SEPA: Impact on structure of payments markets

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1 Banking & Technology Snapshot Digital economy and structural change May 9, 13 Author Heike Mai heike.mai@db.com Editor Bernhard Speyer Deutsche Bank AG DB Research Frankfurt am Main Germany marketing.dbr@db.com Fax: DB Research Management Ralf Hoffmann Bernhard Speyer SEPA: Impact on structure of payments markets In the run-up to SEPA, the infrastructure for cross-border retail payment processing has been put in place by payment service providers across Europe. Payment users still prefer legacy payment instruments. Even though these will be abolished in February 1, only 35% of all credit transfers cleared by Automated Clearing Houses (ACH) in the euro zone were SEPA-compliant credit transfers (SCTs) by the end of 1. SEPA Direct Debits (SDDs) accounted for barely % of direct debits. Adoption rates vary widely between countries, though. The share of SCTs in all transfers at the end of 1 was even lower (an estimated 5%) if all euro area credit transfers are taken into consideration. This estimate includes bilaterally cleared transactions as well as in-house transfers. Notwithstanding many years of preparation for SEPA, ACH clearing in the euro area still reflects national market sizes and clearing arrangements. By 11, there was hardly any change in the ACH league-table. ACH clearing in the euro area was and is highly concentrated. The five dominant clearing houses processed.% of ACH transactions, equivalent to 3.% of all payments made in the euro area in 11. Consolidation of several national clearing volumes on one technical platform has started but must not necessarily lead to an integrated market. Rather, multi- CSMs allow banking communities to retain control of their interbank clearing. There are some signs of national payment markets merging into a single market. But SEPA has not yet been achieved and existing loopholes could be abused to ring-fence national markets even after full migration to SEPA schemes.

2 SEPA offering by banks driven by EU legislation EU regulation causes banks to introduce SEPA 1 EU legal act published Stipulations enter into force Cooperative market reactions 1 Reg (EC) No 5/1 on cross-border payments in euro 3 No different charges for Pan-European Clearing: domestic and (certain) crossborder payments in euro cross-border euro EBA STEP for regulated payments goes live 7 Dir 7//EC on payment services in the internal market (PSD) Cross-border Clearing: EACHA interoperability framework released SEPA Credit Transfer (SCT) launched 9 PSD implemented by member states: harmonised legal framework for payments throughout EU Reg (EC) No 9/9 on crossborder payments in the community Price parity also required for domestic and cross border direct debits 1 Euro area banks must be reachable for cross-border direct debit collection 1 Reg (EU) /1 ("SEPA Regulation") Payment service provider must be reachable for union wide credit transfers and direct debits in euro No more MIFs for crossborder direct debits 1 Deadline for migration to SCT and SDD within euro area 1 Niche products migration to be completed, SCT and SDD deadline for non-euro area countries 17 No more MIFs for national direct debits SEPA Direct Debit (SDD) launched, Core and BB versions Over a decade ago, EU authorities started to push for an integrated market for retail payments. Their vision was that payments between member states could be made as easily and cheaply as within national markets. They expected increased competition, higher economies of scale, more product innovation and price savings for payment users from a single market. In 1, the EU enacted a regulation compelling banks to charge for cross-border payments in euro no more than for domestic transactions. At the time, national retail payment systems were automated and efficient but too different as to allow for cross-border bulk processing. In order to bring down per item costs for cross-border transactions to a domestic cost level, the European banking community joined in a cooperative effort to establish the Single Euro Payments Area (SEPA). EBA STEP, a Pan-European Automated Clearing House (PE-ACH) for retail (bulk) payments was established under the umbrella of the European Banking Association (EBA) in 3. Existing national ACHs also established interoperability standards to permit the clearing of SEPA retail payments between their national home markets. Thus, the political drive to integrate the euro retail payments markets prompted payment service providers to develop and implement new standards and infrastructure in order to offer their clients pan-european payment instruments. By February 1, national legacy payment instruments may no longer be offered, according to EU regulation /1. Sources: European Central Bank, European Payments Council May 9, 13 Banking & Technology Snapshot

3 Switch over to SEPA Credit Transfer - no homogenous picture % share of SCT in all credit transfers as of end 1 Euro area* Euro area - ACH only** Germany France Netherlands Italy Belgium Finland Austria Spain % % % % % 1% * Own calculation based on SCT share per country as of Q 1 and total number of credit transfers per country as of 11 (both latest available ECB data) ** SCTs processed by ACH as a share of all credit transfers processed by ACH in December 1 (monthly data) SCT share per county compiled quarterly by national central banks, reflecting all SCTs as a share of all credit transfers (i.e. cleared by ACH, bilaterally, correspondent banking, on-us-transactions) National markets adopting SEPA at different speeds Since it was first offered in, the SEPA Credit Transfer (SCT) has gained considerable market share, albeit after a slow take-off during the first three years. As an indicator of SCT penetration in the euro area, the ECB uses data provided by the relevant ACHs: by the end of 1, 35% of all credit transfers processed by ACHs were SCTs. Nevertheless, some national markets are poorly represented by ACH data. Considering the entire credit transfer volume in the euro area including bilaterally cleared transactions as well as inhouse transfers suggests a SCT market share of about 5%. National communities vary widely in SCT adoption. Whereas Finnish banks already abandoned legacy payments in favour of SCT by the end of 11, legacy payment instruments still dominate most markets. Among the big markets by transaction volume, SCT penetration is especially low in the Netherlands (3.%), Germany (.7%) and Italy (1.9%). These national markets account for over half of all credit transfers in the euro area. Collections are still made by legacy instruments 3 SEPA Direct Debits (SDD) processed by ACHs in the euro area 1 3.% 1.5% 1 1.% 1 1.5% 1.%.5%.% Nov 9 Dec 1 Dec 11 Feb 13 SEPA Direct Debits (SDDs) have been offered by banks since November 9 but have hardly been used to date. Only.3% of all direct debits processed by ACHs are SDDs (as of February 13). There are no figures available that include direct debit instruments processed outside ACHs. Again, the German market with low ACH penetration is poorly reflected in this SEPA indicator. Source: ECB SDD processed by ACH in mio transactions SDD share in all DD transactions processed by ACH in % Clearing via ACH - still differences between national markets Annual payments, billion 1 1 5% 1 % 1 1 5% 5% % 75% 9% 1% 7% 71% 15% 15% % 71% % 9% Germany France Netherlands Spain Payments cleared via ACH Payments not cleared via ACH Sources: ECB, DBResearch No substantial changes in clearing arrangements to date Payments clearing is done differently in different countries. In France, for example, most retail payments are cleared centrally by an automated clearing house (ACH). By contrast, German banks predominantly use bilateral clearing arrangements. In the euro area as a whole, % of retail payments were cleared by an ACH in 7, and slightly less in 11 (%). The remaining payments are inhouse transactions, or they are cleared bilaterally between banks or via correspondent banking. Until 11 differences in preferred clearing arrangements did not change substantially in the biggest national retail payment markets. More recent market information shows first signs of restructurings, though. 3 May 9, 13 Banking & Technology Snapshot

4 Transaction volumes in the euro area per ACH 5 Billion transactions processed in 11 STET/CORE 13. Equens EMZ (RPS) BI-COMP SICOI Iberpay/SNCE CEC EBA STEP Other 1 ACHs ACH clearing in the euro area still reflects national market sizes and clearing arrangements. Thus, the ACH transaction volume is highly concentrated on a few processors. Although the ACHs increased their absolute processing volumes between 7 and 11, there was hardly any change in their market shares. The ACH ranking by transaction numbers, therefore, remained largely the same. As far as reflected in 11 data, most ACHs were still predominantly national payment hubs. The minor changes that did occur between 7 and 11 in the ACH league table were among the small clearing houses. Notably, EBA s STEP managed to more than double its processing volume to. bn transactions in 11, also because the Finnish and Irish banking communities shifted their payments clearing to EBA STEP. Concentration in ACH clearing unchanged Retail payment systems in the euro area in order of size from largest to smallest Almost no change in high ACH concentration ratio %.% % % % % % % In 11, the three largest ACHs by transaction numbers accounted for 7.% of the entire payment volume processed by euro area ACHs. The five largest ACHs already represented.% of the market volume. The ten smallest ACHs processed only 1.% of all ACH transactions. This structure shows hardly any changes compared to 7, when CR3 stood at 71.3%, CR5 at 5.% and the smallest 1 ACHs represented.7% of the market. Number of transactions processed per ACH in 11 (billions, left) Concentration ratio 11 (cumulative market share in %, right) Concentration ratio 7 (cumulative market share in %, right) Clearing market: concentration ratio depends on point of view 7 Retail payment systems in the euro area in order of size from largest to smallest 1%.% % 7.% % % 31.% 3.% % % Concentration ratio in ACH market (cumulative market share in %) Concentration ratios are much lower, though, when looking at the entire retail payments market. Measured against all retail payments in 11 the three largest ACHs processed 31.% of the total payments volume, the five largest ones 3.% respectively. In 7, concentration ratios were slightly higher with 3.3% for CR3 and 1.1% for CR5. Nevertheless, this more inclusive concentration rate does not give an exact picture of the competitive situation of the clearing market either. Because all retail payments includes in-house transactions, the volume of payments cleared between banks is lower. Thus, the market share of single ACHs in the actual payment volume needing interbank clearing should be higher than shown in graph 7. Concentration ratio in total market (cumulative market share in %) May 9, 13 Banking & Technology Snapshot

5 Platform consolidation across borders Quest for volumes: evidence for platform consolidation Banking community Instruments Migration date STEP (EBA) Italian banks legacy CT Luxemburg legacy CT, SCT Finland SCT 11 Ireland legacy 11 7 German banks SCT, SDD planned for 13 CORE (STET) France legacy, SEPA national ACH Belgium legacy, SEPA 13 Sources: EBA, STET Payments processing is a business driven by economies of scale. Thus, many large players have adopted strategies to extend their business focus beyond national borders and to capture payment volumes by offering multi-csm 1 platforms. This market development is reflected in recent company data. STET, owned by five French banks and being the largest euro area clearing house, is offering its technical platform CORE to other national banking communities. In 1, the Belgian banks decided to abandon their national retail clearing house CEC in favour of STET/CORE. By March 13, the migration was completed, adding the Belgian interbank payment volume to the transaction number processed on the CORE platform. Similarly, EBA STEP has gained the former domestic credit transfer clearing volume of Finland and Luxemburg. Both countries have already replaced legacy payments by SCT. EBA s STEP platform is provided by the Italian processor SIA and processes also domestic credit transfers from six Italian banks. ACHs also compete for hitherto bilaterally cleared payment volumes as SEPA encourages banks to rethink their clearing arrangements. The Irish banking community decided to use EBA STEP for exchanging pre-sorted bilateral files instead of investing in legacy infrastructure. The EBA STEP IET Service went life in October 11. A group of seven German banks will use EBA STEP s Batch Processing mode for exchanging large volumes of domestic retail payments instead of the traditional bilateral garage clearing. Starting in the second half of 13, this will significantly increase the transaction volume processed on the EBA STEP platform. 3 Loopholes to preserve national markets Domestic transactions dominate payments markets 9 Number of transactions in millions, share of cross border transacions in %, %.1%.%.%.% Germany France Netherlands Spain Italy All domestic transactions Cross-border transactions (sent) The vast majority of payments in Europe are domestic. In the five biggest markets, representing % of all transactions in the euro area, less than 3% of payments are made cross-border. Germany has the highest share of cross-border payments with 3.1%, whereas cross-border payments account for a mere.% in Italy. Given this predominance of domestic payments, national banking communities might be tempted to protect national markets from European competition. Indeed, there is some evidence of strategies to preserve payments business within national borders and under national control. 1 3 Clearing and Settlement Mechanism, SEPA compliant clearing house. STET press release, The Belgian banking community has successfully STET press release, The Belgian banking community has successfully completed migration to the new CEC CSM developed and operated by STET, April 13. EBA CLEARING press release, EBA CLEARING provides central processing platform for SEPA payments, 1 st May May 9, 13 Banking & Technology Snapshot

6 So far, platform consolidation means two or more national CSMs on one technical platform but not the merging of two national markets. CSM governance remains with the respective national banking communities: in the case of Belgium, the Belgian banks maintained the legal structure of CEC, their former national ACH, as the body to contract with STET and as a vehicle to govern the Belgian CSM on CORE. Besides, the Belgian central bank will continue to act as the oversight authority and the settlement agent. The foundation of new CSMs as seen in Austria and several non-euro countries, could be interpreted as a move to keep national payment volumes at home. For example, in the transition to SEPA, the Austrian central bank set up a national clearing house for bulk payments (STEP.AT, now CS.A) in a market traditionally based on bilateral clearing. Additional Optional Services (AOSs) allow banks to enhance SEPA payment schemes in order to cater for the needs of certain (usually national) banking communities. AOSs must not affect interoperability and must be disclosed. It is still too early to judge whether the option to introduce AOSs might be abused to put up new fences around national markets. So far, several national communities have published AOSs for SCT and SDD. SEPA is an ongoing project Clearly, many ACHs have prepared themselves to compete for payment volumes beyond national borders and regardless of payment schemes (legacy or SEPA). They compete on production costs, reach and on service levels like clearing cycles and cut-off times. Nevertheless, a single market for payments is not yet assured. Banks will only be able to process retail payments across the euro area by the same internal IT systems and business procedures if CSMs do not discriminate domestic and cross-border payments by way of technical standards, prices or service levels. It is still to be seen whether national banking communities, central banks and ACHs will truly open their markets to the extent that the Single Euro Payment Area can evolve once all legacy payment schemes will be abolished in 1. Heike Mai ( , heike.mai@db.com) May 9, 13 Banking & Technology Snapshot

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