Payment systems take to cyberspace

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Banks’ customers, from the corporate to the individual, demand payment systems that are quick, standardized and reliable. But the growth of the internet and other new technologies has stimulated the creation of payment systems that leave banks out of the equation altogether. By Jack and Wolfi Large.

Supplement: Technology in Treasury Management Guide

by Jack and Wolfi Large

The overall efficiency of business transactions is becoming ever more important. Payments and collections are a small, but non-the-less vital part of business transactions, as the order-to-cash cycle described in Figure 1 shows. Although some payment systems already enable companies to improve efficiency and cut the cost of processing, some new systems and services go even further, not only increasing demand in existing markets but creating new ones. (See figure one).

This article describes how the drivers of corporate treasury and lobbying by treasury associations are forcing the pace in the development of payment systems, and reviews developments in payment systems around the world.

Corporate treasury lobbying

Corporate treasurers are forcing both banks and regulators world-wide to listen to their demands by persistent and dedicated lobbying through their national associations and regional treasury associations, such as the European Association of Corporate Treasurers (EACT) and International Group of Treasury Associations (IAGT). They are focusing on electronic payments and payment standards because corporate needs vary depending on the type and size of a company. Between regions, the payments industry is highly fragmented and moving in different directions.
 
The treasury associations are concerned about the plethora of payment system standards and are encouraging convergence and unification wherever possible – for example, in the development of the UNIFI (ISO 20022) standard for XML payment initiation messages. They are also encouraging the development of XML standards to help automate the financial value chain, particularly the automatic reconciliation of accounts receivable and accounts payable transactions.

Companies of all sizes from all around the world and from all industries are influencing payment system development by their common approach, automating payment and collection processing, centralizing and setting up regional or in some cases global shared service centres/payment factories and forcing the banks to provide low-cost, efficient, multi-country mass payment services.

SEPA: problems and opportunities

The single most important development in payment systems for banks at the moment is the Single European Payments Area (SEPA). In 2002, 12 countries adopted the euro, but the large majority of euro payments are still processed nationally, with almost no pan-European payment and clearing systems.

Since 1999, when the European Monetary Union, with nearly 30 separate national payment and clearing systems, was launched the European Commission has been driving the banks to develop pan-European systems for citizens and businesses to make cross-border payments as easily, safely and efficiently as they can within their own countries and with identical charges. A development programme has now been agreed.
 
In March 2005 the European Payments Council (EPC) committed to the SEPA development timetable and roadmap, described in Figure 2, and, with its Crowne Plaza Declaration, to its being implemented and deployed by 2008. Banks and national organizations are to take care of the implementation of the SEPA deliverables in close cooperation with public authorities and other stakeholders. Gerard Hartsink, EPC chairman, says: “We have proved the capacity of the banking industry to act, for example with Credeuro in 2002. We will need the full support and encouragement of the regulators within very clear objectives, which we can all stick to. The common implementation approach of the euro system and banks and of the other stakeholders is indispensable to realize the 2008 deliverables on time.”
 
And so the Euro-zone is slowly moving towards its goal of fully harmonized payment processes and systems. Already, from January 2006, payments of up to g50,000 can be made cross-border for the same cost as a domestic transfer.

The publication of rulebooks and the EU Payments Directive has required massive effort with so many interested parties. The scale of what is being attempted is enormous and the difficulties of achieving the long-term target of having a new pan-European Automated Clearing House (PEACH), and pan-European debit card scheme fully operational by 2010 should not be under-estimated.

There will eventually be significant benefits from the new SEPA payment systems and infrastructure, but companies will need to make considerable investment to exploit them fully. Finance directors and corporate treasurers can see the future benefits but their problem is what to do now. Philippe Lambrecht, general manager, international cash management, at KBC Bank, advises caution: ‘‘If I was a corporate treasurer today, I would not initiate major changes in operations but leave things as they are. I would closely monitor what is happening in the SEPA landscape and wait until the XML standards and messages are full embedded and supported by a whole range of banks in the Euro-zone. Then, and only then, I would go for full concentration of all payments and collections in the whole Euro-zone through one gateway and from a single bank account.”

To help finance directors and corporate treasurers, Euromoney asked four leading banks in Europe, ABN Amro, KBC Bank, JP Morgan and Royal Bank of Scotland, the three things they would recommend companies do now and in 2007/08, as shown in Figure 3. The recommendations reveal quite different approaches by the banks. The one thing they agree on is that companies need to have a strategy for how best to exploit and manage the introduction of SEPA.
 
Although its introduction will herald a significant reduction in payment system revenues, most banks expect a positive business impact. As they are also expecting a significant concentration of the payment and collection business to achieve the economies of scale necessary to remain profitable, this clearly cannot be so. We could be heading for major over-capacity, forcing some banks and national payment systems out of the business. Companies will need to choose their system providers very carefully.

Few banks are certain of the impact SEPA will have on their branch coverage and partner banking arrangements in the region, but banks with full domestic networks in the SEPA countries believe they will probably retain their branches. Those using partner banks are reviewing the situation. The only certainty is that changes are inevitable.

Payment timing and guarantee critical

There is a general move in companies to classify payments as urgent or non-urgent. Because of the increasing use of shared service centres and payment factories, says Alan Koenigsberg, JP Morgan‘s vice president and product head for in-country and global ACH treasury services: “What our corporate customers really want is faster and cheaper payments and collections, and for us to make or collect them on time, wherever they require worldwide.” Urgent payments are increasingly made via same-day clearing systems (SDCSs) and non-urgent through local automated clearing houses (ACHs).
 
The only other issue is whether a payment needs to be guaranteed or not. Consumers and companies are increasingly using guaranteed same-day payment services. More than 20% of payments in the UK’s CHAPS Sterling service, for guaranteed same-day payments, are for less than £1,000.

The growth of on-line purchasing on the internet, where suppliers need real-time, guaranteed payments before dispatching goods, is increasing the demand for this type of service. But, because internet purchasing is a low-cost model, a key driver for internet payments is that the cost of the services they require must be significantly lower than the charges made by today’s SDCSs. The UK banks are developing such a system, which will also cater for payments originated from telephone and internet banking channels.

In December 2005, after much negotiation and heart-searching, the contract was awarded to Link Interchange Network, which runs the UK’s main ATM network, and Voca, the UK ACH, to build the new Faster Payment Service. The hybrid system that Link and Voca are building, which will be operational by 2007, brings together Link’s real-time single-message switching and clearing expertise with Voca’s high-volume direct credit clearing expertise. The full functional specification has not yet been finalized but it will provide a retail SDCS that is considerably cheaper than today’s. It is expected to offer an irrevocable payment guarantee to give internet merchants confidence in the service.

This model, combining the core functionality of the local real-time ATM/point of sale (POS) system with the local ACH’s functionality, could be used in many other countries, though persuading the banks to integrate with it might be challenging. However, senior bankers in other countries are talking about it.

The bulk of non-urgent non-cash payments are made by cheques and ACHs. The large international cash management banks’ multi-country mass payment services, which use national ACHs, are growing very rapidly.

Deutsche Bank’s db-WorldPAS service, for example, covers 38 countries and transaction volumes have grown by 63% annually over the past five years. JP Morgan’s Global ACH Product covers 27 countries outside the US and has experienced a 60-fold increase between 2002 and 2005. It is now servicing large customers domestically within Europe and Asia as well as cross-border.

New services are being introduced that will expand the impact of mass payment services. JP Morgan’s new internet-based mass payments platform, which is already live in the US and Australia and is being rolled out in 12 additional countries over the next year, caters for a wide spectrum of client requirements, from middle-market companies to large corporations with decentralized payment initiation needs. Says Koenigsberg: “In-country origination of mass payments is still very much a reality as the gap is bridged between where we are today and what pan-European ACH promises for the future and will be required for many years to come in other regions of the world.”

These new payment services are designed to use whatever national or multi-country payment system is appropriate. Deutsche Bank’s  head of product management, global cash management, Andrew England says: “Our mass payments proposition leverages our connectivity to downstream ACH infrastructures as well as our proprietary competency around formats and conversion technology.”

Automating the supply chain

For companies, the automation of the financial supply chain is the most important development in payment systems. It is by no means easy and can take years, and many attempts, to accomplish. It took three years for one high-tech company to refine the order-to–cash cycle described in Figure 4. But when all aspects of the cycle have been improved significant savings can be made. This company saved more than $250 million in working capital and cut its processing costs by 60%.

One of the most successful large-scale developments in financial supply chain automation is the Xign Payment Services Network in the US, which fully automates the order-to-pay process and now has thousands of users and suppliers on the system.

And there are many developments around the world. Some focus on individual problem areas, such as invoicing. For example, Checkfree‘s electronic invoice service provides a ‘collective billing’ facility to support billing and payment at any level in an account/subaccount hierarchy so individual users can access specific sections of statements for review, adjustment and payment capabilities.

And more comprehensive solutions are being developed. In Europe Burns e-Commerce, working with a number of different partners, is focusing on optimizing the transport of full financial data throughout the financial supply chain, using the Burns data exchange platform to integrate finance and supply chain data. It has a live automatic account receivables matching pilot with Hewlett-Packard and Office Depot, shown in Figure 5.

Burns is adding bank statement reporting and supply chain financing to the service. The long-term aim is to overcome the lack of standardization in corporate-to-corporate and bank-to-corporate relationships, and to open up the financial supply chain to new financial instruments. Automation of the whole financial supply chain is coming, but slowly, and for most companies, remains a distant dream.

New opportunities in payment cards

The two major payment card schemes, MasterCard and Visa, with their global networks of more than 24 million merchants and 20,000 member banks, offer a truly worldwide messaging network. They also have payment clearing and settlement systems with single account numbering schemes. All the other payment systems, which are mostly domestic, have different account formats and a separate network (Swift) for the exchange of messages.
 
Card payment systems dwarf all others. In 2005 there were more than 2,500 million payment cards in use, which made well over 55 billion payments with a turnover of over $2,500 billion. In the developed world, almost all economically active adults have at least one payment card and almost every size and type of business accepts payment cards. Yet they are probably the most under-used system for B2B payments.

Both MasterCard and Visa have been expanding their commercial payment services to attract a greater share of the B2B and C2B payment markets. Visa USA has developed a product range that covers almost all business payments, all values of transaction, all numbers of transactions and both low and high volume supplier relationships. It uses a combination of its payment card services, a new large ticket interchange charging structure and its financial supply chain service, Visa Commerce, as shown in
Figure 6.

For both MasterCard and Visa, commercial payment volumes are growing fast, but from a very small base. However, they have been more successful in providing payment services for the internet, where credit and debit cards are the dominant payment method for purchasing online.

Several years ago Visa realized that e-commerce was not going to be limited to the internet, but was going to happen everywhere. It coined the phrase u-commerce, or universal commerce, to describe the ability to conduct commerce anywhere, anytime, over any type of device. Since then, both Visa International and MasterCard have been developing standards, products and services to support this vision.

Already millions of payments are initiated by computers, TV set-top boxes and increasingly by mobile phones. As devices become ubiquitous and are used by enough consumers, payment initiation systems are developed. Ingenico recently developed the world's first-ever terminal accepting payment from an iPod using FM band communication technology, shown in Figure 7.

Although the use of iPods for making payments may well not take off, it is part of a trend for non-bank devices to control and initiate payments, changing the scope of payment systems and creating the need for u-commerce standards.

The biggest revolution

Although banks are getting very excited about SEPA, and the automation of the financial supply chain is very important, the biggest revolution in payment systems is happening outside the banking systems. Some developments are different in the extreme, unorganized, just happening, such as the use of mobile phone units for bribes in Eastern Europe and Africa.

Value, ‘e-money’ is being electronically stored and exchanged without recourse to banking systems. New payment systems do not need banks, but store value in accounts on remote servers and other media, as shown in Figure 8.

And they are creating their own new markets. All the major mobile phone systems now allow account holders to pay for services from their monthly accounts, creating new markets for sports information and so on. The SmartVoucher scheme in the UK has enabled those who do not have a bank account to buy goods and services on the internet, satisfying a new demand.

One of the biggest systems is PayPal, with nearly 90 million accounts, or 30% more than American Express. It is operational in 55 countries, in six currencies (US, Canadian and Australian dollars, euros, sterling and yen). More than 40,000 merchants worldwide are willing to accept payments from PayPal accounts. No bank account or payment card is required. Compared to Visa and MasterCard, PayPal is still small.

But the infrastructure it has developed shows the scale of its vision. There is already a PayPal ATM/debit card for use in stores in the US, PayPal payments can be made from mobile phones and PayPal account holders can move their funds direct on to the money market. Given the scale and speed at which internet shopping is developing, payments from PayPal to PayPal accounts could become significant.

And this is nothing compared to Google. The scale of the opportunity can be estimated using the Google Map service. Find the map showing where you live. Request details of the nearest restaurant or business and you will be presented with a list you can click on to get through to it. Imagine the impact of a linked, dedicated payment system. Google is developing one, although no details are available yet. And Google Earth. Imagine. The possible impact of non-bank payment systems is scary.

Payment systems are developing rapidly in many ways, scary and otherwise. But the key to successful developments continues to be, and is likely to remain, the improvement of overall business efficiency and the opening up of new business opportunities. The devil is in the detail.