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The Single European Payments Area and Cross Border Trade

by Steve Keifer

Much of today’s focus on cross-border trade centres upon the growing volumes of inter-continental trade between Europe and Asia.  However, a far larger amount of trade occurs between buyers and suppliers within Europe itself. Europe is the world’s largest trade region with $3.65 Trillion in annual trade in 2007 or 31.4% of the worldwide total. The majority of the intra-regional commerce in Europe is within the 27 EU member states which enjoy an increasingly harmonised set of regulations for cross-border trade. One of the most complex aspects of creating a free trade zone within the European market has been integration of the various financial regulations, systems and processes. The EU has undertaken an ambitious effort to harmonise everything from currency and taxation to payments and securities. The payments initiative, known as the Single European Payments Area (SEPA), is one of the most complex, but promising of the financial transformations projects underway.

Payment Challenges in Europe

Historically, Europe has been host to a complex set of country-specific pricing, regulation and systems for payment processing. Consumers and corporations who purchase the payment services as well as the financial institutions who deliver the services all suffer from the limitations of today’s model.

Consumers pay different prices for the same banking services depending upon their country of residence. Italians and Germans might pay ten times what a Dutch or French citizen is charged for basic retail banking services.  Geographic limitations constrain today’s service offerings.  Many of the banking services consumers purchase are limited to the home country in which the financial institution is based.  For example, when a Belgian citizen travels to another country such as Austria, his debit card from the Belgian bank will most likely not allow him to withdraw funds from a local ATM. Cross-border funds transfers are another area of frustration.  Payments from a citizen’s home country to payees in other European countries are subject to very high banking fees.

Corporations suffer many similar challenges to consumers. The fees assessed by banks for payables and receivables services vary widely based upon country. A multi-national corporation making a €1000 payment to a supplier might pay €0.75 in Italy, €0.25 in Spain and €0.05 in France. In addition to the variation in fees, the timing, regulations and processes for making payments vary by country as well.  There is one consistency in payments across all European nations and that is cross-border transactions are expensive regardless of the country of initiation. For example, the €1000 payment explained above would cost €20 if it were to be made from a payer using a German account to a payee using a foreign bank.

Financial institutions struggle with country-specific pricing, systems and regulations. Banks must manage their payment products and systems differently in each country. Therefore, it is challenging for financial institutions to gain economies of scale. Regulations and requirements for operating a bank vary by country. As a result, only the largest financial institutions can afford the start-up costs to establish operations in multiple countries.

Single European Payments Area

Starting in the 1990s, the European Union began the SEPA initiative to harmonise and simplify payments across the 15 countries which have embraced the Euro as the national currency. The goal of SEPA is to establish a common set of regulations, processes, standards and technologies for making payments across the Eurozone. Consumers and corporations will enjoy consistent pricing and service levels irrespective of their country of citizenship and the location of their bank account. Surcharges for cross-border transactions within the Eurozone will effectively be eliminated.  As a result, citizens and corporations will be able to make payments in any Eurozone country as easily and cost-effectively as they could in their home nation.

SEPA offers numerous benefits to consumers, corporations and financial institutions. The efficiencies to be gained through SEPA will lead to a 1% increase in GDP for the EU making it more competitive on the world market. The barriers for financial institutions to expand into new markets will be reduced considerably. As a result, competition will increase and pricing levels will converge to a common, market-driven level.

SEPA is part of a larger suite of initiatives being pursued in the EU to harmonise financial processes across the region and reduce cross-border trade barriers. Related initiatives exist in the areas of:

• Currency – The Euro currency has been embraced by 15 countries effectively eliminating the need for foreign exchange transactions between the affected nations.
• Financial Reporting – The Eighth Company Law Directive sometimes referred to as EuroSOX and the International Financial Reporting Standards (IFRS) aim to standardise the regulation of and reporting of corporate financial information across Europe.
• Invoicing – EU Directive EC/115/2001provides a common framework for corporations to replace paper invoices with electronic equivalents that comply with VAT rules.
• Securities – Efforts are underway to harmonise the clearing and settlement systems for securities trading across Europe. Regulations such as the Markets in Financial Instruments and Derivatives (MiFID) will standardise regulations for trading across the region.
• Taxation – Proposals are being explored for a common corporate tax base across Europe, which would greatly simplify the process for computing tax liabilities across various member states.

Harmonisation of financial regulation within the EU greatly simplifies the back-office processes for multi-national corporations. Instead of a country-specific approach, corporations can embrace a Pan-European approach to invoicing, payments, taxation, cash management, financial reporting and import/export processing.

What are the specific benefits of a Pan-European approach to payments that a corporation can derive from SEPA?

Corporate Accounts Payable before SEPA

Because each country had its own regulations and policies for payments, corporations have historically managed their accounting functions at a country level:

• Separate teams were established in each country with the necessary legal, tax and regulatory expertise. Such an approach is expensive as each team requires specialists for each respective function and management personnel to oversee the operation.
• Different finance and accounting systems were utilised in each country. Not only is there a duplication of technology infrastructure, but such a model makes it difficult to share information or to gain region-wide visibility to financial matters.

Corporate Accounts Payable after SEPA

The EU initiatives for invoicing and payments enable corporations to radically transform their approach to accounts payable operations. With SEPA, corporations can now benefit from:

• Centralised Operations – SEPA and other regulations reduce the need for corporations to maintain accounts payable staff in each country with knowledge of local invoice and payment requirements.  As a result, corporations can redeploy all accounts payable personnel to a Pan-European shared service centre or “payment factory.” The shared service centre can perform invoice processing for all countries in the region. Service centres are increasingly being located in low-cost geographies such as Central Europe. Some companies are electing to outsource accounts payable processing altogether to a third party either onshore or offshore.
• Consolidated Systems – SEPA enables a common technology standard for the communication of payment instructions to banks.  Along with other regulatory changes, SEPA therefore reduces the need for local accounts payable applications in each country. Many corporations are rationalising the multiple country-specific applications into a consolidated Pan-European system. For other companies which have initiated an ERP consolidation project, SEPA reduces the level of effort for migration.

Centralised systems and operations can create numerous opportunities for efficiency.  For example, centralising payment processing can help to identify opportunities for multi-lateral netting. Suppose the legal entity in Germany has invoiced the legal entity in Italy €200,000.Conversely, the Italian entity has invoiced the German operating company for €100,000. ather than invoke two separate payment transactions through the banking system, a general ledger entry netting the two transactions can occur through the in-house bank. Centralisation of payment processing also enables enhanced cash forecasting. Leveraging a common Pan-European accounts payable system, treasurers can better forecast outgoing cash flows to determine if they will have a surplus which needs to be invested or if they will need to borrow to cover a deficit.

As the SEPA initiative continues to progress, consumers, corporations and financial institutions will enjoy the benefits of a single, integrated market for banking services across the Eurozone.