In principle the single market is "an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured in accordance with the provisions of this Treaty"(1). In practice payment systems, with one or two exceptions (2), are arrangements made for operations within national frontiers and which do not accommodate payments entering the national payment territory from outside. Nor do national payment systems presently have the capability of addressing outgoing payments from their payment territory to a foreign payment system and vice versa (3).
The Commission regards the role of payment systems as an important factor in the proper functioning of the single market. Payments provide oil in the wheels of the economy and there can be few trading transactions across borders which do not require one or more supporting cross-border payments. Some of these supporting payments are for very large sums indeed, covering many individual items of trade. In such cases, where the value to be paid is high but the volume of payments (at that level of value) is low, the traditional methods of cross-border payment are considered adequate, at least from the perspective of customers (4). The majority in number however (often described as the bulk of the "volume") are for relatively small amounts (80% of cross-border payments are under ECU 15.000 in value (5) ). Low value payments are expensive to process by traditional methods, which involve time-consuming manual treatment, due to the difficulties of passing from one national payment environment to another.
The Commission believes that the aim should be to link payment systems between Member States so that cross-border payments can eventually travel between them as easily, as rapidly and as cheaply as equivalent domestic payments (6). If this goal is important in a single market setting (7) it becomes still more so in the context of monetary union. One of the main micro-economic benefits of monetary union will be to reduce the financial complexities and costs of doing business across borders, represented by currency conversion charges, exchange rate spreads, hedging costs, accounting tasks etc. These benefits will however be limited if there remain high cross-border payment costs and timing disadvantages when paying in the single currency across EMU borders (8).
The Commission has sought to act as a catalyst in the cross-border payments field since 1990 (9). Working closely with the banking industry (10) and with experts of central banks and government, the Commission identified the main obstacles to the efficient handling of cross-border payments (11). Work under the auspices of the Commission or of the EMI is now taking place on all such aspects, both for large and for low value payments.
The Second Banking Directive (12) provides the legal framework within which cross-border banking business takes place within the Community. As a core business under the Directive, forming part of the "List of activities subject to mutual recognition" (13) the provision of payment services is one of the activities which banks have a right to carry on across borders, whether by way of establishment, or at a distance, by way of freedom to provide services, in the EC Treaty sense of the expression.
Given that a bank is free to provide full payment services from its offices in Country A, to residents of Country B, it can realistically do so only if it is permitted to gain access to the relevant payment systems in country B. To belong to a payment system in a Member State without having a physical presence there is known as "remote access". It is commonly accepted that one effect of the Treaty freedoms, taken together with the Second Banking Directive, is to confer a right of remote access on banks wishing to join EU payment systems outside their Member States of establishment.
The right to access (remote or through a branch) is not automatic nor is it unqualified. The payment system, whether run by a central bank or by private inter-bank bodies, has the right to lay down objective conditions on such access, in the interests of the security and soundness of the system.
The possibilities which the Second Banking Directive has opened with respect to the access of branches and remote access, are already being taken up. Such cross-participation by banks in each others' national systems will no doubt contribute in time to the further integration of EU payment systems.
The European Commission's work on payment systems has
two main perspectives:
In 1990 it made a Recommendation (14) on the transparency of cross-border banking services. It also published a Green Paper (15) with the intention of stimulating discussion on all forms of payments across borders within the Community. Since that time the Commission has worked on payment systems issues with the banking industry, central banks and with users in a number of fora.(16)
The Commission's main priority areas to date have been:
Netting and legal risks
In 1990 a committee on Inter-bank netting schemes, chaired by Mr. A. Lamfalussy, then General Manager of the Bank for International Settlements, delivered what was to become a highly acclaimed report on netting, for the Group of ten central banks (23). Seven "minimum standards" were put forward, all of which are still regarded as valid and relevant. Principle no. 1 has been the subject of considerable work on the part of the European Commission, in conjunction with central bank and government legal experts.
Principle No. 1 of the Lamfalussy Report reads as follows: "Netting schemes should have a well-founded legal basis under all relevant jurisdictions." The principle recognises the inescapable fact that the legal rules of more than one jurisdiction will be relevant to payment systems which are international in their membership. This means that not only does the chosen law of the payment system have to ensure settlement finality, but also the laws of participants' home countries may also be decisive. Work on implementing Principle no. 1 is under way and legislative action in pursuit of it has already been taken in a number of jurisdictions (24).
Continuing concern over legal risks by the Committee of Governors
The Committee of governors of the EC central banks re-visited the Lamfalussy principles in their 1992 report on "Issues of common concern to EC central banks in the field of payment systems", also known as the Padoa-Schioppa report. This recognised the importance of removing legal uncertainties which can affect the stability and efficiency of cross-border payments in the EC. The issues evoked in that report go beyond the scope of purely netting arrangements and include legal issues relating to the use of collateral, the use of payment instruments and limits on revocability.
The shift towards real time gross settlement under the aegis of the EMI
Even if all possible precautions are taken (25) there remains a degree of risk in a net settlement system, which central banks regard as being very difficult to quantify, let alone control. Moreover the systemic effects of a failure in a net settlement system have potentially increased and will increase with the power of information technology. These advances enable a multiplication of payments issued by banks during a day, while competition forces banks to credit customers' accounts prior to final settlement.
The central banks' response has been to try to minimise and eventually to eliminate these systemic risks, by reducing the credit risks outstanding during the day within payment systems. Immediate and irrevocable settlement in the books of the central bank would be the ideal answer, but in practice this is not possible because the central bank needs to retain the right to reject a payment which exceeds the available funds to meet it (26).
Work in the EMI continues on the implementation of these real-time gross settlement ("RTGS") systems in all Member States. In principle these should be ready for the inauguration of the TARGET inter-linking system in 1997.
One of the consequences of the Lamfalussy report, referred to above, was to highlight the risks which flow from the inadequate legal framework supporting many cross-border payment arrangements.
The report focused on netting schemes but the point is true of other types of payment systems; even real time gross settlement systems are not considered to be immune from legal challenge from a jurisdiction hostile to the legal arrangements which support such systems. For example the insolvency laws applicable to a bank "a" from Country A may not recognize the finality of the settlement arrangements entered into by bank "a" in the payment system of Country B and might as a result force an unwinding of the settlement.
The Commission is contributing to the creation of an essential minimum legal framework in two ways:
6.1 The proposed Credit Transfers Directive
Correspondent banking has traditionally relied on contractual arrangements of a more or less informal nature, to deal with the questions that arise, such as errors, refunds, charging arrangements etc. For large value transfers, where the number of transactions is small but the values are large, these informal arrangements are generally considered to function adequately. What the Commission's proposed cross-border credit transfers directive aims to provide is a basic minimum framework of bank-customer and inter-bank rights and obligations, intended mainly to support the lower value "mass" transactions (27).
The proposed directive respects the parties' freedom to contract as they wish, by framing almost all of its provisions as "fall-back" or default provisions, which will therefore not apply if the parties have agreed on some other result (the money-back guarantee, however, applies in all cases).
6.2 The work on finality of settlement
The Commission, in its 1994 communication on payment systems (28) announced its intention to reach operational conclusions on legal provisions required to ensure settlement finality, by the end of 1995. At the time of writing, a draft text of a possible directive is undergoing consultation among banks and interested parties. A legislative proposal could still be made before the end of 1995, depending on the outcome of the final meetings with experts, following the present round of consultations.
If the legal uncertainties can be resolved this will, broadly speaking, have the following results:
There are two aspects to the future of payment systems in the forthcoming Economic and Monetary Union. The first is essentially a transitional problem, namely how to adapt to the single currency denomination, whilst keeping all systems operational throughout the changeover period. The second, longer term, challenge concerns the future of "national" payment systems within the monetary union. What changes will be required and what will be the impact of the single currency on traditional methods of doing cross-border business, such as correspondent banking?
7.1 Preparing for the changeover to the single currency
The task facing the payment systems is to convert fully to the ECU by the date of the final and complete introduction of the single currency (Step C in the reference scenario of the Commission's Green Paper on the practical arrangements for the introduction to the single currency) but to remain operational in national currency (mainly at the retail level) to the extent necessary, during the period leading up to the final date (i.e. during Steps A and B of the Green paper scenario).
Large Value Payment Systems
The Green Paper's reference scenario implies a considerable flow of payments in high values (29) from the date when conversion rates are fixed (at Step B). From this date large value payment systems, suitable for carrying large and time-critical payments and providing settlement finality, will need to be operational within and between participating Member States.
Within Member States the mechanisms used to achieve the desirable degree of settlement finality, specified by the central banks, may vary to some extent. However, where the payments are associated with the implementation of monetary policy the TARGET interlinking system being developed under the aegis of the EMI, will have to be used. The TARGET mechanism is in effect a two-tier structure, comprising a national payment system in each country, linking to the National Central Bank and thence via an interlinking mechanism to the ESCB. TARGET as such, will carry payments only in the single currency, but at the national level an operational choice might be made to leave the national system to continue until Step C to carry payments denominated nationally, for conversion into the single currency at some point outside the system e.g. before they enter the TARGET system.
Alternatively, given the concentration of critical mass at an early stage under the Commission's reference scenario, it could be decided to dedicate a national large value system to the use of the single currency from the start of Stage III. In some countries which have or intend to have more than one national large value system, a system would be available to meet both needs, as the sequence of introduction of the single currency develops.
For other large value payments in the single currency, not involving monetary policy, the choice of payment system will be open; clearly the ECU Banking Association's clearing system, will naturally be in a position to "convert", with little or no adjustment, from today's basket ECU, to the single currency, and thus be available to meet the needs of cross-border or domestic large value payments in that denomination.
Retail, or Low-Value systems
The problem of conversion to the ECU is more complex for systems which are retail or low value, because they carry a far large number of payments, from a far greater variety of customers. Preparations for the change at retail level can continue throughout the introductory period. It will clearly be an advantage for banks to have a longer period to deal with the retail changeover, thus avoiding the bottlenecks if all were calling on the same skilled personnel at the same time.
The mutual interdependence in retail payment systems (between retailers banks and customers) is such that most retail payment systems are unlikely to anticipate Step C, by making a conversion to the ECU before the final introduction of ECU notes and coin. It might nevertheless be possible to anticipate Step C (in the retail non-cash field) in some countries or for some specialised retail payment instruments.
Mixed Payment systems
Mixed systems, which carry both large value payments, of the kind which will need to be or will naturally be denominated in the single currency from the beginning of Stage III (Step B) and retail payments which will need to remain "national", cause a particular problem. Banks in the countries concerned are however aware of this and are considering possible solutions, designed to minimise disruption and in particular the number of conversions. One possibility is that high value traffic could effectively be "hived off" into a dedicated single currency system, leaving the old mixed system as a retail payment system.
Once Phase C has been reached - the introduction of notes and coin issued by the ESCB as legal tender - all payment systems in the EMU countries should be denominated exclusively in the single currency. In principle nothing else will have changed, in terms of standards, operating procedures and so on. The European Commission raised the question in its Green paper on the single currency, whether there might not at the same time as introducing the new currency, be an opportunity for more far-reaching changes in technical standards.
In effect the main technical obstacle, which separates the national payment systems, is the variety of incompatible standards for addressing payment orders. There are in fact 15 different systems for 15 Member States, making it impossible for, say, a French credit transfer to run on the Belgian credit transfer system and vice versa.
It has to be said however that the reactions received to this suggestion are not encouraging as to the timing of such an "upgrade". The changeover to the single currency is regarded as quite complex enough without adding further variables. It is likely that the single currency will not therefore, from a technical point of view, bring about a "single European payment systems area" at the outset. Nevertheless it can be expected that once the conversion to the single currency has been made, technical efforts will be re-directed towards making it possible to direct payments rapidly and efficiently to any part of the monetary union. This will already be the case from the start of Stage III for large value payments sent over the future ESCB's TARGET system and competition from privately run systems, such as the ECU clearing system, is likely to extend down to lower value payments.
(1) Treaty on European Union together with the complete text of the Treaty establishing the European Community, Article 7a.
(2) The ECU Clearing System is a genuinely international payment system. SWIFT is international and provides essential payment services, but is not a "payment system"; it transmits the messages regarding payments between its members.
(3) Pilot projects involving the linking of ACH's in Belgium, Germany and the UK are currently undergoing testing. These links involve the translation of a payment from one national format to another.
(4) However, there may be a question over payments which are "time critical" i.e. those payments for which a delay may have serious consequences, e.g. on the part of the receiving bank, or the members of a payment system in which it participates. See further below.
(5) Figures estimated by the European Committee on Banking Standards for 1993.
(6) The Commission announced its intention to work towards this aim in its Green Paper of 1990: "Making Payments in the Internal Market", since confirmed in its Working Document of 1992: "Easier Cross-Border Payments". The first legislative steps were announced in its Communication of 1994 "EU Funds Transfers, Transparency, Performance and Stability."
(7) The goal is in principle agreed by the banking industry even if there is debate as to (a) the time scale within which the aim can be implemented and (b) as to whether cross-border payments can ever attain exactly the same cost and efficiency levels as national payments.
(8) The costs of making a low value cross-border credit transfer amount on average to 24 ECU for a 100 ECU transfer and the average time taken is nearly 5 working days (from research studies carried out by the European Commission in 1993 and 1994 on the basis of a sample of around 1000 transfers between all Member States). At this very low value level the proportion of the cost accounted for by exchange rate spread is small, at less than 1 ECU.
(9) In 1990 the Commission adopted a Recommendation on the transparency of banking conditions related to cross-border financial transactions: 90/109/EEC.
(10) In particular in its two consultative groups, the Payment Systems Technical Development Group and the Payment Systems Users Liaison Group.
(11) Most of the obstacles are the result of three types of difficulty: (1) the lack of standardisation of banking formats and procedures and reporting requirements (2) the absence of a shared legal framework for inter-bank relations across borders (3) the absence of a single currency.
(12) Directive 89/646/EEC of 1512.1989, which entered into force on 1 January 1993.
(13) Activity No. 4 is "Money transmission services" and No. 5 is: "Issuing and administering means of payment (e.g. credit cards, travellers' cheques and bankers' drafts)".
(14) Recommendation 90/109/EEC of 14 February 1990. A recommendation of the European Commission is a legislative instrument of a non-binding character.
(15) Making Payments in the Internal Market: COM (90) 447 final
(16) The Commission formed two consultative groups on payment systems which have met regularly since 1991. The Payment Systems Technical Development Group and the Payment Systems Users Liaison Group. In addition, the Commission particiaptes in the work of the Working Group on Payment Systems of the EMI.
(17) The Commission has recommended a common exemption threshold of at least 10.000 ECU.
(18) A voluntary code of conduct was adopted by the banking industry with effect from 1993; in part this will be replaced by the proposed directive on cross-border credit transfers, which is likely to be formally adopted by the Council in 1996.
(19) A proposal for a directive on cross-border credit transfers was made in 1994 and reached political agreement on a common position in September 1995.
(20) The Commission's legislative programme for 1995 includes the intention to propose a directive on legal issues affecting finality of settlement.
(21) See EMI paper on Minimum Common Principles for payment systems.
(22) The Commission published a draft version of these principles in November 1994. Following consultation they were finalised and adopted in September 1995.
(23) Report of the committtee on inter-bank netting schemes of the G-10 central banks, Basle, November 1990.
(24) Notably Belgium and France in the EU and in the United States.
(25) Such as "capping rules" on net debits, or loss-sharing agreements.
(26) Two residual risks therefore remain namely (1) the credit risk that the receiving bank makes use of incoming payments which are "put in the queue" or rejected by the central bank and (2) the liquidity risk if the number of unsettled payment "gridlocks" the payment nand settlement system.
(27) Under the political agreement on a common position adopted by the Ecofin Council on 20.09.95, the scope of application of the directive would be ECU 25.000 (rising to ECU 30.000 two years after entry into force of the directive).
(28) "EU Funds Transfers, Transparency, Performance and Stability" COM (94) 436 of 18.11.1994.
(29) This flow of high value ECU payments is associated with the concept of establishing at the beginning of Stage III (i.e. at the locking of exchange rates) a "critical mass" of value in ECU.