Bitcoin was devised to avoid regulatory control. The European Banking Authority has other ideas - including AML measures

The European Banking Authority (EBA) has called on national regulators to discourage banks and payment institutions from dealing in so-called virtual currencies such as Bitcoin to “shield regulated financial services” .

The EBA also recommends that EU legislators consider declaring virtual currency market participants who are “at the direct interface between conventional and virtual currencies, such as virtual currency exchanges”, to become ‘obliged entities’ under the EU Anti Money Laundering Directive.

A circular by law firm CMS Cameron McKenna at lexology.com says that the EBA is also calling for a “substantial body” of regulation of virtual currency market participants, including the establishment of governing authorities “accountable for the integrity of a virtual currency scheme and the imposition of capital requirements”, the firm says.

By Edith Rigler

We have all been through it, one way or the other. You buy a new device. In the store, you test it and it works beautifully. When you come home and try it again, however, it no longer works. What could be wrong? Is it a sudden flaw? Is it the connection? Have you been sold the wrong product? Whatever the problem turns out to be, you wish that you could have performed end-to-end testing, in your own environment, from the beginning to the end to ensure that everything worked just fine.

This example is not unlike the situation that many financial services institutions are facing at the moment. In just a few weeks, payment providers and users have to be “SEPA-ready", and will have to follow new rules and standards when making and receiving euro payments throughout Europe. The so-called Single Euro Payments Area (SEPA) end-date of 1st February 2014 has been mandated for the euro zone countries by the EU authorities. The deadline is looming and cannot be ignored. Only the new rules and standards will be legally permissible after the end date, replacing the old rules and standards in full. [A European Commission proposal to extend the end-date by six months is, at the moment, just a proposal: in law, currently, the deadline still stands.]

Banks and businesses have been working hard toward meeting this deadline and becoming SEPA-ready. Some claim that they have been ready for a long time, and indeed have marketed their readiness to their clients. Some see their readiness as a competitive differentiator and claim that they have been SEPA-ready for months or even years. The definition of “ready", however, is in reality about as obscure and undefined as the assurances you were given that the new device which you bought at the start of this article had been thoroughly tested.

Payments business is a network business

The big difference between the general consumer and stakeholders in the payments arena is that the payments business is a network business. No one in the payments business can act alone. Obviously it takes someone to initiate a payment and someone to receive that payment, but unlike a cash payment, at least one bank, if not several, plus a clearing house, are also in the chain. Thus the new software/system/platform which claims to be SEPA-ready can only be considered to be ready if it has passed the litmus test, ie, that the payment which party A made to party B has truly passed through the bank(s) and the clearing system.

It is also worth remembering that although payments are not exactly at the top of everyone's mind, the market is unforgiving when it comes to incorrect or late payments. Consumers expect their salaries to be paid on time, businesses expect to receive payment for their invoices on time and governments are not amused when tax payments arrive late.

Errors can be expensive

For a consumer, not being able to test end-to-end may simply result in frustration and time wasted trying to figure out what exactly did not work, and why. For businesses and banks the criticality of testing and fixing bugs are much more relevant, and costly. Practical experience has shown that the cost of not testing at all, or of insufficient testing, can be significant. Clear2Pay, an internationally-active software house supporting financial institutions globally in their payments processes, has reported that the cost of errors which occur as a result of incorrect testing or lack of testing can be enormous.

This view has been supported by studies undertaken by US software engineers Barry Boehm and Victor Basili. Their work on measuring and quantifying the software development process showed that the cost of correcting bugs during coding is $937, the cost of correcting bugs during the testing stage is $7,136, and the cost of correcting bugs after software has been released is $14,102 per bug. Aggregating these figures for a whole country presents a rather gloomy picture: according to their estimates, software bugs cost the US economy $60 billion per annum. This translates into a whopping $6.8 million per hour, $113,333 per minute or $1,888 per second.

According to Van den Berg AG, a SEPA payments specialist provider with many bank and corporate clients in Germany, many financial institutions have taken the mandatory move to SEPA as an opportunity to consolidate previous multiple payment systems into one, thus automating their banking processes, and optimising financial operations generally. That said, there are vast differences in data quality between countries and industry sectors, and the introduction of the new SEPA direct debit has proved to be a real challenge.

The new payment instrument is more complex than the existing direct debit system as it comprises many different features, rules and specifications. Germany is Europe's largest direct debit country, and Van den Berg has said that there is a great risk that German financial institutions may miss the target. By the end of November 2013, only 10 percent of direct debits were processed in the SEPA format. The result of a survey conducted by ibi research shows that 46 percent of the financial institutions using direct debits will face serious liquidity problems if they are unable to issue direct debits for more than 15 days. This may lead to a domino effect. A firm unable to issue SEPA direct debits will not be able to pay its bills.

How to test whether your organisation is SEPA-ready

There are some basic requirements if financial institutions wish to ensure that they are testing appropriately for SEPA readiness:

1. Testing must be representative. A valid SEPA test must ensure that the right message sets are tested, ie, those payment types that conform to regulation and bank usage.
2. Testing must be realistic and practice-oriented, ie, it should simulate real business scenarios. 
3. Testing process must produce detailed reports which show what went wrong, and why, and where, in the payments chain. A report that simply states that a test did not work out is of little use.
4. Tests should be repeatable. 
5. Tests should be variable, ie, enable a change of just one variable at a time and simulate its impact. 
6. Tests should allow for updates in regulatory requirements or SEPA Rulebook updates.

Adequate testing will be essential

Appropriate testing is a serious business which should not be taken lightly and squeezed in at the end of a payment process change. In fact, testing is a critical component in the product development life cycle. Professional project management is essential. A testing manager must be made responsible for planning the testing process, determining the test phases, assigning resources, developing test cases, ensuring testing is executed, analysing feedback and identifying opportunities for improvement. Perseverance and attention to detail are important traits for the test manager.

While many businesses may claim they have been SEPA-ready for a while, and to have tested the SEPA processes in their own organisation, they may not have tested the functional richness of the new SEPA payment instruments, or have tested them with the whole chain of parties in the payments process. Given that the SEPA deadline is just a few weeks away, it is advisable to test now rather than risk failed payments. While the move to SEPA will ultimately provide significant benefits, financial institutions have been spending large amounts introducing the new SEPA standards, so that it seems foolish to jeopardise those benefits by inadequate testing. 

An edited version of this article previously appeared on Thomson Reuters.

Edith Rigler is an independent payments expert who advises banks, payment systems and payment institutions. She has published extensively on payments issues and held senior positions at a number of global banks. The views expressed are her own.

By Edith Rigler

About three weeks before the so-called SEPA end date (1st February 2014) a 6-month extension of this end date has been proposed. Seldom has a payments topic caused such attention in the media and resulted in so many positive and negative reactions.

What happened?

Many banks, corporates and public authorities have been working hard to reach the SEPA end date of 1st February 2014 by complying with the SEPA rules, formats and standards. But fact is that the migration rate has been disappointing.  As of November 2013, some 64% of all credit transfers within the euro area were SEPA-compliant but only 26% of direct debits were made in SEPA format. In general, these figures might not look too bad. 

But they are averages for the whole euro area and vary significantly by country – some countries have completed their migration, a second group is making good progress, and a third group is lagging far behind. Migration progress also differs widely by type of stakeholder, ie, whether one looks at banks, large or small corporates, associations or public authorities. 

The financial consequences of not becoming SEPA-compliant on time have been discussed widely: liquidity constraints might occur in cases where businesses would not be able to collect via direct debit; payment delays could mean that salaries cannot be paid resulting in consumers’ inability to pay for their mortgages, business bankruptcies might follow, etc. etc. 

The proposal of the European Commission

Considering the low migration pace in some countries the European Commission concluded that “it was unlikely that the SEPA migration will be fully completed on 1 February 2014”.[footnote 1] Moreover, since the SEPA end date meant that payments in non-SEPA format were to be rejected by banks, the Commission stated that “market disruptions could not be excluded” which might affect payment service users, and particularly SMEs and consumers.  

As a result, on 9th January 2014, the Commission proposed to amend the SEPA Regulation of 2012 by extending the end date for a limited period of 6 months. In other words, the current 1st February 2014 end date would be replaced by a new end date of 1st August 2014. Stakeholders which are not SEPA-ready yet would not have their payments rejected until 1st August 2014. They would be able to make payments in the “old” legacy format. The proposal also states that the extension is considered as an “exceptional measure which will not be extended any further”.  

The reactions to the proposal

At present, the Commission proposal is indeed just a proposal and has not been adopted yet. Normally, an 8-week period must elapse between a draft legislative act and the date of adoption. In this case the Commission has asked the EU Parliament and the EU Council for “absolute urgency”, to reach final approval. It seems fairly certain that that will indeed happen.

The Commission proposal came as a surprise to many, including banks and central banks. And the reactions of the media were immediate, critical, outspoken. TV stations reported on the subject, newspapers ran headline articles, associations commented, central banks and banking associations issued press releases. Quite a number of consenting and opposing views became apparent. 

On the positive side, some associations as well as payments providers welcomed a grace period of 6 months to allow SEPA laggards to catch up and avoid chaos in the payments market. On the other side, some observers predicted fear, uncertainty and chaos. Some banks voiced disappointment at the sudden extension of the end-date. Central banks reacted cautiously and recommended keeping the pressure on to become SEPA-compliant by 1st February.

Who wins, who loses?

The impact of the extension of the SEPA end date affects market participants differently:

• Consumers are not impacted. IBAN and national account numbers can be used in parallel until 2016. The new proposal does not change that.
• Banks which are SEPA-compliant may be faced with additional cost and effort. Currently they operate systems that can handle both legacy and SEPA payments. Operating parallel systems and processes is costly though; thus the banking industry was looking forward to being able to reduce the costly  duality. Communication with banks’ client base now needs to be changed, to explain the additional 6-month grace period. This may lead to confusion among clients, may result in thousands of questions and flood banks’ hotlines and overwhelm customer service staff. On the other hand, banks which had started to offer conversion services (converting legacy payments to SEPA format) may see this as an additional revenue opportunity, albeit for only 6 months. Interestingly, the Commission proposal does openly suggest that “payment service providers that have already fully migrated to SEPA might consider providing payments services users that have not migrated with conversion services during this transition period”. 
• SEPA-ready corporates may benefit from the extension: some had made the necessary changes to their systems but had not yet tested the new SEPA formats or had not completed testing yet. The additional 6 months will allow them to continue and/or complete their testing processes. For them the extension will therefore mean a reduction of risk that something goes wrong come 1st August.
• Corporate laggards, ie, those that had not completed or even started their SEPA projects yet, are the winners in the proposal: they now have an additional 6 months to reach the finish line.

Further questions arise

So the proposal will benefit some and is seen as negative by others. However, the proposal does raise general questions which are independent of whether the proposal is adopted or not:

• What does an extension or a regulatory end date mean for the credibility of the EU authorities? The SEPA end date has been well known, and was publicised, discussed, analysed and communicated for years. EU authorities kept stressing that there was “only a Plan A”. The Commission proposal now obviates this statement. All of a sudden a Plan B seems possible. Will market participants pay much attention to future regulations and their deadlines?
• What exactly does the proposal impact? As usual with payments, the devil is in the detail. Will the deadline for new Rulebooks (currently set for November 2014) be moved as well? Will the October 2016 deadline for non-euro area countries also be moved by 6 months? 
• Although the proposal states that no further extension beyond 1st August will be granted, it does say that the Commission and the ECB, together with national authorities will continue to monitor the migration process “and will be ready to take any additional measures, as appropriate”. This seems somewhat contradictory and needs explanation.
• What will happen should the proposal for an amendment not be adopted? Or, as some market participants have recommended, could the proposed extension period be shortened, to 3 months rather than 6 months?

In conclusion, the Commission proposal may have unwittingly resulted in one very positive impact: the media have now raised the awareness that there is a SEPA deadline – whatever it might turn out to be – and that changes in the payments markets are afoot. What was previously often seen as a purely operational project has now made it to the headlines. And that can only be applauded.

[Footnote 1] Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) Nr. 260/2012 as regards the migration of Union-wide credit transfers and direct debits, 9 January 2014.

Edith Rigler is an independent payments expert who advises banks, payment systems and payment institutions. She has published extensively on payments issues and held senior positions at a number of global banks. The views expressed are her own.

European Central Bank says is deadline still in place

At the 11th hour, the SEPA clock stopped ticking – well, for six months anyway. The deadline for the full switchover from legacy payment systems to the new single Euro payment area protocols for eurozone credit transfers and direct debits was to have been 1 February 2014. Yesterday, the European Commission threw in the towel – but it wants it back on 1 August.

Despite the efforts made by many banks and their corporate clients, the rate of take-up has not proved to be quick enough. As of last November, the rate of migration was just 64.1% for SEPA credit transfers (SCTs) and a lowly 26% for SEPA direct debits (SDD).

The EC now admits that, despite its efforts to raise awareness, it is “very unlikely” that full migration to SEPA will have happened by 1 February.

Potentially severe consequences

But because the deadline is a legal requirement, the EC said it is likely that banks would refuse to handle non-SEPA-compliant payment instructions. This, the EC said, would have “potentially severe consequences for citizens and companies”.

Now, the EC proposes amending the SEPA rules with a so-called “grandfathering clause” allowing banks (and other payment service providers) to handle legacy payments alongside SEPA-compliant payments for a limited six-month extension period to 1 August. It emphasised that this is “an exceptional one-off measure”.

The ECB “takes note”

In a seemingly stony-faced response, the Eurosystem of the European Central Bank said it “takes note” of the proposal, adding, “Strong and successful migration efforts have been carried out by stakeholders in the euro area…  the pace of migration is high and accelerating, and the vast majority of stakeholders will complete their migration on time.”

As far as the ECB is concerned, “the SEPA migration end date of 1 February 2014 remains”. Eurosystem “urges all market participants to complete the transition of all credit transfer and direct debit transactions to the SEPA standards by this date.”

And as if to prove the point about punctuality, the ECB’s SEPA web page still has a countdown clock ticking the days, hours, minutes and seconds until 1 February.

The Eurosystem SEPA web page with links to the EC proposal and Eurosystem's response can be found here.