SEPA Clearing and Settlement Challenges For Banks
Whether you are a small, local oriented bank or a large European player, payments may not be a core business but they are always involved in your product proposition. The single euro payments area (SEPA) will have a major impact on payments business in Europe; it introduces new standards, new products and a wider range of services.
SEPA means extra investments and a potential change in future exploitation costs. Competition will increase as new opportunities arise and new entrants enter the SEPA world and the distinction between domestic and cross-border payments in euro disappears (with the likely downward pressure on payment prices). The market place is on the move; payments will become a commodity and a volume business.
Recent studies (e.g. Cap Gemini, World Payments Report) indicate that only 4000 of the 9000 banks that currently operate in Europe are active in the payments space. Only 30 banks will have the volumes to cost-efficiently process payments in the SEPA world. The capability to ‘switch’ between the different routing options ensures a competitive price can be negotiated. These banks will even offer insourcing services. More seriously, SEPA will force about 1000 banks to move away from payments and around 2970 banks will continue to offer payments but lack the volume to be able to process payments competitively.
Looking at the payments value chain, financial institutions have different sourcing options. A bank can choose to outsource multiple elements of their payments value chain or opt for just one element depending on their capabilities in the value chain and the value of these capabilities in respect to their strategy.
In general, for the smaller banks, when looking at the payments value chain and SEPA, outsourcing or co-sourcing are logical steps to take but certain elements are more appropriate for outsourcing considerations than others.
This article discusses the sourcing options that the 2970 smaller banks will have for SEPA clearing and settlement. These are banks for whom payments are not considered ‘core business’; who do not have the volumes to bargain low pan-European automated clearing house (PE-ACH) prices and/or process payments cost efficiently; and who are not eager to invest in connections and testing to PE-ACHs. These are all reasons to search for a tactical (short term) solution to ensure reachability and origination of SEPA payments and therefore SEPA compliance from 1 January 2008, and to explore the different strategic (long-term) sourcing options for clearing and settlement.
Small banks that have decided in the long term to outsource a major part of the payment value chain but have not yet actively looked for partners must do so now. Banks that never considered outsourcing before now have a reason to do so. But the sourcing discussion can go beyond SEPA. Banks do not want to outsource SEPA payments only; they are looking for a partner for current domestic payments and true international payments (TIPs) as well.
This complicates decision-making around SEPA. Including current domestic payment products in-sourcing discussions, especially when multiple countries are involved, makes the 1 January 2008 deadline difficult to meet. With the Payments Services Directive (PSD) not yet implemented, local law and specific local product requirements are applicable that introduce a lot more complexity in comparison to ‘standardized’ SEPA products. Full insourcing of the payment value chain, including multiple domestic payment practices, will be a lot easier in 18 months time after implementation of the PSD and standardization of SEPA.
Is the clearing and settlement outsourcing discussion new for Europe? Not really, it is already common practice in Europe to use another bank as a clearing and settlement partner through local or EBA clearing – outsourcing of clearing and settlement.
Today, financial institutions use local ACHs to clear and settle domestic payments in their ‘home’ country. To effect cross-border payments in Europe they can make use among others of the EBA with services, such as STEP1, Euro1 or STEP2 Credeuro service or banks can make use of their correspondent network to reach the beneficiary.
Looking at local clearing and settlement in the Netherlands, all Dutch banks are connected to the ACH Equens (formerly Interpay) as costs per transaction are low and alternative models do not exist. This is contrary to Belgium where costs for connecting to the CEC/UCV (Belgian ACH) are high. Only large players are direct participants of the CEC/UCV and small banks participate indirectly via a direct participant.
The same applies for the EBA; to process payments through the STEP2 Credeuro service (settlement via Euro1) a bank can participate directly or indirectly. As a direct participant of EBA, a bank needs to fulfil certain criteria (legal, financial and operational), such as direct access to Target, have a certain short-term credit rating and have a substantial amount of own funds. Furthermore, per transaction an amount is paid where the amount is less if you process higher volumes. As a small player, you need to use a direct participant to take advantage of their relationship with EBA, which means a lower tariff per transaction and no need to fulfil the specific obligations of EBA, such as a guaranteed amount of own funds.
The EBA PE-ACH for SEPA will likely follow a similar path, thereby introducing reasons for small banks to find partners for their clearing and settlement process.
In view of SEPA, a bank needs to choose the ‘SEPA-circuit’ it wants to participate in and they are free to choose whatever they want. More specifically, a bank is free to organise clearing and settlement access for ‘reachability’ in a different way than for ‘origination’.
Assume EBA PE-ACH is the only PE-ACH as of 1 January 2008. What are the options for the smaller banks to reach their beneficiary banks? Assuming the small volumes, direct connection to EBA PE-ACH seems unattractive considering the costs involved:
In view of SEPA, the following clearing and settlement sourcing options are available to a bank:
When considering your clearing and settlement approach the correct (combination of) sourcing option(s) is dependent on:
Small banks need to decide now how to organise their SEPA clearing and settlement and the search for a partner seems the only choice for smaller banks. Looking beyond SEPA, a partner may even be able to add more services by taking over the processing of additional products (e.g. TIP processing and remaining post-SEPA local domestic payments) or, when you are ready to outsource more parts of the product value chain, by taking over additional processes of the payment value chain.
At this moment in time, looking for a future proof partner may not be the greatest concern for small banks; but, in order to be ready for SEPA, small banks should think now about SEPA clearing and settlement partners. This partner will organise their routing of SEPA payments in such a way that attractive prices and customized value added services can be offered, while the outsourcing bank can avoid investment, but it does not necessarily need to be the partner for the future.
Is organizing SEPA clearing and settlement a first step towards full outsourcing? Yes, it will be for some as it removes barriers that could not be removed before and creates partnerships that have the potential to grow broader in the value chain. Still, it is unlikely that all 2970 small banks will outsource their complete payment value chain. As several sourcing options could be appropriate, smaller banks need to continuously monitor developments in the market place and should keep their doors open to new opportunities and new partnerships within the SEPA world.
Keep in mind your strategy for the long term, the possibilities of SEPA at short notice and the willingness to make investments yourselves. Anticipate developments by staying flexible in your sourcing choices to make sure you benefit from the competition that will arise in the clearing and settlement market space.