What EU airport regulators can and should learn from SEPA

"The European single sky". In the wake of the volcanic ash disaster that brought European skies to a standstill, experts are calling for a more united approach across Europe's aviation regulators.

The handling of airport closures across Europe highlighted the fragmented approach that exists among European governments, airport regulators and air traffic control. Commentators now suggest that  a more harmonised approach to air traffic control and airport safety across the EU is needed.

What has this got to do with transaction banking, you may ask? Well efforts to unite Europe's skies reminded me about efforts to unite European payments under the Single Euro Payments Area (SEPA) initiative. And if SEPA is anything to go by airport regulators could have their job cut out for them.

Of course, SEPA not only tried to harmonise existing European payment schemes, but instead proposed replacing them with new pan-European schemes for cross-border credit transfers and direct debits, which end users have been slow to adopt. No one is proposing a new EU-wide airport traffic control system per se, but linking airport traffic control systems across Europe does present its challenges, and one can already hear the national politicking and objections that are likely to emerge as different national regulators and interests jockey for position.

Europe may have a single currency, but it appears that the EU is far from united when it comes to most other things and EU-wide payment mechanisms or airport traffic control systems, are no exception. While these concepts may sound good on paper, in reality they are difficult to implement and are often hijacked or impeded by parochial interests.

Paying the price of electronic payments

Cash is no longer king, despite the fact that for the last decade or so we have heard transaction banks bang on about the supremacy of cash, at least to corporate treasurers that are cash-rich or looking to unlock cash trapped in inefficient parts of their business.

However, a report published by the UK Payments Council, concludes that cash's reign as king is over with cash usage rising just 7% over 10 years and comprising just 59% of all transactions (down from 73% a decade ago), with more consumers using electronic forms of payment such as debit cards, online payments or contactless cards.

Unlike the US, which while declining year on year, still has some challenges in terms of weaning companies and their customers off paper cheques, by 2018 the Payments Council predicts that fewer than 1% of UK payments will be made by cheque.

Yet, with the increasing use of electronic payments whether it is debit or credit cards, ACH or online, comes the increased risk or threat of fraud, particularly as transaction volumes rise. Jim Woodworth, head of business services at payments software provider, ACI Worldwide says financial institutions need to ensure that their systems are able to support the growth in the number of electronic payments, while reducing the risk of fraud.

Nick Ogden, founder and CEO of Voice Commerce, which provides voice authentication solutions for payments, also highlighted the heightened fraud implications associated with increased use of electronic payments whether it is cards or mobile. "The threat of fraud and identity theft becomes more prevalent as hackers get better at cracking these new payment technologies," he says.

This highlights the need for the industry to devise more secure means of authentication, that are cost effective and non-intrusive for the user. So as more payments are made online, banks not only face the challenge of ensuring their legacy payments infrastructure, some of which dates back 30 years or more, is up to scratch, but also that they are able to monitor and detect potentially fraudulent transactions in real time and to ascertain someone is who they say they are when making a payment without the user having to jump through too many onerous hoops.

And as electronic solutions revolutionize the way we pay, are consumers and companies likely to place more onus not only the speed and efficiency with which they can make a payment, but also how secure it is? In other words when we shop around for payment services will security be more front of mind than it has been historically?

Transaction banks vye for a slice of the remittances market

One aspect of the cross-border payments business that global transaction banks have failed to monopolise is remittances. Estimates from the World Bank suggest that the global remittance market increased 63% in the five years leading up to 2009 with more than $550 billion worth of funds remitted by immigrants living abroad in 2008.

Any bank can see the huge revenue potential if they are able to capture a substantial share of the global remittances market. However, the global remittances business is still dominated by non-bank money transfer providers such as Western Union and MoneyGram. One of the reasons for that is that remittances tend to touch the "unbanked" in emerging markets - people that don't have a bank account or ready access to one.

Banks, also being risk averse, have hesitated to enter this space particularly given the onerous regulatory requirements it entails for them in terms of compliance with Know Your Customer (KYC) and Anti-Money Laundering legislation. That perhaps explains why figures suggest that, in the US market at least, there are only about 100 banks that offer consumer remittance services with any meaninful volumes.

Yet, some banks like Citi and Bank of America have made forays into the remittances space, either alone or in conjunction with partner banks to offer consumer remittances at a lower cost than the traditional money transfer agencies.

Deutsche Bank is the latest entrant to this space. While it has no interest in selling remittance services to consumers directly, as part of its growth strategy for its Global Transaction Banking business, this week the German bank announced a strengthening of ties with payments network Eurogiro, which connects postal organisations globally.

Deutsche has taken an 8% equity stake in Eurogiro and plans to expand its offering to Eurogiro's network of postal organisations, post banks and othe financial institutions beyond US settlement services to encompass multicurency services. In return Deutsche gains access to Eurogiro's enviable global footprint across emerging markets without having to build a bricks and mortar presence itself.

Paul Camp, head, cash management, financial institutions at Deutsche Bank says the strategic investment in Eurogiro is part of Deutsche's Global Remittance initiative which combines Eurogiro's reach with the bank's existing capabilities as well as its plans to leverage mobile and SMS.

Camp was coy about Deutsche and banks' overall share of the global remittances space, but said its overall share was quite small  (Deutsche's share of total cross-border payments globally is 5% based on SWIFT traffic volumes) but that it was looking to grow its presence. "However it is not a risk free market," he says, "given the AML and KYC issues."

Deutsche will be relying on the partner banks and postal organisations within Eurogiro to have the right risk controls in place while it will provide them with multicurrency settlement capabilities. It is also working with mobile technology provider Luup to expand its mobile payments capabilities particularly in the B2B space. Mobile is deemed to be a useful technology in the remittances space because it allows people without bank accounts to receive money.

On the whole whoever, both banks and the money transfer agencies have been slow to leverage mobile technologies in the remittances space. They have been pipped to the post by telecom companies like Vodafone which partnered with Safari.com in Kenya to launch M-PESA, a mobile money transfer system which has more than 7 million subscribers.

The banks have yet to clearly demonstrate what additional value they can bring to the remittances space, however, the gloves are off, and Western Union and MoneyGram can expect increased competition from banks, telcos and pre-paid card providers.

Accuracy and quality of payment data

In these credit challenged and uncertain times,ensuring payments are processed on time without the need for manual repair at additional cost, has perhaps never been more important. After all who wants to be on the receiving end of a payment that is held up because it does not contain the correct Bank Identifier Code (BIC) or International Bank Account Number (IBAN), particularly if that person is relying on that payment to finance some other aspect of its business.

In that respect the accuracy and quality of payments reference data has become increasingly important. It should come as no surprise then that the rumor mill has been working overtime regarding a potential tie-up between payment reference data provider CB.Net and Accuity, a leading provider of payment routing data and AML software.

CB.Net's flagship product is its Standing Settlement Instructions (SSI) database, BankSearchPlus, which also validates and links IBANs to BICs, which is important in the context of the Single Euro Payments Area for straight-through processing of payments.

Accuity also has Reference Directories which are used to increase STP in payments and to facilitate the efficient processing of cheques and wire transfers, so the tie-up with CB.Net seems a logical one as banks, regulators and vendors look to make cross-border payments processing more efficient and cost effective.

The 'Project Turquoise' of payments

Lafferty Group has an interesting news story on its web site about European banks being in "secret discussions" to set up a pan-European debit card scheme to rival Visa's and MasterCard's.

According to the report on Lafferty, the banks involved in the discussions are Societe Generale, Deutsche Bank, Dresdner Bank, Commerzbank, ABN AMRO, ING and Rabobank. The report states that they are "unhappy" with the likelihood that MasterCard's Maestro may become the dominant provider of debit card network services in Europe.

The European Commission and the European Central Bank have also expressed concerns about competition in the debit cards space in Europe. The Lafferty report says discussions amongst the banks are in the formative stages and that they are considering leveraging the work already done by the Euro Alliance of Payment Schemes, which has established bilateral links between domestic card processors.

There has been a lot of activity on the card processing side in preparation for the Single Euro Payment Area, with Voca joining forces with Link to give it card processing capabilities so it can compete more effectively with the likes of Equens in the Netherlands. US-based First Data is also looking to become a leading global card processor and has made a number of European acquisitions in the last 12 to 18 months.

Italy's SIA-SSB, the result of a merger between Società Interbancaria per l’Automazione – Cedborsa S.p.A. and Società per I Servizi Bancari – SSB S.p.A., is also a leading European debit and credit card processor with 48 million payment cards issued and more than three billion transactions managed in 2006. It also recently acquired Hungarian card processor, GBC.

The Lafferty Report says that "there are contrasting opinions" on the level of progress achieved by the banks holding the secret discussions, which suggests that not much progress has been achieved at all. This is not the first time that banks have considered setting up a rival debit card scheme, but previously there was not enough support from the banks to do anything.

What is different this time? Well SEPA is in the air, anything is possible, but banks in the payments space have not been as fleet of foot as their investment bank counterparts when it comes to setting up rival market schemes and infrastructures.

We have seen Project Turquoise, a multi-lateral trading facility set up by seven leading investment banks to rival the domestic exchanges in response to regulatory pressures from MiFID. Are we likely to see the 'Project Turquoise' of the debit card world being announced by leading European payment banks any time soon? It seems unlikely.

Still confused about BICs and IBANs?

Following on from my comments last week about the mishandling and confusion surrounding correct usage of BICs and IBANs for eurozone payments, Eiger Systems, which provides a data validation solution for bank account identifiers and international bank account numbers, has added further fuel to the debate by saying that it is not enough to just have the correct IBAN (International Bank Account Number) on cross-border euro credit transfers.

From 1 January this year, the inclusion of BICs and IBANs became compulsory for cross-border credit transfers in the eurozone as well as countries such as Iceland, Liechtenstein, Norway and Switzerland. BICs and IBANs were introduced as a means of increasing the straight-through processing of cross-border payments in euro, thereby reducing the costs associated with manual repair and handling of payments.

Yet, whilst BIC and IBAN information is included on most bank account statements, and has been for some time, there still appears to be a general lack of understanding on both corporates' and banks' part as to correct format and handling of this information.

In my previous post, I remarked on LogicaCMG's survey findings which indicate that banks expect payment processing costs to increase in the first year of SEPA's introduction as they anticipate that not all cross-border transfers will contain the correct account ID information, which means payments will be delayed or require manual repair.

And whilst there are software solutions that enable companies to check the correct formatting of IBANs, Jonathan Williams, principal market strategist, Eiger Systems maintains that the accuracy of the IBAN data also needs to be checked - an extra layer of verification that not all software solutions provide, Williams claims.

There is a world of difference between correctly formatting an IBAN and ensuring that the data underlying the IBAN is correct, or even exists,” says Williams. “Banks and corporates must make this link between format validation and data validation. Only if the data is validated at the same time that the format is validated can corporates hope to avoid repair or rejection charges and the payment delays that inevitably result."

In in its efforts to streamline, standardise and make cross-border euro credit transfers more cost-effective (or the same as domestic transfers), the industry appears to have only added an additional layer of complexity for customers.

Can the industry safely say that it has gone out of its way to adequately educate customers and banks about the correct use of BICs and IBANs? More importantly, are companies likely to face increased costs and inefficiencies pertaining to cross-border euro credit transfers post-SEPA because of incorrect account formatting?

Processing costs could rise under SEPA

Following on from the confusion amongst US companies about the use of BICs and IBANs when sending cross-border payments to the eurozone under the new SEPA framework, research commissioned by LogicaCMG, indicates that banks anticipate increased costs from incorrect addressing and routing of payments post-SEPA. And guess who is going to have to pay for that - undoubtedly the banks will pass on the costs to customers.

Based on a survey of more than 100 of the top 500 banks in the eurozone, as well as the UK and Sweden, Coleman Parks which conducted the research on behalf of LogicaCMG, found that 63% of banks anticipate increased costs from handling exceptions and 60% anticipate an increase in the number of payments returned to the originator.

The banks estimate that failed SEPA transactions and exceptions could cost them in the region of €1.3 billion (presuming an STP rate of 80%) in 2008, based on anticipated transaction volumes in the first year of SEPA's introduction.

Another 17% of banks surveyed expect difficulties in identifying the correct intermediary routing information for receiving banks, yet, according to the LogicaCMG study, only 60% of eurozone banks have plans in place to resolve the issue of IBAN and BIC transaction addressing and routing.

The whole issue of BICs and IBANs has been mishandled from day one, with banks not educating customers enough about the need to include correct account ID information in order to avoid repair costs and payments being held up. Furthermore, the concept of an International Bank Account Number is somewhat of a misnomer given that it is only recognised within Europe, and is not an internationally accepted account ID reference. In the US, for example, the IBAN contains too many characters to be accepted by local clearing systems.

LogicaCMG's findings indicate that the cost of cross-border payments is likely to increase in the months following SEPA's introduction as the number of failed transactions rises. This runs counter to what SEPA is all about in terms of reducing the cost of cross-border payments within the eurozone, and surely the industry only has itself to blame given that there is still widespread confusion amongst customers and banks about the correct use of BICs and IBANs.

The threat of non-bank payment providers

One of the good things about the current spate of private equity interest in financial technology vendors is that it allows analysts and journalists, to indulge in some healthy speculation.

And that is just what Gareth Lodge, a European banking & payments analyst at TowerGroup has been doing since the announcement of private equity firm, Kohlberg Kravis Roberts & Co's (KKR) announcement of its $28 billion bid for payments processor, First Data.

KKR is no stranger to the world of buyouts having already secured in the region of $104.5 billion such deals so far this year. The US-headquartered payments processor is a desirable catch given that its strategy to grow outside its core US business by making acquisitions in Europe, the Middle East and Asia, has helped boost the fortunes of First Data International.

Lodge estimates that First Data has made at least 15 deals or alliances in Europe alone in the last 10 years, including its recent purchase of Polcard in Poland for $330 million.

An injection of private equity capital is likely to aid First Data's bid to become a truly global payment processor, enabling it to finance further acquisitions in the Middle East, Asia and Europe. And despite First Data spinning off money transfer provider Western Union, Lodge believes KKR's investment may also see the payments processor make a bigger play for the international remittances market, which is currently dominated by money transfer agencies and a handful of banks.

It will also 'deepen the pockets' of First Data, which Lodge believes is in a much stronger position financially than European payment processors such as Voca and Equens, to play an enlarged role in Europe post-SEPA.

"Voca is still paying for its core processing renewal ... and even though they had a capital call recently, it hasn't got the kind of funds First Data has, which spent at least half a billion over the last 18 months alone in Europe," says Lodge.

But for us speculators out there, what is even more interesting is the prospect that other bidders for First Data could enter the fray. Lodge says First Data has a clause which gives the company 50 days to find a better offer, which may seem unlikely given that KKR's $29 billion offer, is, according to Lodge, one of the largest private equity buyouts ever.

Yet, Lodge and other analysts at TowerGroup have been wracking their brains thinking of other potential bidders for First Data and the list they have come up with makes the mind boggle. Banks like Citi and RBS which have been linked to the Barclays' bid for ABN Amro cannot be ruled out. However, interest from non-banks like Microsoft, Google and supermarket chains, Tesco and Wal-Mart are also plausible, says Lodge.

Acquiring a payments processor with credit card processing capabilities and a global footprint would be a major boon for these companies, says Lodge. And whilst Tesco has worked with banks like RBS to deliver financial services in the UK, rumour has it that they do not plan on working with RBS outside of the UK. "Either they [Tesco] are trying to find a partner to work with in those regions or Tesco are going to go it alone," Lodge postures. "It [Tesco] is big enough to get a banking license, which would radically change the model."