SEPA: From Compliance to Innovation
With SEPA fully effective from the start of this month there are opportunities for banks to re-evaluate ‘tactical’ operating models. This means moving from compliance to innovation, fully leveraging the efficiencies that SEPA brings and seeking value-adding solutions.
Many banks were caught out by the timelines and scale of the SEPA migration challenge. This came at a time when they were coping with increased regulatory burdens post-2008, pressure on revenues and expenses and reduced investment spending. There was also significant uncertainty regarding how individual and local markets within the euro area would develop additional optional services (AOS) and niche products for SEPA.
In this environment, banks focused on SEPA compliance, mainly converting to SEPA through existing infrastructure, operating models and correspondent banking partners. The time pressures that banks have been operating under and uncertainty over the development of niche local products led to sub-optimal solutions being adopted.
The status quo will not be maintained under SEPA, particularly when it comes to the correspondent banking landscape. ‘One size fits all’ will no longer be enough in determining how correspondent banking models evolve into the future.
This is because there are three distinct categories of banks affected by SEPA:
How these banks adapt their operating models and processes to deal with SEPA instruments will differ, with a partnership approach potentially bringing significant benefits across all scenarios.
Banks within the euro area are under pressure to reduce costs as economies struggle to emerge from the region’s post-2008 sovereign debt crisis. Many of these banks do not have the investment capital available to embark on SEPA transformation projects and develop new SEPA-based products and services. For these banks direct membership of low-value clearing systems may not be a strategic priority; hence they will be looking to outsource SEPA processing.
Non-euro area EU banks are still developing in terms of how they access SEPA as the deadline for compliance for such banks is 31 October 2016. There is an opportunity for these banks to develop their SEPA strategies and the services they will offer to customers. While they are already using existing SEPA partners in the euro area, they may be limited to sending or receiving SEPA credit transfers (SCTs).
A mandatory migration to eXtensible markup language (XML) solutions by October 2016 is likely to require these banks to expand their capabilities, triggering a move into SEPA direct debit (SDD) solutions, which are available through the same XML connectivity.
The need to have a full set of SEPA services in these non-euro countries will become more pressing over time, as SEPA itself facilitates the single market and more cross-border trade in the euro. This will make it increasingly important for these banks to partner with the right transaction bank, committed to this SEPA space and able to offer the full suite of services and the right value-add.
The final category – that of international banks based in countries outside of the EU – was recently addressed by the European Payments Council (EPC), the coordination and decision-making body of the European banking industry in relation to payments. In April 2014, the EPC published Criteria for Participation in the SEPA Schemes for communities of banks or financial institutions outside the European Economic Area (EEA), in recognition of the growing interest in SEPA from financial institutions in countries outside the EU.
Some neighbouring countries and territories have already joined SEPA schemes, such as Switzerland, Monaco and San Marino. The new EPC criteria address additional countries which can demonstrate economic links and legal relationships with the EU as well as sufficient euro payments traffic.
Beyond the EU
The EPC’s move marks the beginning of the ‘internationalisation of SEPA’, enabling non-EU banks to participate in the initiative on the same basis as those inside the EU. There is a definite aim to expand SEPA to a larger area than the EU; countries such as Turkey, which are heavy users of the euro in tourism and in trade, could theoretically become SEPA participants if they meet the criteria. This would enable banks, and their underlying customers, in the country to benefit from the greater transparency and shorter execution times that SEPA delivers.
This internationalisation holds potential for medium and supra-regional banks to service their clients with local cash management capabilities in SEPA markets. Traditional wire payments may not always meet the requirements of increasingly sophisticated clients located outside of the EU.
Industry guidance had already clarified that banks located outside SEPA should be able to benefit from the low-value, low-cost automated clearing house (ACH) access into Europe. The EPC has now additionally adopted a formal position regarding the expansion of SEPA schemes, laying the ground for innovation and offerings to non-SEPA banks as part of the next wave. However, challenges remain in this space especially around the formalisation of a robust SEPA receivables solution. These will need continued industry and regulatory collaboration.
The Impact of SEPA
SEPA removes one of the most significant cost burdens for banks operating across borders in Europe – the need to operate and maintain myriad clearing house connections or correspondent banking relationships to transact low value cost-effective euro payments. Under SEPA, clearing houses are obliged to provide their users with reach across the euro area for credit transfers and direct debits. This means a bank can use one pan-European clearing house for all its euro transactions.
The rationalisation of clearing house connections and correspondent bank relationships is an inevitable consequence of SEPA and will evolve over time. The rationalisation of clearing house connections is most relevant for those global and regional banks with operations in multiple countries, which are committed to the transactional banking space. This rationalisation exercise will bring efficiency gains to these banks and also significant benefits in terms of standardising their product offering.
Large banks operating many different IT systems and processes in order to cater for different cross-border payments formats have viewed SEPA as a strategic opportunity to streamline their systems and processes. For some, this has meant changing their systems vendors and implementing a new, global payments platform. Additionally, some banks have reduced their nostro accounts across Europe. This will enable banks to realise significant cost savings over time. A number will opt to forgo direct connectivity to clearing houses and instead will select a SEPA partner bank to provide access.
These changes will lead to a shift away from relationships based on local access towards ones that are based on efficiencies and enhanced product offerings. For example, at present local or single market banks, which have a smaller footprint, typically have opted to use partner banks that can provide them with access to low-value clearing systems in different countries. Under SEPA, however, these banks may no longer require such partner banks as they will be able to access all countries on an equal footing via a pan-European clearing house for SEPA.
While this has been a possibility since SCTs were introduced in January 2008, practicalities have prevented a widespread move to such a model. The continued existence of local payment conditions and niche products in certain countries has created a barrier. As these niche products can continue in existence until February 2016 they will continue to slow down the ‘partnership’ rationalisation rate.
Conversely, SEPA is a trigger for banks to use partners on a grander scale as they seek out efficiencies and improved products. The banks that use partners in this way can free-up their resources to focus on more value-added services.
The Case for Partnership
There are some compelling reasons for banks to consider partnership in the SEPA environment. In terms of the regulatory and macro environment, SEPA will affect banks significantly in a number of ways.
By introducing standard direct debit and credit transfer instruments, SEPA represents another step in the commoditisation of payments. Additional factors include the opening of the market to more competition, technology developments and changes in regulation. In the payments space, competitive differentiators will shift towards more value-added services such as electronic invoicing for corporates, reconcilement and payment visibility services to name just a few.
Another impact of SEPA is apparent in the loss of previously ‘protected’ domestic payments flows. Local and single country banks risk losing cash management business as their corporate clients look to benefit from SEPA by rationalising their bank relationships. A local cash management bank is no longer necessary under SEPA, as clearing houses provide reach across the euro area. The larger transactional banks, which can draw on economies of scale, can more competitively service the single market than local banks that have a limited euro footprint.
Some of Europe’s larger banks decided early on that they would use SEPA as an opportunity to insource payments volumes from other banks in Europe. Together with this strategy, these banks adjusted their sales strategies by targeting corporates in markets that previously preferred to use indigenous banks. As SEPA is a single format used for both domestic and cross-border payments, corporates are no longer locked into using a bank familiar with their country´s domestic format.
Commoditisation will also lead to further transaction pricing compression at a time when many banks are struggling to contain costs. The pressure on their revenues, expenses and investment are prevalent in Europe – for some banks, payments may no longer be a viable business economically.
These factors and others will drive them to review their entire operational models to ensure that they are fit for purpose and aligned with strategic priorities in the new SEPA environment.
The Changing Nature of Partnerships
SEPA will have a significantly greater adverse impact on smaller local banks, which will be unable to offset the price pressure and the loss of existing volumes by either attracting new volumes or leveraging internal operational economies of scale to the same extent as transactional banks.
There are multiple benefits for local banks – or those with a limited euro footprint – in adopting a partnership approach with a larger transactional bank. These include reduced ongoing expenses, such as hardware and software maintenance. Additionally, the SEPA schemes involve annual rule book changes, which also require revisions to operating systems. By partnering, smaller banks get to outsource many of the headaches associated with managing the velocity of changes, local practices and emerging AOSs and do not have to maintain the same level of staff to keep up to date with all evolving SEPA requirements.
Partnering is not only about reducing costs; revenue generating opportunities can also be created. Partnerships can give banks access to new or additional capabilities, such as specific schemes in the direct debit space or offerings around AOS in particular countries. Banks also gain access to expertise in implementing SEPA on a pan-European basis.
A partner bank can also deliver standardised services across multiple payments needs in addition to SEPA, which will deliver internal efficiencies that can benefit the bank’s end-to-end client offering.
Successful partnership models are already being established in the SEPA environment. Ireland’s Permanent TSB, for example, leveraged Citi’s SEPA platform and Indirect Participant offering to migrate its domestic volumes to SEPA. Citi provides Permanent TSB clients with full access to the SEPA schemes and processes around 45m transactions annually on behalf of the Irish retail bank. Permanent TSB is therefore able to provide its account holders with the full range of SEPA services. The solution was implemented during the second half of 2013 and the bank’s domestic Irish flows are now routed through Citi London and into the SEPA scheme. This end-to-end solution is seamless to Permanent TSB’s clients.
Outside the SEPA area, Citi has worked with a large regional bank with a substantial corporate client base and significant euro payment flows into Europe. Historically, the bank leveraged low-value payment services across Western Europe and a number of other countries and this was a critical part of its strategy. Due to the discontinuation of the local low-value systems, the bank required a solution to maintain existing ACH services for clients with substantial payments into the SEPA zone.
Citi provided the bank with access to SEPA, using a file-based, host-to-host solution. Full ordering party details pass down the payments chain, enabling the bank to continue to support low-value euro payments to SEPA countries for its corporate clients. This demonstrates how it is possible for non-European banks to leverage SEPA and although the solution was for the migration of existing ACH flows it could be equally applicable for new flows.
Despite delays, SEPA has become a reality. While it is early days the initiative will significantly change cash management in Europe and provide banks with the opportunity to develop innovative new services for clients.
This opportunity, however, cannot be fully realised through the tactical solutions many banks have developed for SEPA. By partnering with banks with scale and expertise, euro area, non-euro area and international banks will be able to access SEPA cost effectively and remain competitive in the new payments landscape.