Questions & Answers

The "Berlin Group" first met in Berlin, hence its name, in October 2004 and currently has participation of 13 major players in the card industry from 8 different euro-zone countries, together representing 18 billion card transactions annually within SEPA.

The group which is made up of major national card payment systems, shares the ambitions and vision of the European Central Bank (ECB), the European Commission (EC) and the European Payment Council (EPC) on card payments in a Single Euro Payment Area (SEPA).It proposes that this vision would be best reached by capitalising on and preserving the high levels of efficiency, brand awareness, security, convenience and ease of use already achieved in current national debit card schemes.

The group decided to explore the feasibility of this concept with likeminded card schemes within the euro-zone.

The principle goal is to meet the aims of the EPC, the ECB and the European Commission with regard to a Single Payment Area, and in particular to be compliant with the SEPA Cards Framework which is being developed by the EPC.

The current participants can be found here.

Participation in the Berlin Group does not imply either endorsement of any of the solutions identified in the Feasability Study, or a commitment to implement them.

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1.2 What underlying business principles are shared by the participants?

There is a general consensus amongst the participants that the implementation of the SEPA vision for card payments should be based on the following business principles:

Governance over a SEPA card scheme should remain within the European banks.
The implementation should save costs for the participants and their member banks: this is based on the observation that current costs of cross-border card processing today are relatively high and substantial cost savings should be able to be achieved by reproducing the performance achieved today by national card systems to the SEPA zone, in order to meet a rising need to save costs in cross-border processing.
The business model should offer a Level Playing Field (equal conditions) to all participants, thus enabling continuous increase of efficiency and stimulation of innovation. This requires coherent legislation and regulation throughout the SEPA euro-zone.
Implementation should:
- enable universal card acceptance and consistent card usage and cardholder experience across SEPA;
- leverage on the current high levels of efficiency, brand awareness, security and convenience in current national debit card schemes;
- integrate a method for interchange fees in order to achieve efficient co-operation between competitive banks. The principle of interchange fees is the preferred and proven method;
- be flexible enough to adapt to a changing environment.

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1.3 Why are domestic schemes central to your approach?

Today, almost all countries in Europe rely on their national card schemes which are characterised by:

high volumes of card transactions,
a high level of efficiency,
an outstanding level of security (with low levels of fraud),
a strong brand awareness among retailers and the general public,
high levels of trust by users of their national schemes and appreciate the convenience of using them.

National brands offer a level of coverage and quality of service, currently not provided by international schemes.

Increase of merchant card acceptance and cross-border usage is considerably restricted due to the fees applied by the international brands to cross-border card transactions within SEPA.

What is more, because of their waiver policy and strong regional differences, the international brands lack a coherent set of rules and standards which lead to different levels of security, conflicting cardholder and merchant behaviour and an inconsistent card acceptance in Europe and elsewhere.

International schemes are characterised by high membership and operation fees, and a commercial offering which is globally expensive. Banks lack direct control and governance in the international schemes, and are therefore unable to influence the schemes' future product development or rules and regulations.

The Berlin Group is therefore examining a true European, evolutionary, low-risk and pragmatic approach in which payment cards can be used within SEPA based on the strong fundamentals and leverage of current national schemes and processing structures.

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1.4 Does your approach require re-building of an international payment system?

Functionally, international payment systems are based on an architecture with a central switch for authorisation, clearing and settlement processing. The approach analysed by the Berlin Group is based on bilateral connections between partners using an IP-based VPN with de-centralised processing at the gateways to the VPN - without requiring a central switch. In this way, it is not necessary to replicate infrastructures developed by the international payment systems.

Furthermore certain central services of the international payment systems are no longer required, and with the introduction of the euro, currency conversion no longer necessary. Also other central services, like central stand-in are not necessarily required, so that a European payment system could easily operate without a central switch.

The approach is based on leveraging existing infrastructures at the level of current processors within the national card schemes. The additional work to be done at the gateways relate to sorting messages for each participating partner, so that they can be sent directly to the appropriate partner, and to setting up a settlement process with each partner. Participants in a multilateral card processing network could then - at their discretion - decide on setting up additional central services, e.g. net-settlement.

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1.5 Is your approach not too protective of vested interests and investments?

The Berlin Group believes that a true SEPA can best be reached by building on past investments and currently available infrastructures. This allows for an evolutionary migration approach where goals and achievements represent a balance between self-regulation and regulation. In comparison, a "revolutionary" approach would prove to be too costly, and the market is not willing to pay for it.

Although some new investments will have to be made in an evolutionary approach they are considered to be minimal because of use of earlier acquired and developed infrastructures, knowledge and experience.

The group considers it good business practice to limit investments and re-use earlier investments where possible, and will finalise the Feasibility Study and Implementation Plan, which are currently under study by mid-2005.

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1.6 How does your approach contribute to competition in the field of payment systems?

The approach analysed in the Berlin Group Feasibility Study is based on the assumption that banks or groups of banks (as in the current national systems) should be free to enter into bilateral agreements and to process transactions bilaterally if they so wish. As such, the current national systems may be regarded as multilateral systems which are currently limited to a country within SEPA because of international system rules. Federating current national systems within SEPA would be equivalent to extending the current national systems based on bilateral or multilateral agreements.

The model analysed in the Feasibility Study does not limit negotiations between partners of bilateral transaction processing, but facilitates such negotiations and makes it easier to agree on standards. This widens the scope for flexible solutions between different partners and engenders competition at a European level.

Federating national systems is therefore an opportunity for banks which will lead to additional competition in the field of card processing within Europe. Banks or groups of banks will only make use of it, if they are able to save costs or if they are able to introduce new products into their relevant markets faster than with the international card systems. Therefore the Berlin Group has analysed not only the technical feasibility of bilateral / multilateral card processing, but also the implications on communication costs and ongoing card system costs.

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1.7 What makes the Berlin Group qualified for realizing this SEPA initiative?

The participants in the Berlin Group all share extensive experience, expertise and a well-proven track record of delivering high volume, high performance (secure, reliable), well managed and efficient electronic payment infrastructures in their respective markets. They all have an outstanding reputation in reliability, integrity and security with their client base (banks, merchants, cardholders).

The participants know each other for many years now and have extensive experience of working together through previous efficient and fruitful co-operation. Work in the field of technical standardisation takes advantage of, and builds upon, specific technical harmonisation work carried out by joint initiatives which have already started and are ongoing, especially where it concerns harmonisation of EMV implementation requirements and the work to achieve mutual recognition of security certifications for components of payment systems.

The Berlin Group operates as a focused core group. It believes that a clear action plan based on a pragmatic, bottom-up approach with actual deliverables, milestones, priorities and timetable allows it to move forward rapidly and achieve the required interoperability within SEPA (whilst initially focusing on the euro-zone).

Participants in the Berlin Group currently process 18 billion transactions within SEPA annually.

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1.8 In the past, similar initiatives had haltering successes. What makes this initiative different and what makes you confident that it will work?

Similar concepts which were originally developed in the early 1990s were either successful (as is the case with Eufiserv, developed by the Savings Banks) or sometimes less so. In hindsight, there are several reasons. First of all, at the time of past initiatives, network architectures were not as advanced as they are today, and secondly, currently available standards and technology can now deliver low-cost and high-speed pan-European networks. In addition to that, the environment of cross-border card transactions in Europe has changed in many respects in recent years: the introduction of the euro made it possible to drop currency conversion between euro-countries, card payments in general are in the maturity phase of the product life cycle, when generic advertising of card usage becomes less important and product differentiation between banks becomes more important, and with the on-going harmonisation of the technical foundations of card payments (e.g. introduction of EMV) it has become easier to come to a simple and coherent set of rules and standards, thus simplifying transaction processing. The huge consolidation in the banking environment that materialized in the 1990s added extra uncertainty in commitment to such projects, and this situation was further accentuated by major projects such as introduction of the Euro, the Y2K problem and EMV were being announced and planned and drew away attention from management and other required skills.

Such elements which were legitimate risk factors in the past, hardly exist today, and the combined political pressure to realize SEPA by 2010 and the concerted action from strong European card industry partners, leads the Berlin Group to believe that the time is right to deliver on SEPA.

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2 Feasibility Study

2.1 What are the results of the Feasibility Study?

The guidelines for the "Berlin Group" Feasibility study are to:

develop a bottom-up approach which is intended to complement the work carried out by the European Payments Council SCF Draft Force,
define a solution which can be implemented through a phased approach and which is flexible enough to adapt to a rapidly changing environment, while remaining SEPA compliant,
contribute its findings to the EPC Cards Working Group, should the EPC so wish.

The Feasibility Study examines an alternative approach to those offered by the international card schemes, not by building a new international card system at a European level, but by enabling existing national systems to be inter-linked on the basis of bilateral/multilateral agreements. From a functional point of view this would be done through an IP-based VPN between gateways of the current national systems, without requiring changes to cards or terminals or to the national processing requirements.

Although it is clear that important clarifications on the final SEPA vision are still needed, the Berlin Group has used the currently available information which already delivers tangible results. To date, the Feasibility Study clearly shows that:

common technical standards for authorisation processing and clearing and settlement processing can be defined, so that the implementation of bilateral transaction processing can be based on uniform and harmonised technical standards throughout Europe;
a functional architecture based on an IP-based VPN, connecting participating gateways is technically feasible and would lead to significant cost savings in terms of communication costs;
bilateral/multilateral card processing can be designed in such a way that a central switch is not needed and that all necessary processing functions can be carried out at the level of the gateways to the VPN, thus leveraging existing investments at the processors of current national systems;
bilateral/multilateral transaction processing does not necessarily imply significant central scheme management costs, since governance, maintenance of specifications, marketing and other back office functions can be organized differently in an environment of federated national systems. A federation of national systems with minimum central co-ordination could also lead to significant cost-savings in terms of scheme management costs.

Based on these findings a phased implementation plan has been proposed:

Phase I would start with bilateral agreements based on common principles and standards as well as on the usage of existing consolidated experience and technology. To support the establishment of bilateral agreements the Berlin Group will develop common technical standards for authorisation and clearing/settlement processing as well as on the usage of an IP-based VPN. In addition to that it will provide common basic rules and principles for bilateral agreements.
Phase II will represent the multilateral extension of bilateral agreements. The common set of basic rules and principles for Phase I should be conceived in such a way as to allow further migration towards a common euro-zone acceptance system in Phase II.

Phase II will allow for transactions to be processed under common rules and a common acceptance label, thus saving transaction fees which are levied today by the international card schemes (even if the transaction is not processed through their networks). A common framework including terms of acceptance, authorisation and settlement standards, EMV implementation, interchange and common processes for disputes will de developed for Phase II.

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2.2 What are the benefits for member banks resulting from the Feasibility Study?

2.2.1 What are the possibilities to save costs?

The Feasibility Study has identified two major areas where direct cost savings can be realised. First of all, it is possible to save communication costs by using an infrastructure based on an IP/VPN without a central switch. In addition it would be possible to save scheme management fees, if scheme management were to be organised on the basis of a federation of national systems without central marketing for a generic brand.

The approach proposed in the Feasibility Study is based on the perception that the highest efficiency is currently realised at national level where the majority of transactions take place. Federating national systems will preserve current national efficiencies, save costs in cross-national processing and allow for individual migration planning towards common technical standards within each participating scheme. It would also saves costs which would arise if current national systems were to be diluted within international card schemes, since such a situation would require that new technical standards would have to be implemented immediately within every country in SEPA.

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2.2.2 Where can economies of scale be realised?

Based upon the consideration, that economies of scale have already been realised today at the level of the processors of the current national systems which are responsible for the majority of transactions within Europe today, it seems sensible to leverage these existing economies of scale also for cross-national transactions in SEPA. The model analysed in the Feasibility Study is therefore not aimed at economies of scale at a central processor, but at minimising investments for the banks. This can best be reached by inter-linking current national systems.

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2.2.3 What are the effects of the Feasibility Study compared to the proposals of the international schemes?

The model analysed in the Feasibility Study is aimed at saving costs in intra-SEPA card transaction processing for banks compared with the conditions currently proposed by the international schemes.

This aim is based on the expectation that issuing banks will experience pressure from both sides - decreasing cardholder transaction fees (e.g. due to the "Regulation (EC) No 2560/2001 of the European Parliament and the Council of 19 December 2001 on cross-border payments in euro") and decreasing interchange revenues (due to current examination of interchange fees by the European Commission) and that currently the most sensible way to optimise the payment card business model is to save costs in transaction processing.

In addition, the bilateral agreement model which is planned for Phase I leaves room for negotiations between participating partners to determine the interchange level bilaterally. For Phase II after clarification of the position of the European Commission a common interchange methodology could be foreseen.

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2.3 What are the necessary investments?

Federating national systems does not incur substantial investments in the short term, since it simply relies on inter-linking of existing national systems.

Inter-linking national systems requires setting up a gateway to an IP/VPN which would have to support the message formats as defined by the Berlin Group for authorisation and clearing/settlement. In addition it would imply setting up a bilateral settlement process with each participating partner. Cards and terminals are not affected by this.

Using an IP/VPN avoids the need for a central switch and leverages existing infrastructures at the level of the current national processors instead of re-building the infrastructure of international card schemes.

In the long term migration towards common standards is possible (based on individual migration plans at the level of each participating national system). Such a migration would lead to additional investments, but could be carried out independently by each participating scheme within its own investment cycles.

At the same time major communication investments, which would be necessary if current national systems had to be substituted by brands of the international card schemes, can be saved.

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2.4 How is innovation promoted in an environment of federated national systems?

The possibility to implement innovations based on bilateral agreements increases innovation and competition within SEPA. Compared to the international card systems no global agreements are necessary prior to implementation of innovations.

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2.5 The initiative aims at bilateral exchanges in a first phase. Is this really an efficient model?

In the past bilateral exchanges between multiple partners in different areas of the world would have implied the setting up of "(n * (n-1))/2" infrastructure links, which would indeed be inefficient. However, modern network technology and architecture based on an Internet Protocol Virtual Private Network (IP/VPN) enables a very efficient and intelligent switching infrastructure to be set up. (Additional) participants would have to develop an infrastructure link to this IP/VPN only once and, after being certified for the service, simply plug in to the network. Since a central switch is not required any more, costs can be saved.

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2.6 How can one be sure that the proposed approach will not generate costs which will be on a similar level to current international schemes?

The model analysed in the Feasibility Study is based on a federation of national systems and on leveraging current investments at the national level. This is not restricted to technical investments but would also leverage current brand awareness and governance structures at the level of national systems:

For marketing purposes the participants of bilateral/multilateral card processing can leverage the image and brand awareness of their current national acceptance systems. The current national acceptance systems already offer today the largest coverage of their respective markets and there is no need for generic card brand marketing to expand acceptance. Cardholders can expect that their cards work at any terminal of any participating national scheme. Marketing at the cardholder side could restrict itself to the marketing of the issuing bank, who would simply inform its cardholders on the countries where general acceptance is possible. Thus the individual brand of the issuing bank comes into the fore and no extra costs for marketing of a generic issuing brand is required. On the acquiring side, if more than only a few countries participate, a generic acceptance brand would help to ease acceptance. However, even the introduction of such an acceptance brand does not necessarily require extra promotion/communication costs, since it is not a constituent component of a multilateral scheme of national acceptance systems, but can be introduced over time via the normal promotion/communication channels between each issuing bank and its cardholders and the acquiring banks and its merchants.
Federating national systems will allow leverage in terms of governance and maintenance from current national schemes. Since the functional model is based on interlinking national systems, it will also be possible to base governance and maintenance on the co-operation of those bodies which are already responsible today for governance and maintenance of the participating national systems. Instead of a centralized approach, a federation of national systems with a minimum of central co-ordination is proposed, thus limiting any central costs to a minimum.
No central back office functions, e.g. stand-in processing, blacklist distribution etc. are foreseen, so that no extra costs for the implementation and operation of central back office functions have to be included in the case of bilateral processing.

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2.7 How can full SEPA acceptance be achieved?

Bilateral connections between national systems can be implemented in addition to current international acceptance systems. This means that partners in a bilateral communication could benefit from it in selected regions within SEPA, without being obliged to cover the entire SEPA (euro-zone) with bilateral connections right from the start.

The implementation of multilateral connections between national systems could then take place progressively where it is possible to save costs between the participants.

Although only the current national systems reach 100% acceptance in their respective markets and only the sum of the current national systems covers 100% of the European market, there is no need to start bilateral connections between all current national systems at the same time. In case of absence of a bilateral agreement between two SEPA countries, the international acceptance systems could provide a fallback solution. By using the international acceptance systems in addition to bilateral agreements it is also possible to provide for global acceptance of European cards.

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2.8 Would the solution proposed by the Feasibility Study exclude competition?

Federating national systems does not mean, that international or other card schemes are excluded from the market. For example, international schemes may participate as a provider of national systems in certain countries as well as a fallback solution in those relationships, where no bilateral agreement exists. They could compete freely on the market by providing their services.

In this way federating national systems is regarded as contributing to competition compared to the situation where national systems would be diluted within or migrated to one of the international systems.

The technical standardisation which goes along with federating national systems contributes additionally to competition. The participants of the Berlin Group have already in the past started to work on the technical harmonisation of card based acceptance systems throughout Europe. This encompasses the implementation of EMV as well as the mutual recognition of security certifications or the development of technical standards for future terminals. All these initiatives contribute to an open market of payment system components and lead to increased competition.

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2.9 Is the model of a federation of national systems flexible enough to be able to adapt to market requirements?

Due to the requirement to come to uniform rules for all participating parties all over the world within the international systems, international card schemes have to provide "one size fits all" solutions, which are governed centrally (outside Europe) and based on a top-down approach.

Federating national systems in Europe allows for individual business agreements between each participating national system and leads to an evolving, growing solution that can easily be adapted to the needs of banks, and the requirements of the European Central Bank and the European Commission. In contrast to the international card schemes it is based upon a bottom-up approach.

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