In the first installment of a two part commentary, Chris Skinner reviews the Payment Services Directive released in December 2005. In part two - to follow in February - Chris will conclude with a review of the costs implied to Europe's securities markets by MiFID, the Markets in Financial Instruments Directive, and assess the impact of these two regulations on Europe's financial markets overall.
2005 was a year of revolutionary change in the European financial services markets. Whether anyone noticed is hard to say, although the rumblings about legislative agendas of the European Commission certainly hit the radar with MiFID and Sepa. The coming year, 2006, will sort out the winners in the pan-European race to change and some of the likely losers. Why is 2006 so critical, and what is the logic for these changes and the likely results?
It was back in 1992 that European nation states gathered to endorse a European Economic and Monetary Union (EMU) through the signing of the Maastricht Treaty. Since 1992, there have been many debates, discussions, arguments and even displacements of Europe’s political leaders, but the drive towards Union continues at a pace. The reason for EMU’s existence is the vision to create a European economy that can compete on an equal footing with the USA and other global markets. However, the vision is continually challenged by the hiccups of political and commercial agendas which seek to change it from being an Economic and Monetary Union to either being a federated Europe at one extreme or an abandoned Europe at the other.
This is why, within this debate, the financial markets of Europe have such a key role in either supporting or blocking the Union. Kicked around like a political football, Europe’s financial markets are at the core of the Economic and Monetary Union, because it is the financial markets that provide the capillaries and arteries to allow the trade to flow without clots or blocks across Europe’s borders. That is why Europe’s political leaders have focused so heavily on driving change into the financial arena.
The first outcome of the political changes to financial services was a variety of Directives which laid the foundation for the introduction of the euro currency in 1999. These directives worked to an extent, but had flaws. As a result, Europe’s political leaders gathered again in 2000 and signed the Lisbon Agreement which introduced a second phase of change. A cornerstone of this second phase of change has been the drive to create a single, integrated and free-flowing European financial marketplace through the Financial Services Action Plan (FSAP).
The FSAP comprises 42 directives, most of which have already been implemented by the 25 member states of the European Union. These include Savings Directives, Risk and Capital Directives, Fraud and Money Laundering Directives, Insurance and Pension Fund Directives, Solvency and M&A Directives and so on. Name almost any area of financial services and there is a directive that relates to it.
As mentioned, most of these Directives have already been debated and translated into national laws. However, two are now Directives with looming deadlines that have already caused a stir during 2005. The reason is that these two specific directives are massive pillars of change. The two directives in question are the Directive for Payments Services in the Internal Market, or the Single Payment Area (SPA); and the Markets in Financial Instruments Directive, or MiFID. The former will be law by 2010 and the latter by the end of 2007.
Why are these two directives causing so many howls of pain and derision from Europe’s financial markets? Primarily because they are extremely costly, entail massive change and deliver little benefit unless you are a pan-European player.
Let’s have a look at what these Directives might imply.The Single Payment Area (SPA)
The SPA came into existence in its early form with the introduction of the EU Regulation 2560/2001. This regulation was announced in 2001 and implemented in July 2002 for cash withdrawals and card payments, and extended to credit transfers in July 2003. The nature of the regulation is that all electronic transactions within the euro zone of €12,500 or less have to be charged at the same level as an equivalent domestic transaction. This limit rises to €50,000 in January 2006.
Within EU Regulation 2560/2001 there were other nuances which were specifically intended to harmonise and standardise cross-border payments. For example, all credit transfers must be denominated in Euros, and need to include the Iban (International Bank Account Number) and the BIC (Bank Identification Code).
This may sound like small beans, but for some of Europe’s banks it involves massive change.
First, there is the loss of revenues from cross-border credit transfers and cash withdrawals. For example, pre-2560/2001 a bank customer withdrawing €100 from an ATM outside their domestic European country in 2001 would have been charged €4 on average. Overall, these charges were making healthy margins for the banks and involved little investment.
Secondly, there is the pressing requirement to create new infrastructures and clearing systems. After all, you could not have ACHs (Automated Clearing House) and central bank RTGS (Real-Time Gross Settlement) systems operating in 25 countries efficiently and at a cost-base to support zero-margin transaction structures under this new charging regime.
As a result, the banks all got together in 2002 and created the European Payments Council (EPC) to oversee the launch of a Single Euro Payments Area (Sepa), and the EPC has since focused upon creating a PE-ACH (Pan-European Automated Clearing House) and a PE-DD (Pan-European Direct Debit). The achievement of the launch of these ACH-based systems by 2008 will allow minimal or zero charging structures across the Eurozone, e.g. the 12 countries that use the euro but not the non-euro countries like Britain and Denmark.
All of this is detailed in a series of TowerGroup reports, each of which are about 12 to 16 pages long so I am not going to explain it here. However, there are a few things that have happened in the last month that are interesting.
First, Charlie McCreevy – the European Commission for the Internal Markets of Europe and the man who owns the Plan, the Financial Services Action Plan (FSAP) that is – released the Directive on 1 December 2005, and made a number of specific statements about its implications.
For example he said: "I count on the banking industry, which is responsible for removing the technical barriers which stand in the way of a Single Euro Payment Area, to accelerate its work."
Reading between the lines, that loosely translates as: "I count on the banking industry who are focusing upon the Eurozone to pull their finger out and start working out how to make Europe’s payments work".
This is apparent because the release makes it clear that the Directive includes the Swedish Krona, the British Pound, the Polish Zloty and the Hungarian Forint. As a result, all the work done to date on creating a Single Euro Payments Area has to be extended from a Euro area to a European Area. In other words, a Pan-European ACH and Pan-European Direct Debit, not a Eurozone PE-ACH and PE-DD.
Another point made in the release is that the "Single Payment Area will benefit each and every European and bring big-money savings to the EU economy to the tune of €50-€100 billion a year".
Reading between the lines, that means: "The banks have been making huge amounts of money at European citizens expense and so we are going to get rid of their margins on payments".
This too is clear because the cost of the SPA to Europe’s banks will be in excess of €40 billion. That figure is based on two calculation. The first is that at least €29 billion of revenue will be lost, which is the figure ABN Amro identified as the top-side of a single payment area for just the euro. Bear in mind this is now for all European countries, not just the Eurozone, and that number will increase. Second, TowerGroup estimates that there will be at least an additional €10 billion investment in new European payments infrastructures between 2006 and 2009, to create the new PE-ACHs, PE-DDs, RTGSs and so on. At least €40 billion lost to the banking industry that goes to the citizens and businesses of Europe.
The point about what this means to Europe’s banks is perhaps best summed up in this abridged statement from the release: "The price to provide a basic payment service is €34 a year for the average customer in the Netherlands compared to €252 in Italy. Price is not the only difference. In some Member States payments are executed the same day or even in real time, whereas in other Member States the same payment can take three days or longer."
This means that many banks in Europe will lose revenues whilst many others will get out of payments altogether. For the latter, they will have to ask the question: "What do we do now?" Deliver improved and differentiated client service through integrating outsourced payment services might be one answer.
For a small few – the ABN Amros, INGs, BNPs, Citigroups and JPMorgans of this world – SPA brings into play a new era of mega pan-European bank payment services. These payment gorillas will take over from the small players, will bear the brunt of the investment costs and reap the bulk of the commercial rewards.
That is where the SPA is heading and it will be here by 2010. As Charlie McCreevy makes clear: "We will work with the industry and ECB as closely as possible to make sure it happens by 2010."
In other words, it will happen by 2010 if he has anything to say about it. In fact, what it really means is that if you are in the payments business and you have not worked out your strategy – to be a payments gorilla, a payments service provider to the gorillas, a payments client of the gorillas or a non-payments provider of financial services – you better make your mind up fast in 2006 as the clock is already ticking.Chris Skinner is a director of TowerGroup and founder of Balatro.
Web links: www.towergroup.com
Author's email: Chris Skinner