Working towards compliance
As reported in the 'Legal and Regulatory Issues' sections of the Newsletter, there are currently a host of regulatory initiatives in the pipeline, which will affect banks and other businesses providing payment services. One important change which will take effect shortly is a provision of the Payment Services Directive (PSD), which stipulates that from 1 January 2012 onwards a payment must be credited to the account of the payee's bank1 by the end of the next business day after the point in time of receipt of the payment instruction. This particular PSD provision is commonly referred to as the 'D+1' requirement.
Banks which are currently working towards compliance to execute payment transactions in line with 'D+1', might want to pay particular attention to its impact on deferred-execution payment transactions and 'R-transactions' (rejects, refusals, returns, reversals, recalls and refunds).
Impact of 'D+1' on deferred-execution payment instructions
The principal area of difficulty is with deferred-execution payment instructions. Article 64 (2) of the PSD allows a payment service provider () and its customer to agree to delay the execution of payment instructions to a particular future date - for example, to pay rent at the end of the month. It may be desirable, in some cases, for the to 'earmark' the funds which the customer will need for the future payment. When a 'earmarks' funds in an account, it is essentially blocking them for further use by the client, although the client will continue to receive interest on the funds (where applicable) because they have not yet actually been transferred.
Without 'earmarking', which accept deferred-execution instructions may take a degree of credit risk on their customers. For example, if a bank commits itself irrevocably to make a credit transfer on the (future) execution date, which may happen if the bank puts in payment instructions into an inter-bank clearing and settlement system, then the customer may have withdrawn the funds in its account before the actual execution date arrives. If the bank has no choice about the timing of its commitment, the bank will wish to carefully consider whether it is willing to offer the payment service concerned. In some cases, deferred-execution will not cause a problem. An example of this is when a customer makes an online credit transfer instruction on a Friday evening and then wants to make an automatic teller machine (ATM) withdrawal over the weekend. If the two debits exceed the customer's Friday afternoon balance, the bank may want to disallow the ATM withdrawal. Can the bank therefore 'earmark' the funds, which are committed to the online credit transfer, even though the transfer will not be executed until the clearing systems open on Monday? Here the answer is yes because the PSD is framed in terms of 'business days'. This means that the online credit transfer instruction is going to be executed within the 'D+1' timeframe.
Another example of transactions where 'D+1' does not apply, is cash movements associated with securities processing. In various securities contexts a payment is committed several days in advance of the actual transfer: for example where an agent bank provides a settlement service relating to stock-exchange trades where the trade is done on day 'T' and settlement occurs on day 'T+3' or 'T+2'. In these cases the PSD does not apply, because Article 3(i) of the PSD exempts payment transactions related to securities asset servicing from its scope, so the bank is free to 'earmark' the funds if it wishes to do so.
Impact of 'D+1' on R-transactions
There are a number of processes, commonly called R-transactions, which are designed to allow to reject a payment. The Single Euro Payments Area () scheme rulebooks, developed by the European Payments Council (), refer to rejects, refusals, returns, reversals, recalls and refunds. R-transactions can also get tangled up in the 'D+1' rule: some R-transactions may have to be processed within a 'D+1' timeframe.
This might seem surprising because most people would think that R-transactions are simply a continuation of, or adjunct to, the original payment instruction, and that there is no real meaning to the 'point in time of receipt' when you are looking at an R-transaction. The European Commission however, seems to think that some R-transactions should be treated as completely separate payment transactions as evidenced in its answers to frequently asked questions (see link below) about the PSD. There is therefore a danger that the European Commission and the courts will think that the 'D+1' timeframe applies to some R-transactions as well as the main payment transaction.
who wish to offer their clients R-transaction services may therefore be subject to the very tight 'D+1' processing timetable set out under PSD Article 69, at least for some types of R-transaction. It may be prudent to agree with clients that these transactions will be treated as deferred-execution transactions.
More change is on the way
Banks are working hard to comply with the implementation of 'D+1'. Unfortunately however, the ramifications may (as explained above) require some adaptation or augmentation of client documentation for some services as well as operational change.
In this context, should keep in mind that the forthcoming 'Regulation Establishing Technical Requirements for Credit Transfers and Direct Debits in Euro' - the Regulation - will not only set end dates for the process of migrating national euro-denominated payment schemes to the pan-European schemes, but also supplement the PSD in various ways. This could require yet more changes to client documentation and will certainly involve more operational upheaval. Further down the road the PSD will be reviewed by the European Commission and the revised prudential framework, which has been settled by the Basel Committee of Banking Supervision (Basel III) will be implemented. This is all going to cost money, and will need to factor the possible financial impact into their strategic thinking, IT planning and client relationship management.
Dermot Turing is a Partner in the international financial regulatory team at Clifford Chance.
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1The term 'bank' is used in a non-discriminatory fashion and does not exclude payment service providers which are not banks.
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