provides is the key to maximising profit in the post-SEPA era. Exploiting the benefits of the borderless SEPA eurozone rests on the business’s ability to choose outsourcing partners on their service- and cost-benefits, rather than their location. Fail to implement a flexible IT and you may find that your business is unable to realise the potential benefits SEPA offers through the removal of geographical constraints, because your business is still limited by the constraints of inflexible data communications technology. Only those banks that follow the lead of forward looking ACHs and implement edge of the enterprise flexible IT will have the agility needed to prosper in the post SEPA landscape.


1 Tower Group – Chris Skinner, Why Flexible Payments Architecture are Key, 16 June 2006
2 Tower Group – Ralph Silva, Consolidation in the European FS market, 4 Dec 2006
3 Tower Group – Chris Skinner, Why Flexible Payments Architecture are Key, 16 June 2006
4 Tower Group – Chris Skinner, Why Flexible Payments Architecture are Key, 16 June 2006
5 Tower Group – Ralph Silva, Consolidation in the European FS market, 4 Dec 2006

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