Making it pay

Most statements about pan-European direct debit PEDD focus on how this SEPA deliverable will ease the way for increasingly mobile consumers to make pan-European direct debits. However, the real key opportunity for banks to reclaim lost revenues lies in pan-European direct debit services for the corporate and government market.

Part of the larger European harmonisation process, PEDD has been championed as a victory for common sense for the European consumer, but touted as another revenue reducing initiative for financial institutions. The fact remains that PEDD impacts all banks operating in the Eurozone. The extra pressure on revenue streams is unavoidable in the short term, but longer term, differentiation through extended value added direct debit services is the way forward.

PEDD, a part of the overall Single Euro Payments Area (SEPA) initiative, is the payment instrument and scheme that by 2010 will have totally replaced currently existing domestic direct debiting schemes. PEDD entails a new set of standards and formats as well as a set of strict rules governing relations between creditor and debtor, their banks, as well as the between the banks themselves. Banks are expected to start offering PEDD – as well as the other SEPA instruments related to credit transfers and cards – to their customers by the beginning of 2008. Then during a transitional phase between 2008 and 2010, PEDD will co-exist with the current domestic direct debiting schemes.

SEPA and diversity across the eurozone

With PEDD, an issuer of direct debits can collect funds from debtors throughout the entire single euro payments area using a single bank account, a single payment instrument and a single set of formats and standards. For large transnational corporations, the opportunity to streamline operations, banking relations and IT infrastructure is clear.

PEDD is also a major challenge for the European banking community. It is now commonly known and accepted that, with the advent of SEPA, banks face a potential decrease in revenue (linked, amongst others, to a decline in the volumes of lucrative cross-border payments), an increase in competition from foreign European banks, and large-scale investment in order to become SEPA-compliant. For PEDD, the need for such investment can be explained by the disparities between the PEDD scheme and the various domestic schemes in operation today. These differences are numerous and often fundamental, and largely centre around formats, underlying data, mandate flow and verification, direct debit timelines and exception handling.

Clearly, the implementation of PEDD is not just a ‘formatting issue’. The new pan-European scheme differs from domestic schemes by its very business rules. There can, therefore, be no quick-fix solution consisting of mapping the PEDD format into a domestic format for processing within the banks’ legacy direct debit applications.

M-PEDD – direct debit for all seasons

The M in M-PEDD stands for ‘multipurpose’, as the M-PEDD ‘scheme’ enlarges the scope of the pan-European direct debit to include the b2b, g2c spaces. For many market observers, the business case for the latter (from the bank’s point of view) is considered poor, the scheme benefiting the consumer the most.

On 31 January 2006, the Euro Banking Association (EBA) announced that 59 major European banks had agreed to underwrite a project for developing an infrastructure for the interbank processing of pan-European direct debits. The project, dubbed M-PEDD, is due to go live by mid-2007, ahead of the EPC’s 2008 deadline. Clearly, this proactive stance sends out a strong message that the banking community is committed to meeting the deadlines laid out in the EPC’s roadmap for SEPA.

Stakeholder implications

Rather than trying to link 25 different national schemes with different data formats and identifiers, the professed aim of the PEDD initiative across Europe is a single scheme, using single standards on which all players can compete with each other. The competitive landscape is changing and business agility will increasingly mark the winners.

The market will gradually work towards the final PEDD goals. While aspiring to the 2008 deadline is laudable, the question is whether the PEDD goals are realistic or too aggressive, and how quickly the systems can be built. Most of the automated clearing houses (ACHs) are funded by the market, normally on a cost-recovery basis, so they need to have the systems running with sufficient volumes before costs are recovered. As the systems are handling relatively low-priced transactions, time is also needed to recover costs.

Market forces are a big driver when domestic systems and standards need to be retired and replaced with something that is more efficient. Efficiency is a function of profit, cost and volume and that will be slightly different in each country. Full compliance may be in place for 2010, but it will only get more efficient as market forces push its development.

Opportunities and issues

The transition period may not be pleasant; the true benefits of the new regime will certainly not be realised until the plug is pulled on the old systems and any period of dual operation will be costly. Overall, however, the opportunity is also obvious; lost revenue streams from the current process can be offset by a massively increased potential customer base – almost the entire European continent.

Exploiting new markets in a highly competitive theatre will promote best service. Costs and charges will be largely uniform across the continent, so differentiation can be gained only through value-added services and flexibility to move to meet market needs.

Inevitably, strategic direction remains vital to financial institutions. Some smaller, domestic players may be opting to outsource their operations. Conversely, larger players will be able to realise large economies of scale through centralising processing and may insource into their direct debits processing centre.

The onset of PEDD and M-PEDD will dictate some level of infrastructure realignment; this may be adapters and interfaces, but will most likely be a more thorough re-evaluation of payments infrastructure. Either way, core systems will need upgrading to some extent. To manage the revenue shortfall from PEDD, financial institutions will take this opportunity to realign processes and increase efficiency. Increased straight-through processing (STP) through enhanced use of BICs and IBANs, and the gains from automated exception handling and speedier connectivity, will drive the process towards operational excellence.

On the other side of the fence, most direct debits are originated from corporations. Their existing mandates will all have to be renewed to meet the new PEDD requirements. This is a large task and requires careful management from both corporations and financial institutions. It is essential that a smooth transition is achieved if public confidence in the new initiative is to be maintained.

PEDD: a five-point checklist

The PEDD project is multi-faceted by offering opportunity and prescribed upgrade in equal measure. Below are five of the elements that will prove most important to success and profitable operation under the PEDD initiative. While PEDD is bigger than these success factors, handling them opportunistically offers the greatest potential for differentiation, revenue and added value services.

1. ‘On us’ routing or not
   Fundamental to routing decision-making is handling of ‘on us’ and not on us direct debits. This covers both incoming and outgoing transactions. The PEDD processing system’s routing process determines whether the debtor’s account is held by the bank or by a counterpart bank (i.e. whether the transaction is ‘on us’ or not). This has large cost implications and, with the onset of PEDD, particularly in cross-border bank operations and in multi-bank environments. Proper handling of on us and not on us direct debits will ensure appropriate internal routing for all transactions within international banking groups and cross-border operations.
2. Scheme timeline verifications
   Timelines for direct debit processing across Europe vary and this is compounded by the way that various scenarios are handled. What actions should be taken if there are insufficient funds? What if the transaction is rejected? What timeframe is offered to object to the terms of a direct debit? Under PEDD, timelines for the various scenarios are fixed. It should be noted that M-PEDD timelines are more flexible and are still under discussion. In essence, the system must verify that transactions comply with the rules defined under the direct debiting scheme. Flexibility to adapt the process rules that enforce and verify the timelines must remain paramount.
3. Mandates
   Before the bank applies a direct debit to one of its customer’s accounts, that direct debit may be subjected to a mandate verification process, which checks that a valid mandate exists. In certain cases, mandate verification is not required; certain direct debiting schemes include so-called ‘non-pre-authorised’ direct debits for which no mandate check is necessary. Likewise, in some schemes, the mandate is verified by a central institution (e.g. the ACH), banks are therefore not required to verify the existence of a mandate. Sophisticated handling of the mandates, from entry through to lifecycle processing, dictates the automation levels and overall process efficiency and is also important for user (debtor) acceptance of/confidence in the new direct debit instrument.
4. Stop payments
   A debtor can instruct their bank (or the debtor’s bank may take this action on its own initiative) to block some or all direct debits to an account. This ‘blocking’ instruction is referred to as a stop payment. Stop payments can be defined by a combination of criteria – debit account, creditor Id (i.e. originator Id, or biller), mandate reference, specific transaction reference/Id, minimum and Maximum amount. Handling stop payments in a configurable manner will maximise operational efficiency and improve the overall level of service offered.
5. Processing the 4-Rs
   Returns, refunds, reversals and rejections are known as the four R-transactions. Efficient handling of these exceptions offers opportunity for streamlining and service level improvement. The R-transactions are dual faceted in that their origination is important; incoming and outgoing R-transactions are handled separately. Incoming R-transactions are received from the Pan-European Automated Clearing House (PE-ACH) and must be reconciled within the bank and verified. Outgoing R-transactions, however, can be created under various circumstances, automatically.

It remains vital that the appropriate accounting systems are managed and that the customer reporting service informs the customer of the existence of R-transactions – advice to the debtor for outgoing items, and advice to the creditor for incoming items.

Watch this space…

While PEDD certainly meets the single European market goals, financial institutions need to consider their longer-term direct debit strategy. Is there a wider foreign market? What value-added services can be offered? Are there any insourcing or outsourcing opportunities? Time is tight and operations have little time to realign and rationalise. While the true benefits of PEDD will be realised quickly by the consumer, banks may need longer. What is certain is that nothing will be gained until the old systems are turned off. This implies that we will not have the true picture on the success of PEDD until beyond 2010. Watch this space.

Mark Hartley is VP Strategy and Marketing at Clear2Pay and as such leads the team responsible for Clear2Pay’s Open Payment Framework – a platform for ‘best of breed’ SOA-based payment solutions that embraces the (European) banking community’s SEPA needs, including a multi-purpose pan-European direct debit processing platform for Participants Banks.