Payments and payment systems

Cash management
Authors
Stephen Pigney	Cash Management Consultant

Introduction

The role of treasury in an organisation continues to grow in importance and is now widely recognised as a vital partner in all financial aspects relating to a company. A continuing and essential role of treasury is the management of payments both to and from a corporate entity and managing the resulting liquidity positions. This is a key role of the treasurer, to maximise the efficiency of working capital and cash management, providing the "life blood" of the business. This article provides an overview of commonly used domestic payment instruments and related mechanisms for cross border payments. It also looks at the types of payment systems employed to process and settle domestic payments and initiatives to support execution of cross-border payments.

Payment systems and the ways in which they offer services to users continue to evolve, driven by advances in technology and consumer demand and expectation. Following the lead of the UK, which introduced the Faster Payments Scheme in 2008, many other countries/regions, including the US and the Eurozone, are seeking ways of introducing faster payment schemes to improve value dating and remove any float from the existing clearing system. The UK Faster Payments Scheme is now used extensively to make payments and standing orders up to GBP100k in just a few seconds on a 24/7 basis. Annual volumes of FPS in the UK now exceed one billion per annum; more than double the annual volumes of cheques issued.

In April 2014, Paym was introduced in the UK to allow member banks and building societies to provide mobile phone payment capability, using only a mobile phone number. While this service at the time of writing is predominantly "Person-to-Person" (P2P), it can also be used by small businesses, providing its bank offers that service. However, some banks are already providing corporates and other organisations with bespoke mobile phone payment and collection services. Together and over time, it can be expected that the Paym scheme will only increase the potential of this becoming a significant payment mechanism within the UK.

Changes across the Single Euro Payments Area (SEPA) have been substantial. Following the introduction of SEPA Credit Transfers (SCT) in 2008 and SEPA Direct Debits (SDD) in 2009, SCT and SDD have effectively replaced local clearing systems across the countries within the Eurozone although local differences do still apply. A number of local niche payment systems with a market share of <10% and a number of country specific systems have EU agreement to continue until 1st February 2016. For non-EUR countries within the SEPA, the migration date for domestic EUR payments and collections has been set as 31 October 2016. To provide the legal foundation for the creation of an EU-wide market for payments, the European Payment Services Directive (PSD) has been adopted into national law across all of the 34 countries within the SEPA, including the Principality of Monaco. The PSD was a prerequisite for the introduction of SEPA Direct Debits. The most recent country to join the EU was Croatia, which joined on 1 July 2013 and has adopted the PSD, although, initially at least, it will continue to use the Croatian Kuna (HRK).

In July 2013, the European Commission issued the proposal for a Directive of the European Parliament and of the Council of the European Union on payment services in the internal market, commonly referenced as the revised Payment Services Directive (PSD2). Following consultation, the proposal is expected to be approved by the EU Parliament by the end of 2015, following which Member States will have to implement into their national legislation by the end of 2017. There are other significant developments which may lead to further changes to global payment systems. These include blockchain technology and distributed ledgers, which have the potential to clear and settle globally in real time. However, these are at an early stage of development and it is not anticipated that these will have a major impact in the short term.

These recent changes, potential developments and any future changes will affect the way a corporate makes and receives payments. As such all businesses will need to consider the changes in the payments market and review existing practices to benefit from potential process and cost efficiencies in the management of such items. Payment system changes will also assist authorities such as the Financial Action Task Force (FATF), the intergovernmental body established to develop and promote policies to combat money laundering and terrorist financing. Whichever method is used to make a payment, it may be subject to value dating, float and finality, and it is important for any business to understand the effect of these, particularly as usage of these practices could give rise to hidden or opportunity costs to the company. This article describes bank float, although float may affect any part of the end to end procure to pay process; eg the time a cheque is in the post before it is received by the beneficiary or the time between delivery of goods and production of an invoice.

The definition of these terms is:

• value – the moment when funds become useable funds to the beneficiary, in the sense that they can be used to reduce borrowing, earn interest or be withdrawn;
• bank float – the time lost between a payer making a payment and a beneficiary receiving good value; and
• finality – the time after which a payment is considered to become irrevocable and cannot be returned without the permission of the beneficiary account holder.

Details of payment instruments and settlement and clearing systems within individual countries together with clearing practices are described in the relevant country guides in this Handbook.

Payment and collection instruments

Some payment methods may be more costly and take longer than others for the beneficiary to receive good value. Therefore, to ensure maximum efficiency in the payment process, a number of factors should be taken into account when selecting an appropriate payment instrument, including:

• acceptability of payment method to recipient;
• market practice in relevant country;
• service requirements e.g. speed, access to recipient;
• costs and float time;
• convenience and administrative efficiency, e.g. connectivity with treasury systems; and
• payment risks, eg settlement (credit) risk, counterparty risk and risk of misappropriation.

Collection and payment instruments generally fall into the categories shown in Figure 1.

Figure 1: Collection and payment instruments
Paper-based instruments	Electronic instruments
Cash Cheques Bank transfers or giros Postal giros Bills of exchange Promissory notes Banker's drafts	Urgent electronic funds transfer Standard electronic funds transfer, giros or Automated Clearing House (ACH) payments Plastic cards (credit/charge cards, debit cards, purchase cards) Standing order Direct debit Electronic bills of exchange Internet Mobile phones

Paper-based instruments

Cash

Cash is generally discouraged as a means of corporate payment as it is expensive to transport and secure, difficult to control and generally does not earn interest until it has been banked and credited to the company's account. However, it remains a key payment method in retail markets and countries with less developed banking structures. Where cash is a significant form of payment, companies need to manage large cash receipts both efficiently and effectively and many use security carrier companies to collect and transport the cash to a bank's cash centre. In addition, in some countries, such as the UK, retailers offer "cash-back” facilities, which have the effect of reducing the amount of physical cash in the store and replacing the value with more efficient card payment types.

Cheques

The cheque is one of the most common instruments or means of exchange with high usage in countries such as Egypt, France and the US. However, the use and acceptability of cheques in all of these countries continues to decline in favour of electronic or card payments and is forecast to decline further in coming years. This will be hastened by retailers refusing to accept cheques in their stores in favour of electronic/card methods, a trend which has been growing for the last few years. In addition, some countries, such as South Africa and Kenya, have introduced limits for the maximum value of a cheque that can be cleared through the local cheque-clearing system. Cheques in excess of the maximum amount have to be cleared by the local real-time gross settlement system (RTGS - see below).

Except when there is a maximum value limit for cheques, they are processed through local clearing systems (see below) and presented either physically or via an electronic image where cheque truncation is used (such as in the US following the introduction of the Check 21 Act in 2004) for payment at the drawee bank. At this point, the drawee bank debits the drawer's account. The proceeds are credited to the beneficiary's bank, usually to its clearing settlement account held at the Central Bank, before finality is provided to the beneficiary. In countries that have a high volume of cheque usage, cheque clearing is a highly automated process, and therefore attracts low costs, albeit still higher than non-urgent electronic or card payments.

While cheques are subject to bank float – the time it takes a cheque to clear through the system – they are also subject to other types of float such as production time, postage time and the time before the recipient deposits the cheque into the bank. Clearing times can vary dramatically depending on the country concerned and the city or town in which the cheque is drawn. Typically, local cheques will be cleared within one to three days in countries that have developed sophisticated cheque clearing systems. In some remote areas with a less sophisticated banking structure, such as in parts of Asia and Africa, a cheque may take several days to clear. Even in areas such as these, countries are upgrading or introducing new systems to reduce cheque clearance times. Other practices exist: for example, in some countries post-dated cheques are not allowed to be processed, whereas in others (eg Spain and UAE) they are common and generally acceptable.

Where a company receives a substantial number of cheques and other documents it may consider using a cheque "lockbox” service to benefit from processing and cost efficiencies. Lockbox services originated in the US as a way to obtain clearance of cheque items received from across the country more quickly and efficiently. They are still widely used in the US, despite the introduction of Check 21, as well as in other countries in the world where cheques are a common form of payment. This involves using a third party to receive and open letters containing payments from customers. Cheques and paper credit remittances are then recorded and batched for bulk lodgement, either in paper or electronic form, at a local bank or submission to the beneficiary, together with remittance advice slips completed by the lockbox company. The lockbox company is then able to provide information on the items processed to their clients in a variety of ways but primarily via electronic channels to provide automatic reconciliation. Some European lockbox companies can also process giro based payments and other payment related information.

The benefits that can accrue to companies in outsourcing their remittance processing are:

• lockbox providers are resourced to handle extreme fluctuations in volume – this saves a company hiring a large workforce or buying expensive cheque processing machinery;
• larger volumes give providers economies of scale, including greater use of building and equipment, and "round the clock” processing – eg savings can be passed on to clients or the company can improve its margin;
• internal controls can be improved; and
• items normally reach the banking system faster than a company could achieve itself.

Paper-based bank transfers or bank giros

Bank transfers or bank giros are paper-based instruments that can be used to pay funds into a beneficiary's account. If the account is not held at the bank or branch of deposit, the item has to go through a credit clearing system. The various types of giros range from a simple blank or customised credit form completed in a bank, which is lodged with the bank cashier either with cash or cheques attached, to the more sophisticated "accept” giro used in countries such as the Netherlands and the Nordic (Scandinavia, Iceland and Finland) countries. "Accept” giros are normally supplied and completed by the payee and will be sent to the payor along with an invoice. The payor will sign the giro (ie accept it) and forward it to his/her bank. The bank will debit the payor's account and put the giro in the clearing system for the credit of the payee.

In some countries the physical forms are cleared and pass through the clearing system in the same way as cheques (eg UK). In countries with a more sophisticated system, giros are dematerialised (i.e. the details are captured electronically at the depositing bank) and only the information passes through the clearing system (eg the Netherlands and Nordic countries). Giros normally take one to three days to pass through the banking system, and thus, do create float. Unless printed with an invoice, paper-based giros can be manually intensive in their preparation, require physical delivery to the bank and require manual processing by the bank. Therefore, this can be a more expensive instrument to use in some countries. Bank fees may include a charge to both the depositor and the beneficiary, and banks may also take some compensation through value dating.

Postal giros

Postal giros are similar to bank giros, but are often processed through a separate clearing system operated by the local post office; through which the depositors will initiate the transactions. In some countries, the post office and bank circuits are connected and operate to the same standards (eg UK, Netherlands), but in others, the two are separate or do not interconnect well (eg Switzerland, Sweden). In the latter case, it may be necessary for companies to hold an account with the post office as well as with a bank to ensure that the full remittance detail is received for payments made via each system to enable reconciliation.

Bills of exchange

Although often regarded as an international and foreign currency based instrument associated with import/export trade transactions, bills of exchange are often used domestically, particularly in continental Europe and parts of Asia. The definition of a bill of exchange, as provided by the UK's Bills of Exchange Act 1882, Section 3:

1. A bill of exchange is an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money to or to the order of a specified person, or to bearer.
2. An instrument which does not comply with these conditions, or which orders any act to be done in addition to the payment of money, is not a bill of exchange.

Once accepted by the drawee (payor) a bill of exchange is a legally binding document for all parties. In fact, a cheque is a form of bill of exchange drawn on a bank and payable on demand and in the UK is covered more specifically in the Cheques Acts 1957 and 1992. A bill of exchange is often a dual instrument. It can be both a method of payment and a method of granting the payee credit. If the drawee is sufficiently creditworthy or if the bill has been confirmed (endorsed by a bank), the drawer (payee) may be able to discount the bill prior to maturity to raise funds. Bills can be, and often are, drawn payable at the drawee's bank, and would therefore be debited to the drawee's account on presentation/maturity. Clearing bills often creates float and finality of payment will normally be a number of days after presentment/maturity in case the bill is returned unpaid (rather like a cheque).

Promissory note

This instrument is similar to a bill, and was used extensively in continental Europe for trade-related transactions between counterparties that were usually well known to each other. In the UK, Part IV of the Bills of Exchange Act 1882 is devoted to promissory notes. Section 83 defines a promissory note as follows:

• "A promissory note is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay, on demand or at a fixed or determinable future time, a sum certain in money, to, or to the order of, a specified person or to bearer”.

A promissory note does not have the legal standing of a bill of exchange and may not be able to be discounted, unless the drawer is considered a strong credit risk and the beneficiary is considered able to successfully complete the contract leading to payment being due.

Banker's draft

A banker's draft is similar to a cheque, but is drawn by a branch of a particular bank on its head office. It could, therefore, be regarded as a banker's cheque, the effect being that the payment is "guaranteed” by the bank. Banker's drafts, which may be denominated in any freely tradable currency, are normally more expensive to obtain, and if lost or stolen, they can be "stopped” like a cheque. It is still a recognised method for paying for goods and services when the vendor insists on payment in a form that ensures he gets his money (albeit subject to the comments above) at the same time as exchanging an asset (delivery against payment), although with the development of same day and immediate electronic systems its usage has declined. The company or person buying the banker's draft will pay for it on issue, whereas the beneficiary will only obtain value once it clears (like a cheque). Therefore the bank benefits from the float until the draft is presented for payment.

Electronic instruments

Most banks provide corporate customers with a range of internet banking and Host-to-Host (H2H, computer-to-computer data transmission) channels which are connected to the providing bank's branches and subsidiaries. These systems enable the submission of domestic and international electronic funds transfer instructions, both payments and collections, to be initiated from accounts at the customer's bank or, in some cases, other banks. In addition, these channels also provide corporates with account information on accounts held with the providing bank and can also provide information on accounts held with other banks using SWIFT MT940/942 messages originated by the account holding bank.

The majority of banking platforms allow payments to be imported and data to be exported from/to a corporate's TMS/ERP system in bulk. This negates the need for double keying of data thereby improving straight through processing, cash position visibility, security and control. Most bank-to-bank corporate information and the majority of cross border corporate funds transfers are transferred via the Society for Worldwide Interbank Financial Telecommunications (SWIFT – see below).

Urgent electronic funds transfers

In most developed countries, high-value electronic payment systems clear funds on an urgent (same-day) basis. However, settlement can occur the day following initiation where market practice dictates, pre-end-of-day cut-off times are in place or in less-developed banking environments. Normally urgent electronic payment systems do not create float, although they may create intra-day credit exposure issues, and finality depends on when settlement occurs (covered below). These types of system are for credit transfers only, and items will generally be submitted to banks via browser-based electronic banking channels, H2H channels, or SWIFT.

Standard electronic funds transfers

These types of payments may be referred to as:

• automated bank transfers;
• automated giros; and
• automated clearing house (ACH) transfers.

They are essentially automated versions of the paper-based instruments discussed above. They are usually future value-dated payments, and may or may not create float, depending on the country clearing cycle, the bank, and the credit standing of the customer. In some countries, standard electronic funds transfers may also create credit exposures where the bank transmits the transactions to the clearing house and is liable to pay the clearing house in one or two days time, debiting its customer at the time of settlement between the banks. The risk to the bank is that the customer will not have the funds on the debit day. Some banks, where there is no regulation regarding value dating practices, may debit less creditworthy customers with immediate effect in order to clear that risk. More creditworthy customers may be given a "clearing facility”, often referred to as a "Settlement Risk” limit to cover the potential risk before final settlement.

Finality of payment varies, as settlement between participating banks normally takes place during the settlement day on a net basis. Therefore, finality can occur the day following settlement if settlement takes place near or at the end of the day. Items will typically be submitted by companies via electronic/internet banking or H2H channels. Such systems typically handle "one-off”, low value or non-urgent payments as well as bulk repetitive credit transfers, such as payroll. As already mentioned, the introduction of the SEPA Credit Transfer has introduced standardisation for making non-urgent payments across those countries that are members of the SEPA. For example under the PSD, value dating for payments and collections has been standardised across the SEPA so that the parties to a payment or collection know when they will be debited or credited. See the SEPA section below for further information.

Standing orders

A standing order is generally a domestic instruction given by an account holder to his/her bank to pay a beneficiary a regular amount of money on a periodic basis (i.e. monthly or quarterly). The bank carries out the instruction by debiting the customer's account and crediting the beneficiary by forwarding a payment to his/her bank, usually electronically, thus creating float unless a payment is made via a system such as the UK Faster Payment system where debit and credit is almost immediate on the same day for items up to £100,000. A standing order can be cancelled either by the payer or the account holding bank. However, standing orders provide certainty in terms of value date and finality for the beneficiary, either on the day or the day after the credit is received to the account.

Direct debits

The direct debit is a similar payment method to the domestic standing order, except that instead of the remitter instigating the transfer, the beneficiary originates a debit which is transferred through the clearing system to the account holder who is due to make the payment. In order to accept direct debits on an account, banks in most countries will require the owner of the account to be debited to give them authority prior to the commencement of the service.

The account holder's consent to this authority is acknowledged in a direct debit mandate. Debits are originated via the local ACH system, which processes the debit to the account holder and the credit to the beneficiary in accordance with local market practices. For example, in the UK, both credit and debit are usually applied to the account on the same working day so there is no float benefit to the banks. However, this can and does differ in other countries, where there can be a variance between the debit to the account holder and credit to the beneficiary. Some countries, such as Italy, currently provide a direct debit system that requires the payor to confirm the amount being collected by the payee before the payment can be made. This system will be replaced in 2016 as it must become SEPA compliant. In some countries there is either no direct debit capability or no interbank direct debit service, so a good knowledge of local systems and practices is required prior to using direct debits in any country.

Direct debit systems are an entirely electronic process and, therefore, the transactional charges levied by the banks tend to be low, dependent on the delivery channel. Like cheques, however, direct debits can be refused by banks and finality of payment varies considerably from country to country. In some cases, finality can take several weeks as direct debits can be governed by consumer protection laws. Through the introduction of the SEPA Direct Debit, there is now a standardisation of the processes and practices relating to direct debits across the 34 countries and principalities that make up the Single European Payment Area. However, a number of local, domestic payment/collection niche systems which account for less than 10% of a country's volumes, and other local schemes, for which a waiver has been obtained, remain (such as Pagares in Spain, which can continue until 1 February 2016).

Electronic bills of exchange

Some European countries, such as France, currently make common use of electronic bills of exchange. The existing process is that a beneficiary (drawer) electronically draws a bill on a drawee at the drawee's bank. The drawee will "accept” the bill and it will be warehoused by the drawer's bank until maturity, at which point it is cleared electronically via the local ACH. The accepted bills give the drawer the opportunity to raise finance by discounting the bills in the system if so required. In France, where these bills are known as lettres de change relevé (LCRs), payment is passed to the holder four days after maturity and the drawee is debited three days after maturity. Clearly, this creates float in the banking system and finality will take place on the day following payment (ie start of business five days after maturity). However, following full implementation of SCT and SDD it is expected that these types of instruments will be considered for SEPA-compliant schemes, although no end date for these types of services has yet been set.

Plastic cards

Plastic cards take a variety of forms and include credit, debit, pre-loaded, charge and purchasing cards. In addition, many cards now have "swipe and pay” and/or "wave and pay” functionality so that low-value purchases can be made simply and easily. Developments continue around pre-paid cards; for example, the Oyster card issued on the London Underground enables travellers to charge their cards so that they do not require a physical ticket for travel and the Octopus card is widely used in Hong Kong for low-value purchases. The benefit of such a card is that the user can top up the card using a variety of methods, making payment for small, low-value items more efficient and less costly for the beneficiary. While Oyster cards are still widely used on the London Underground, recent developments in “wave and pay” functionality have enabled travellers to simply use their existing debit or credit cards.

Any "credit cards” supplied by a company to its staff are more accurately described as charge cards, or purchasing cards. Charge cards are a similar means of payment to a credit card, but the full amount must be paid when the account is rendered (normally monthly). Most charge card holders also pay an annual fee. In many countries, banks have combined the functions of the cash dispenser card, cheque guarantee card, and debit card into a single card. It is worth noting that in many countries, such as the UK, the cheque guarantee element has been removed from the card functionality. From the receiving company's point of view, plastic cards are simply a payment mechanism that may be used by some of its customers.

What is important to any company accepting plastic cards is the interchange charges levied by the merchant acquiring company (normally a bank or other financial institution that "buys” the transactions from the retailer at a discount). These include transaction fees for debit cards and turnover fees for credit cards charged by the card acquirer that processes card payments on behalf of the retailer. These charges are often negotiable and depend on the volumes of transactions, the average transaction size, the method of processing and the credit quality of the transactions. Float time and finality of payment on credit and charge cards vary not only from country to country but also from company to company, depending on the deal negotiated with the card acquirer. In addition to traditional debit, credit and charge cards, many corporates now use purchasing cards to purchase low-value items/services. Usage can be limited to certain outlets, eg service stations or hotels, which reduces the risk of misuse at the same time as reducing the administration costs of handling small purchases and improving the quality of reporting and VAT management.

Internet

Purchases via the internet continue to increase as providers offer greater security and users become more comfortable with buying goods in this way. Most purchases are made using traditional plastic cards, although as internet usage grows providers are offering different secure payment methods and new entrants, such as PayPal and Apple Pay, have entered the market, although of course they will still need to use the traditional banking systems to collect funds from and make payments to the ultimate payors/beneficiaries.

Mobile phones/devices

This article has already referred to the Paym capability in the UK, enabling money to be transferred simply using a mobile number linked to a participating bank account. Other initiatives, for example M-Pesa in Kenya, provide mobile phone users with a mobile “wallet” linked to the mobile, from which payments can be made and received. These types of payment services do, of course, need to pass items through the existing bank systems, but they are gaining in popularity as users have more confidence in the security and control of the functionality. Currently, the majority of mobile phone payments are made on a Consumer to Consumer (C2C) basis, but it is expected that this will extend to Business to (and from) Consumer (B2C) as technological advancements make this more readily available and corporates adopt developing payment methodologies. Similar to debit and credit cards, mobile payments can be made using “wave and pay”, making it simple for the consumer to pay and for the company to receive the payment.

Facilitation of cross-border payments

Cross-border payments are executed using the same basic instruments as are used for domestic payments. However, there are some additional complexities in the use of these payment mechanisms in a cross-border context. Some key points are considered below.

Correspondent banking

A correspondent bank is a bank, usually in another jurisdiction, where a bank without local presence holds an account, commonly referred to as a "Nostro account” (from the Latin noster – "our”). An account with a correspondent bank can be used to settle fund transfers between these two banks. The correspondent bank then executes a domestic payment on behalf of the foreign bank holding the Nostro account. Correspondent bank relationships are normally bilateral, with each bank holding a bank account in its own country for use by the other. Instructions to receive or pay funds are commonly via the SWIFT international messaging system.

Foreign currency cheques

When receiving a currency cheque drawn on a bank in another country, it must be cleared in the country on which it is drawn to obtain good value. To obtain value for a currency cheque, it may either be "sent for collection” or "negotiated”. Negotiating a foreign currency cheque will give the payee immediate funds minus costs, as detailed below. Where a cheque is sent for collection, value will be given by the bank when it has received value itself. When sending cheques for collection to countries with slow clearing systems or practices it might be several weeks before the beneficiary is credited with the cleared funds.

To obtain value for a currency cheque using the collection method, a company must deposit the item with its domestic bank in the appropriate manner. The bank will send the cheques in a batch, together with others received in the same currency from other customers, to the country on which the cheques are drawn for clearance. This could be the receiving bank's own branch in the country of the currency (if that branch is a member of the cheque clearing system). However, it is more likely to be sent to its local correspondent bank in that country (bundles of cheques with covering credits are often referred to as "cash letters”). On receipt the correspondent bank will put the cheques into the clearing and, when it receives finality, will credit the value of the cheques (less any charges it may levy) to the presenting bank's Nostro account in their books. Once the presenting bank has been notified that the funds have been received in their account, they will credit the company's account in their books (debiting the Nostro account). If only a local currency account is maintained by the customer with the collecting bank, the bank will, on the instructions of the customer, convert the foreign currency amount received to local currency and credit the customer's account with the proceeds, less its charges.

Sending a cheque for negotiation is a process similar to a "bill discounted”. Banks will purchase the cheques "with recourse” and credit a customer's account immediately with the local currency equivalent of the cheque, less the amount that covers the interest on the value of the cheque while it is being cleared, plus exchange commission. With some banks, the exchange rate used to convert the currency reflects both elements. The amount of the interest deducted will depend on the currency of the cheque, the interest rate (benchmark plus risk margin) agreed for that company and the time it will take for the bank to be given good value by its correspondent. "With recourse” means that in the event that the cheque is returned unpaid, the customer's account will be debited at the exchange rate pertaining on the day the cheque is returned. This presents a foreign exchange risk to the payee of the cheque, and they will need to consider how to manage this potential risk. Customers usually favour negotiation when the amount is large or they have cashflow requirements, even though the charges are higher than those for collections, as they receive money immediately into their account. Negotiation is also attractive where currencies are fluctuating adversely as the payee has certainty of the amount to be credited to his/her account.

International direct debits

An international direct debit service operates in much the same manner as its domestic equivalent as detailed above. Items are delivered into each country's clearing system, either by a local branch of the service provider or one of its correspondents to a local account. Funds collected can be remitted either to a currency account held in the originator's home currency or converted to the receiver's base currency and repatriated. Companies must send a file of transactions to its bank providing this service. The items are then reformatted into the receiving country's local ACH format and either transmitted via a private data network or SWIFT (using a file transfer service) to the appropriate bank in each country. Some banks offer a guaranteed availability schedule for each country. Of course, with the advent of SEPA, companies can collect direct debits across the Eurozone in euros (see below) without the specific need to utilise an International Direct Debit service, unless such direct debits are part of a wider country direct debit requirement by the originator.

Clearing and settlement systems

There are two basic ways that domestic clearing systems settle:

• end-of-period net settlement; and
• real-time gross settlement.

A third option is a hybrid of these two: intra-day net settlement. This is practised by a number of system, such as the US Clearing House Inter-bank Payment System (CHIPS) and the Faster Payments Scheme in the UK.

Net settlement systems

Generally, net settlement systems (NSS) represent the traditional approach to clearing, where all the payments and receipts to clearing members are processed via a multilateral netting system. The result is one single amount being paid or received across each bank's settlement account with the Central Bank at the end of each business period. Cheque clearings are still settled on this basis in most countries. When electronic clearing systems were developed, settlement was usually based on the cheque model. Often low-value electronic ACHs settle on a net basis (e.g. BACS in the UK, ACH in the US, Autopay in Hong Kong), but settlement risks associated with NSS can cause concerns when used for high-value transactions.

The issue with net settlement in high-value, same-day clearing systems is that it can give rise to intra-day exposures between participating banks. Funds received and credited to a customer's account by a clearing bank do not become "final” until settlement occurs at the period end. Through using NSS methods it is possible to build a large exposure to a clearing participant that may be unable to settle at the end of the period, leaving the receiving bank and beneficiary with a potential loss. Some NSS do insist that participants lodge collateral to support these intra-day exposures. While NSS traditionally settle at the end of the day, in order to overcome settlement and collateral issues, some NSS now undertake intra-day net settlement at agreed times during a day, and to that extent have become a hybrid NSS without the need to move to full RTGS.

With CHIPS in the US, members also set intra-day limits against other participants to ensure that they do not build up too much exposure to any one institution. At the end of each period all positions between participants are netted off and the participating banks settle with each other across settlement accounts that are held specifically for this purpose with the Central Bank in that country. Net payers to the system are debited and net receivers are credited as appropriate.

UK Faster Payments

The UK Faster Payments Scheme (FPS) is a hybrid NSS, settling three times during the day, Monday to Friday (albeit FPS works on a 24/7 basis). This scheme was introduced by UK banks to provide a GBP same day low value payment service to users. It was developed primarily to remove float from internet, telephone, manual and electronic payments. Now that the scheme is firmly established, corporate services including bulk file submission via Direct Corporate Access have been introduced by some banks, so that corporate payers can benefit from the system. The maximum amount for credits and standing orders transferred via FPS is £100,000. FPS is an additional clearing scheme and will not replace BACS in the UK. Direct debits will continue to be collected via BACS.

Herstatt risk

This type of risk is named after Bank Herstatt that failed in 1974 and refers to risks that span more than one market – usually involving foreign exchange or securities instruments. In the case of Bank Herstatt, the bank had entered into a number of foreign exchange deals and received payment from its European counterparts, but went into liquidation before it delivered the counter-value to its non European counterparts. The only way to eliminate settlement exposure of this nature entirely is to settle both the debit and credit transaction at the same time using real-time gross settlement (RTGS) processes.

Real-time gross settlement (RTGS) systems

As RTGS systems are designed to eliminate settlement risks, payments are cleared singly and bilaterally as they occur. In recent years, RTGS systems have replaced net settlement systems for high-value same-day transactions in most developed and developing countries around the world. In Europe, European Union countries provide RTGS services via TARGET2 (see below) to achieve same day settlement across participating countries. Worldwide, a growing number of countries are moving to real-time settlement of large transactions.

With RTGS, as a payment message is moved through the clearing house, the paying bank's account with the Central Bank is debited and the receiving bank's account is credited. As there are no end-of-day procedures, such systems do not create intra-day exposures between participants and provide beneficiaries with immediate finality once the receiving bank credits its account. However, exposures may still arise between the settlement bank and the Central Bank if there are insufficient funds in the settlement accounts. Different countries have different methods of handling this. In Switzerland, where the large-value clearing (SIC) was the first RTGS system in Europe, the Central Bank does not allow settlement accounts to overdraw, although some intra-day credit is available in the form of intra-day repos. Banks in Switzerland have real-time access to their accounts and must check their balances before sending payments into the system. Shortages must be funded from facilities granted by other banks. In the EU, including the UK, the RTGS systems do permit settlement banks to overdraw their accounts intra-day with their National Central Banks, if it is secured with the deposit of acceptable collateral. The US Fedwire system works similarly. The Federal Reserve Bank does however have the right to charge intra-day overdraft interest on any utilisation.

Cross-border messaging and settlement

There is no single global payment system. However, the following initiatives have made a significant contribution to the cross-border payments environment:

SWIFT (The Society for Worldwide Inter-bank Financial Telecommunications)

Established in 1973, SWIFT is a telecommunications network owned and used exclusively by over 9,000 financial institutions in 200 countries for the exchange of financial data between members. It is not a payment system, clearing system, or a settlement system. SWIFT uses a set of strict standards which enables standardised messages, when correctly formatted, to be generated, received and interfaced by banks and local clearing systems in a fully automated way. The concept of automated messages passing all the way from the originator of the payment through to the receiver is known as "straight through processing” (STP). To improve efficiency, most countries have built electronic links between SWIFT and the local RTGS clearing system. For example, most members of Clearing House Automated Payment System (CHAPS) in the UK and CHIPS in New York have installed a direct link between SWIFT and their internal systems which enables a correctly formatted incoming payment, received from an overseas branch or correspondent, to be streamed directly into the local clearing. SWIFT standards are used extensively in international cash management (and international banking in general). SWIFT has developed sets of standards covering various types of bank transactions (see Figure 2 below).

Figure 2: SWIFT Standards covering various types of bank transactions
Message series	Types of transaction covered
000	System messages
100	Customer payments
200	Bank-to-bank applications
300	Foreign exchange and money market transactions
400	Documentary collections
500	Securities transactions
600	Precious metals and syndications
700	Trade transactions (letters of credit)
800	Travellers cheques
900	Balance and transaction reporting

SWIFT Corporate Access

Since the early 2000s, SWIFT has developed its Corporate Access models, initially via the Member Administered Closed User Group and latterly the SWIFT Corporate Environment (SCORE) model. Since the criteria to join as a SCORE member were relaxed in 2009, in effect there is now little difference between the two models and all corporate users now join as a SCORE member. Corporate members have access to a number of SWIFT payment messages and services although of course the bank with which it communicates must also be a member of SCORE. SWIFT initially introduced "Alliance Lite” in 2008 to extend corporate and small financial institution use of the SWIFT network. Alliance Lite2 was launched in 2012 primarily for lower volume users and users not requiring full integration with SWIFT. Alliance Lite2 provides a cloud based connection to the SWIFT network with messages and files being exchanged using the SWIFT secure Browse service. Access is through security tokens; however the user must be registered as a SCORE member.

Corporate membership allows a company to use standard SWIFT formatted messages to deliver/receive payment messages to/from its bank and receive account information on accounts it holds with its SWIFT Corporate Access providers, as well as other banks using traditional SWIFT statement messages. By integrating SWIFT with its own internal systems, corporates can achieve a greater level of control and STP, leading to increased interoperability, better administration and greater efficiency. Currently, more than 1,500 corporates benefit from using SWIFT Corporate Access in more than 80 countries worldwide.

TARGET2

TARGET (Trans-European Automated Real-Time Gross Settlement Express Transfer system) was originally introduced in 1999 to provide a real-time gross settlement system for the euro. TARGET was both a tool of the European Central Bank (ECB) in moving liquidity between National Central Banks (NCB) within the EU and a mechanism for settling commercial cross border euro payments. Payments are processed one by one on a continuous basis, providing immediate settlement and finality of payment.

Since 2002 the Eurosystem, comprising the ECB and the NCBs of those countries that have adopted the euro, developed a replacement for TARGET. The new system, TARGET2, went live in 2007 and full migration to TARGET2 was completed in 2008. TARGET2 is run by the Eurosystem under the responsibility of the Governing Council of the ECB. The NCBs of France, Germany and Italy jointly provide the single technical infrastructure and operate it on behalf of the Eurosystem. All of the eurozone countries have migrated to TARGET2 and have chosen to close their legacy RTGS systems upon migration. The design of TARGET2 reflects the increasing integration of the eurozone and the converging business needs of its main users. It will also assist in any enlargement of the European Union and the eurozone. TARGET 2 is a system that will:

• provide extensive harmonised services via an integrated IT infrastructure;
• improve cost-efficiency; and
• be prepared for rapid adaptation to future developments, including the enlargement of the Eurosystem.

All of the countries that have adopted the euro have joined TARGET2. Of the existing non-euro EU members, the Danish NCB participates in TARGET2, while the Swedish and UK NCBs do not. Three countries that have not yet adopted the euro – Bulgaria, Poland and Romania – are members of TARGET2 and transact certain euro payments through this system.

The European Banking Association (EBA)

The EBA was initially founded in 1985 to promote the European Currency Unit (ECU) and facilitate its use by developing and managing the ECU clearing system. Following the launch of the euro, EBA developed the old ECU clearing into a cross border high value euro clearing (EUR01), which settles on a NSS basis. The Euro Banking Association now plays a major role in the financial industry through the development of European payment infrastructures. This led to the creation of the European large-value clearing system, EURO1, and, in addition, the low-value payment system STEP1 and a PE-ACH (pan-European automated clearing house), STEP2, to support SEPA. The EBA is also considering "STEP3”, with a view to exploiting the opportunities offered by e-commerce.

Figure 3: Summary of SEPA Direct Debit Schemes
Feature	SDD Core	SDD Core -1	SDD B2B
Collecting from businesses and consumers	Can be used to collect from a business or a consumer		Can only be used to collect from a business
Single/one-off/recurrent transactions	Can be used for both single/one-off and recurrent transactions
Transaction amount limits	No technical limit is imposed by the scheme, although a PSP may establish a credit limit to account for potential unpaids/returns
Scheme cycle times	Current timescale One-off/first DDs D-5 Subsequent DDs D-2 Proposed time from 11/16 One-off/first DDs D-1 Subsequent DDs D-21	One-off/first DDs D-1 Subsequent DDs D-1
Return period	A return must be settled within five bank business days of the original debit date		A return must be settled within two bank business days of the original debit date
Refund rights for authorised direct debits	A “no-questions asked” right of refund for eight weeks following the debiting of the debtor’s account. Funds will be credited to the debtor’s account upon request		The debtor is not entitled to obtain a refund of an authorised transaction
Refund right for unauthorised direct debits	In the event of an unauthorised direct debit, the debtor’s right to a refund extends to 13 months as stipulated in the PSD. Under the B2B scheme, this should not, in practice, occur as the Debtors Bank has to check that the mandate was authorised when it was established.
Verification by debtor’s PSP of authorisation for direct debit	The Core Schemes do not require the debtor’s PSP to ensure that the collection is authorised		The B2B Scheme requires the debtor’s PSP to ensure that the collection is authorised by checking it against the mandate data
PSP – Payment Service Provider

Single European Payment Area (SEPA)

The European Payments Council (EPC) launched its SEPA White Paper in May 2002. This declared that "the European banks and credit sector associations share the common vision that euroland payments are domestic payments and joined forces to implement this vision for the benefit of users". In support of this initiative, the European Commission published the initial proposal for a "Payments Services Directive” (PSD) in December 2005 to provide a common legal framework for payments across the EU. This was finally approved by the European Parliament and Council 2007 and has now been adopted across the EU and other EEA countries. As already discussed earlier in this article, a revised PSD (PSD2) is expected to be approved by the end of the year. Once approved by the EU Parliament, this will need to be implemented by Member States by the end of 2017.

The goal of the European banks and regulatory authorities, now largely achieved, is to create a single payment area across the European Union. SEPA enables pan European payments to be made as easily and efficiently as, and at no greater cost than, the national domestic payments that it has now replaced. The EPC's roadmap was designed to deliver payment schemes to comply with the PSD, and the EPC has established Rule Books to cover credit transfers, direct debits and cards. It is now focusing on further innovation in the area of mobile and online payments and e-invoicing. The EPC Rule Books provide standardisation of electronic payments and collections, allowing efficient euro cash management through one or more Pan European ACHs (PE-ACH)/Clearing and Settlement Mechanism (CSM). These bodies provide clearing and settlement services to financial institutions for SEPA payment and collection products.

The SCT was introduced on 28 January 2008, initially with a maximum settlement period of D+3 although this was reduced to D+1 at the end of 2011. The SDD was introduced in November 2009 and EC regulation required that all banks that offered domestic euro Direct Debits commercially were obliged to offer SDD as a debtor bank (i.e. a bank that maintains the account of the payor) by November 2010. In practice, this was achieved by August 2014. SDD offers a Core and B2B Scheme. In addition a Cor-1 Scheme has been developed and is currently only widely used in Austria, Germany and Spain. The Cor -1 Scheme has the same characteristics as the Core Scheme except that it has a faster cycle time. Both the B2B and Cor–1 Scheme are optional in the SEPA countries unless specified by a country’s regulator. Changes are planned to the Core scheme from November 2016. As of that date, all collections can be presented on a D-1 basis; the same as the Cor-1 Scheme. Key components of these schemes are detailed in Figure 3 above. These initiatives resulted in all non-urgent euro payments and direct debits across the SEPA being made in compliance with the SEPA scheme as at August 2014. The exception to this is for local domestic instruments with a market share below 10%, which can continue to be used until 1 February 2016, and other local schemes for which a waiver has been obtained, such as Pagares in Spain. Banks in non-euro member states must be able to receive SCT and SDD by 31 October 2016.

Cross-border direct debit interchange fees have been abolished, but interchange fees for domestic direct debits will remain until February 2017. However, interchange fees will still be permitted for "R” transactions (Returns and Rejects). Following full adoption, the European authorities’ expectation is that SEPA will allow payments to be made throughout the whole SEPA area from a single bank account, using a single set of payment instruments, as easily, cost effectively and securely as is the case in any of the individual SEPA countries today. With migration to harmonised SEPA payment schemes largely complete, the EPC has changed its structure to further enhance governance and stakeholder involvement. A number of newly created bodies have been established, responsible for managing the administration and evolution of the SCT and SDD schemes.

There are three important points to note. Firstly, SEPA euro payment schemes are now available in 34 countries – the 28 EU countries, the European Economic Area (Iceland, Lichtenstein and Norway), San Marino, Switzerland and Monaco. These additional non EU countries have agreed to operate the EPC SEPA euro payment schemes in accordance with the legal provisions of the PSD. The SEPA will continue to expand – Andorra will join in 2016 and Jersey is expected to submit its application to join the SEPA by the beginning of 2016. Guernsey and the Isle of Man are also considering whether to join the SEPA. Secondly, the PSD impacts the provision of sterling payment services in the UK, as well as other non-eurozone countries within the EU such as Denmark and Sweden, with regard to maximum processing times and harmonisation of obligations and responsibilities. Thirdly, the PSD framework provides for binding integration of the provisions contained in previous directives and regulation on low-value payments. These have enabled a single SEPA market to be created for the pricing of euro payments and a current requirement to use SWIFT Bank Identifier codes (BIC) and International Bank Account Numbers (IBANs). BICs are not required for national transactions in most EU countries. The regulator has stated that BICs will not be required for cross-border transactions after 1 February 2016. The euro countries that currently have a waiver in relation to this must comply by 1st February 2016. Payments Service Providers (PSPs) in non-euro countries must permit the BIC to be optional for their clients by 31 October 2016. There is no maximum value on transactions that can be processed through SEPA, although payments in excess of €50,000 may attract additional charges if there is any additional reporting or regulatory requirements in place in any country within SEPA.

Continuous linked settlement (CLS)

A number of the world's largest foreign exchange banks have joined together in 2002 to form a company: CLS Services Limited. This company is based in the UK but owns CLS Bank Inc, a US-based "Edge Act” bank. Banks that operate under the "Edge Act” can only undertake international business in the US. They are not allowed to compete for US domestic banking business. CLS Bank is regulated by the Federal Reserve Bank, the US Central Bank, and can handle transactions denominated in 17 currencies: GBP, USD, JPY, EUR, CHF, CAD, AUD, DKK, NOK, SEK, SGD, HKD, NZD, KRW, ZAR, MXN and ILS. This bank acts as the common counterparty between all participating banks and settlement between the bank and members takes place throughout the working day. This system, even more than RTGS systems, has the ability to eliminate Herstatt risk (see above) from the international bank-to-bank foreign exchange markets. The system also reduces the risks and costs associated with settling high-value foreign exchange transactions using international funds transfers. Like any netting system, it considerably reduces the number of bank-to-bank payments and settles on a NSS basis throughout the working day.

Each day prior to settlement in each currency, CLS calculates the funding required of each Settlement Member on a multilateral netted basis for each currency, after taking into consideration all payment instructions of the Settlement Member that are due to settle that day in that currency. Settlement takes place to a strict timetable, which is based largely on the working day in the currency centre of each currency. To take full advantage of the benefits of the system, banks have been required to re-engineer their systems and working practices around the CLS timetable. They have also built new or modified existing systems to be able to pass on the benefits of lower risk settlements to their customers (mainly other banks, but also some larger companies). Members also have the opportunity to re-engineer their liquidity management to take advantage of the fact that less funds are tied up in the system either as collateral in the form of money market instruments or Central Bank balances. CLS has a proven operational record and has effectively reduced settlement risk across the currency markets and is actively encouraging global corporates to use the system, although they will have to join via an existing member bank. CLS membership can assist corporates to comply with increased regulatory requirements, while at the same time improving their cash and liquidity management through better forecasting and multilateral netting.

Supply-chain financing solutions

A number of countries, such as France and Spain, have been offering domestic supply-chain financing services for a number of years. These services typically provide the beneficiary of a future dated payment being able to obtain early value by discounting the payment once they have been advised that it is in the clearing system.

There is an ever-increasing focus from corporates on effective working capital management. This, coupled with the growing interest amongst banks and other financial institutions on providing finance linked to the underlying commercial transactions between a buyer and seller, has increased interest on various supply chain financing solutions. In particular, the so-called "reverse factoring” solutions, of which the French and Spanish local solutions are examples, are now being offered more widely. These solutions are payment-driven financing models seeking to provide cost effective liquidity directly to corporate supply chains.

The link between payments and the supply chain is receiving increased attention at an industry level. In particular, there is a drive in Europe to link SEPA payment developments to finance and business process initiatives, such as electronic invoice management. There is an increasing overlap between financial functions such as payments and the related underlying business processes. As a result, it is possible that payment systems will broaden to encompass flows of related commercial information, offering corporates the opportunity to view and manage their working capital more effectively to the benefit of the whole business.