Cash management: The Sepa revolution quietly creeps in

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Unprecedented co-operation between European banks has, at last, created a single euro payments area. It will transform the cash management business and possibly the whole banking industry. Laurence Neville reports.

Sepa and the PSD: a brief history
What does SEPA involve?
What corporates must do

More Sepa coverage

ON JANUARY 28, 2008, the Single Euro Payments Area becomes a reality. No flags were waved, no confetti was thrown and no Euro-anthems were played. This effort to harmonize national payment systems – seen by some as the culmination of the introduction of the euro and the final stage in the creation of a true single market – debuted without anyone outside the cash management industry even noticing.

Why the deafening silence on such a momentous occasion? To be sure, Sepa has nothing like the popular impact or appeal of the introduction of the euro, which might have contributed to keeping it off the front pages. Perhaps more important, Sepa – although a bank-led initiative – has got bogged down in European Union inertia, resulting in its introduction being staggered, and therefore lessening its impact.

But what about banks, which are at the heart of Sepa? Shouldn’t they be cheerleading its introduction? In truth, an embarrassed hush seems to have descended on some of the leading cash management banks operating in Europe. Having hyped up Sepa and garnered little response from corporates, they have reflected soberly and decided that Sepa should be treated as a marathon – not a sprint.

What is beyond dispute is that Sepa will prompt competition between banks that will change the shape of the cash management business, and possibly of the broader banking market in Europe. It will also – eventually – offer significant opportunities for corporates, both in how they use their cash and, potentially, in how and where they operate. Say it softly then – Sepa really is a revolution.

A slow start

The quiet revolution of Sepa – the first stage of which is the Sepa Credit Transfer (SCT), which launched on January 28 and allows the easy transfer of euros (see What does SEPA involve?) – began with a whimper. “In reality, although most of the main banks are claiming to be ready for the SCT, the deadline is symbolic since very few clients will be able to initiate Sepa payments,” says Martine Goubert, senior adviser in cash management at BNP Paribas, speaking before SCT’s launch. As important, the readiness of banks themselves is questionable.

Gerard Hartsink, chairman of the European Payments Council, the decision-making and coordination body of the European banking industry in relation to payments, concedes that only 4,120 of about 8,000 banks in Europe had signed an adherence agreement confirming their capability to send or receive a SCT a week before it launched. “[But] many of the banks that have yet to sign are specialist vehicles that are not involved in the payments industry – we believe 90% of all banks in the payments business are signed up,” he says.

Although the launch of the SCT is not a big event in terms of volumes, it is still significant for the banking industry. “This is the first time that the entire payments industry is covered by the signing of a document that sets out standards,” says Hartsink. “In the US, the Federal Reserve and leading banks are known to be jealous of Europe’s achievement and we should be proud of it.” In addition, the degree of cooperation between banks has been profound. “Never before have banks in Europe worked together for such a substantial common goal,” says Hartsink.

Christian Westerhaus, head of payments strategies and infrastructures in global transaction banking-cash management at Deutsche Bank in Frankfurt, agrees that the creation of uniform business rules across Europe is a big accomplishment and notes that Sepa is also a remarkable technological achievement. “Sepa involves usage of a new file format based on a global standard called ISO 20022 XML,” he says. Such a detail might sound arcane. However, as Westerhaus notes, EU banks are the first to use what will become a global standard for payment transactions – giving them a competitive advantage.

How will Sepa change cash management?

Leading cash management banks are quiet about their Sepa build-out costs – and the burdens of maintaining legacy payments systems for the foreseeable future in addition to Sepa systems. One observer estimates that Sepa build costs could be “hundreds of millions”. Moreover, as Peter Jameson, Sepa market manager in EMEA cash management at Citi in London, notes diplomatically, there is no prospect of any rapid return on investment. “Our infrastructure has been built for strategic reasons rather than short-term revenue generation,” he says.

The conventional wisdom about Sepa is that the scale of technological change it necessitates will hasten consolidation of the banking industry. The costs of introducing Sepa-compliant technologies – which depend on huge payment volumes to deliver a return on investment – are simply unrealistic for medium-sized and smaller banks. As a result of their inability to adequately service their customers, smaller banks will eventually lose out to large regional and global players.

However, the argument that cash-management business will simply migrate to larger banks is overly simplistic. First of all, it assumes that smaller banks won’t put up a fight. “Payment services are key for banks – everyone wants to keep and increase their business,” says BNP Paribas’ Goubert. “The question is how to improve your offering in order to develop your market share.”

Certainly, local banks will face a competitive threat as existing revenue streams are eroded through regulation and competition. But rather than capitulate, they will instead have to decide whether to build, buy or outsource their infrastructure requirements relating to Sepa. “There is still a substantial contingent of banks that are trying to ignore this reality but more banks are open to considering partnership to address the issue,” says Jameson.

Mike Hampson, head of financial institutions, transaction banking at ABN Amro in London, says that as banks see the revenues associated with payments declining they will focus on their options to a greater extent. “Sepa is just one catalyst for this change and very few banks will have made a decision to outsource prompted solely by the need to be ready for the introduction of the SCT – and there’s no way that the five or six major payments banks could have handled the volumes if much of the market had moved to outsource,” he says. “But it will have started smaller banks thinking strategically.”

So if business is not simply to migrate to the largest players, what will the industry look like in a few years? Jameson believes we should look to the US as an indicator. “In the US, there are still thousands of small banks but they aggregate their needs and buy their services from a handful of large banks,” he says. “Large banks don’t want to service a niche client base but they are in a position to provide white-labelled or outsourcing services for them.”

Weakening the investment case

The challenge of encouraging corporates to prepare for Sepa has been compounded by two factors. The first is corporates’ natural hesitancy to spend money when they don’t have to – there are plenty of other immediate claims on their investment dollars, such as Basle II, IAS and Sarbanes-Oxley. “Sepa is not a compliance issue for corporates, it’s a business decision that they have to make,” says Anne Boden, head of transaction banking Europe for ABN Amro in London. “Whether a company makes that decision now, or defers it, is a commercial decision that will be based largely on the level of advancement of their cash management situation and its immediate requirements.”

For example, if a company is about to open a new office in a European country or begin a new relationship with an Enterprise Resource Planning (ERP) provider, clearly it will move straight to Sepa. "But there is no immediate need for corporates to move to Sepa in the absense of such changes," says Boden. "After all, the existing schemes may work perfectly well for them."

The second, related problem is that the introduction of Sepa has been staggered – weakening the investment case further. Although the SCT transfer has gone live, the Sepa Direct Debit (SDD), which shares some architecture with the SCT, will not be launched until November 2009, and the Cards Framework as yet has no timetable for implementation (see Sepa and the PSD: a brief history).

Additional uncertainty has been caused by national migration plans for Sepa: not all countries have published one and those that have are vague about switch-off dates for domestic payments – a crucial consideration in most corporates’ planning for Sepa. For example, France – which has published one of the most comprehensive migration plans to date – says that it will announce a plan to shut down domestic payments systems once a critical mass of 70% of payments have migrated. But until that date is announced, many corporates simply won’t make the switch.

“The differences in implementation of Sepa and national migration plans comes about because of the different decision-making structures between banks, governments and other stakeholders in different countries,” says the EPC’s Hartsink. “Such a difference was inevitable even if it is not desirable.” Hartsink says that several states are updating their implementation plans and there should be greater clarity within six months, including on what constitutes critical mass.

As if the Sepa investment case was not muddled enough for corporates, the EU’s Payment Services Directive (PSD), which facilitates parts of Sepa and also imposes new and costly consumer protection, should enter member states’ law in November 2009 (see box). It applies to all national payments, including existing payment products, which will co-exist with new Sepa products for the foreseeable future. Most important, the PSD is mandatory and will therefore automatically take priority over Sepa in terms of investment. But working out how Sepa and the PSD interact and how and when to move to Sepa is extremely complex.

“Few clients are ready to press ahead with Sepa now – people are anxious to see what the PSD will bring,” says BNP Paribas’ Goubert. “Budgets for 2008 have already been set and before now it has been impossible to demonstrate the benefits of Sepa to the CFO of a company.” Goubert says that the crucial issue for corporates is when it will be profitable for them to move to Sepa. “At the moment, corporates cannot see the gains when – for the majority of large companies – most payments are within countries and the main banks already provide efficient pan-European cash management solutions for international companies,” she says.

How to sell Sepa to corporates

As Citi’s Jameson candidly admits, there has been a lot of bluster about Sepa, and some banks have been overly bullish in advance of its launch. “Sepa is a hugely positive step but it is not immediately going to be the solution to everyone’s problems,” he says. “A payment is just a payment and clients don’t like to be oversold.” Jameson says that banks need to position Sepa correctly relative to existing automated clearing house payments and explain clearly where it will and won’t work, and when these issues will be resolved. “Clients don’t just need information – they are hungry for advice,” he says.

For corporates with a centralized structure and a single ERP provider that are already sending a file with payments in multiple currencies to a single bank, SCT is just one new instrument to add. But decentralized corporates face changes that could affect their business units, ERP systems and bank relationships. “For these companies, Sepa will be an important catalyst for centralization,” says Jameson.

The key is to align Sepa with corporates’ other broader goals around standardization, rationalization, centralization and technical innovation, according to Jameson. Deutsche Bank’s Westerhaus says that a light touch is necessary. “Deutsche Bank has set the requirements for corporates’ Sepa instructions so that they are as flexible as possible. Once they provide Iban and BIC, their payments can be executed and they will receive Sepa pricing, which could save a medium-sized company several thousand euros.”

Once the confusions surrounding Sepa and the PSD are clarified, the combination of increased efficiency – leading to lower costs – and directly lower costs, as a result of cheaper Sepa pricing, are likely to prove a winning combination. “Critical mass for Sepa may not arrive until 2011 but the pace will quicken in 2009 once the SDD goes live,” says ABN Amro’s Boden. “It is beyond dispute that having one payment method for euro payments will be advantageous for corporates. But Sepa is about long-term gain.”