Driving the SEPA Train How to Implement the SEPA Cards Framework

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Driving the SEPA TrainHow to Implement the SEPA
Cards Framework

• EBUG Seminar, Lisbon
• Wednesday 26th April 2006

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SEPA - Opening up Europes Payments Markets The
Story So Far

• Long delays banks did not deliver on promises
• National interest not EU
• Protectionism not open market
• Threats of regulation
• Overdoses of politics
• Monopolies and duopolies
• Major infrastructural projects

Lack of progress, not good enough!
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• Politics is the art of looking for trouble,
• finding it whether it exists or not,
• diagnosing it incorrectly and applying
• the wrong remedy
• Sir Ernest Bevin, 1930

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Agenda

• SEPA Background and Content
• Overview of SEPA Cards Framework (SCF)
• Analysis of Implementation Options
• Summary and Conclusions

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The F Word - A Story of Failure

• Failure to achieve ECs vision
• Failure to think EU / euro-zone
• Failure to standardise
• Failure to inter-operate
• Failure to consolidate

Over 15 Years of Delay and Vacillation in
Delivering an Open and Common Payments
Infrastructure But now we have SEPA
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At last the SEPA train has left the station
2006
You can be upfront with the driver, or sitting
comfortably in First Class, or being thrown
around hanging off the back or left in the
Station!
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SEPAland - The SEPA Vision

• SEPA is achieved when people can make payments
  through the whole euro area from one bank account
  or by using one card as easily and safely as
  national payment is conducted today the choice
  of bank or location should make no difference
  all euro area payments should become domestic
• Gertrude Tumpel-Gugerell, ECB, September 2004
• ECB rationale for SEPA
• Current account access by card anywhere
• Common processes for all payments (not just
  cards)
• Improved banking competition

SEPA will do for electronic payments and cards
and what the euro has done for cash
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Key Owners of the SEPA Concept

1. European Central Bank owns broad requirements
   and timing responsible as for euro
2. European Commission owns harmonisation plan
   15 years pressure legal framework
3. European Payments Council design/specification
   self regulation

Key stakeholders are merchants, corporates,
consumers, government and representative
associations
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SEPA Scope the vision for tomorrow
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SEPA Infrastructure Impacts

• SEPA is a major harmonisation project which will
  replace the fragmented national payment
  infrastructures
• All payments will be carried out using common
  frameworks, rule books and the new Legal
  Structure (PSD)
• Every citizen, bank, merchant and corporate
  enterprise will be impacted by the SEPA
  implementation
• SEPA is not about cross border payments, it is
  about standardising each national market

12 euro 29 EU
Population 310m 470m
Corporates 17m 25m
Banks 7k-8k 9k
ACH Schemes 10 20
Card Schemes 14 18
POS 4.5m 6.2m
ATMs 238k 326k
Electronic txns 50bn 73bn
SEPA is the most significant change in EUs
payments in the past 20 years
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SEPA - EPC Timeframe
Feasible for ACH schemes but realistic for
cards?
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SEPA the Size of the Change

• Year 2000
• The euro..
• SEPA

How do you eat an elephant? one piece at a time
.. and customers will be looking for solutions
to help digest it
Tower Group estimate
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Comparison SEPA Schemes Design Features
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SCF General Observations

• Framework is a multi-national compromise so is
  a great achievement
• Applies to all general purpose euro payment cards
  - focus is on debit
• Self regulatory framework not a scheme, lower
  cost schemes must adapt banks follow
• SCF does not substitute for card scheme
  rules/regulations
• Principle is to foster competition at debit
  scheme level but potential for ICS duopoly
• Scheme brand/infrastructure unbundling has the
  greatest potential for change particularly ICS

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SCF Impact on Card Schemes
SCF Statement SCF Statement
Scheme Organisation/Activities must ensure legal/commercial barriers removed Separation of Scheme Governance from Processing and other functions no longer mandate use of processing services no longer self certify
Participation transparent and non discrimatory criteria Principles of Interchange Fees MIF and bilateral acceptable local MIFs allowable with SEPA wide default
Licensing single licence enables offer of all scheme products/services on us applies to the SEPA EMV Supporting Technology commitment to EMV for all cards (credit/debit) by 1st January 201
Scheme Pricing transparent pricing, no bundling Liability Shift all schemes to introduce liability shift rule plus incentives
Open Business Model no discrimination, ensure merchants/ATM owners can accept SEPA compliant cards from other schemes Fraud commitment to fraud statistics/reporting
Operational Quality must provide benchmarks and how policed
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SCF Impact on Card Schemes contd
SCF Statement
Issuer Authorisation all transactions to be online or offline by chip
Cardholder Experience must be consistent at POS/ATM schemes cannot mandate specific payment application, common flow, English mandated
Merchant Experience one single terminal to access multiple acquirers merchants free to switch acquirers and can accept any scheme (SEPA acceptance parity)
Inter-operability all four domains must have inter-operability cardholder to terminal card to terminal (EMV) terminal to acquirer acquirer to issuer
Certification Principles open market certification no longer only a scheme function
Terminal Certification schemes to release terminal security requirements post certification approval/allowable
Scheme Rules schemes to commit to convergence over non competitive elements
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SCF Impact on Acquirers
Business Technical / Operational
Potential new scheme membership rules governance Merchant communication campaign on SCF/SEPA impacts/benefits Common consistent experience for cardholders Changes to merchant contract terms removal of barriers to acceptance New terminal strategy elimination of multiple terminals New SCF/SEPA card acceptance policy by 2008 for one or more SEPA compliant card schemes in terminals New rules for provision of DCC (PSD) EMV/SCF compliance/acceptance for all cards schemes /terminals Implementation of SEPA compliant card scheme Potential new core terminal applications and upgrades New multi acquirer terminal application in some countries Acceptance of multi function cards New terminal to host interfaces New acquirer to issuer interfaces Possibly new clearing and settlement arrangements (eg. Berlin Group) Build new processes for fraud management/reporting Implementation of EMV by 2010 and liability shift
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SEPA Impact on Debit Card Issuers
Business Technical / Operational
Potential new scheme membership rules, governance Offer at least one SCF compliant card provided from 1st January 2008 onwards All general purpose cards issued become SCF compliant Re-issuance of cards to new scheme Communications plan potential brand change Communication campaign SCF/SEPA benefits to cardholders Complete migration to EMV by end 2010 New rules for consumer redress (PSD) Implementation of new debit scheme infrastructure Implementation EMV for all cards issued Implement new standards for cardholder to terminal interface card to terminal (EMV) issuer to acquirer interface Potentially new debit/credit default features for multi application cards Implementation of new/modified card management processes Implementation of new/modified authorisation and credit management systems Possibly implement new clearing and settlement arrangements
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SCF Key Issues

• SCF was the easy bit how to implement and
  enforce?
• Is scale and scope beyond banks/schemes/EPC?
• Created by team of experts within ECB broad
  requirements
• Pressing need for standards and guidelines
  terminals POS/host, issuer, acquirer
• Need to remove many national blockages and
  barriers
• New operational model chargebacks, merchant
  accounting, PINS/HSMs

Can current structure manage specification and
delivery of Europes largest ever project card
share 7bn to 8bn
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European Infrastructure ChangeWhat Does History
Tell Us?
Past Cards Infrastructure Projects SCF
Phased smaller projects more successful large much less (EMV) Large scope 12 domestic plus all euro systems no phases yet
Strong consumer/merchant proposition Weak consumer but strong merchant
Good business case Short term poor long term good
Strong commitment large national banks will to fund Strong large bank commitment, but no funding
Interbank company implements and provides delivery service EPC represents all banks and monitors, but no more
Strong scheme mandates incentivise change (EMV example) Lack of basis for mandates no operational revenues
What structures to use for implementation?
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Four Strategic SCF Implementation Scenarios

• Scenario 1 Open Market Devolved Strategy
  (Current)
• Scenario 2 Separate Implementation Only Company
  (SEPACo)
• Scenario 3 New Infrastructure and
  Implementation Company
• Scenario 4 Regulated Implementation

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Scenario 1 Open Market Devolved
Strategy(Current)
Schemes sign up to concept and compete, banks
make choices. Scheme/infrastructure separation
stimulates processor sector. Implementation
devolved to national associations, no central
co-ordination body. Standards developed by
consensus, networks evolve through market demand
by processing sector. Current timelines retained.
Strengths Weaknesses
EPC monitoring Leverages banks ownership of schemes (pressure) Open market competitive principles for schemes Open market competitive principles for network construction (Berlin Group) Strong commitment by largest banks Standards/guidelines to be produced Poor history of open market driven developments No central control or network Voluntary body EPCs limited resources No experience of implementation No mandates incentives/penalties Aggressive delivery dates
Conclusion chances of success modest
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Scenario 2 Separate Implementation Only
Company(SEPACo)
Separate governance needed, professionally
managed, fully funded SEPACo. Powerful mandate
to co-ordinate, lead, plan, monitor, manage.
30-40 staff 20m-30m per annum. Sets standards,
best practice, network architecture,
certification/compliance. Operates PMO, owns
macro SEPA plan. Negotiates revised time scales
- two years slippage. EPC allowed to fine
non/slow participants.
Strengths Weaknesses
EPC continues to provide leadership Professional project managers (lower risk) Realistic road map construction Standards rapidly developed Separation of policy/execution Incentives and penalties Cost of SEPACo set up/operation Does not deliver an infrastructure No guarantee of success EPC member resistance to penalties
Conclusion would work but who pays?
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Scenario 3 New Infrastructure and
Implementation Company
Follows traditional interbank model. NewCo
created (includes SEPACo functions), permanent
infrastructure to implement SEPA and operate
network to link all national debit. Builds
network equal to that of Visa/MasterCard, draws
in Berlin Group. NewCo sets standards for all
aspects.
Strengths Weaknesses
Professionally implements/delivers Avoids fragmentation Equal to and competes with ICS networks Delivers solution for direct debits/credits High cost and risk Uncertain volumes/efficiency improvement Unfair cost sharing Already exists within ICS
Conclusion workable but cost/risk
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Scenario 4 Regulated Implementation
Commission decides will only happen through
legislation. SCF turned into a regulation.
Highly prescriptive, mandates deliverables and
timelines. Includes regulation of interchange
and MSCs. Penalties if not achieved. PSD
tightened up to strengthen legal framework.
Strengths Weaknesses
Ensures all schemes and banks sign up to SEPA/SCF Penalties strong motivator Level playing field for competition Regulations more directive than SCF Support from some bank players Pioneering regulation of standards specifications Banks work to rule work arounds Unintended consequences and collateral damage High risk project EC micro manage Failure damages EC credibility
Conclusion an interesting option!
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Summary Assessment of Scenarios
Scenario Feasibility Risk Complexity Cost Certainty of Delivery
Scenario 1 Current Open Market Strategy ??? H ???? L ??
Scenario 2 SEPACo ??? M ?? M ???
Scenario 3 New InfrastructureCo ?? M ??? M/H ???
Scenario 4 Regulated Implementation ? H ????? H ?
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Conclusions - SCF

• SEPA Europes largest infrastructure project
  will impact all
• Timeframes highly ambitious, unlikely to be
  achieved for cards
• Europe poor history of major EU wide change (euro
  excluded)
• Current implementation plan suitable for ACH
• SEPACo and NewCo unlikely to be funded
• Some form of regulation highly likely

Thats the way politics goes!
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• Politics is not the art of the possible.
• It consists of choosing between the
• disastrous and the unpalatable
• J K Galbraith, 1969

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Peter JonesManaging Director44 (0) 20 8891
6244peter.jones_at_pseconsulting.com