SEPA - Changing the Game for Cards
The introduction of the single euro payments area (SEPA) on 1 January 2008 will lead to the largest change in the structure of the European cards industry for over 30 years. Its aim, to create a single payments space, initially in the eurozone, but eventually throughout the EU, will be welcomed by Europe’s largest banks and merchants. It should also mean cheaper and easier cross-border payments for consumers.
SEPA will see the removal of many commercial and technical barriers to entry in each of the participating countries. Multinational banks have been increasingly frustrated by national restrictions. And retailers are unhappy that they have little or no choice of payments solutions providers in many markets. This will change, as under SEPA merchants will eventually be able to choose their acquirer and processor from anywhere within the eurozone.
Currently, the European payments industry has been profoundly nationally focused. Many European countries have their own national debit scheme, their own technical standards and their own processing companies. This has been frustrating the EU and other interested parties in its efforts to build a single payments space in the eurozone.
SEPA will lead to a major standardisation of the European payments industry, not only for cards but also for ACH transactions. In the card market, SEPA is forcing the implementation of EMV chip cards and new Europe-wide technical formats, which should lower costs for the industry and remove barriers to entry. Following the introduction of the Payment Services Directive (PSD), SEPA will harmonise payments legal frameworks across the continent and this again will help to create a single market.
While there is a widespread view that SEPA will cause a major change on the current ‘patchwork quilt’ of national debit card schemes using Visa or MasterCard for cross-border interoperability, there is much less agreement on the eventual end state of the market. The SEPA Cards Framework (SCF) was careful to say that a number of different models could be classified as SEPA-compliant. There are very many industry players who believe that eventually the international brands of Visa and MasterCard will be dominant on Europe’s debit cards. However, there are also many who feel that a genuine alternative is needed and the European Central Bank is increasingly vocal about this issue.
Banks across Europe want to generate increased economies of scale and greater reach; SEPA will give this added impetus. Those banks that operate in multiple markets see SEPA as a significant opportunity to reduce costs by centralising infrastructure and back office processes, and to also innovate new payment products.
The consolidation of banks who are the customers and frequently the owners of processors will inevitably have a major impact on the processing market going forward.
But there are cost and scale issues within the processing industry itself. Processors who need to become SCF-compliant may have to invest heavily in upgrading existing infrastructures, and those costs will have to be met by their shareholders. In an increasingly open market, there uncertainty about whether there is a sound business case for these investments if viewed from a single national market perspective so the pressure is on to consolidate the processing industry. Banks in Austria, Belgium, Germany and Sweden have already sold their national card processors, and more are likely to follow. In the search for scale economies and additional business, some national processors are planning to link bilaterally in order to take volume away from the international scheme processors.
However, this raises an issue about the separation of payment scheme and processing services. There is significant pressure from European and national regulators – and banks – to have these two activities separated. In the world envisaged by the European Payments Council and the European Commission, use of a card brand should not define the interbank network to be used for switching. The SCF states that scheme and processing must be separated and several national regulators such as in the Netherlands are aggressively pursuing this policy.
The international card schemes are also getting ready for SEPA by lifting the mandate to use their networks for European transactions and they are changing their pricing structures. But has the leopard really changed its’ spots? According to research carried out by First Data in 2006, only 25% of banks believe international card schemes will fully separate schemes from processing and 34% believe that the schemes will try to avoid the requirement by making cosmetic changes only. There are already new requirements from the card schemes requiring banks to send them copies of transactions even if their networks are not used. Not exactly the level playing field that the SEPA architects envisaged.
The survey clearly showed that over 60% of banks want alternatives to Visa and MasterCard’s authorisation and clearing services. Even banks that accept the inevitability of the international schemes winning the argument about the debit card brand do not want to become over reliant on these organisations by using them for interbank processing services as well.
The European Commission is also concerned about the lack of competition in the retail banking and cards industries. The Sector Enquiry into the EU’s retail banking industry published in January 2007 concluded, ‘several significant competition issues in the European payment cards market confirm the need for strong competition law enforcement in close cooperation with national competition authorities’. Vertical integration, including that between scheme and processor, is clearly on their agenda.
With this in mind, First Data made a series of proposals to the European Payments Council to ensure that a level playing field exists in cards processing as this is essential for SEPA. Among the proposals are:
With this kind of framework in place, processors will feel confident about investing in the developing SEPA market and this will generate both the revenue generation and cost reduction benefits that are being looked for by European banks.
Banks have a three-year period to December 2010 to migrate from national to SEPA-only solutions. Whatever the end-game for the rival debit brands, the number of cards processors will fall significantly as a result of bank consolidation and the commercial pressures brought about by SEPA.
It is estimated by industry observers that in less than 10 years the number of processing companies in Europe will fall from the current level of over 70 to a maximum of 10 and possibly less. Scale will be crucial – organisations with less than five billion transactions annually will find it hard to survive. As a result, many European markets will no longer have national processing companies or clearing houses.
There will be substantial benefits, too. All commonly used standards will be in the public domain, opening up markets to more competition. And it will become increasingly difficult to protect a market through the use of technical standards. Also, economies of scale generated as a result of SEPA as well as standardised processing models will lead to a significant reduction in transaction charges. These changes will ultimately benefit all stakeholders – banks, merchants, and consumers.
However, there are still some major unknowns. For example, will ACH and card processing converge? Will major card schemes fully separate their processing? What approach will banks take towards their historic investment in processors? How will SEPA rules be further defined? Will a significant number of non-banks utilise their new freedoms from the PSD and become direct participants in payment schemes?
Whatever happens, SEPA will fundamentally change the European cards market in the next few years.