The European Committee (EC) is preparing legislation for the migration of domestic payment and collection products to the single euro payments area (SEPA) Credit Transfer (SCT) and SEPA Direct Debit (SDD) schemes. In December 2010 the EC presented a final proposal for a regulation. This regulation does not follow the European Payments Council’s (EPC) SEPA Rulebooks, but defines the ‘technical requirements’ to which the processing of credit transfers and direct debits in euros must comply.
Establishing the scope for which payment transactions the regulation does and does not apply is essential. The regulation of December 2010 included urgent customer transfers; however this was an unintended inclusion. Card transactions at a point-of-sale (POS) were also unintentionally put into the scope of this version of the regulation, in an effort to include the German ELV transactions. The EC Regulation has now been adjusted to exclude these transactions.
However, the June 2011 unofficial version of the regulation still impacts a number of payment flows, which most banks are not aware of. Banks could face potentially significant consequences, with huge additional investments required, while adherence to these regulations does not result in real benefits to the market and the banks themselves. It is highly questionable whether the EC Regulation will and, more importantly, can be adjusted to exclude these payment flows.
Flow 1: Internal Payment Processing
One of the technical requirements in the regulation states that a payment service provider (PSP) should use message formats based on ISO 20022 XML standard when transmitting payment transactions to another PSP. The main purpose of this requirement is that payment transactions are exchanged in a uniform format between banks and payment systems, thus help to achieve mutual interoperability.
But what does it mean by ‘another PSP’? When transmitting payment transactions to a different bank or clearing house, there is clearly another PSP involved, but according to the Payment Service Directive (PSD), two different legal entities of the same bank must also be seen as two separate PSPs.
This would imply that a bank should use ISO 20022 XML formats when processing payment transactions between different legal entities of the bank. As the following examples show, a wide range of internally processed transactions could be affected by this requirement, for example:
- On us’ credit transfers and direct debits between payment accounts of different legal entities of the bank.
- Internally processed cash management transactions between payment accounts of the same customer, held within different legal entities of the bank.
- ‘On us’ credit transfers and direct debits between payment accounts of the same legal entity of the bank, which are internally cleared via a different legal entity of the bank.
Many large banks, but also co-operative banks, will be faced with this situation as their organisational structures consist of different legal entities. It is probable that most banks do not use ISO 20022 XML formats when transmitting internal payment transactions between their different legal entities. This change will require huge investments from a bank, while on the other hand it remains unclear who would benefit from this change.
The customers of the bank would notice no differences in payment processing as result of the used format, so long as all the required data elements are always passed on in internal payment transactions. As no external payment services providers are involved in the processing, the change to ISO 20022 XML formats for interoperability purposes is in this case irrelevant.
Flow 2: External Payment Processing
Banks haven’t questioned the inclusion of the ISO 20022 XML format requirement in the regulation when transmitting payment transactions to other banks and clearing houses. This requirement, however, impacts the external payment processing of banks more than most banks currently foresee, particularly when MT103 formats are used. A few examples are:
- MT103 conversion services for the exchange of SCT transactions that large banks offer to smaller banks will no longer be allowed when both banks are located within the EU region.
- Cross-border transactions between EU Member States with cost option OUR can no longer be executed. The EC Regulation does not prohibit the usage of the OUR option itself, but no bank supports the exchange of OUR payments in ISO 20022 XML format at the moment.
- Re-account services, which large network banks offer to other banks in order to provide access to local clearing houses for their corporate customers, can no longer use the MT103 format for the initiation and receipt of payment transactions when the bank and its customers are located within an EU Member State. The local payments will migrate to SCTs and the exchange will have to be in ISO 20022 XML format.
Flow 3: International Cash Management
The EC Regulation could also affect international cash management transactions with third party banks. When these transactions are not settled via a large value payment system, the MT103 format may no longer be used. Furthermore, the request for transfer via a MT101 message can be seen as a payment order according to the definitions of the EC Regulation.
Two requirements of the EC Regulation will impact this request for transfer:
- The IBAN must be used as account identifier. MT101 messages that still use the BBAN as account identifier will have to be changed to include the IBAN.
- When multiple requests for transfers are included in a MT101 message, this message will also have to change to ISO 20022 XML format as payment orders that are bundled for transmission require the usage of this format. A temporary exemption of this requirement is possible until 1 August 2016.
Essentially, the required change of format for multiple MT101 messages has no direct advantage for the customers, provided that these messages include the IBAN as account identifier. The fact that the single MT101 message and the multiple MT101 message for customers outside the EU region will still be allowed, is furthermore hard to explain.
However, banks must bear in mind that when the multiple MT101 message is currently supported as customer to bank format, their customers can request the use of ISO 20022 XML formats as replacement. According to the EC Regulation, banks will be obliged to grant these requests.
Are the Effects Counterproductive?
The main purpose of the EC Regulation is to force the migration of domestic credit transfer and direct debit products to SCTs and SDDs, thus creating an integrated market for electronic payments (e-payments) in euros, with no basic distinction between national and cross-border payments. Both EU citizens and businesses will benefit when this is accomplished. Banks will also benefit from this migration as systems for the processing of ‘legacy’ products can be phased out.
The EC Regulation recognises that one integrated market for e-payments can only be accomplished when technical interoperability between payment service providers is ensured. The EC Regulation therefore requires the use of standardised messages, i.e. ISO 20022 XML messages, between PSPs. This requirement is in itself correct, but the scope of this requirement affects more payment flows than the EC Regulation was initially set up for.
In particular, when the internal payment processing of a bank must comply with this requirement, no real benefits will accrue either to the bank or their customers. The bank could be faced with huge investments in order to comply with this requirement. This can only lead to higher processing costs in the long term, while one of the reasons for creating an integrated market for electronic payments was to obtain lower transaction pricing.
In view of the above it would seem that the consequences of the current EC Regulation can’t be the true intention of the EC. The final decision is expected later this year. With regard to the internal payment processing, the EC should be encouraged to make the necessary amendments to exclude the explicit use of the ISO 20022 XML formats when processing payment transactions between different legal entities of the same bank. If this should prove to be impossible, then leniency on the part of the competent authorities would be appropriate on this point.
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