In my last post I outlined the five primary forces that I think are fundamentally changing the way corporations approach back office finance functions and their banking partners.  However, one of the dynamics I did not explore is the dependency of the business model changes on technology.  Changes to accounting systems and bank connectivity will be critical factors in the success of corporate transformation efforts.  To realize cost efficiencies, A/P organizations must be able to efficiently route payment instructions to their key banking partners using highly reliable, secure and cost-effective communications channels.  To benefit from a centralized treasury, cash managers must be able to obtain detailed, up-to-date account statements from their financial institutions in order to perform end-of-day investment and borrowing activities. 

I have compiled a list of the top five forces I think are transforming the technical interfaces banks and corporate customers use to communicate electronically.  These five forces are the technology changes complementary to the business model changes outlined in my last post:

1.       ERP Consolidation – More multi-national corporations have a project underway to standardize and consolidate the various ERP applications being utilized within their enterprise.  Standardization enables consistent business practices across divisions and the creation of shared service centers.

2.       SWIFT Connectivity – Several hundred large corporations have registered to participate in SWIFT’s corporate access programs (SCORE).  SWIFT connectivity can reduce the costs and complexity associated with corporate banking communications by replacing the mix of web, fax and host-to-host transmissions with a single connection to banks worldwide.

3.       ISO 20022 XML – Otherwise known as the Universal Financial Industry (UNIFI) standard, ISO 20022 XML is designed to replace the myriad of local file formats (e.g. EDI, NACHA) used for payment processing around the world with a single, global message scheme.  See my blog entry on ISO 20022 for more details.

4.       Multi-Bank Cash Reporting – Multi-bank reporting applications aggregate end-of-day and intra-day balances for all accounts onto a single web portal.  Treasury personnel with visibility to all cash positions at bank accounts worldwide are better equipped to perform cash forecasting, borrowing and investment activities.

5.       Bank Relationship Management Software – Bank connectivity has become such a complex issue for corporations that several ERP vendors have introduced specialized software modules to simplify integration.  For example, SAP recently introduced its “Bank Relationship Management” application.  See my blog entry on SAP BRM for more information.

For those interested, I published a more detailed view of the 10 Forces Transforming Corporate Banking Connectivity on the www.gxs.com web site.

IndyMac, Fannie Mae, Freddie Mae…government seizures, government bailouts, government regulations…can the banking crisis get any worse?  And this was just the last two weeks!   Earlier this year, we witnessed the collapse of Bear Stearns in the US and the nationalization of Northern Rock in the UK.   For each bank who has failed there are five more who have escaped immediate peril but continue to suffer distress from rapidly falling stock prices - Wachovia, Washington Mutual and Lehman just to name a few.

It is difficult to tell whether we are near the end of the subprime mortgage fallout or still in the beginning.   However, one absolute certainty is that 2008 will be recorded in the history books as a period of unprecedented loss and radical transformation the banking industry.  Experts predict that the final tally of losses will reach $1 Trillion.  The banking sector will become even further consolidated as institutions collapse or seek buyouts from healthier firms to survive.  Access to capital will be more challenging to obtain as lending practices become more stringent and tighter regulation emerges. 

Bear Stearns on e-Bay - Found on a Reuters Blog site

The subprime mortgage crisis is not the only source of radical change in the banking industry this year.  A less publicized, but perhaps equally significant transformation is occurring across Europe this year as part of the Single European Payments Area (SEPA).  Much like the credit crisis, SEPA will result in significant losses to banks.  Payment fees collected could decline between 30 to 60%, the equivalent of €13-29B of foregone revenues.  But unlike the credit crisis, SEPA losses will not be the result of a series of unplanned events leading to catastrophe.  Instead SEPA is a deliberate, methodical attempt to evolve the banking system that will provide substantial long term benefits to both consumers and businesses.   SEPA is not a new phenomenon.   Planning for the changes has been occurring within the European banking sector for over a decade now.  However, since the SEPA initiative’s progress has not been well communicated outside of Europe, I thought I would take a few minutes its goals and benefits.

Background to SEPA 

Historically, Europe has been host to a complex set of country-specific pricing, regulation and systems for payment processing.  For example, consumers pay different prices for the same banking services depending upon their country of residence.  Italians and Germans might pay ten times what a Dutch or French citizen is charged for basic retail banking services.  Geographic limitations constrain today’s service offerings.  Many of the banking services consumers purchase are limited to the home country in which the financial institution is based.  For example, when a Belgian citizen travels to another country such as Austria, his debit card from the Belgian bank will most likely not allow him to withdraw funds from a local ATM. 

Corporations suffer many similar challenges to consumers.  The fees assessed by banks for payables and receivables services vary widely based upon country.  A multi-national corporation making a €1000 payment to a supplier might pay €0.75 in Italy; €0.25 in Spain and €0.05 in France.   There is one consistency in payments across all European nations and that is cross-border transactions are expensive regardless of the country of initiation.  For example, before SEPA the €1000 payment explained above would have cost €20 if it were to be made from a payer using a German account to a payee using a foreign bank. 

Single European Payments Area 

Starting in the 1990s, the European Union began the SEPA initiative to harmonize and simplify payments across the 15 countries which have embraced the Euro as the national currency.  Consumers and corporations will enjoy consistent pricing and service levels irrespective of their country of citizenship and the location of their bank account.  Surcharges for cross-border transactions within the Eurozone will effectively be eliminated.  As a result, citizens and corporations will be able to make payments in any Eurozone country as easily and cost-effectively as they could in their home nation. 

SEPA offers numerous benefits to consumers, corporations and financial institutions.  The efficiencies to be gained through SEPA will lead to a 1% increase in GDP for the EU making it more competitive on the world market.  However, the productivity improvements will not come for free.  The gains will be achieved at the expense of the banks.  And they will be substantial.  As I mentioned above, SEPA’s impacts could reduce bank’s payment revenues by 30-60% or €13-29 Billion below 2010 expected results.  One of the greatest areas of impact will be cross-border payment fees which will be reduced from between €16 to €24 per transaction to under €0.50 per transaction.  Another contributor to revenue declines will be the normalization of fees across the EuroZone.  As the region is transformed into a single, common marketplace for retail and corporate payment services, competition will drive prices to their lowest common denominator.

Why are banks willing to participate if they lose so much money? 

While SEPA requires banks to sacrifice short-term payment fee revenue, it offers a promise of much larger long-term revenue and profitability gains.  In today’s model, regulations and requirements for operating a bank vary by country.  As a result, only the largest financial institutions can afford the start up costs to establish operations in multiple countries.  With SEPA the barriers for financial institutions to expand into new markets will be reduced considerably.  As a result, banks can expand their geographic footprint to capture a larger share of the larger EuroZone market and its 300 million citizens.  Furthermore, banks can offer a unified product set across the various countries gaining significant economies of scale in back office operations.

SEPA is, of course, just one part of a broader plan to harmonize the financial systems throughout the European Union.  The EU has similar initiatives completed or underway for invoicing, currency, taxation, securities and financial reporting.  Europe’s success has not gone unnoticed.  The Middle Eastern nations of Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and the UAE have already started efforts to unify their economies through the establishment of a common currency by 2010.  2010 is only 18 months away.  And we can only hope that confidence in the banking sector will have been restored by then…

SAP recently introduced a new application specifically designed to simplify electronic communications between companies and their financial institutions.  The new application has not received much attention by the press or analyst community, but it should have!   If anyone is well positioned to break down the barriers of straight through processing between corporate and their financial institutions, it is SAP.  In nearly every multi-national account I visit with SAP is already established or will soon become the financial platform of choice for multi-national companies.  SAP should be able to leverage its position as the epicenter of corporate cash management to provide simplified, straight through processing between its ERP modules and the treasury applications of leading banks.

What is SAP’s Bank Relationship Management module? 

So what is SAP’s strategy to simplify bank communications?  The vision revolves around the new Bank Relationship Management application, which is part of SAP’s “Financial Supply Chain Management” suite of software which also includes online bill presentment &payment; cash and liquidity management; collections management; dispute management; in-house cash and treasury & risk management.

How does SAP BRM simplify bank connectivity? 

SAP offers three key integration features that will greatly simplify bank connectivity for multi-national corporations:

1.       ISO 20022 XML support – 20022 is the new Universal Financial Industry standard developed jointly between TWIST, SWIFT, OAG and IFX.  Read my earlier post on ISO 20022 for more background information.  ISO 20022 is a game changer as it offers one file format that corporations can use to communicate payment instructions regardless of geography or financial institution.  Instead of a corporate having to create different file formats such as SWIFT FIN, ANSI X12 EDI, EDIFACT and NACHA for each banking relationship, the company can produce all its payment instructions worldwide in the single ISO standard.  SAP BRM can output payment instructions in this one standard ISO 20022 XML format which can then be directly transmitted to the bank.

2.       SWIFTNet Integration – SWIFT is a bank owned cooperative that operates a highly reliable, secure network designed exclusively for banks to exchange messages and files with one another.  Historically, access to the network has been restricted to financial institutions, but SWIFT has recently opened its services up to non-financial corporations.  Corporate Integration to SWIFT greatly simplifies bank integration by providing a single interface for all banking communications.  Instead of a corporate establishing an individual Internet (or private line) connection with each of its financial institutions, the company can send all of its banking transactions to SWIFT who will perform the routing on the corporate’s behalf.  SAP BRM includes pre-packaged adapters for corporations to connect to SWIFTNet.

3.       Enterprise Application Integration – Leveraging the Netweaver technology, SAP BRM provides tight integration with the other Financial Supply Chain modules such as cash and liquidity management; collections management; in house cash and treasury and risk management.   As a result, corporations do not need configure file transfer scripts and complex maps to route outgoing payment instructions from their financial modules to their banking partners.  Receivables and account statements flow through directly from the bank to the appropriate financial module.  Such an approach is powerful, because corporations using the full SAP financial suite can obtain straight through processing out of the box with minimal integration work.

Will SAP succeed with its ambitious plans to simplify bank communications? Yes and no.  While SAP does offer compelling technology, its solution is limited to software technology.  The challenges with bank connectivity are not the lack of strong technology or for that matter governing regulations or universal standards.  The greater challenges are related to:

• Skill Sets – The new technology paradigms such as SWIFTNet and ISO 20022 XML promise to greatly simplify connectivity processes.  However, there is currently a shortage of IT professionals with practical experience in the new technologies.
  • SWIFTNet - Connecting to SWIFTNet, for example, requires an extensive testing and certification process as well as the purchase of proprietary security technology and the establishment of expensive disaster recovery infrastructure.  Many corporates will not have the budget or expertise to perform SWIFT integration with their in-house IT organizations. 
  • ISO Skill Sets - ISO 20022, much like any XML format, is a complex document structure that requires both specialized functional knowledge to understand the various data fields and advanced technical skills to develop maps.
• Budgetary Pressures – Both corporations and financial institutions have significant investments in the legacy payment technologies and standards.  Corporate treasurers are under pressure to reduce back office administrative costs year-over-year.  Financial institutions continue to experience price erosion due to the perceived commoditization of cash management services.  Consequently, to utilize SAP’s BRM along with SWIFTNet and ISO, both corporate and financial institutions will have to fund expensive modernization projects in an environment of ever decreasing budgets.  
• Recent Investments - Many financial institutions have payment hub projects underway to replace mainframe-based legacy applications with new SOA platforms.  However, these institutions have not necessarily factored the new standards and technologies (e.g. ISO, SWIFTNet, SAP BRM) into their strategies.  Similarly, numerous corporate have established in-house banks with file and messaging gateways in the past five years.  The new corporate banking interfaces were designed to deliver similar functionality to SAP BRM.  Although the prior investment in banking gateways should be viewed as sunk costs, it will be challenging for IT organizations to secure budget to decommission and replace technology platforms they just established.

Over a five year horizon, I predict SAP’s Bank Relationship Management will become the de facto bank communications gateway for multi-national corporations.  However, adoption will be inhibited by the economic, organizational and technological factors outlined above…

Steve Keifer

© Copyright 2008 GXS, Inc.  All Rights Reserved.

I first learned about ISO 20022 some 18 months ago.  I remember first thinking about the name.  I said to myself this new payment standard must be intended to replace the 20021 different formats the global financial community uses today for payments.  Unfortunately, while perhaps very fitting, that is not the origin of the name.  However, that is the intention.  While there probably are not 20,000+ standards yet, it is not an understatement to say that there are hundreds if not over a thousand in use today.

Why are there so many payment standards? 

Banking, like most service sector segments, has historically been a business that focused on local markets.  It is only within the past 20 years, that regulations changed so that banks could easily operate within more than one US state or that banks could economically operate in multiple countries within the EU.  As a result, when electronic funds transfer and payment technologies were introduced in the 1980s, each country created their own technology standards in isolation.   Message formats were standardized based upon the central clearing and settlement systems operated by each country’s central banks.  For example, in the US, Federal Reserve’s ACH and FedWire; in the UK, BACS and CHAPS; in France, SIT and so on.  Today, not only do we have different payment message structures for each country, but each country also has different file formats for each payment type (e.g. check, automated clearinghouse (ACH) and wire transfer).  And it doesn’t stop there.  It is not only the message structure that differs between payment files, but the content as well.  For example, a payment in one country may require a complete street address, city name and postal code, the same type of payment in another country may only require the postal code.   To complicate matters even further, the non-bank corporations tend to utilize a different set of standards (e.g. ANSI X.12 , EDIFACT, OAGi) to exchange payment information with their banking partners. 

Numerous organizations including OAGi, RosettaNet and TWIST have each made an attempt to standardize payment message formats at varying levels.  ISO 20022 is the most promising effort yet towards a common payment information standard. 

What is ISO 20022? 

ISO 20022 is also known as UNIFI (UNIversal Financial Industry message scheme).  The official definition from www.iso20022.org is “UNIFI provides the financial industry with a common platform for the development of messages in a standardized XML syntax, using:·         A  modelling methodology (based on UML) to capture in a syntax-independent way financial business areas, business transactions and associated message flows;·         A set of XML design rules to convert the messages described in UML into XML schemas.”  Although, the discussion above describes ISO 20022 in the context of payments, the standard has ambitions which extend far beyond that domain.  The scope of ISO 20022 is all financial messages including Payments, Foreign Exchange, Trade Finance and Securities.  And the standard is beginning to gain widespread adoption as organizations such as TWIST, OAGi, RosettaNet and SWIFT have begun to embrace it.Who is using ISO 20022? ·         SWIFT – SWIFT is embracing ISO 20022 as the preferred XML format for messages exchanged on the SWIFTNet service used by over 8,000 financial institutions in over 200 countries to exchange financial transactions.·         SEPA - ISO 20022 is one of the key unifying standards that will harmonize payment technologies and standards throughout the European Union with the Single European Payments Area (SEPA).  For example, ISO 20022 will be a foundational standard for TARGET 2 (Trans-European Automated Real-time Gross Settlement Express Transfer System), the next generation, real time settlement system for Pan-European payments.