What is a clearing and settlement mechanism?
According to the European Central Bank (ECB) publication, ‘The Payment System’, a clearing system means a “set of rules and procedures whereby financial institutions present and exchange data and/or documents relating to transfers of funds or securities to other financial institutions at a single location (e.g. a clearing house). These procedures often include a mechanism for calculating participants’ mutual positions, potentially on a net basis, with a view to facilitating the settlement of their obligations in a settlement system.”1 In other words, a clearing system enables, for example, the exchange of funds (money) and messages between two payment service providers () executing a payment transaction. The overarching term used for payment systems in the meaning of ‘funds transfer systems’ and other clearing and settlement arrangements is ‘clearing and settlement mechanism’ (CSM)2. These funds transfer systems can be as well as separate business – public or private – entities (which may or may not be owned by banks).
Separation of scheme management and clearing and settlement mechanisms in the Single Euro Payments Area
It should be noted that there are different payment system models existing globally. In some regions, a payment system provider may be responsible for both the development of the underlying payment schemes as well as the clearing and settlement of payments. In the Single Euro Payments Area () however, there is a clear separation between scheme development and the provision of clearing and settlement services.
The European Payments Council (), in close dialogue with the stakeholder community, develops the Credit Transfer () and Direct Debit (SDD) Schemes which help to realise . The is an international not-for-profit association which makes all of its deliverables, including the Scheme Rulebooks and adjacent documentation, available to download free of charge on the Website. The payment schemes, as defined in the and SDD Rulebooks, maintained by the , contain sets of rules and technical standards for the execution of payment transactions that have to be followed by adhering . For more information, refer to this dedicated page on the Website: ‘What is a Payment Scheme?’ (See ‘related links’ below).
Services offered by competing CSMs, based on the payment schemes, are governed by market forces and are outside the scope of the . To view the list of all CSMs that have disclosed to the by letter their intention to be and SDD-compliant, refer to the ‘related links’ below.
To strengthen the dialogue between the as the and SDD scheme manager and the organisations taking care of the clearing and settlement of transactions, the ‘ Clearing and Settlement Forum’ was created in 2011. The forum, which addresses exclusively technical and operational issues, allows sharing best practice to ensure efficient end-to-end processing of payments in line with the Scheme Rulebooks and Implementation Guidelines. The forum is co-chaired by the and a representative of the CSMs. Any CSM that has formally declared to be in the process of becoming -compliant or provides CSM services in a community which prepares to become compliant is represented in the forum. The ECB acts as an observer in the Clearing and Settlement Forum.
Clearing and settlement of transactions: questions and answers
From 1 February 2014 onwards, organisations making payments in the euro area will have to carry out euro credit transfer and direct debit transactions in line with the core provisions set out in the ‘Regulation (EU) No 260/2012’, establishing technical and business requirements for credit transfers and direct debits in euro – also known as the Regulation. Effectively, this means that as of this date, existing national euro credit transfer and direct debit schemes in the euro area will be replaced by and SDD. The EU legislator, i.e. the European Parliament and the Council of the EU representing EU Member States, formally adopted the Regulation in February 2012.
Market participants are currently in the process of working towards achieving compliance with this legislative act. In October 2013, the ECB published updated qualitative indicators to assess preparedness across the transaction chain in each country (see ‘related links’ below). The most recent qualitative indicators, which reflect the assessment by national central banks as of the third quarter of 2013, confirm that 3 will be ready. In the majority of euro area countries, have already completed preparations. These indicators also demonstrate that a large majority of stakeholders on the demand side in the 17 euro area countries are expected to make the transition on time.
To date, the transition to and SDD has evolved at a different pace: according to the quantitative indicators also published by the ECB (see ‘related links’ below), as of September 2013, the share of transactions amounts to 56.3 percent and the share of SDD transactions has reached 6.8 percent. The quantitative indicators measure the share of and SDD transactions as a percentage of the total volume of credit transfers and direct debits generated by bank customers in the euro area.
CSMs have processed transactions since started rolling out services to their customers with the launch of the Scheme in January 2008 and the and SDD Business to Business (B2B) Schemes in November 2009. Based on data made available by the ECB, there are some 36 billion credit transfers and direct debits processed annually in the euro area4; i.e. CSMs will handle this volume in line with the requirements from 1 February 2014 onwards. José Beltrán, Chairman of the Board of the European Automated Clearing House Association (EACHA), and Erkki Poutiainen, Chairman of the Board of CLEARING, report on the preparations of CSMs and their readiness for the mass migration of euro credit transfers and direct debits to the -only environment.
Newsletter: In September 2013, 56.3 percent of credit transfers generated by bank customers in the euro area were SCTs. To date, i.e. since the launch of the Scheme in January 2008, CSMs processed more than 7,000 million transactions. In your view, is the following statement accurate: “The clearing and settlement of transactions is a done deal. We do not expect any difficulties in moving to an -only environment by 1 February 2014 in the euro area”?
José Beltrán: The CSMs in the euro area as well as the non-euro area, which are members of EACHA, are central to the clearing and settlement of both SCTs and SDDs. They have been leaders in making the necessary investments, developments and preparations to support the market’s migration to the payment schemes. The Scheme was launched in January 2008, so a priori, no major challenge is expected in the interbank to CSM space. However we should be cautious not to be overly confident as close to 50 percent of euro credit transfers have yet to migrate to by the 1 February 2014 deadline applicable in the euro area. This is not only dependent on the CSMs or their users; i.e. . Ultimately, the volume is generated by bank customers who must migrate to and SDD. I would therefore agree with the statement but we need to stay focused to ensure a smooth transition by 1 February 2014.
Erkki Poutiainen: In principle the answer is YES. I base my view on the fact that SCTs have been cleared and settled with increasing volumes since 2008 and several communities have already moved their national credit transfer flows to the formats and processing channels. However, as the migration of large volumes is stretched to the last minute, we need to be prepared to act upon any exception scenario we can think of. Possible errors caused in any part of the payment chain will very likely show up also in the processes of a clearing system, which by nature is a hub. This preparedness is now the primary short-term focus for CLEARING.
Newsletter: In September 2013, 6.8 percent of direct debits generated by bank customers in the euro area were SDDs. To date, i.e. since the launch of the and B2B Schemes in November 2009, CSMs processed more than 350 million SDD transactions. Did CSMs find that processing SDD transactions would be more complex than processing SCTs and, if so, what are the reasons?
José Beltrán: The SDD Scheme is a major challenge to all communities. The legacy direct debit instruments existing today at national level are often very different from the SDD Scheme. In the case of direct debits every community had over the years embedded services and features in the customer to bank space in support of their specific market practices and consumer demands. The introduction of SDD has meant making many changes to the processing chain beyond the basic clearing and settlement component. From a CSM point of view, processing SDDs is not more complex than processing SCTs, but we need to appreciate that the changes required by and their clients to become SDD-compliant are very significant, and often require major investments and implementation projects.
With this in mind, the EACHA CSMs involved in migration have run, and continue to run, specific migration programmes for their communities to fine-tune the end-to-end exchanges of SDDs, running exception handling scenarios, operational recovery, etc. Again, it is worth noting that perhaps the even bigger challenge with regard to SDD is in the customer-to-bank space, where equally are carrying out preparation programmes with their customers to help them make the transition. We can say that we are all working towards achieving a successful migration to SDD.
Erkki Poutiainen: Creating and implementing the Scheme was a rather straightforward affair, since there were relatively few discrepancies between the different credit transfer schemes across Europe. had already been exchanging credit transfers at a cross-border level in Europe prior to the launch of the Scheme and there was a shared understanding of how this should work. So had a pretty high level of maturity from its start.
SDD is a different story. It is the first direct debit instrument introduced at a pan-European level and it is a more complex scheme by nature. Since mandate5 concepts and the handling of direct debits considerably differ from one European legacy scheme to the next, many and corporates have had to face a steep learning curve in their migration efforts. I believe it is true to say that CSMs and bank-internal processes have mostly been ready for a while now – STEP2, for example, has been offering SDD services since November 2009 and the D-1 option6 since November 2012. But millions of small and medium-sized enterprises (SMEs), associations and clubs across Europe are still struggling to adjust their internal processes, enterprise resource planning (ERP) systems and customer data to the new requirements. There is a lot of support by and IT providers, but getting all creditors, (i.e. bank customers collecting direct debit payments), ready for SDD remains a major challenge and will be key to a disruption-free end-to-end processing of these collections.
Newsletter: In its first migration report published in March 2013, the ECB warned against the risks of late migration. The also frequently recommended that payment service users should aim to complete migration as early as possible. The fact of the matter however is that mass migration to SDD will happen only at the last stage of the transition period leading up to the 1 February 2014 deadline. Consequently, CSMs will have to manage what could be described as ‘big bang’ SDD migration. How do CSMs prepare for this situation?
José Beltrán: In this respect, for the EACHA CSMs supporting migration it is business as usual. The euro area CSMs process around 95 percent of all credit transfers and direct debits cleared in CSMs today that will migrate to and SDD. Consequently, handling mass volume does not represent a particular situation for either the CSMs or their participants; i.e. . It is often a change within the CSM from processing in one clearing service to another with a different data set.
For the EACHA CSMs communities we are pleased to share that although the wide average migration rates published by the ECB do indicate a ‘big bang’ scenario for SDD leading up to 1 February 2014, some CSM communities have already achieved very high rates of migration. Indeed in some communities 100 percent migration has been achieved with regard to both and SDD.
Having said this, the challenge of end-to-end coordination is enormous and despite all efforts by CSMs and their participants to be prepared, there is a need to plan for the unexpected. For this, every community is working very closely with their CSM through special support teams and open communication channels.
Erkki Poutiainen: In practice, the big bang migration of SDD means that tens of thousands of corporates will send for the first time and within a very short period of time large numbers of direct debit collections in a new data format and including new data, such as the International Bank Account Numbers (IBANs) of the debtors. This challenge requires the highest level of attention by all the parties involved in the end-to-end processing. To optimally support this scenario at CSM level, CLEARING has been running a comprehensive Large Volume Exchange Program with those users that will send and/or receive very high domestic transaction volumes via the STEP2 Services. This program includes a major testing exercise and a very close monitoring of the ramp-up activities of all parties involved. We have, for instance, introduced an alert system that ensures that both STEP2 and the receiving bank are pre-informed about massive volume increases during the ramp-up period.
Newsletter: Do CSMs expect any specific difficulties with regard to the processing of transactions as of February 2014 and, if so, what would these be and how will you mitigate related risks of payment failures?
José Beltrán: As I mentioned earlier, the SDD migration has also represented the migration of a number of related services, provided by or centralised in CSMs depending on the community. Our preparations have extended beyond the clearing and settlement service and additional specific tools have in some cases been developed to support the and their customers. These tools cover data set management, mandate processing and management, account switching and non-financial messages. This is to say that the risk management undertaken by the community is not limited to and SDD clearing, but that the whole processing chain has often been redefined. As I mentioned earlier, our CSMs are working with their communities to identify and mitigate any potential risks.
Erkki Poutiainen: As referred to above, clearing systems are a central place in the payment processing chain and errors that occur at any level in the chain are likely to surface in this hub and may cause disruptions there. Together with the STEP2 users, CLEARING has been putting major effort into identifying such risk scenarios and their potential sources, which are more often than not related to the fragmentation of the payments infrastructure in Europe. This work has helped us to fine-tune our operational contingency measures, so that we should be in a position to better mitigate the impact of any disruptive scenarios on the good functioning of the STEP2 Services and the payments business of our users.
Clearly, the preparations of the financial industry have extended far beyond the clearing and settlement space. To that effect, CLEARING has delivered additional optional services around account switching and mandate handling to optimally support different communities in their migration. In our case, these services have been implemented with a view to making them available to banks all across Europe, which should help to further foster integration beyond 1 February 2014.
Newsletter: So, you are confident that full migration to and SDD in the euro area by 1 February 2014 will be smooth sailing for CSMs?
José Beltrán: We have completed our preparations, the CSMs are ready and we know that all stakeholders are doing their utmost to become -compliant, but nothing is ever smooth sailing. So, ready to sail through the storm if there should be one. It is likely to be a bumpy ride but we need to be confident on the outcome.
I will take the opportunity to add that in the EACHA CSM space we are already working on the evolution of the payments market beyond the migration. We are looking at the optimisation of clearing, settlement and related services to support our customers in meeting consumer expectations for faster exchanges with regard to online and mobile payments.
Erkki Poutiainen: No one can say that this will be smooth sailing. However, if all participants in the chain do prepare in a sensible manner, our boat will master these rough waters and successfully sail towards a horizon of opportunity in the post- world. But in order to get there, we will need to have all hands on deck and tackle any challenges in a coordinated manner.
Newsletter: Mr Beltrán, Mr Poutiainen, thank you very much.
José Beltrán is Chairman of the Board of the European Automated Clearing House Association (EACHA). Erkki Poutiainen is Chairman of the Board of CLEARING. Etienne Goosse is the Secretary General.
Related articles in this issue:
SEPA Fact Check: The SEPA Benefits Projected by EU Governments, the European Parliament, the European Commission and the European Central Bank (1999 – 2013). SEPA is an EU integration initiative driven by EU governments and the EU institutions. Note: the European Payments Council is not part of the EU institutional framework
SEPA 2014 - the European Central Bank Reiterates: "Everybody Has to be Ready on 1 February 2014 or Risk Disruptions in Their Individual Handling of Payment Orders." European Central Bank publishes second SEPA migration report and warns against risks of 'Big Bang' migration scenario
SEPA 2014 - the State of Play (October 2013): a Large Majority of Stakeholders Are Expected to Meet the 1 February 2014 Migration Deadline. Late Movers Must Catch Up. Now. The most significant risk to business operations is non-compliance, i.e. failure to meet the SEPA migration deadline applicable in the euro area mandated by EU law
Related article in previous issue:
The Global Payment Systems Analysis (GPSA) Identifies Key Change Drivers Impacting the Industry. A comparative analysis of system rules and trends ( Newsletter, Issue 16, October 2012)
1 European Central Bank: ‘The Payment System. Payments, Securities and Derivatives, and the Role of the Eurosystem. Editor: Tom Kokkala’. .
2 Additional terms used in the context of clearing and settlement are: automated clearing houses, payment systems and infrastructures.
3 According to the qualitative indicators published by the ECB in October 2013, in Estonia are at risk of not being ready for SDD by 1 February 2014.
4 European Central Bank Blue Book Statistics.
5 A mandate is signed by the debtor (payer) to authorise the creditor (payee) to collect a payment and to instruct the debtor's payment service provider to pay those collections.
6 Based on the standard time cycle of the Scheme, the payer’s bank must receive the request for a first direct debit collection or for a one-off direct debit collection at least five business days prior to the due date. The Rulebook includes the possibility to use a shorter time cycle for the presentation of both first and recurrent direct debit payments by allowing the biller's bank to send the payments to the payer's bank at least one inter-bank business day prior to the due date. This option caters for the needs of certain businesses which require a shorter time cycle for direct debit payments than the standard cycle.
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