SEPA is One Year Away: What’s the Risk View across the Payment Processing Chain?

Looking at the overall market for payments, in the light of the single euro payments area (SEPA) migration end date of 1 February 2014, the next 12 months will see a speed of migration unheralded in global terms. Based on the European Central Bank’s (ECB) November 2012 ‘readiness’ statistics, it will see traffic of some 4.5bn credit transfers and 10bn direct debits migrating to the SEPA schemes. This means each payment processor as well as each payment initiator in the SEPA region needs a migration strategy and execution plan.  The latest gtnews Payments Survey also gives a good indication of treasury readiness, or otherwise.

The final scope of SEPA migration is being firmed up imminently, with 1 February 2013 the legal date by which national payments bodies need to notify the European Commission (EC) of specific minor local payment instruments, which may be exempted from the 2014 end date, and the confirmation of conversion services that banks may provide in the retail sector to promote migration to corporates, public bodies and others.

The level of bank readiness is demonstrated in principle by the current high degree of reachability across the SEPA credit transfer (SCT) and direct debit (SDD) schemes. Given that the European Commission (EC) regulation 260/2012 governing the migration end date puts a significant onus on payment initiators, the nature of the migration challenge over the next 12 months is very different for banks than for their customers. For the banks it is largely a matter of ensuring scale in processing while maintaining customer service and managing country-specific issues. On the customer’s side, however, any ‘in scope’ bulk payment submissions must be migrated to SEPA extensible mark-up language (XML) mandatory standards, including the population of additional data elements – which may include direct debit mandate information not currently held by the customer.

The bottom line for corporate customers is to own your migration to SEPA payment instruments.  This article aims to help that cause, by analysing the migration risk view across the payments processing chain and proposing key metrics to monitor during migration.

High Level SEPA Processing Chain

To ensure control of your SEPA migration effort, an end-to-end view is required. You have only successfully migrated if and when the payment has reached your receiver in the intended manner, and SEPA payments are reaching you in the manner intended by the sender. An understanding of challenges in the bank-to-bank space is useful, in assessing your end-to-end migration risk.

The payments value chain for SEPA shown below in Figure 1, for outbound payments or collections, starts with your submission to your bank. In certain localities this could instead be your domestic automated clearing house (ACH) payments processor – for example Equens in the Netherlands – although there may be restrictions to maintaining this model in SEPA, which are beyond the scope of this article.  Given the requirement to migrate to SEPA payments, there may be a migration service provider who can be used to intercept the payment flow, re-format and enrich your payment files to make them SEPA-compliant (more on this in the next section).

In the bank-to-bank space, payments are processed, validated and settled in bulk at bank identifier code (BIC) level.  If your bank is not a direct participant of the European Banking Association’s (EBA) SEPA clearing celaring scheme – the EBA being the only clearing house with direct pan-European reach – there may be another bank or processing provider between your bank and the receiving bank; adding delays and potentially processing errors.

Figure 1 below shows the three core areas of migration risk in the bank-to-bank space and those for the corporate-to-bank space; both described in greater detail below.

Figure 1: Payments Value Chain for SEPA.

Source: Luka Miliša

A Customer View on Bank Readiness:

As indicated above, the three main considerations for banks will be:

• Processing scale.
• Country-specific processing.
• Customer service.

Processing scale challenge: Processing scale will be a significant challenge for some banks, for two reasons:

• Early tactical solutions for SEPA processing are not scalable. During the global financial crisis peak in 2008-09, when decisions were being made over investment into SEPA, a number of banks opted to defer investment in order to conserve capital.
• The business case for implementation of a scalable solution will include a level of operational or technological consolidation, increasing the scope and complexity of delivery and threatening regulatory SEPA migration end dates.

That said, if the investment was well-timed and well-executed, these projects should be starting to focus on minor improvements based on specific customer requirements and country-specific services. However, as often happens with technology, implementation dates only shift in one direction – further into the future – reducing the functional richness of the final product. In simple terms, this means that some regional banks will not have full customer propositions across their eurozone footprint in place to support mass migration this year. In these cases, regional banks will focus on their home or ‘core’ markets to the detriment of specific local services in those eurozone countries which are not significant bottom line contributors.

A special consideration should be given to those banks headquartered in the UK, US and other regions outside the Eurozone, with proportionally smaller branches or subsidiaries inside the eurozone. Often, a country-specific effort and funding would be needed for SEPA scalability and migration projects in these bank branches and subsidiaries, and in trying to keep costs down they may deliver solutions which are not reflective of the bank’s overall brand or scale. If your bank fits this category, you would be well advised to seek not only verbal assurances, but also early ‘live proving’ payment runs to test the correctness of processing yourself. To ensure these runs are useful, check that the receiving party is able to validate the correctness of processing on their side, and equally, test the inbound SEPA payments flow with an interested customer.  The key performance indicators (KPIs) indicated later in the article can be used as a useful ‘cheat sheet’ for testing correctness.

Country specific processing and customer service: There are two flavours of country-specific processing:

• Additional Optional Services (AOS) registered with the European Payments Council (EPC), which include several services designed to mimic current domestic processing and additional customer rights in the domestic payments market – for example use of the Greek character set in the Greek market.
• Country-specific business rules; while not explicitly lodged as European-wide AOS, there are a number of local services present in current domestic payments infrastructures. An example is the switching service (overstapservice) in the Netherlands and Belgium, designed to ease the process of changing bank accounts for retail customers. This gives the customer the ability to instruct their previous bank to redirect payments and direct debits from their old account to the account now held with their new bank. Another example is salary processing in the Spanish retail market, where salary payments are identified by a specific scheme code, allowing the retail bank to include specific salary information in credit decisions. While XML allows for optional definition of the payment purpose, there is currently no specific agreement on the use of this field in Spain.

While each of these challenges is relatively detailed and specific, it has the potential for impacting your employees’ salary payments, or supplier payments not reaching your beneficiaries, indicating areas of SEPA migration risk which you need to address with your bank.

As well as support for local market specificities, a specific service level which has emerged as an area of competition is cut-off times for payment submission. Because of the market infrastructure design where multiple banks and clearing houses are involved in processing the transaction, those banks with the most direct reach to other banks will have a significant advantage and could offer you more time to achieve the required payment value dates.  Further KPIs relating to customer service are shown later in the article.

Corporate Readiness Challenges

Most significant payment submitters, namely major corporate treasuries and government institutions, already have SEPA migration plans in place and will be ramping up their efforts during 2013 along with their banking partners. A December 2012 Eurofinance survey supports that view, showing 52% of companies polled are in the process of mobilisation, with only 12% still to make a start on their SEPA migration projects. While those in both categories need to act with utmost urgency, overall the figures show good progress. the gtnews Payments Survey shows that 37% are not ready.

The three core areas of migration risk for corporates are:

• XML submission: Ensuring your bulk payment files are correctly formatted and that the content is sufficient to allow you, your bank and the beneficiary to maintain processing and reconciliation levels.
• BIC /International Bank Account Number (IBAN) enrichment: Making sure that on all euro payments you are able to identify the bank account by the BIC and IBAN. Now is the time to make sure that each of your suppliers, employees and payment beneficiaries has provided you with the required information. Bear in mind that any organisation in the SEPA is legally required to include BIC and IBAN on invoices.
• SEPA Direct Debit (SDD) mandate information: SDDs requires the creditor to manage and store direct debit mandates. In some SEPA markets this is a change compared with the domestic direct debit. Bridging this gap would require both a migration (of existing mandates to SDD mandates) and a change in business process (with technology change) to ensure you can fulfil your regulatory obligation. In some domestic markets, such as Belgium, the local banking community has provided automated services to assist the migration effort.

While there are a number of excellent offerings in the market to provide value added services to assist with each of the above, the EC regulation firmly places accountability over the initiated payments in the corporate’s court. This means that even where you ‘outsource’ this effort, correctness of the output remains the treasurer’s responsibility.

Corporate Payments Opportunity

The regulation mandating SEPA migration end dates establishes minimum requirements for payment services providers (PSPs) to process SEPA-compliant messages.  Two key requirements will enable further efficiencies across your payments made in the SEPA:

• Ability to quote reference parties to support payments-on-behalf-of (POBO) structures; enabling users to both receive payments and send payments with clearer identification. This supports payment factories and shared service centres (SCCs) processing.
• Requirement to pass on all remittance information on XML data elements received from the submitter (up to 140 characters), through to the bank of the receiver.

To employ this capability on inwards payments (i.e. receipts from customers), make sure to tell your customers how to format payments correctly on invoices, alongside the BIC and IBAN which you are already providing, or similar documents preceding the payment.

Until now not all organisations have been able to do this, as legacy internal system constraints and legacy payment messaging in domestic schemes prevented the same level of information richness. As this requirement opens the door to richer and more meaningful information being attached to the payment, the process of reconciliation between the payment and its underlying business transaction is made easier.

KPIs for Migration Health

In preparation for migration to SEPA payment instruments, you will be tracking specific statistics relevant to getting ready, such as the percentage of customer direct debit mandates held in each country of operation in SDD format, percentage of supplier accounts in your enterprise resource planning (ERP) system identified by BICs/IBANs and percentage of BICs/IBANs on the payroll system, or similar in the case of pension, benefit or dividend payments.

However, once you reach an acceptable level of readiness internally and start processing SEPA payments, the following metrics should be necessary in tracking the success of migration. For each KPI, establish the target for the metric from your current processing.

For both inbound and outbound flows:

• Level of returns and rejects: For outbound payments, are you getting more payments rejected by your bank or returned by the beneficiary bank?  For inbound payments, you may also monitor the number of invoices as your bank may return an inbound payment and would be unable to advise you that has happened (otherwise you would have received the payment).
• Reconciliation/quality of remittance information: Are your systems hitting the same automated reconciliation levels as with the legacy payment types?
• Speed of processing (value dates): Both SCTs and SDDs adhere to strict value dating schemes, which may differ from local payment instruments. To avoid payments arriving late to your beneficiaries make sure you clarify timelines with your payments processor or bank.
• Billing correctness: Is your bank applying correct charges for the services provided?
• Statement and advice correctness: Is your bank providing full unaltered information on statements and advices?

The first two of the above could particularly cause significant operational issues as even a single percentage point deterioration in straight-through processing (STP) for domestic payments across a significant volume will impose significant and unsustainable operational overhead.  This drives a requirement for a slow and steady migration in multiple tranches, rather than a ‘big bang’ approach.

Conclusion

As the migration to SEPA payment instruments nears its final stretch, the challenge is shared between payment initiators and their banks or processing partners. The EC regulation by design places an onus on payment initiators to drive the pace of migration. As treasurers drive their migration effort forward, it is important to understand what others in your industry are doing to meet these challenges.  There are advantages in co-operating with others in the non-competitive aspects of compliance to ensure a standardised interpretation and implementation of the regulation.