Payments are at the core of any fintech company’s offering. Whether they focus on payments themselves, lending, or investment, those companies sitting in multi-party flows of funds most likely have to manage bank credit transfers and direct debits in their products. In Europe, doing so means accessing SEPA (the Single Euro Payments Area) and its different payment schemes.
Depending on its activities, maturity, and goals, a fintech company has to decide how to access SEPA. This article explores why some companies regulated as payment institutions (PIs) and electronic money institutions (EMIs) decide to become SEPA indirect participants.
A quick recap on SEPA
SEPA payments rely on a four-corner model, based on one originator account holder and its PSP (payment service provider, in most cases a bank) and one beneficiary account holder and its PSP. PSPs are not directly connected to each other, but are interconnected through a CSM (clearing and settlement mechanism) for the clearing and settlement of their payments.
Account holders can be individuals, governmental or non-governmental organisations, companies, or any other entity that holds an account with a PSP.
Payment service providers can be credit institutions (often referred to as a bank), payment institutions, or electronic money institutions. A key role and responsibility of PSPs is to send and receive payments on behalf of their customers by holding customer accounts and connecting to the CSMs.
Clearing and settlement mechanisms are responsible for executing the clearing process between PSPs. They aggregate all payment orders between two PSPs across a time frame. At a set point, the CSM then “nets” the payment orders, determining a “gross” payment amount – called the final position – which is then transferred from one PSP to another in a final step called settlement.
There are two ways of accessing SEPA as a company: as a “corporate customer” of a PSP or as a SEPA participant. However, only some companies can become SEPA participants and only some companies can sustainably stay as “corporate customers” of PSPs.
When sending and receiving SEPA payments through a bank isn't enough
Accessing SEPA as a corporate customer
Most companies access SEPA and its payment schemes as “corporate customers” of their PSP, as opposed to SEPA direct or indirect participants, as we will explore below. Being a corporate customer means that a company will rely on its PSP(s), most often banks, to hold their accounts and send and receive payments from and to those accounts.
In the case of fintech companies that might want to allow their users to deposit funds on a wallet or send and receive SEPA payments, it means that a PSP like a bank or a BaaS will actually perform these operations.
Those fintech companies will work with the corporate cash management department of the bank, and the bank will hold the accounts of the fintech.
When being a corporate customer falls short
First, only some companies can even consider becoming SEPA participants. Indeed, only regulated electronic money institutions, payment institutions, or credit Institutions (i.e., banks), referred to as “financial institutions” as a whole, can apply to participate in SEPA. For those regulated companies, the question arises when their volumes grow.
In the corporate customer model, companies are bound to use their bank’s IBANs, in their bank’s name. It means that whenever end users receive credit transfers and direct debits from corporate customers or have to send credit transfers to corporate customers, the company name appears as the account holder name, but not as the financial institution name.
The company’s bank name appears instead. This can lead to a confusing user experience and even impair end users’ trust in the company’s seriousness.
In addition, more payments mean more edge cases, potential errors, and scenarios to manage. As corporate customers, companies don’t have direct control over the mechanisms to handle these cases and have to rely on their banks. Banks can take time and charge significant fees to manage a recall of funds or a failed direct debit.
Finally, companies using the corporate customer model rely on one or more intermediaries to process their payments, meaning as many potential points of failure and business counterparts with their own compliance requirements and margins to preserve.
To overcome those limitations, regulated fintech companies can choose to become SEPA participants.
The benefits of becoming a SEPA indirect participant
Two ways of becoming a SEPA participant
There are two ways to become a SEPA participant: direct and indirect.
While SEPA direct participants connect directly to the CSMs, SEPA indirect participants partner with a bank, which is itself a SEPA direct participant and becomes their “sponsor bank”.
On a high level, direct participants will have lower running costs on payments because connecting directly to the CSMs requires no middleman (the sponsor bank) that usually takes a fee on each payment. In addition, they can themselves become sponsor banks and generate revenue from this activity.
On the other hand, being an indirect participant “only” requires connecting to a sponsor bank, which is quicker and less expensive than developing and validating an integration with a CSM. The regulatory process is also lighter, as the sponsor bank bears some responsibility on behalf of the indirect participant.
But before even considering the economic equation, the main reason PIs and EMIs will choose the indirect participation model over the direct one is that in order to be a direct participant, you need an account at the European Central Bank (ECB). And to have an account at the ECB, you need to be a credit institution, i.e. a bank.
The benefits of being a SEPA indirect participant rather than a corporate customer
Becoming a SEPA indirect participant gives PIs and EMIs extended controls and visibility on their SEPA payments. Indeed, it opens access to (and the obligation to support) additional payment flows called R-transactions.
R-transactions include the ability for indirect participants to send and receive return and recall messages and associated reason codes that most banks don’t transfer to their corporate customers.
Concretely, R-transactions enable PIs and EMIs to manage cases like direct debits sent to closed or blocked accounts, incorrect account numbers, or duplicate payments themselves. They can build their own fallback rules when such issues happen and decide their own policy regarding charging – or not – end users at the root of those cases.
Own IBANs and BIC
As SEPA indirect participants, PIs and EMIs will issue IBANs in their name for held accounts. It means that when end users receive credit transfers or direct debits from PIs and EMIs, or send them credit transfers, they will see the PIs and EMIs’ names associated with the payment, instead of the bank’s name for corporate customers.
SEPA indirect participants have their own BIC. Their IBANs are tied to their BIC, instead of their bank’s in the corporate customer model. This enables them to change sponsor banks without migrating their customers’ accounts and, therefore, without any impact on their customers.
Lower payment fees
Banks charge payments differently for corporate customers and indirect SEPA participants. While they will vary from bank to bank, payment fees will often be lower for indirect SEPA participants, which can lead to significant savings for companies with high payment volumes.
How to become a SEPA indirect participant
Becoming a SEPA indirect participant not only solves major pains for relevant fintech companies, it opens strategic opportunities. While it is a lighter process than becoming a direct participant, it still represents a sizable project.
On the operational side, indirect participants are responsible for running the proper anti-money laundering checks on their customers, whereas the bank manages this process for corporate customers.
In addition, some compliance steps are required, from regulatory and industry entities alike, such as getting a BIC (bank identifier code) from Swift and registering with the European Payment Council. In order to be reachable through SEPA, indirect participants also need to be registered on a SEPA CSM, that will route payments from / to the sponsor bank, which in turn will transfer payments from / to the indirect participant.
A sponsor bank can work with multiple SEPA CSMs, and allow their indirect participants to choose their preferred CSM."
Finally, SEPA indirect participant applicants will need to connect to their sponsor bank connectivity systems, which always differ from the corporate customers’ ones in terms of file formats, and sometimes in terms of technical integration.
How Numeral helps SEPA indirect participants
Numeral has already integrated with major SEPA sponsor banks and worked with several PIs and EMIs to become SEPA indirect participants.
In addition to providing SEPA indirect participants with connectivity to their SEPA sponsor banks, Numeral enables them to manage essential processes, including:
Sending and receiving SEPA credit transfers, SEPA direct debits, and SEPA instant credit transfers
Managing payment status report messages
Confirming or rejecting incoming SEPA instant credit transfers
Sending and receiving recalls, returns, and inquiries
Reconciling settlements and safeguarded accounts
Managing funds across settlement and safeguarded accounts
Those processes can be fully automated via an API and managed manually via a user-friendly dashboard when necessary.
If you are exploring becoming a SEPA indirect participant, do not hesitate to contact us.