CSM Interoperability: The Situation in Europe Today

The January 2008 launch of the the single euro payments area (SEPA) Credit Transfer scheme (SCT) has, so far, not altered the European clearing and settlement landscape. There are multiple channels for banks to clear and settle retail and commercial payment transactions within the European Union (EU). In particular, transactions, other than card-based ones or those transactions that are processed on intra-bank/intra-group platforms, are cleared and settled at national level via bilateral arrangements (either informal, or formal involving the national central bank) or clearing house arrangements. Intra-EU cross-border credit transfer transactions are currently settled through a variety of payment systems, including correspondent banking arrangements, and the Euro Banking Association’s (EBA) facilities. In addition, a number of retail and commercial payment transactions are cleared and settled through the TARGET system.

However, the definition of common, pan-European standards (SEPA data models) for credit transfers and direct debits paves the way for a substitution of national standards or, at the very minimum, easier interoperability between systems (bank-to-processor and processor-to-processor). This should make the location for clearing and settling transactions irrelevant – provided a number of features are available. For banks, business requirements and regulators’ demands to guarantee full reachability for SCT and SEPA Direct Debit (SDD) transactions are another driver reshaping the European clearing and settlement landscape.

In this context, achieving economies of scale is becoming a more potent necessity than strictly national considerations, but is now balanced with considerations regarding liquidity. Regulators generally welcome any sign of consolidation in the number of clearing houses as a promise to lower the cost of payment transactions – although the pace and form of that consolidation is still left for the market to decide.

While many would agree with the description of the current situation and the drivers for SEPA migration, obtaining a similar level of consensus with regards to the shape of the infrastructure that in future will support the retail and commercial payments market has proven much more elusive. Apart from the Eurosystem (noting that, in line with the policy declaration issued by the Eurosystem in August 2005, some national central banks participate in one form or another in the clearing of SEPA retail and commercial payments, mostly with the objective of ensuring that there is sufficient choice for banks), there are four dominant situations:

1. Members of national communities who clear retail and commercial payments mostly via bilateral arrangements see little incentive for migrating to a central infrastructure, which would increase their costs by adding an extra layer of complexity, without generating corresponding economies, as generally only a limited number of counterparties are involved. Neither liquidity maximisation considerations nor the necessity to establish arrangements to substitute multilateral interchange for direct debits provide an incentive either.
2. Members of (the few) national communities operating a clearing house with very large volumes generally tended to view the future as an extension of the present and expect their system to attract users from other communities. Full reachability across SEPA is achieved via services branded by the clearing house concerned and agreements with other clearing and settlement mechanisms for delivery of payments outside the clearing house’s area of operations. Interoperability is, of course, essential to achieve this.
3. A pan-European interoperability framework has been formulated and agreed by the main clearing and settlement mechanisms in SEPA. The concept owes much to a project from the 1990s. A number of issues have however not been addressed yet, e.g. what is the liability of each party in the chain, how about compliance with systemically important payments systems (SIPS) principles, how does the model work for direct debit and return transactions? It is anyhow difficult to view this approach as more than a transitional solution – which may well last for the duration of the migration to SEPA.
4. Volumes cleared via the STEP2 platform have grown steadily, and two national banking communities have shifted all or part of their payment traffic.

The crisis has certainly provided additional urgency to the widely shared intellectual acknowledgement that in the future there could be a single (or at most a very limited number of) channel(s) for sending and receiving any payment transaction within (and even beyond) SEPA. This urgency will be instrumental in helping decision makers investigating options that only recently would have been considered taboo. A reshaping of the clearing and settlement landscape is now underway.

In the name of urgency, however, the following dimensions should not be lost – also from the perspective of policy makers:

• Concentration of mechanism providers is certainly unavoidable. In spite of the potential for continued economies of scale, will these always be reflected in price evolution, also as regards indirect participants?
• What place will there be in the future landscape for continued innovation, under which business model?
• Larger clearing and settlement mechanisms will require a bigger say in the definition and evolution of standards. What balance can be found with the requirements of credit (and soon: payments) institutions, and again will the voice of indirect participants be heard?