Cablegate: New Legal Payments Framework: Monetary Integration

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 07 FRANKFURT 002410

SIPDIS

SENSATIVE

STATE FOR EUR PDAS RIES, EB, EUR/AGS, AND EUR/ERA
STATE PASS FEDERAL RESERVE BOARD
STATE PASS NSC
TREASURY FOR DAS LEE
TREASURY ALSO FOR ICN COX, HULL
PARIS ALSO FOR OECD
TREASURY FOR OCC RUTLEDGE, MCMAHON

E.O. 12958: N/A
TAGS: ECON EFIN EUN
SUBJECT: New Legal Payments Framework: Monetary Integration
at Retail Level

T-IA-F-05-016

This cable is sensitive but unclassified. Not/not for
Internet distribution.

1. (SBU) Summary: The European Commission (EC) intends to
propose a directive for payments services in the internal
market by June or September. A legally consistent framework
for the EU payments market, providing for transparency of
payment services contracts, competition and consumer
protection, is an essential building block for a Single
European Payments Area (SEPA) in which banks handle all euro
area payments as "domestic," essentially superceding purely
national payments systems. The EC's goal is for citizens to
be able to make payments around the euro area as simply and
as easily as they make payments in their home national
markets today, if not more so. This is monetary union
integration at the retail level, the next big push that
could help drive up efficiencies and competition to benefit
EU consumers and industry.

2. (SBU) Realizing the vision is easier said than done.
The EC has been laboring over a draft directive for several
years and still faces considerable difficulties. The
European banking industry, after being legislatively forced
in 2001 to charge equally for domestic and cross-border
payments, created the European Payments Council (EPC) to
"get in front of the issue." The EPC has drawn up a roadmap
on how banks would voluntarily cooperate to develop
instruments, standards and infrastructure so national
payments systems could migrate into a European one, creating
a SEPA by 2010. Truth be told, only a small portion of the
56 billion or so annual payment transactions are cross-
border. In other words, the business case for SEPA is not
compelling for individual firms. The noble SEPA project has
been slipping, despite the prodding of the European Central
Bank (ECB).

3. (SBU) In a surprise move, Commissioner McCreevy has
threatened to include industry standards and deadlines for
the SEPA into the new legal framework directive. Member
states will meet in mid-April to consider the idea. The EPC
has responded with a resolution underlying its commitment,
but the Commission is looking for firm assurances. Banks
are content with the current profitable national payments
systems, so they have little commercial incentive to change.
EU policy officials, on the other hand, may want to
accelerate the creation of a SEPA through legislation,
hoping to reap its potential benefits sooner rather than
later. End Summary

The Vision
----------

4. (SBU) Walk into a bank in Austria, make a transfer from
your home bank in Germany to pay a contractor in Spain for
work on your Costa del Sol villa. Or to pay for a car
directly from the manufacturer in France. Done as quickly,
easily and as inexpensively as you would make such a
transfer for repairing your chalet in Kitzbeul or buying a
car from a Vienna dealership. That is the vision for the
euro area. Even though euros are legal tender throughout
the euro area, cash is an expensive and inconvenient method
of payment. A euro area payments system would increase
competition in goods and services, increasing inefficiencies
to benefit consumers and industry alike.

5. (SBU) To realize this vision requires legal certainty
and standardization of forms and processes. Legal certainty
means that the users (customers) and providers of payment
services (banks, card companies, money remitters) operate
within the same legal framework of rights, obligations and
transparency. Standardization means that banks use common
instruments, standards and infrastructure for the execution
of transfers among themselves on an inter-bank basis. The
EC's new legal framework for payment services would cover
the first part; an initiative by the EPC would cover the
latter, creating the SEPA.

Legal Framework for Payment Services
------------------------------------

6. (SBU) The EC launched a consultation in December 2003
for a new legal framework directive. Its overall objective
is to provide a consistent legal framework for a European
payments market by providing a harmonized set of rules for
all payment services. This would increase legal certainty
and reduce compliance costs, allowing for economies of scale
and cost and price reductions. The EC also wants to ensure
a level playing field and enhance competition between
payment service providers. Banks tend to be the larger
players, but payments via direct debit cards, payment cards,
money transmitters, and e-payments or m-payments are other
important forms of payments. Allowing payment institutions
authorized in one member state to be "passported" to operate
throughout the EU would enhance competition, in the
Commission's view. The EC also wants to have a consistent
level of consumer protection and improved transparency.

7. (SBU) The EC's working draft contains general rules for
payment service providers, requirements for being authorized
as a payment institution, rules on payment services
(transparency of conditions, provision and use of payment
services, authorization of a payment service transaction,
the execution of a payment transaction, fraud prevention,
out-of court redress), and harmonization and mutual
recognition among EU member states. The directive would
establish a Payments Committee, composed of member state
authorities competent for payment systems, to help ensure
national implementation measures are harmonized and enter
into force at the same time. The EC's work schedule
indicates the proposal should be issued in June.

8. (SBU) Commentators generally share the EC's overall
objective. The EC, however, has been having a difficult
time committing to paper the legal obligations that would
make it a reality - being consistent with the reality of how
markets function and specific payments transactions take
place. The European Payments Council, an organization of
European banking associations, the Payments System
Government Expert Group, and the Payment System Market
Expert Group have provided the EC comments on its drafts.
The fifth modified working draft was issued at the end of
2004 and still attracted much criticism. Two general
criticisms have been that the drafts have changed
substantially from one version to the next and have not
reflected many of the views offered by industry.

Issues
------

9. (SBU) As the UK and Austria Presidencies will have the
lead on directing the proposed payments services directive
through the Council process, Finance Ministries and central
bankers in those countries are tracking the key issues that
have arisen in the drafting process. The following are some
issues largely based on conversations with these experts and
well as comments from some industry experts.

10. (SBU) Third Country Leg: The scope of the draft
directive would apply to payment services where either the
payer's payment service provider or the payee's payment
service provider is located in the EU, unless stated
otherwise. A payment service provider is a natural or legal
person whose regular business includes the provision of
payment services to payment service users. This means that
if the customer making the payment in Greece, using a Greek
bank for a payment to a person in the US, the payment
service in the US would be subject to the directive. Or if a
US person were to use its US bank to make a transfer to the
Greek person, that payment service would also be covered.
11. (SBU) While the draft would restrict the application of
obligations on fees and execution time to transactions
within the EU, other obligations, such as on the
availability of funds and liability for the execution of a
payments transaction, could be read to apply to entities in
third countries. Apart from the extraterritoriality issue,
commentators have pointed out that EU payments providers
should not be held liable for transactions outside the EU
where such providers are subject to different rules. The
EC's view is that the EU-based payment service provider's
experience in dealing with entities in third countries
should allow it to incorporate risks dealing with such
entities in the provision and pricing of its services. The
pricing of such risk is not a market price and would drive
up costs and likely decrease service, in the view of some
market experts.

12. (SBU) Second Party Transactions: Even without the third
country leg, there is a question of the extent to which a
payment service provider can be held accountable for an
entire transaction. German bankers' have pointed out that a
payment service provider should be obliged by its contract
for the use of its services (i.e. a customer directing it to
make a payment a vendor with an account in another bank),
but it cannot control or be held liable for the non-
performance of another service provider (i.e. whether the
vendor's bank will transfer the funds to the vendor's
account). One US bank made a similar observation, noting
that under the US Uniform Commercial Code, the originator's
bank is not liable where there has been defective execution
on the part of some intermediary banks or beneficiary banks.

13. (SBU) Competition: The directive would allow for the
authorization of payment institutions, like Western Union
and other providers of money remittances. Some member
states, like Germany, require money remitters to be
associated with a bank. UK officials take the view that
such point-to-point remittances that do not extend credit
hold very low risks and authorizes them as separate
institutions. ECB officials have expressed concern about
the prudential aspects of allowing payment institutions to
operate on a "lighter regime, " while banks are concerned
that they will be at a competitive disadvantage and deprived
of attracting customers to their local offices where they
advertise and sell other consumer services. The EC is keen
on opening up competition in this area to help drive down
consumer costs.

14. (SBU) Liability: Several issues have arisen on
liability. The draft directive would limit the loss to the
payment service user resulting from the lost, stolen or
misappropriate payment verification instrument to euro 150.
Some commentators have accepted this level, others question
why consumers should bear any loss, while others suggest
that the consumer should bear more financial liability.

15. (SBU) A more problematic issue is that the recent
working draft abolished the upper limit of euro 50,000 to
which the provisions of the directive would apply, meaning
it would apply to all transactions. This, coupled with the
liability provisions on disputed transactions or
unauthorized transactions would open payment service
providers to potentially large risks, including increasing
the risks of fraud committed by their clients, which would
lead to reducing services. This would be particularly true
in third country transactions mentioned above where the EU
service provider would have a difficult time redressing
potential abuses.

16. (SBU) Calling Back Transfers: The draft directive
would accord the payer the right to refund a payment
transaction which already has been executed under certain
conditions, e.g. his authorization did not include the exact
amount of the payment transaction at the time of its
authorization or the amount of the executed transaction is
contrary to the payer's "legitimate expectations," e.g. due
to changes in exchange rate. The request for a refund needs
to be made within six weeks of the payer being informed of
the transaction and, in any case, before three months after
the execution of the transaction. German bank commentators
note that such a recall could be applicable to card
transactions but not bank transfers. A major US card
payment company, however, points out that some charges are
not knowable in advance, such as car rentals that exceed the
initial contract dates, a service offered to the consumer.

17. (SBU) Application to Card Transactions: The draft
seeks to have uniformity for all payment services, but
German bankers and a US card payment company point out that
many of its provisions, including the very definition of a
"payment transaction" (the "deposit, withdrawal, or transfer
of funds from a payer to the benefit of a payee), applies to
the payment transaction from the payer to the payee.
However, the scope of the obligations would apply to payment
services initiated by the payee at the authorization of the
payee, e.g. card transactions (credit card services would
not be covered by the directive). One solution would be to
re-craft provisions for different types of payment services;
another solution would be not to include card transactions
in the directive.

18. (SBU) Waiver for Micro Payments: The working draft
would permit member states to waive requirements for
authorization and supervision of payments institutions where
such institutions (a) have less than six million
transactions a year and (b) hold a vital role in micro
financial intermediation, such as for underprivileged social
groups whose recourse to other payment services is limited;
and the waiver is in the public interest for law and order
and the effective implementation of money laundering rules.
This waiver would be particularly useful for the UK and
other member states that have large minority social groups
that rely on informal money remittance systems.

19. (SBU) Corporate Carve Out: The draft directive would
allow payment service providers and corporate users to agree
to different rules, so called service level agreements. As a
UK expert pointed out, the directive would make little sense
being applied between a multinational corporation and a
global investment bank. Others suggest that small and medium-
sized enterprises also have the leverage to strike deals
with payment providers and the legal resources to make it
stick, so they too should have the option not to apply the
rules.

20. (SBU) Cash: The most recent draft unexpectedly had an
expanded scope that included cash deposits and withdrawals.
Industry experts observe that they have not had time to work
through the implications of such a major change. Potential
effects include delaying the deposits of cash, changing the
way providers handle cash deposits (including out of hours
and automated arrangements), and requiring supermarkets that
provide "cash back" to be authorized as a payment
institution.

SEPA: Roadmap and Reality
-------------------------

21. (SBU) Common standards for payment services would serve
as the basis for inter-bank payments systems. In June 2002
the European Payments Council (EPC) was established to help
put into place a Single European Payments Area (SEPA) by
June 2010. Working backwards implies that by January 2008
citizens and commercial enterprises should be able to use
pan-European instruments, services and standards for
national payments. Initially this would mean that these pan-
European activities would be in parallel with national ones.
This would allow customers to make national and cross-border
payments from one account. National instruments, services
and standards would be gradually phased out, replaced by pan-
European ones. National infrastructures would be abolished
or transformed to a pan-European infrastructure.

22. (SBU) In December 2004 the ECB issued its third
progress report towards a single European payments area in
which it lamented that support for the "SEPA project and its
objective had weakened." The ECB presented its expectations
for the development of the necessary payments instruments,
standards and infrastructure. It concluded that if banks
were not able to get their acts together on a voluntary
basis, then the ECB might adopt regulation. An Austrian
central bank expert confirmed that, in his assessment, the
project had slipped by two years.

23. (SBU) With respect to instruments, in November 2002 the
EPC adopted the Credeuro Convention for cross-border
straight through processing (STP). STP instructions include
International Bank Account Number (IBAN), the beneficiary
customer, and Bank Identifier Code (BIC) of the
beneficiary's banks. Crederuo covers credit transfers of up
to 12,500 euros, and guarantees a bank customer charges at
the level of a domestic transfer and a maximum execution
time of three days. In April 2003 the EPC adopted the Inter-
bank Convention on Payments (ICP) to support Credeuro and
harmonize inter-bank charging practices. Four countries
(Germany, France, the Netherlands and Sweden) have
transposed the ICP into national banking industry
agreements. The ECB would like to see Credeuro and the
supporting inter-bank charging convention become the
compulsory minimum standard for all retail cross-border
credit transfers by January 2006.

24. (SBU) To compete with national systems, by January 2008
the ECB wants to have same day value payments at the euro
area level (called "Prieuro") and Credeuro as options for
national credit transfers. Also by the same date the ECB
wants to have pan-European direct debit (PEDD) as an
optional standard available for all euro area customers'
national direct debits. This would help ensure that PEDD
would be used on a euro-wide basis by 2010.

25. (SBU) Uniform standards are essential to realize smooth
straight through processing for payment transactions. For
credit transfers the ECB suggests that the EPC implement a
common account identifier (IBAN) for both national and cross-
border credit transfers and direct debits in SEPA. The ECB
also encouraged the EPC to define and implement standards
for straight through processing, including a unique standard
for electronic payment initiation and automated
reconciliation.

26. (SBU) On infrastructure the EPC adopted a model for the
European retail infrastructure, the pan-European automated
clearing house (PEACH). The European Banking Association
Clearing Company established the first and, to date, the
only PEACH. The PEACH only handles transactions up to
12,500 euros, provides for 3-day execution time, and is
limited to credit transfers. This is an expensive, narrower
and slower system compared to national systems that realize
lower costs through economies of scale, execute transactions
in one day, and cover direct debits. The ECB wants national
strategies for the migration of national infrastructure
systems to handle pan-European transfers. This could entail
transforming efficient national systems into PEACH compliant
systems or setting up completely new infrastructure.

Progress on SEPA: Public Policy Choices
---------------------------------------

27. (SBU) The ECB's disappointment with the speed of banks'
voluntarily working toward SEPA is understandable. The ECB
holds the vision of an integrated euro market for retail
payments as an important step for consumers and industry to
reap more benefits of monetary union. Bankers' lack of drive
is also understandable, since the SEPA requires a commitment
of time and resources whose commercial pay-off is uncertain
as long as efficient national payment systems exist. Cross
border payments account for less than 5% of the 56 billion
annual payment transactions. There are little economies of
scale to be realized from such business.

28. (SBU) From a public policy perspective, the
externalities of a SEPA appear to be large, promoting
competition in goods and services on the European level to
the benefit of consumers and industry. Individual banks may
not find the business case for setting up cross-border
payments systems, but together they could all benefit by
have one payment system for the euro area rather than the
present 25.

29. (SBU) According to UK officials these considerations
motivated Commissioner McCreevy to get involved. In a March
10 speech McCreevy stated that banks need a "clear political
signal," opining that he was convinced of "huge benefits" in
making the investment for a SEPA, delivering "significant
savings for banks, industry and consumers." Musing that "we
cannot sit on our hands forever," McCreevy declared, "We
will do what is needed to ensure that industry delivers a
single payments area. If necessary, the Commission will
make some agreed industry standards mandatory and include
the roadmap for the SEPA in our draft legal text." One way
that the Commission could spur faster action, in the view of
UK experts, would be to require transactions be executed
within one day - essentially the norm for domestic
transactions.

30. (SBU) The Commission will meet with member state
experts on April 12 to discuss how to proceed. If there is
agreement to include SEPA issues in the proposed directive,
the Commission is likely to delay launching the directive
until September and would open up any new working draft to
another round of public consultation. Meanwhile, the EPC
has adopted a resolution that underscores its resolve to
create the SEPA and has explained its work with banks on
plans to migrate national systems to euro area systems.
Whether this and other promises are enough to dissuade
Commissioner McCreevy from proceeding with legislation on
SEPA is a matter of on-going discussion.

Observations
----------------

31. (SBU) SEPA is an important goal for the European
Monetary Union and the EU internal market. Having a common
payments framework is an essential block of the SEPA.
However, including all forms of payments beyond just the
banking payments that would be processed in SEPA, has
complicated the EC's task. With such an ambitious
undertaking, incorporating expert comments is important to
get the draft legislation close to right the first time.
After a few false starts, such as with the Prospectus
Directive which needed to be totally re-written, the
Commission has used informal consultation to good effect.
That practice should continue in the new legal framework
directive on payment services.

32. (SBU) As much as industry may resent being forced to
act in an area it had promised action, experience suggests
that such prodding may be necessary. In the run up to the
introduction of the cash euro, survey after survey revealed
how banks had charged significantly more for cross-border
transfers than domestic ones. Time after time, banks
promised to take action at the urging of the ECB, but failed
to do so. Frustrated, on the eve of the introduction of the
euro, Finance Ministers and the Parliament adopted a
regulation requiring equal charges on cross-border transfers
to those on domestic transfers. Despite cries of anguish,
banks have complied. The EPC was created, in part, so banks
wouldn't be forced to action again, allowing them to get
ahead of the issue and help shape the debate. The EPC has
gotten a wake up call.

33. (SBU) Keeping true to its own "impact assessment"
approach to new regulations, the Commission should make a
credible case for the externalities of proceeding with
legislation for an SEPA. No doubt it could do so, but
reports from those who have seen the impact assessment are
not convinced. Avoiding being pre-empted by the ECB may
also motivate the Commission to adopt legislation. The
ECB's threat of adopting regulations to spur the development
of a SEPA is a direct challenge to the Commission's right of
initiative for legislation. The ECB already crossed into
the Commission's territory by elaborating standards on
clearing and settlement. Proposing legislation would allow
the Commission to control the issue and give a political
signal that banks should get their act together.

34. (SBU) The mismatch between SEPA, applying to the euro
area, and the draft proposed directive, applying to the EU,
could raise the question whether the new framework is
important for those countries that have not (or may not)
adopt the euro in the foreseeable future. That is, why
burden the market with standards on payment services if the
market will not benefit from the efficiencies of the SEPA?
The issue could be a real one as the UK will have the EU
Presidency and be charged with steering the issue through
the Council. UK officials, however, believe they have more
to gain if they advance issues that are in the interest of
the many even if they themselves might have other views.
The UK will likely push the work program giving the
Austrians a good basis to continue the Council's work next
year.

35. (U) This message has been coordinated with US Embassies
Berlin, London, and Vienna and USEU.

36. (U) POC: James Wallar, Treasury Representative, e-mail
wallarjg2@state.gov; tel. 49-(69)-7535-2431, fax 49-(69)-
7535-2238

Pasi

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