Letter from Europe: Payments Unification

Events in Europe have an uncanny way of becoming relevant to the rest of the world. That's just one reason that an initiative known as SEPA is worth a close look in 2004.

At the behest of regulators, the European Payments Council intends to unify the national and pan-European payments organizations into a Single Euro Payments Area, or SEPA, by 2010.

Indeed, European banks have been told that they'll have to offer cross-border transactions using the same pricing that they use for domestic transactions. "The implication is that the banks in Europe are going to have to learn to live with lower revenues on correspondent and cross-border business," says Eric Sepkes, vice president and director of global financial institution strategy at Citibank's global corporate and investment bank, and a 30-year veteran of the organization. Sepkes is also a member of APACS and the European Payments Council.

Adding salt to the wounds, the transformation to SEPA will cost plenty. "It puts huge landed costs on everyone initially," says Sepkes. "This is not something where you can turn the lights off today in one environment, switch them on tomorrow, and it's all new."

But from a macroeconomic standpoint, SEPA does have its benefits. Lower revenues for the banks come from lower transaction costs for their customers-and not just European customers. "It is not just for EU citizens or EU corporates," says Sepkes. "The regulation is written to cover any account holder of a euro account in the EU. Even an American entity that has an account in the EU will be covered by it."

Therefore, banks that make the investment to connect to SEPA may enjoy a competitive advantage in the global economy over those that do not. "Companies that don't [currently] have euro accounts in Europe may see some benefit by changing," says Sepkes. "For a dollar account, they don't get the benefit."

2 Requirements

Getting to SEPA will require at least two things: First, the creation of at least one Pan-European Automated Clearing House (PE/ACH); and, second, a standard message format.

On the first task, the Euro Banking Association (EBA) has piloted STEP2, a PE/ACH designed for small-value payments. "Through that one ACH, you'll be deliver payments to any bank within the EU-and therefore to any banking customer," says Sepkes.

Creating the hub is the easy part. It's the spokes that get tricky. "A PE/ACH will use its own payment message format, which is different to the other ones that exist today," according to Sepkes. "Why? Because all of them are different."

That's right: Each country in Europe-even Liechtenstein-has its own ACH system. What's more, none of them is politically suitable for use in a PE/ACH, says Sepkes, "because you'd be giving an advantage to the corporates that bank from those countries."

So EBA was the first to come up with a new format, but that raises another problem. "Ninety-eight percent of all transactions are domestic," points out Sepkes. That leaves the shiny new hub with its pretty spokes handling 2 percent of Europe's payment volume. "It wouldn't be economically viable," says Sepkes. "ACH is about volume-you'd never become competitive."

Thus the eminently logical conclusion: Move the national ACH networks onto the PE/ACH. "Whether we'd need only one PE/ACH is a debate, but you definitely need a single message format," says Sepkes. "But for any PE/ACH to compete, it has to have accessibility to all of the bank accounts in Europe."

Even though 2010 is far off, 2004 is not too early to formulate a strategy. "Banks have been doing an ostrich approach to this issue, burying their heads in the sand and pretending it's not going to happen," says Sepkes. "The regulator has dragged their heads out of the sand. But I don't think they've cleared the sand out of their eyes yet."