The PSD: Challenges and Opportunities for Banks and Corporates
At present, European Union (EU) and European Economic Area (EEA) Member States are in the process of transposing the Payment Services Directive (PSD) into national law. Although there was not much fanfare, the legislation actually entered into force in the UK on 2 March 2009 and the PSD regulatory regime will be in place on 1 November 2009. The UK government has said it is committed to early implementation to help firms consider the incoming requirements and prepare for compliance. This means the UK is the first EU state to pass the PSD into national law.
The PSD provides a new legal framework for payment services in the EU and the EEA. The purpose of the PSD is to:
The PSD is an ambitious regulatory initiative covering all 30 members of the EU/EEA. The PSD will therefore re-shape the payments landscape in Europe and is arguably more extensive in scope than the single euro payment area (SEPA) initiative, which primarily covers the efficient processing of euro payments. In contrast, the PSD covers the following:
As the countdown to the 1 November 2009 deadline begins to quicken, the questions that need answering are: how many banks will be compliant in time to make the deadline? And, perhaps equally important, what role will corporates play in driving adoption?
It appears that a significant number of EU banks are losing confidence in their ability to meet the impending deadlines and rules of the PSD. A recent survey conducted by PSE Consulting of 37 banks and payment service providers found that as many as 25% believe they are unlikely to be ready by November 2009. And nearly 75% of those questioned felt that transposition into national law would not be available until Q3, leaving very little time to be compliant before 1 November 2009.
The type of scenario we are likely to see is one in which banks move towards PSD compliance gradually, hoping that there is strength in numbers and that regulators will take a lenient approach before penalising non-compliance.
In this way, the implementation of the PSD is likely to prove similar to Regulation 2560, which was passed in 2001 and eliminated price differences between cross-border and national payments within the EU. Regulation 2560/2001 took a long time to put into practice and its original goal remains an underlying objective of the SEPA initiative. This legislation meant that, in theory, a customer could bring suit against a bank for charging significantly higher fees for properly structured (BIC and IBAN compliant) cross-border payments in EU currencies, including euro and sterling. Although the European Commission (EC) investigated a few cases and the European Central Bank (ECB) did some audits, banks have escaped being heavily penalised for failing to comply.
At this time, it is unclear what penalties will be put in place if a bank does not comply with the PSD. Are they going to lose their banking licence? That outcome is unthinkable, particularly given today’s economic climate. It’s a very real possibility that regulators simply will not be in a position to actively enforce the PSD’s mandates.
For example, the Financial Services Authority (FSA) in the UK has limited resources in terms of personnel to enforce the new regulations. With few available resources, the FSA may struggle to carry out major audits to identify who is, for instance, not giving the foreign exchange (FX) rate upfront to customers when making cross-currency payments in any EU currencies. The FSA can lay down the rules, but it cannot necessarily ensure those rules are being respected.
FX rate visibility is just one of the many new challenges that the PSD creates for banks. Key provisions of the PSD include faster execution time, faster availability of funds, transfer of full amount, full transparency to customers and defined refund periods.
The value date, or the day specified for the bank to debit and credit funds, is much stricter under the PSD, therefore bringing an end to the practice of back-value dating for debits and forward-value dating for credits which allow banks to earn float. Under the new legislation, the debit value date from the payer’s payment account must not be earlier than the point in time at which the amount of the payment transaction is debited to the payment account. Furthermore, a payment must be credited to the payee’s account at the latest by the end of the next business day. Hence, the PSD introduces a fast execution time of only D+1. Until 1 January 2012, a payer and his bank or payment service provider (PSP) may agree on a period no longer than three business days (D+3). A further business day is allowed for paper-initiated transactions (but not more than four business days in total).
The PSP or bank of the payer, the payee’s bank and any intermediary bank must transfer the full amount and refrain from deducting charges from the payment itself. However, subject to an agreement between the payee and the PSP, the payee’s PSP may deduct charges from the payment. Thus, from an operations perspective, the PSD will present banks with new challenges in the back and front office. In general bank fees must be known in advance and need to be applied separately, in addition to transferring the full value of the payment.
On the front end, banks will have to provide customers with much more information. Under the PSD, customers will enjoy a more harmonised service as the legislation is very explicit about transparency and information requirements. Banks and PSPs must provide full transparency to customers before and after a payment is executed (i.e. inform customers of the maximum execution time, all charges payable, provide a breakdown of charges and confirm the exchange rate, if applicable).
Thus, the bank must provide information relating to all bank charges at both ends of the transaction. Not just how much the client will be charged in one country, but how much the receiving bank is going to charge, along with the charges of any intermediary bank involved. Currently, many banks are working hard on their service level agreements (SLAs) with different partner banks in other countries in order to obtain the necessary information on fees required by the PSD.
Complying with the information component of the PSD will require the development of new front-end capture screens capable of displaying data at a granular level. Few banks already possess this type of sophistication and many face the prospect of upgrading their front-end e-banking platforms. This is something that is not likely to happen overnight, and may not happen at all if banks foresee an uphill climb in creating a compelling business case.
In order to comply with these new requirements regarding execution times and transparent charges, banks need to ensure that, if they accept an instruction to make a payment, they will be able to fulfil the contract to deliver the payment in accordance with the terms and conditions offered. In this sense, it will be very important that banks capture all of the information required from customers in order to complete the payment successfully at the front end. As a result, they will need to be confident they capture accurate beneficiary account and routing code (sort code) details.
In the EU, this will increasingly involve the proper capture of BIC and IBAN details, which are steadily becoming the norm for quoting beneficiary account details for not only cross-border payments but also domestic transfers. It is anticipated that the PSD will help to drive wider adoption of these standardised payment details. Banks, therefore, need to ensure they are capable of validating BICs and IBANs, as well as other local bank account and routing code details, bearing in mind that the PSD covers payments in all currencies of the EU/EEA, including sterling of course. This will help businesses and banks maximise straight-through processing (STP) and reduce costs, while complying with PSD.
The last few years have shown that many corporates have been slow to collect IBAN and BIC details from their suppliers. There is, therefore, growing adoption of software solutions, which enable corporates to construct IBANs based on Basic Bank Account Numbers (BBANs), the conventional format of domestic bank account numbers which vary from one country to another.
Undoubtedly, the top global cash management banks will feel obligated to comply with the PSD because of the importance to their payments business. Although the EC does, of course, want Member States to transpose the directive into national law in a very consistent and harmonised way, some aspects of the PSD are optional. In this way every country in the EEA possesses some ‘wriggle room’ for interpreting the PSD, due to the existence of a series of so-called ‘Member State Options’, whereby a number of articles are subject to Member State discretion. As a result, the leading five or six banks will have a lot of work to do since the EEA countries in which they are present may each implement the PSD in a slightly different manner.
Such a scenario creates a considerable challenge for large banks operating throughout the EEA. If a bank maintains a presence in every country, it must ensure compliance within every jurisdiction. But complying with the PSD is worth it for these major banks because the PSD effectively makes a solid business case for insourcing payments from other banks.
The global banks realise that some of the smaller banks (i.e. Tier 2 and beyond) may fear that complying with the PSD will prove too great a task. A number of smaller banks, which may operate solely in one country, and even bigger banks that are less advanced in payments technology, are finding they have to at least consider turning to global cash management banks to outsource their payments. Through such a partnership, major banks can allow smaller banks to use their payment systems and their reach – not just in Europe but beyond – through a white-labelled managed payment service.
Some banks are understandably uncomfortable about outsourcing their payments business to a bank who may one day become a local competitor for their own customers. Alternative models are, therefore, being structured to create bank-agnostic externally hosted white-labelled platforms, which will allow banks to access the necessary technology for achieving an efficient payments and reporting capability. At the same time, such an approach would reduce total cost of ownership, minimise project risk and accelerate time to market.
Make no mistake; the PSD is good news for corporates. The PSD does, of course, create the legal framework for SEPA and the harmonisation of payments across the eurozone, but, because the directive covers all EU currencies, it has a much wider remit. The PSD sets out rights and obligations for users and providers of payment services throughout the EU/EEA with the aim of creating a legal framework from which a bank client could take legal action against a bank to enforce their rights.
One of the things corporates should bear in mind is that through this directive, they now have more rights. This does not need to translate into courtroom litigation. Taking advantage of new-found rights can be something as simple as voicing their expectation – strongly – that a bank should comply with the PSD. But before corporates can demand – and expect – compliance with the PSD, there is an immediate need for greater education.
At the recent Association of Corporate Treasurers (ACT) Cash Management Conference in London, the head of payments & cash management at a major UK bank asked the audience about the level of interest in the PSD. Most participants shook their heads, effectively indicating that they were probably not aware of the breadth of the legislation or simply did not understand the impact on their business.
For corporates, the PSD will increase competition between banks and ultimately force banks to offer better deals on payments within the EEA It will also allow corporates to better manage cash flow. Not only will they be able to reduce costs because bank charges are lower, but there will also be fewer claims for additional fees later, thus creating bank charges that are clearer and easier to understand. Ultimately, the PSD will encourage greater standardisation, similar to the strict rules regarding the use of BIC and the IBANs in order to improve STP.
At this point in time, the PSD is comparable to a stage in the Tour de France, when a lone cyclist inevitably sprints ahead, forcing the entire peloton to react with great urgency and speed. Today, the banks are in this scenario – watching each other and waiting for someone to make a break. Perhaps one or two of the big banks have edged slightly ahead but they are well within reach, enabling the peloton to follow closely neither exerting too much effort nor spending too much money.
It is surprising that in today’s global markets when information and international communication are available at the click of a button, the world of cross-border payments is still so opaque. Speaking about international payments, a large corporate recently mentioned to me that it is not uncommon for their organisation to learn three or four weeks after a payment has been initiated that additional charges have been taken by the remitting bank because charges which the bank in the receiving country applied were greater than the fees the sending bank was expecting to pay. It is therefore a great relief that the PSD has the potential to bring greater transparency and efficiency to cross-border payments and strengthen the relationship between banks and their corporate clients.