Regulating Stored Value Facilities in Australia: Review and a Proposal for Reform
By: Sophie Anja Kaarina Burbidge
A Thesis in fulfilment of the requirements for the degree of Doctor of Philosophy
University of New South Wales
Faculty of Law
August 2018 UNSW Thesis / Dissertation Sheet
Surname/Family Name : Burbidge Given Name/s : Sophie Anja Kaarina
Abbreviation for degree as give in the University calendar : PhD Faculty : Law School : Law Regulating Stored Value Facilities in Australia: Thesis Title : Review and a Proposal for Reform
Abstract:
This Thesis examines stored value facility regulation in Australia and compares it to that in Hong Kong and Singapore. It concludes that in its current form, Australia's stored value facility regulatory regime is unnecessarily complex, does not provide sufficient competitive neutrality between issuers nor adequately support innovation, and the application of its consumer protection provisions is uncertain.
Stored value payment methods have the potential to be a significant source of competition to traditional payment methods, but the existing regulatory regime in Australia limits their ability to grow.
Existing stored value legislation is no longer adequate; time, innovation and the emergence of non-bank issuers has led to the need for revision of old legislation and in some cases new legislation. A flexible regime is needed to effectively capture and regulate all products. This Thesis proposes that a regime with two prudential tiers and a third non-prudential tier, separate from the existing ADI regime, is the best model for stored value facilities in Australia. The upper tier should capture those products determined to be large and widely used. The second tier should capture those products with lower value that are sufficiently large enough to require some level of prudential regulation. The third tier should apply consumer protection provisions to products operating between the low value exemptions and the prudential tiers. The existing regulatory exemptions for limited-use facilities should remain.
Regulation should allow products to graduate from the exemptions and between the tiers as appropriate. ASIC's ePayments Code should be made mandatory for all stored value facility issuers. The use of clear and transparent criteria to determine the appropriate regulatory tier should remove the need for the RBA's system of declarations. To monitor developments in the market and assess the impact and compliance burden of existing regulation, an organisation such as the Council of Financial Regulators should take on a coordinating role for the stored value regulators.
The regulatory regime proposed in this Thesis provides greater clarity, competitive neutrality, support for innovation and consumer protection within stored value facility payments in Australia.
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UNSW is supportive of candidates publishing their research results during their candidature as detailed in the UNSW Thesis Examination Procedure.
Publications can be used in their thesis in lieu of a Chapter if: • The student contributed greater than 50% of the content in the publication and is the “primary author”, ie. the student was responsible primarily for the planning, execution and preparation of the work for publication • The student has approval to include the publication in their thesis in lieu of a Chapter from their supervisor and Postgraduate Coordinator. • The publication is not subject to any obligations or contractual agreements with a third party that would constrain its inclusion in the thesis
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This thesis has publications (either published or submitted for publication) ☐ incorporated into it in lieu of a chapter and the details are presented below
CANDIDATE’S DECLARATION I declare that: • I have complied with the Thesis Examination Procedure • where I have used a publication in lieu of a Chapter, the listed publication(s) below meet(s) the requirements to be included in the thesis. Name Signature Date (dd/mm/yy) Sophie Burbidge 26/02/2019
i Preface
Thank you to Ross Buckley and Jonathan Bonnitcha, my PhD supervisors, whose invaluable help and encouragement made this Thesis possible.
Thank you to my Dad, who has been my greatest support. Table of Contents
Regulating Stored Value Facilities in Australia: ...... i Review and a Proposal for Reform ...... ii Regulating Stored Value Facilities in Australia: ...... iii Review and a Proposal for Reform ...... iv CHAPTER ONE: INTRODUCTION TO THESIS ...... 1 1. INTRODUCTION ...... 1 2. RESEARCH QUESTIONS ...... 6 3. COMPARATIVE LAW RESEARCH METHODOLOGY ...... 8 4. THE METHODOLOGY OF THE FUNCTIONALIST APPROACH ...... 16 5. CHAPTER SUMMARY ...... 21 6. THEORETICAL FRAMEWORK ...... 23 7. CONCLUSION ...... 28 CHAPTER TWO: DIFFERENTIATING STORED VALUE FACILITIES ...... 30 1. THE DEVELOPMENT OF STORED VALUE FACILITIES ...... 30 2. HOW REGULATORS DIFFERENTIATE STORED VALUE FACILITIES ...... 32 3. STORED VALUE FACILITIES: FINDING THEIR PLACE IN THE PAYMENTS ECOSYSTEM ...... 48 4. TO WHAT EXTENT ARE STORED VALUE FACILITIES LIKELY TO BE ADOPTED IN AUSTRALIA? ...... 57 5. CONCLUSION ...... 60 CHAPTER THREE: REGULATORY APPROACHES AND AUSTRALIA’S REGULATORS ...... 63 1. RISKS CONCERNING REGULATORS ...... 63 2. THEORETICAL APPROACHES TO THE REGULATION OF ELECTRONIC MONEY ...... 64 3. REGULATING THE AUSTRALIAN PAYMENTS SYSTEM ...... 78 4. CONCLUSION ...... 88 CHAPTER FOUR: AUSTRALIA’S CURRENT REGULATORY FRAMEWORK ...... 90 1. AUSTRALIA’S E-MONEY REGULATIONS ...... 90 2. REGULATION BY THE AUSTRALIAN PRDUENTIAL REGULATION AUTHORITY ...... 92 3. REGULATION BY THE RESERVE BANK OF AUSTRALIA ...... 101 4. REGULATION BY THE AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION ...... 105 5. MAIN ISSUES WITH THE EXSTING REGULATORY FRAMEWORK ...... 110 6. CONCLUSION: PREPARING FOR A DIGITAL ECONOMY ...... 116 CHAPTER FIVE: COMPARATIVE INSIGHTS ...... 120 1. INTRODUCTION ...... 120 2. REGULATORY REGIMES ...... 121 3. A COMPARISON OF REGULATORY ISSUES ...... 129 4. CONCLUSION ...... 157 CHAPTER SIX: CLARITY AND CONSUMER PROTECTION ...... 161 1. DEFINITIONAL AND LEGAL UNCERTAINTY ...... 162 2. DEFINITION OF STORED VALUE FACILITIES IN AUSTRALIAN REGULATIONS ...... 168 3. TECHNOLOGICAL NEUTRALITY IN STORED VALUE FACILITY REGULATION ...... 179 4. ASIC’S CONSUMER PROTECTION PROVISIONS ...... 184 5. RECOMMENDATIONS TO IMPROVE THE EXISTING STORED VALUE REGULATORY REGIME ...... 185 6. CONCLUSION ...... 199 CHAPTER SEVEN: INNOVATION AND COMPETITIVE NEUTRALITY ...... 201 1. ‘BANKING IS NECESSARY, BANKS ARE NOT’ ...... 202 2. THE BENEFITS OF A LEVEL PLAYING FIELD FOR ISSUERS ...... 204 3. AN ANALYSIS OF COMPETITIVE NEUTRALITY BETWEEN STORED VALUE ISSUERS AND PRODUCTS IN AUSTRALIA ...... 209 4. DESIGNING A NEW SYSTEM ...... 219 5. GOVERNMENT RESPONSE TO A GRADUATED REGIME ...... 232 6. GOVERNMENT-INDUSTRY INITIATIVES ...... 234 7. CONCLUSION ...... 237 CHAPTER EIGHT: RECOMMENDATIONS AND A PROPOSAL FOR A GRADUATED REGIME ...... 240 1. ADDRESS UNCERTAINTY WITHIN THE EXISTING REGIME – CLARIFY NAME AND DEFINITION ...... 242 2. REVIEW AND CLARIFY THE REGULATORY PERIMETER ...... 244 3. INTRODUCE A GRADUATED SYSTEM ...... 246 4. SEPARATE STORED VALUE REGULATION FROM THE ADI REGIME ...... 248 5. INCREASE CONSUMER PROTECTION ...... 250 6. ADDRESS COMPETITIVE NEUTRALITY AND INNOVATION ...... 251 7. RETHINK THE ROLES OF THE REGULATORS ...... 252 8. CONCLUSION ...... 254 BIBLIOGRAPHY ...... 257
CHAPTER ONE: INTRODUCTION TO THESIS
1. INTRODUCTION 1 2. RESEARCH QUESTIONS 6 3. COMPARATIVE LAW RESEARCH METHODOLOGY 8 4. THE METHODOLOGY OF THE FUNCTIONALIST APPROACH 16 5. CHAPTER SUMMARY 21 6. THEORETICAL FRAMEWORK 23 7. CHAPTER CONCLUSION 28
1. INTRODUCTION
1.1 Preparing for a Cashless Society
Stored value payment methods have the potential to be a significant source of competition to traditional payment methods, but the existing regulatory regime in Australia limits their incentive and ability to grow.
The current stored value regulatory system in Australia, which is currently neither comprehensive nor entirely coherent, is in need of reform. Whilst reviews of Australia's financial system have been undertaken, reform of the stored value payment system is overdue. Australians make millions of payments worth billions of dollars every day; its payments systems are an essential part of the financial system.1 A strong economy and stable financial markets require well-functioning payments systems to facilitate lending and repayment of money, purchase of goods and services, the hire of labour and investment of capital.2
1 Productivity Commission, ‘Competition in the Australian Financial System,’ (Draft Report, January 2018) 274 < https://www.pc.gov.au/inquiries/current/financial-system/draft/financial-system- draft.pdf>. 2 Rhys Bollen, ‘Best Practice is the Regulation of Payment Services,’ (2010) Journal of International Banking Law and Regulation 408. 1 Stored value facilities are a subset of electronic money (herein, e-money) defined as currency that does not have physical form but to which legal value has been assigned. E-money is a digital alternative to cash, and digital and virtual currencies are included within its ambit.3 Stored value facilities are cards and devices that have been preloaded before use with funds, thus holding value outside the traditional banking system.4
Countries around the world are taking their first steps toward becoming cashless societies. The use and influence of e-money and stored value payments as a type of electronic payment is increasing. In 2015, the Global System for Mobile Communications reported that e-money was available in 93 countries, with 134 million active e-money accounts with an average of 33 million transactions processed each day.5 Governments in several major markets are using regulation to wean their populations off cash, actively seeking to reduce its role in their economies. Denmark has removed the obligation for certain retailers to accept cash at night.6 Swedish retailers are already not obliged to take cash; around 900 of Sweden’s 1,600 bank branches no longer keep cash or take cash deposits, and many no longer have ATMs.7 The European Central Bank announced in 2016 that it would phase out the €500 note by 2018 to encourage consumers to complete high value purchases via electronic payment, rather than with a large stack of banknotes.8 In 2016, India gave short notice before removing from legal tender status its two highest denomination notes, the
3 European Commission, Banking and Finance ‘E-money,’ (2018) < https://ec.europa.eu/info/business- economy-euro/banking-and-finance/consumer-finance-and-payments/payment-services/e-money_en>. Crypto-currencies as a completely de-centralised currency are not within the scope of this Thesis. 4 A detailed discussion of what constitutes a stored value facility, and its range of payments products in contained in Chapter Two. 5 Global System for Mobile Communications, ‘State of the Industry Report: Mobile Money,’ (Report, 2015) 6 < https://www.gsma.com/mobilefordevelopment/programme/mobile-money/state-of-the- industry-2015/>. 6 ‘Danish households opt out of cash payments,’ (Analysis, no. 24, Danmarks Nationalbank, 12 December 2017), 6
As the use of cash decreases, consumer expectations as to convenience are rising, enabling electronic payment technologies such as contactless cards, mobile wallets and digital currencies to gain traction. Kenya has moved from being a primarily cash- based economy to one that makes extensive use of mobile payments, thanks to the M- Pesa system, that enables transfer of almost half of Kenya’s GDP.11 In Sweden, homeless people carry credit card readers supplied by the charitable Situation Stockholm magazine, as very few passers-by carry cash.12 Turkey aims to be a cashless society by 2023, launching Troy – which has credit, debit and prepaid facilities to boost electronic payments.13 In 2015, Ecuador became the first government to formally issue a digital currency.14 Other examples of government influencing payment product choice include the tax on cheques in Ireland, tax deduction capabilities of card payments in Korea, and the expansion of the Basics cards and use of reverse EFTPOS for medical payments in Australia.15
9 Simon Mundy, Amy Kazmin, Kiran Stacey, ‘India demonetisation fails to purge black money,’ The Financial Times (online), 31 August 2017 < https://www.ft.com/content/7dbe0e14-8d8a-11e7-a352- e46f43c5825d>. 10 Bryan Harris, Kang Buseong, ‘South Korea to Kill the Coin in Path Towards “Cashless Society,”’ The Financial Times (online), 1 December 2016 < https://www.ft.com/content/ bf5c929c-b78d-11e6-ba85- 95d1533d9a62>. 11 ‘Mobile Currency in Kenya: the M-Pesa,’ (Case Study, Centre for Public Impact, 21 March 2016) < https://www.centreforpublicimpact.org/case-study/m-currency-in-kenya/>. 12 Liz Alderman, ‘In Sweden, a Cash-Free Future Nears,’ The New York Times (online), 26 December 2015 < https://www.nytimes.com/2015/12/27/business/international/in-sweden-a-cash-free-future- nears.html>. 13 Ricardo Esteves, ‘Turkey payments system TROY is live: cashless society by 2023,’ Finance Feeds, 29 April 2016 < https://financefeeds.com/turkey-payments-system-troy-live-cashless-society-2023/>. 14 John Dennehy, ‘Ecuador launches new digital currency – but most residents know little about it,’ The Guardian (online), 27 February 2015
The establishment of real time payments platforms around the globe is further encouraging the shift toward electronic payments.22 The Australian New Payments Platform (NPP), launched in February 2018, is expected to increase electronic payment usage in Australia in two ways. First, accelerating availability of funds through implementation of rapid payee identification by use of mobile phone numbers and email addresses instead of bank account records should simplify electronic transfers
16 Westpac, ‘Australian smartphone users predict the nation will be cash free by 2022,’ (Media Release, 21 September 2015) < https://www.westpac.com.au/about-westpac/media/media-releases/2015/21- september/>. 17 Mary-Alice Doyle, Chay Fisher, Ed Tellez, Anirudh Yadav, ‘How Australians Pay: New Survey Evidence,’ (Consumer Payments Survey, Reserve Bank of Australia, March 2017); T Durden, ‘Goldman asks, “Have we reached Peak Cash?,”’ ZeroHedge, 25 March 2017. 18 Behind Finland, the United States and the Netherlands; ASIC, ‘Fintech: ASIC’s Approach and Regulatory Issues’ (Paper presented at the Money & Finance Conference, Melbourne, July 2016) 4 < http://download.asic.gov.au/media/3962105/melbourne-money-and-finance-conference-2016- fintech.pdf>. 19 Australian Payments Network, ‘The Digital Economy,’ (Australian Payments Network Milestones Report, Seventh Report, May 2017), 4. 20 Ibid 9. 21 Doyle, Fisher, Tellez and Yadav, above n 17. 22 Michael Edwards, ‘Is Australia on the brink of becoming a completely cashless society,’ ABC News (online) 27 March 2017; Australian Payments Network, ‘The Digital Economy,’ above n 19, 9; Blockley and Yuzon, ‘The Evolution of Cash: An Investigative Study,’ above n 15, 20. 4 between individuals engaged in consumer-to-consumer transfers.23 Second, the introduction of the NPP, a payments system that allows for richer data to accompany each payment transaction should encourage businesses formerly reluctant to abandon cheque usage for business-to-business transfers in favour of a direct entry system because of the need for data to accompany each payment transaction, to move to electronic payments.24
Worldwide, the use of new electronic payments technologies has introduced new issues to the market, and opportunities to adopt advantageous technologies in the financial system abound. Ubiquity of payment technology, a willingness on the part of consumers to use less cash and government support through policy action are all encouraging the move away from cash. As coins and notes become increasingly outmoded, card payments too are likely to follow, as payments processed using a smartphone or device gain rapid wide acceptance.25 The rapid permeation of digital technology into the payments sector has transformed providers, products and services, generated competition and changed the way that users interact with the system.26 The potential for continuing rapid change in the financial industry engendered by widening acceptance of electronic money poses a major challenge for payments regulators. Regulations that anticipate and address the requirements of a cashless society should be in place to assist this transition.
It is in Australia’s public interest to have a comprehensive regulatory regime for its payment systems. Moving money around an economy within an inefficient or overpriced payments system occasions wasted costs to society.27 As new payment technologies and providers evolve within the Australian market, regulation must
23 New Payments Platform Australia, What is the New Payments Platform? (2018) < https://www.nppa.com.au/the-platform/>. 24 Blockley and Yuzon, ‘The Evolution of Cash: An Investigative Study,’ above n 15, 20. 25 Access products link the payment device to the consumer’s bank account. 26 David Murray, Kevin Davis, Craig Dunn et al, ‘Financial System Inquiry Final Report’ (Final Report, Australian Government, 7 December 2014) (Murray Report) 143 < http://fsi.gov.au/publications/final- report/>. 27 Ibid. 5 evolve and adapt to prepare for an ever-widening range of fast, secure and reliable electronic payment methods.
2. RESEARCH QUESTIONS
This Thesis considers the existing regulatory regime for stored value facilities in Australia, and proposes changes that support the needs of the market, industry and consumers as payments technologies progress.
The primary research question considered throughout the Thesis is:
How effective is Australia’s regulatory regime for stored value facilities?
In order to answer this primary research question, the following secondary questions are considered:
1. Does existing Australian regulation of stored value facilities capture all relevant products? 2. How does Australian regulation fare in terms of clarity, competitive neutrality, openness to innovation and client protection? 3. Are similar problems better or differently addressed in other jurisdictions? 4. Should Australia modify its current regulatory regime to address possible benefits derived from comparison with comparable jurisdictions, and if yes, how?
The normative criteria of clarity, competitive neutrality, openness to innovation and client protection have been chosen as they were recurring themes relevant to stored value facilities identified in interviews conducted by the author with, and submissions to government by, regulators and industry. For this research, the clarity of regulations is determined in terms of definitional and legal certainty, and the existence of any overlapping provisions or gaps in the scope of the regulations. It includes discussion of whether or not regulations apply in a technologically neutral way, that is, whether the
6 medium of payment technology (for example, card-based products vs digital wallets) affects the application of the regulation.
Competitive neutrality is assessed in terms of the extent that a regulatory environment treats stored value products that fulfil the same function in a similar way, regardless of whether the issuer is a bank or non-bank institution. This Thesis does not advocate absolute competitive neutrality between issuers, but adopts the OECD definition of an ideal level of competitive neutrality as being ‘where no entity operating in an economic market is subject to undue competitive advantages or disadvantages.’28 The appropriate level of competitive neutrality will achieve balance between market stability and openness to innovation, and will be different for each product, depending on the assessment of their level of risk to the market and consumers. Openness to innovation is considered by how easily a new product or issuer can reach the market and whether an existing product can develop within the market. Consumer protection refers to whether clients’ money in the stored value float is protected in cases of, for example, issuer insolvency, fraudulent or unauthorised transactions or lost cards or devices.
The issues of money laundering and data security are not addressed in this Thesis. Whilst they are both highly relevant to stored value payments facilities, their impact and management is not significantly different from that of other electronic payments products and thus they have not been included within the scope of this research.
The Thesis adopts both a doctrinal and a comparative approach to answer the research questions. The utilisation of a doctrinal approach has been deemed appropriate as the research focuses primarily on law and legal concept,29 and uses legislation and industry reports as its primary information sources. The comparative approach is adopted to consider alternative approaches to the regulations under examination.
28 Organisation for Economic Co-operation and Development, ‘Competitive Neutrality: Maintaining a level playing field between public and private business,’ (Report, 30 August 2012) 17. 29 Terry Hutchinson, Nigel Duncan, ‘Defining and Describing What We Do: Doctrinal Legal Research,’ (2012) 17 Deakin Law Review 1, 83. 7
This research provides a basis for systematic exposition of the regulations governing particular payments products, analysing the relationship between those rules, explaining areas of difficulty and predicting future developments.30 In addition to identifying relevant legislation and regulations I refer to and consider government reports and industry submissions. The information gained from interviews with regulators and industry in Australia, Hong Kong and Singapore is drawn upon throughout the Thesis. Some international academic papers are examined, as are general news articles, weekly publications and industry working papers.
3. COMPARATIVE LAW RESEARCH METHODOLOGY
Comparative analysis of other jurisdictions has been undertaken to ascertain how comparable jurisdictions have navigated the problems of stored value facilities and to suggest solutions to those problems in the Australian context. Comparison of legal systems assists in relating the content of legal norms and institutions to general economic and social processes in a way that may not be observable by the study of individual legal systems alone.31
The Thesis compares Australian regulations with those found overseas and affords particular focus to the legislative regimes in Hong Kong and Singapore. Both are city- states and each has a large stored value market wherein non-financial institutions are permitted to issue stored value products; they adopt different regulatory approaches from that employed in Australia.
30 In accordance with the Pearce Committee’s definition of doctrinal research; Dennis Pearce, Enid Campbell, Don Harding, (Pearce Committee), Australian Law Schools: A Discipline Assessment for the Commonwealth Tertiary Education Commission (Australian Government Publishing Service 1987). 31 Tatyana Alexeeva, ‘Developing the Methodology of Comparative Legal Studies,’ (2010), Research Projects, National Research University Higher School of Economics, St Petersburg < https://www.hse.ru/en/org/projects/26406665>. 8 In the Octopus card Hong Kong has the world’s most used smart-card system,32 and it has a relatively strict licensing regime for stored value facilities. Its regulatory framework for stored value products is comprehensive. A banking ordinance has regulated multi-purpose stored value products since 1997. In November 2015, Hong Kong promulgated a new regulatory regime for stored value facilities and payments systems, the Payments Systems and Stored Value Facilities Ordinance (herein, the Ordinance). Under the Ordinance, the Hong Kong Monetary Authority (HKMA) has implemented a mandatory licensing system for multi-purpose stored value facilities.
Singapore, another useful comparator market has a very liberal regulatory regime and, as in Hong Kong, its stored value facilities are widespread and integral to its payments market. Singapore’s regulatory regime allows anyone wishing to establish a stored value facility to do so without capital or qualification requirements; in consequence its payments ecosystem has a high volume of stored value facilities. For stored value facilities that exceed a particular threshold of deposits, currently S$30 million, Singapore does have a comprehensive regulatory regime. This liberal regulatory regime has made Singapore one of the more attractive jurisdictions for those seeking to set up an online payments business.
It will be apparent that I have not dealt with the United States of America, one of Australia’s most important trade partners. I have not considered the USA as a primary comparator country due to the complexity of its current regulatory regime, analysis of which would support a thesis of its own. United States (US) federal law on payments activity is neither comprehensive nor overarching, and its state laws are often conflicting.33 Analysis of the US stored value regime would involve comparison of the regulatory regime in each state and its interaction with the federal law. Selected
32 Lam Tak Ming, ‘Value Chain Flexibility with RFID: A Case Study of the Octopus Card,’ (2011) 3 International Journal of Engineering Business Management,’ 44-49, 46. 33 Heather Morton, Gift Cards and Gift Certificates Statutes and Legislation, National Conference of State Legislators (22 April 2016), National Conference of State Legislatures
Functional comparative law postulates a factual approach to analysis whilst recognising that facts must be understood within their functional relation to society.34 The theory relies upon an acceptance that regulations are comparable if they fulfil similar functions in different legal systems. It starts from the premise that the function of law is to respond to social problems and that in essence all societies face the same problems.35
Methodologically appropriate examinations of foreign legal systems must be conducted before they can be used as models or for self-reflection.36 From amongst the comparative law methodologies, I have chosen to use a functionalist comparative approach to compare the two jurisdictions with Australia. I do not compare in their entirety all regulatory aspects of each jurisdiction, but rather compare regulations where they exhibit similar functions. Analysis of different regulations as possible responses to a common problem will assist in determining the form of regulatory solutions that best address key issues faced by Australia.
To gain information about the evolving payments system, a literature research was conducted that examined journal articles, theses, government and industry reports and newspapers that addressed regulation of electronic payment systems. Information about regulating the Australian payment system was gained particularly through regulator reviews and industry submissions.
In the decade and a half after the Wallis Inquiry in 1997 Australia experienced both domestic and international economic and financial crises. It implemented a major
34 Ralf Michaels, ‘The Functional Method of Comparative Law,’ (2005) Duke Law School Faculty Scholarship Series, Paper 26. 35 Ralf Michaels, ‘Comparative Law,’ in Basedow, Hopt, Zimmermann (eds), Oxford Handbook of European Private Law (Oxford University Press, 2006). 36 Colin Picker, The Value of Comparative and Legal Cultural Analyses of International Economic Law, (PhD Thesis, University of New South Wales, 2012), 9. 10 regulatory reform agenda that saw growth in superannuation, changes in industry structure and the emergence of new competitive dynamics and technology.37 These seismic changes occurred against a background of significant global macroeconomic trends and expanding activity. As a result, Australia’s financial system was in need of review, and in 2014 the Financial Systems Inquiry (FSI) examined the Australian financial system. Following extensive consultation with relevant stakeholders, the Final Report of the FSI was released in December 2014; sixteen years had passed since the previous Inquiry.38 Throughout the Thesis I shall refer to the recommendations of and submissions to the 2014 Financial Systems Inquiry, its preliminary reports and government and industry responses.
The FSI Final Report envisages an ideal system as one that manages financial and systemic risk that is balanced with financial regulation that takes into account the regulatory impact on costs and flexibility and innovation within the regulated industry.39 It advises policy-makers to achieve this through promotion of a competitive and stable financial system that contributes to Australia’s productivity and growth whilst meeting the needs of users with appropriate financial products and services; and by the creation of a regulatory environment conducive to an expanding body of dynamic and innovative financial service providers.40
The Final Report outlines forty-four recommendations for improvement of the Australian financial system. These recommendations it states are directed to the ultimate aim of developing a dynamic, competitive, growth-oriented and forward looking financial system for Australia.41 It reasons that a more competitive and innovative financial system with minimal distortions will improve allocative efficiency and drive sustainable growth.42 Recommendations numbered 14, 16 and 39 have particular impact upon stored value facilities. Recommendation 14 relates to the
37 Murray, David, Dunn et al, above n 26, 8, 233. 38 Stan Wallis, Bill Beerworth, Jeffrey Carmichael, et al, Financial Systems Inquiry Final Report (Final Report, Australian Government, March 1997, ‘the Wallis Inquiry’). 39 Murray, David, Dunn et al, above n 26, 36, 146. 40 Ibid. 41 Murray, David, Dunn et al, above n 26, 15. 42 Murray, David, Dunn et al, above n 26, 12. 11 importance of collaboration to enable innovation; Recommendation 16 advocates the creation of a separate regulatory regime for purchased payment facilities; Recommendation 39 discusses the importance of technological neutrality, that is to say, the same regulatory principles should apply regardless of the technology used.
The submissions to the FSI from industry participants are particularly relevant sources for this Thesis as they identify key issues in the current regulation and their effect on industry participants. I have identified general and recurring issues relating to electronic payments and stored value facilities addressed in the two rounds of submissions and I address these issues through my research questions and recommendations. Key submissions are those from the regulators ASIC, APRA and the RBA, and those from industry leaders including PayPal, Visa, MasterCard and Tyro. Whilst submissions are in essence self-serving, they are useful in identifying common issues affecting regulated bodies and in considering alternative solutions to the current regulation.
The 2015 Government Response to the Financial Systems Inquiry, considered with industry responses to the Inquiry provide additional insight into how stored value regulation affects different players in the payments field. My arguments are further informed by regulator responses and their associated submissions. In 2015, following the FSI Final Report, the RBA announced that it would conduct a review of card payments regulations. Submissions for the Review were required by April 2015, and the RBA’s Conclusions Paper was released in May 2016.43 The Australian Payments Council is currently developing an Australian Payments Plan for payments system improvements, and received submissions until July 2015.44 The submissions to the plan and its ‘Viewpoints’ paper are relevant resources for the Thesis.45 Recent relevant
43 Reserve Bank of Australia, ‘Review of Card Payments Regulation,’ (Conclusions Paper, May 2016) < http://www.rba.gov.au/payments-and-infrastructure/review-of-card-payments-regulation/review-of- card-payments-regulation-conclusions-paper.html>. 44 Australian Payments Council Website, Australian Payments Plan Consultation, (2016) < http://australianpaymentscouncil.com.au/australian-payments-plan-consultation/>. 45 Australian Payments Council, Viewpoints, (May 2015) < http://australianpaymentscouncil.com.au/wp- content/uploads/2015/05/Australian-Payments-Plan-Consultation.pdf>. 12 reports include APRA’s 2017 discussion paper on phased licensing46 and the Productivity Commission’s 2018 Final and Draft Reports on Competition in the Australian Financial System.47 These reports and submissions illustrate the variance and convergence of the interests of the different actors, and identify different regulatory options for the management of stored value products.
The Report of the 2012 Australian National Retail Association Gift Card Inquiry addresses current regulation of gift cards, and potential future developments, and contains a recommendation for a voluntary code of practice for retailers. 48 The report is limited to gift cards, which represent only a fraction of stored value devices and while of some general use it essays no comparison with regulations in other jurisdictions.
Other government documents relevant to this Thesis include APRA’s Guidelines on Authorisation of Providers of Purchased Payment Facilities,49 the RBA’s Declarations and Exemptions for Purchased Payment Facilities,50 annual reports of the Council of Financial Regulators,51 the Australian Payments Network ‘Milestones’ Reports52 and APRA’s 2018 Response to Submissions.53 Industry reports such as the Annual Reports
46 Australian Prudential Regulation Authority, ‘Licensing: A phased approach to authorising new entrants to the banking industry,’ (Discussion Paper, 15 August 2017). 47 Productivity Commission, ‘Competition in the Australian Financial System Draft Report,’ above n 1; Productivity Commission, ‘Competition in the Australian Financial System,’ (Final Report, No. 89, 29 July 2018) < https://www.pc.gov.au/inquiries/completed/financial-system/report/financial-system.pdf>. 48 Australian National Retailers Association, Gift Card Inquiry, March 2012. 49 (2010) < http://www.apra.gov.au/adi/Documents/ADI_GL_Providers_of_ Purchased_Payment_Facilities.pdf>. 50 Reserve Bank of Australia, Declarations and Exemptions for Purchased Payment Facilities, (October 2012) < http://www.rba.gov.au/payments-and-infrastructure/payments-system- regulation/declarations-and-exemptions-for-purchased-payment-facilities/>. 51 Australia’s Financial Regulatory Framework,’ (Annual Report, Council of Financial Regulators, Reserve Bank of Australia 1999) < http://www.rba.gov.au/publications/annual-reports/cfr/1999/aus-fin-reg- frmwk.html>. 52 For example, Australian Payments Network, ‘The Digital Economy,’ above n 19. 53 Australian Prudential Regulatory Authority, ‘Licensing: A phased approach to authorising new entrants to the banking industry,’ (Response to Submissions, APRA, 4 May 2018) < https://www.apra.gov.au/sites/default/files/phased-licence-response-paper-20180504.pdf>. 13 of Eftpos Australia,54 Deloitte Australia,55 and consultative reports by the Committee on Payments and Market Infrastructures56 are also considered. These provide additional information about the regulatory regime of stored value facilities, but provide little assistance for any analysis of the regulatory challenges and how their shortcomings might best be addressed.
The Centre for International Finance Regulation (CIFR) has conducted a research project entitled ‘The Regulation of Stored Value Payment Systems in Australia:’ The research project analysed Australia’s regulation of stored value facilities and made recommendations to improve the current regime.57 The project produced two working papers and three submissions, published from 2015 to 2016. That research project has provided valuable information for this Thesis regarding the current regulatory regime but it does not attempt any analysis of comparable regulatory regimes.
There are some analyses and recommendations within the literature examining the current stored value regulatory regime in Australia, but there remains academic space for more in-depth analysis to be conducted. There is very little academic research that focuses on the regulations that govern stored value facilities in Australia, and as far as can be reasonably ascertained, none which conducts a functional comparison with the leading stored value markets, Hong Kong and Singapore. There is only minimal research that examines the gap in the regulation of stored value facilities in Australia.
I have conducted a number of research interviews to determine the relevance of my research and to test the accuracy of the tentative conclusions that I had formed. Those interviews took the form of consultations with Australian, Hong Kong and Singaporean
54 For example, Eftpos, ‘Collaborating for the Future,’ (Annual Report, Eftpos Australia, 2013)
3.1 The Comparative Approach: Why is the Comparison being made?
The rapid global spread of stored value payments and its impact on global trade renders comparative study of regulatory systems increasingly important. An understanding of the comparative legal treatment of stored value products is an essential aspect of the smooth transaction of electronic payments across borders involving the interaction of different legal systems to take place.
Examination of comparative law may lead to new insights into Australian law. As Professor Ralf Michaels has observed, ‘looking through the eyes of foreign law enables us to better understand our own.’58 The problems in Australia’s regulatory system are complex and answers to those problems no less complex; we should look to other jurisdictions to see the approaches taken to address similar issues. German legal scholars Konrad Zweigert and Hein Kötz have said the reason comparative law is so effective is ‘the legal system of every society faces essentially the same problems, and solves these problems by quite different means though very often with similar results.’59 The same authors observed that comparative law is an ‘école de vérité’
58 Ralf Michaels, ‘The Functional Method of Comparative Law,’ in Mathias Reimann, Reinhard Zimmermann (eds), Oxford Handbook of Comparative Law, AW 339-382 (Oxford University Press, 2006), 342. 59 Konrad Zweigert, Hein Kötz, An Introduction to Comparative Law, (Oxford University Press, 3rd ed 1998), 34. 15 which extends and enriches the ‘supply of solutions’ that may be used to address these problems.60
In this Thesis, a ‘micro-comparison’ is being made, that is the comparison is of specific legal institutions or problems, of the rules used to solve actual problems or particular conflicts of interest.61 It is the study of laws and regulations and the procedures by which the rules are applied that enables the researcher to understand why a foreign system solves a particular problem the way it does.62
According to Professor Mark Van Hoecke looking at the way in which practical problems of solving conflicts of interest are dealt with in different societies and under different legal systems allows the researcher to perceive these problems independently of the doctrinal framework of the compared legal systems.63
4. THE METHODOLOGY OF THE FUNCTIONALIST APPROACH
4.1 How is the Comparison being made?
Comparative law has developed a series of legal techniques, known collectively as the functional method.64 Following Zweigert and Kötz’s An Introduction to Comparative Law,65 the functional method is often taught as
…‘the’ method of comparative law… optimistically supported by the alleged conclusion that rules and concepts may be different, but that most legal systems will eventually solve legal problems in a similar way.66
This proposition has been criticised by Professor Michaels:
60 Ibid 15. 61 Ibid 5. 62 Ibid. 63 Mark Van Hoecke, ‘Methodology of Comparative Research,’ Law and Method (2015), 9. 64 Francesca Bignami, ‘A new field: comparative law and regulation,’ in Francesca Bignami & David Zaring (eds), Comparative Law and Regulation: Understanding the Global Regulatory Process, (Edward Elgar, 2016), 40. 65 Oxford University Press, 1998. 66 Van Hoecke, ‘Methodology of Comparative Research,’ above n 63, 9. 16
In short, ‘the functional method’ is a triple misnomer. First, there is not one (‘the’) functional method, but many. Second, not all allegedly functional methods are ‘functional’ at all. Third, some projects claiming adherence to it do not even follow any recognizable ‘method.’67
An appropriate methodology must be established: What the researcher will compare and how, largely depends on the research question(s) and research interest. The method followed should serve that goal.68 The importance of establishing a research aim when choosing an appropriate functional method is sharpened by the variety of functional methods available.69
The Thesis adopts and applies the idea of functional equivalence: ‘Institutions…are comparable if they are functionally equivalent, if they fulfil similar functions in different legal systems.’70 The comparison poses and seeks to answer the question asked by Professor Emerita Esin Örücü, ‘Which institution in System B performs an equivalent function to the one under survey in System A?’71 In answering Professor Örücü’s question one recalls the words of Zweigert and Hötz, ‘in law the only things which are comparable are those which fulfil the same function.’72
Application of the functional method may be outlined as involving the following steps:
• establish a common problem, shared by multiple jurisdictions, • identify the legal solutions to that problem that exist in the different jurisdictions, • assess the degree of similarity or difference within the various legal solutions.73
67 Ralf Michaels, ‘The Functional Method of Comparative Law,’ above n 58, 342. 68 Van Hoecke, ‘Methodology of Comparative Research,’ above n 63, 9. 69 Ibid. 70 Ralf Michaels, ‘The Functional Method of Comparative Law,’ above n 58, 342. 71 Esin Örücü, The Enigma of Comparative Law: Variations on a Theme for the Twenty-First Century, (Springer, 2013), 29. 72 Zweigert and Kötz, An Introduction to Comparative Law, above n 59, 34. 73 Bignami, ‘A new field: comparative law and regulation,’ above n 64, 41. 17 Those steps taken; evaluate the different solutions to identify the form of the ‘better’ law to recommend to lawmakers.74 The evaluative criteria upon which the normative assessment is made is outlined below.
Should implementation of that process result in a recommendation to substantially mirror an existing foreign segment of functionally equivalent legislation, a normative assessment will usually need to be undertaken. Of such normative assessments, Professor Michaels has observed ‘functionalist comparative law sometimes asserts an explicitly normative function’75 with Professor Francesca Bignami adding that functional comparative law has become the ‘prevalent normative theory for how legal and political operators should compare to prescribe new law.’76
This author respectfully adopts the cautionary note introduced by Professor Michaels that functional equivalence itself cannot be the evaluative criterion - a ‘functionalist comparison can open our eyes to alternative solutions, but it cannot tell us whether those alternative solutions are better or not.’77
4.2 What is being Compared?
In considering the appropriate response to this question, I am again indebted to the guidance proposed by Professor Michaels, ‘if functions are relations between institutions and problems, then the first task is to find the problem to be solved by legal institutions.’78
This Thesis looks at the laws chosen to govern stored value facilities, the process by which these rules are applied and the outcomes of these choices.
74 Zweigert and Kötz, An Introduction to Comparative Law, above n 59, 24; Bignami, ‘A new field: comparative law and regulation,’ above n 64, 41. 75 Ralf Michaels, ‘The Functional Method of Comparative Law,’ above n 58, 380. 76 Bignami, ‘A new field: comparative law and regulation,’ above n 64, 41. 77 Ralf Michaels, ‘The Functional Method of Comparative Law,’ above n 58, 380. 78 Ibid 366. 18 Professor Michaels holds that the criteria of evaluation must be different from the criteria of comparability – the evaluation remains a ‘policy decision, a practical judgment, under conditions of partial uncertainty.’79 The better of several laws being that which fulfils its function better, functional law serves ‘as a yardstick to determine the better law.’80 As Professor Michaels observes, ‘the functional method asks us to understand legal institutions not as doctrinal constructs but as societal responses to problems.’81
Comparison is made only of functionally equivalent laws themselves. The Thesis does not compare sociological backgrounds of the regulators, nor the historic processes or internal dynamics of the regulators. Drawing on examination of the Australian regulatory system82 I conclude that the normative criteria to be used in the comparison are:
• the clarity of regulations; • whether the regulations apply in a sufficiently competitively neutral way to all types of issuers; • how those regulations support openness to innovation and market entry of new products whilst maintaining market stability; and • the stringency and efficacy of the client money protection rules.
When differences are apparent from comparison of regulation it is crucial to be explicit as to the factors that make one the better law, and why.83 The normative criteria chosen for assessing the regulations are different for each of the issues, and are outlined as the evaluation is made.
Some weaknesses are to be borne in mind when applying the functional comparative approach. ‘Importing rules and solutions from abroad may not work because of a
79 Ibid 375. 80 Ibid 342, 373. 81 Ibid 364. 82 Chapter Four. 83 Bignami, ‘A new field: comparative law and regulation,’ above n 64, 43. 19 difference in context.’84 Solutions from other jurisdictions may prove impossible to adopt, at least without significant modification, because of differences in court proceedings and legal interpretations, differing powers of authorities, or the general societal context into which the contemplated solution must fit.85
In examination of regulations I consider the approaches of both principle-based and rules-based regulation. The principle-based approach of regulation focuses on objectives and outcomes rather than on the processes used to achieve them.86 Instead of focusing on compliance with a set of rules, principle-based regulation sets an overall objective that is to be achieved.87
The Final Report of the Australian 2014 Financial System Inquiry concluded that the principles underpinning a well-functioning financial system include the balancing of competition, innovation, efficiency, stability and consumer protection, the management of financial and systemic risk and assessment of the impact of financial regulation on costs, innovation, flexibility and industry. 88 I have accepted these normative criteria as useful benchmarks for evaluation of the chosen regulatory regimes, and have added clarity and competitive neutrality as they are particular areas of concern for providers of stored value facilities as determined from industry submissions.
Rules-based regulation is comparatively rigid, and may result in imposition of requirements that are not appropriate for all affected entities, or may not cover at all entities and activities intended to be regulated.89 The Final Report recommended that regulators aim to balance efficiency, resilience and fairness in a way that builds public
84 Van Hoecke, ‘Methodology of Comparative Research,’ above n 63, 3. 85 Zweigert and Kötz, An Introduction to Comparative Law, above n 59, 17. 86 Julia Black, Principles Based Regulation: Risks, Challenges and Opportunities (London School of Economics and Political Science, 2007), 8. 87 Ibid. 88 Murray, David, Dunn et al, above n 26, 7. 89 Ibid. 20 confidence, and that intervention should only occur where the benefits to the economy outweigh its costs.90
The Thesis considers the advantages and disadvantages of the two approaches when proposing solutions to the identified regulatory challenges. I evaluate each regulatory system in terms of its clarity, its effectiveness in balancing openness to innovation with maintaining stability, whether it maintains competitive neutrality in providing a relatively level playing field for similarly risk-weighted products and issuers, and whether it is sufficiently flexible to cover both existing and likely future ranges of products.
5. CHAPTER SUMMARY
The Thesis is presented in eight chapters. Chapter One introduces the Thesis topic and outlines why it is essential that regulators prepare for an economy where there are less cash payments and an increasing number and type of digital payments. It defines the research questions and chooses the normative criteria needed to answer them, and outlines and justifies the chosen methodologies of doctrinal and functional comparative approaches. It describes the theoretical frameworks of New Institutional Economic Theory and Regulatory Theory within which this research sits. Reference to the existing literature is made to demonstrate the position of this Thesis within the existing body of writing on the subject of regulating stored value facilities.
Chapter Two provides a background to stored value facilities in Australia and around the world, outlining their use and importance. It examines the current range of stored value facilities, from gift cards to digital wallets, and describes what may well be the next generation of stored value facilities. It outlines the difference between open loop and closed loop products, bank and non-bank issuers, and fintech and techfin entities. Chapter Two examines the place of stored value facilities within the wider payments ecosystem, and looks at the primary users of these products. Finally, it considers the
90 Ibid 15. 21 extent to which stored value facilities will be adopted in Australia and emphasises the importance of correct regulation of such products.
Chapter Three examines different approaches to regulating stored value facilities, affording particular focus to the wait-and-see approach, the in-advance approach, and the approach of responsive regulation. It discusses the dominant regulatory theory adopted by Australian regulators, considering co-regulation and the twin-peaks model, and outlines the roles of the Reserve Bank of Australia (RBA), the Australian Prudential Regulatory Authority (APRA), the Australian Securities and Investments Commission (ASIC) in supervising stored value facilities.
Chapter Four discusses Australia’s existing stored value regulatory framework, identifying key issues and regulatory challenges. It outlines APRA’s approach of bringing stored value facilities, termed purchased payment facilities, under the existing authorised deposit-taking institution (ADI) regime through conditional licensing, how APRA differentiates products on the basis of whether or not they hold ‘stored value at risk,’ and considers the proposed restricted ADI licensing regime. Chapter Four examines the RBA’s role in granting declarations, authorisations and exemptions for stored value facilities, which determine whether or not products are captured by certain existing regulations. It outlines ASIC’s role in regulation of non-cash payments, the influence of self-regulation and the application of the ePayments Code. In conclusion, Chapter Four identifies the main issues and weaknesses of the existing regulatory framework and advocates the need for Australian regulators to better prepare for an increasingly digital economy.
Chapter Five is dedicated to comparative insights, examining with particular focus the stored value regulatory regimes of Hong Kong and Singapore. The stored value products currently available in overseas jurisdictions and the manner in which they are regulated are described. Chapter Five outlines the relevant jurisdictional differences between Australia, Hong Kong and Singapore and the comparative success of stored value products in each market. The regulatory regimes of each jurisdiction are examined in terms of their clarity, competitive neutrality, support for innovation and
22 extent of client money protection. In its conclusion Chapter Five discusses to what extent these comparative insights can benefit the existing Australian regulatory regime.
Chapters Six and Seven analyse Australia’s regime according to criteria identified in the chosen methodology and propose changes to the existing regulations. Chapter Six discusses the definitional and legal uncertainty of stored value facilities within the current regulatory regime in Australia and around the world. It examines the application of definitional exclusions and considers whether the regulations in Australia are technologically neutral. It outlines the extent of consumer protection within Australian regulations and discusses how it may be improved. In its conclusion it proposes recommendations to improve the existing regulatory regime in terms of its clarity and protection of client funds.
Chapter Seven discusses the relationship between the competitive neutrality of stored value facility issuers and the openness of a market to innovation. It outlines the role and importance of government in creating a sufficiently level playing field for similarly risk-weighted products and analyses the regulatory regime in Australia in these terms. It discusses changes proposed by various government and regulator reports and determines the recommendations considered most beneficial for Australia.
In Chapter Eight, I summarise the proposed recommendations made throughout the previous Chapters that address the identified issues of clarity, competitive neutrality, openness to innovation and consumer protection. Chapter Eight outlines a best practice model for the regulation of stored value facilities in Australia that balances management of risk with support for innovation in a way that is technologically neutral and capable of meeting future regulatory challenges.
6. THEORETICAL FRAMEWORK
This Thesis draws upon both new institutional economic (NIE) theory and regulatory theory in its analysis of existing and potential regulation. The importance given to 23 regulation by this research places it within the framework of NIE; regulatory theory provides the benchmark against which regulation is to be measured.
6.1 New Institutional Economic Theory
New institutional economic theory is based upon an economic perspective that examines the roles of institutions, that is, social and legal norms and rules, in furthering or inhibiting economic growth.91 NIE theory builds upon the principles of neoclassical economic theory but adds that it is the broader institutional framework that influences the behaviour of the economy.92 For the purposes of this Thesis, it is the theory that frames the relationship between institutions and economic activity. In terms of the chosen normative criteria, the clarity of regulations and sufficient consumer protection may affect the confidence of consumers and merchants have for the payments system, and providing support for innovation and appropriate competitive neutrality may improve the efficiency of the payments system, all of which may in turn impact the wider economy.
Professor Douglass North (1920-2015), a Nobel prize winning American economist, was a prominent member of the NIE group in the 1990s. Professor North has defined institutions as
…the rules of the game of a society…humanly devised constraints that shape human interaction…whether political, social or economic. They are composed of formal rules (statute law, common law, regulations), informal constraints (conventions, norms of behaviour, and self imposed codes of conduct), and the enforcement characteristics of both.93
91 The Ronald Coase Institute, About New Institutional Economics, (2016) < https://www.coase.org/newinstitutionaleconomics.htm>. The term ‘new institutional economics’ was coined by Oliver Williamson in 1975 in Oliver Williamson, Markets and Hierarchies: Analysis and Antitrust Implications, (New York, NY, Free Press, 1975). 92 Julio Faundez, ‘Douglass North’s Theory of Institutions: Lessons for Law and Development,’ (2016) 8 Hague Journal on the Rule of Law 2, 373-419. 93 Douglass North, Institutions, Institutional Change and Economic Performance (Cambridge University Press, 1990), 6. 24 NIE theory extends economic analysis by focusing on the institutions, defined as the social and legal norms and rules that underlie economic activity, asserting that those institutions are key to understanding the interrelation between the policies and the economy that determine the consequences for economic growth or decline.94 The influence and interrelationship of laws, social systems and culture and their effects on technological changes are the particular focus of NIE, and of this Thesis.95
Professor North’s work inspired global development agencies to shift attention from technical economic issues towards broader institutional concerns. This new approach was adopted by the World Bank and is reflected in its motto – Institutions Matter.96
NIE theory shares concepts with neo-classical theory; ideas such as the basis of the theoretical approach to choice, ‘scarcity breeds competition’ is one example.97 It extends neo-classical theory by identifying institutions themselves as a critical constraint upon choice, postulating that institutions are rarely created with the intent that they should be socially efficient, but are created to serve the interests of those with sufficient determinative power to impose new rules favourable to themselves. In a market with significant transaction costs, bargaining strength impairs the efficiency of outcomes, and thus shapes long run economic change.98
Professor North states that institutions are crucial determinants of the efficiency of markets because a large part of a nation’s income is devoted to transactions.99 He advances the proposition that as they define and enforce economic rules, it is polities that shape economic performance; different institutional structures such as legislative regimes and regulatory authorities have the capacity to harmonise or divide relations between different parties.100 For example, within the stored value field, regulation that
94 Douglas Arner, Financial Stability, Economic Growth, and the Rule of Law, (Cambridge University Press, 2007), 18. 95 Andy Ellis, ‘Using the New Institutional Economics in e-Government to deliver transformational change,’ (2004) 2 Electronic Journal of e-Government 2, 129. 96 Faundez, ‘Douglass North’s Theory of Institutions: Lessons for Law and Development,’ above n 92. 97 Douglass North, Institutions, Institutional Change and Economic Performance, above n 93, 3. 98 Ibid. 99 Douglass North, The New Institutional Economics and Development, (Washington University, 1993), 2. 100 Ibid 7. 25 does not provide competitive neutrality between issuers for similar products may increase the tensions between bank and non-bank issuers, and between start-ups and market incumbents.
This Thesis illustrates how participants in the payments system are affected differently by regulations, how some issuers bear a heavier regulatory burden than do others, distorting competition. Employing concepts developed within NIE theory, I offer insights into the operation and effects of the interrelationship between regulations and society, including how inadequate regulation can adversely affect the financial system. For example, a regulatory environment that provides a sufficiently level playing field for issuers of similar risk-weighted products is one that benefits competition and the wider economy. Competition from new providers forces existing providers to become more efficient, thereby contributing to productivity and healthy development of a dynamic and growth-oriented economy. NIE provides the framework for relating the chosen normative criteria to wider social goals such as the functioning of an efficient and reliable payments system.
The limitations of NIE and the functional comparative approach are acknowledged. That legislation in different jurisdictions employs different terms does not itself fully explain differences in the regulation of stored value products observed around the world. Market and regulatory differences are observed in jurisdictions employing similarly-worded legislation seemingly directed to bringing about the same end result. Differences in payment cultures and demand levels, business models and payment institutions may all affect local demand for stored value products. Nevertheless, as certain patterns in regulation and use of products are examined some overarching conclusions may be drawn.
6.2 Regulatory Theory
In order to assess what form of regulation will prove effective and appropriate in addressing particular situations and desired outcomes some understanding of
26 regulatory theory is needed; a fortiori, in designing and drafting regulatory solutions to remedy identified problems it is essential.
Positive regulatory theories, theories of market power and of government opportunism, examine the reasons why regulation occurs.101 Normative regulatory theories investigate what type of regulation has proven to be most efficient or optimal.102 To identify the characteristics of effective regulatory regimes this Thesis considers mainly normative theories of regulation.
Generally, financial services regulation is directed to achievement of public policy goals, improvement of overall community wellbeing and living standards through social inclusion, reduction of the incidence of market failures and poverty, and the like.103 In accordance with regulatory theory, throughout the following Chapters ‘regulation’ is employed to include all forms of social and economic influence, whether state-based or emanating from sources such as markets or organisations.104 To determine whether regulations are future-proof and flexible enough to respond to emerging issues without the need to create new rules, I have considered regulations in accordance with regulatory theory.105 I address both activities that restrict and those that encourage particular patterns of behaviour.106
While this is certainly not a purely theoretical thesis, understanding of the relevant theories allows for deeper understanding of the issues identified, and therefore accordingly assists in devising meaningful solutions. NIE theory assists in the recognition and acknowledgement of the impact on regulation of non-legislative factors; regulatory theory aids determination of the means by which regulation may be best utilised to meet the problems.
101 Johan den Hertog, ‘Review of Economic Theories of Regulation,’ (Discussion Paper Series 10-18, Tjalling C Koopman’s Research Institute, Utrecht School of Economics, 2010), 4. 102 Ibid. 103 Ibid. 104 Robert Baldwin, Martin Cave, Martin Lodge, Understanding Regulation: Theory, Strategy and Practice, (Oxford University Press, 2nd ed, 2012). 105 Julia Black, Principles Based Regulation: Risks, Challenges and Opportunities, above n 86, 8. 106 Bollen, ‘Best Practice is the Regulation of Payment Services,’ above n 2, 391. 27 7. CONCLUSION
Electronic payments, continually increasing throughout the world, may well eventually replace cash completely. Regulators globally must prepare a political and legal framework within which they can operate. In 2016 the Australian Government observed that ‘as financial services become more globalised and technological disruption more relevant, we need to keep pace with innovation and banking and finance to stay competitive.’107
Appropriately regulated, these comparatively novel payment methods have the potential to impose efficient allocation of resources and the introduction of products better suited to consumer and market needs, thereby enhancing capital productivity and economic growth.108 The creation of an effective and proportionate regulatory regime for stored value products would promote reduction of the overall cost of the payments system. Reduction in usage costs throughout the payments system should assist Australia to become more competitive and to achieve higher domestic economic growth.
In this Thesis I seek to demonstrate that the Australian regulatory framework for stored value facilities does not sufficiently capture the range of products available today. I outline how the existing regulations were designed, and which products fall within its scope. I discuss the range of new products and examine why they do not fall comfortably within the existing regime.
I analyse Australia’s regulatory regime in terms of its clarity, its effect on bank and non-bank product issuers and whether there is sufficient competitive neutrality between the various issuers, how well the regime supports innovation, and what consumer protection it provides in order to form my evaluation. I examine the corresponding stored value regimes of Hong Kong and Singapore using the same terms
107 Australian Government, ‘Supporting Australia’s FinTech future,’ Media Release (21 March 2016). 108 Stephen Lumpkin, ‘Regulatory Issues related to Financial Innovation,’ (2009) 2 OECD Journal Financial Market Trends 1, 1. 28 to find regulatory alternatives to Australia’s regime. Following this evaluation and analysis, recommendations are proposed to address the identified deficiencies in the current regime.
Throughout the Chapters that follow this Thesis seeks to demonstrate the importance of government and regulators supporting the growth of stored value payment facilities through the application of graduated functional frameworks within the payments system. Functional frameworks of this nature reduce barriers to innovation whilst ensuring that regulation is broadly risk-based. Properly designed, they provide light and early regulation of new entrants, who pose fewer risks to the system, and allow regulation to be targeted at those aspects of the system where experience has demonstrated it is needed most. A clear regulatory framework will provide clarity for the market and new entrants, and aid in lowering barriers to innovation, product development and market entry.
This Thesis contends that a greater level of gradation within the existing regulatory framework is called for in the public interest. To achieve more proportionate regulation stored value facilities must be permitted flexibility within their regulatory regime so that they may operate with lower compliance costs, thereby enhancing competitive neutrality between competitors with similar risk-weighted products and better facilitating participation by non-traditional financial institutions.
29 CHAPTER TWO: DIFFERENTIATING STORED VALUE FACILITIES
1. THE DEVELOPMENT OF STORED VALUE FACILITIES 30 2. HOW REGULATORS DIFFERENTIATE STORED VALUE FACILITIES 32 3. STORED VALUE FACILITIES: FINDING THEIR PLACE IN THE PAYMENTS 48 ECOSYSTEM 4. TO WHAT EXTENT WILL STORED VALUE FACILITIES BE ADOPTED IN 57 AUSTRALIA? 5. CONCLUSION 60
Stored value payments technology is still developing, and there is no universally accepted definition of what constitutes a stored value payments facility. This definitional uncertainty has meant that it is not always apparent which facilities are captured by existing stored value legislation. This Chapter outlines the range of technologies and facilities that should be captured by stored value regulation.
Section One of this Chapter outlines the development of stored value facilities. Section Two provides a discussion of the stored value facilities available globally, from simple store gift cards through to complex digital systems, and notes how regulation has differentiated between the different types of stored value facility. It discusses the various issuers of stored value facilities and notes how regulations affect each issuer differently, raising the issue of competitive neutrality. Section Three describes how stored value facilities operate and their place within the wider payments system, and Section Four discusses the extent to which Australian users have adopted stored value facilities.
1. THE DEVELOPMENT OF STORED VALUE FACILITIES
‘E-money’ is defined in this Thesis as electronically stored monetary value represented by a claim on the issuer which is issued on receipt of funds for the purpose of making
30 payment transactions and which is accepted as a means of payment by persons other than the issuer.109 Stored value e-money is monetary value itself, and not a means of accessing funds in a credit or savings account. The value is used to pay for goods or services from suppliers other than the issuer and therefore does not include mobile airtime or frequent flyer mileage which can only be used on the issuer’s network, and that value must be redeemable for cash.110
Stored value facilities are available in many different forms, targeting different users and markets. The first stored value products were used as a means of payment for small sum transactions; they proved more efficient than credit cards and safer and more convenient than carrying around large quantities of cash.111 Originally introduced as paper gift certificates, they were quickly supplanted by store cards with value recorded on a magnetic strip. These products did not require personal identification numbers (PINs), nor involve the use of signatures. This technology was soon adopted for use in university libraries and on public transport.
The cards were in turn developed to operate through an embedded integrated circuit chip, dubbed ‘Smartcards.’ Integrated circuit chips began replacing the magnetic strip on cards, and new wearable devices such as mobile phones, wrist watches and custom-made jewellery began supplanting the cards themselves. The embedded chip accesses the funds, which may be stored on the device itself or in a digital wallet, using Near Field Communication (NFC) technology.112 The value may be redeemed for cash, transferred to another user, or most commonly, used in exchange for goods or services.113 The emergence of contactless cards and devices has seen consumers using
109 Katharine Kemp, Ross Buckley, ‘Resolution powers over e-money providers,’ (2017) 40(4) UNSW Law Journal 1540, 1543; EU E-Money Directive: Council Directive 2009/110/EC of 16 September 2009 on the Taking Up, Pursuit and Prudential Supervision of the Business of Electronic Money Institutions [2009] OJ L 267/7, art 2(2). 110 Kemp and Buckley, ‘Resolution powers over e-money providers,’ above n 109, 1543. 111 Blockley and Yuzon, ‘The Evolution of Cash: An Investigative Study,’ above n 15, 60. 112 Near field communication is a form of contactless communication between devices such as smartphones and tablets. 113 Boon-Chye Lee, Olujoke Longe-Akindemowo, ‘Regulatory Issues in electronic money: A legal- economic analysis,’ (1999) Netnomics 1, 53-70. 31 stored value products for larger value purchases both online and at traditional brick and mortar retailers.114
Stored value facilities may, alongside their payment function, offer rewards through loyalty schemes and bonus schemes and have proved an effective means of collecting data related to consumer transactions. The generalised use of digital mobile technology in cards, phones, tablets and watches is transforming the payments and financial processes of consumer economic activity, removing the physical constraints imposed by the differing location of customers and merchants, and reducing the costs of transmission, storage and collection of information.
In addition to the differences that arise from the system of operation, further distinctions are made by those charged with regulating such facilities. In particular, whether the facility is a limited use card or device and whether it is issued by a bank or non-bank will affect the manner in which it is regulated. Certain stored value facilities, such as digital wallet only facilities, which have no physical card or device, do not fit comfortably within existing regulation. I elaborate on this view in Chapter Four.
2. HOW REGULATORS DIFFERENTIATE STORED VALUE FACILITIES
Adoption of payments through the medium of stored value facilities has contributed to an evolution towards a digital society, characterised throughout the world’s global payment systems by movement away from cash in favour of the use of electronic money. This ongoing change has promoted efficiency, speed, convenience and security in retail payments. It is a significant catalyst to the growth of globalised trade.
In this section I examine four main types of stored value facility: open and closed loop systems, limited use products, ‘fintech’ products and ‘techfin’ products. I examine and
114 Nobuhiko Sugiura, ‘Electronic Money and the Law: Legal Realities and Future Challenges,’ (2009) 18 Pacific Rim Law & Policy Journal, 3. 32 consider the characteristics of each type of product relevant to those charged with designing adequate and proportionate regimes for their regulation.
2.1 Open Loop and Closed Loop Systems
There are two main systems of stored value facility; closed-loop (single-purpose) systems and open-loop (multi-purpose) systems. Closed-loop systems store value on the card or device and may only be used to acquire goods or services provided by the product issuer. The early stored value facilities, gift cards and campus cards, are examples of closed loop products. Due to their limited storage capacity, they were (and remain) typically used for low value payments and can usually be purchased without evidence of identification or prior credit history.115 These are most commonly issued by a non-bank provider, such as a merchant, school or university.
Open-loop products differ from closed-loop products in that the issuer of the card or device is not necessarily the provider of the goods or services. They utilise payment networks such as VISA or MasterCard, may be used wherever those networks are accepted and they have the capacity to withdraw funds through ATMs and Point of Sale terminals.116 Such products typically allow high values to be loaded and stored on the cards or devices. The Australian ‘Travelex Money’ Card is an example of an open- loop product; it is a multi-currency prepaid card that uses the MasterCard network, with a balance limit of AU$100,000 and access to the global ATM network.117 Most providers of open-loop facilities are banks.
Closed-loop products pose significantly less risk to consumers and the payments system than do open-loop products.
115 Lisa Sotto, Tania Perez, ‘Privacy Considerations for Stored Value Cards,’ (2006) 1 Journal of Payment Systems 4. 116 Mohammed Khairuddin, P Zhang, Asha Rao, ‘Risk Mitigation Strategies for the Prepaid Card Issuer in Australia,’ (Paper presented at the Australian Information Security Management Conference, Perth, 2008), 1. 117 Travelex Money Card, Travelex (2018) < https://www.travelex.com.au/travel-money-card>. 33 2.2 Limited Use Products
Regulators may differentiate those facilities which are of limited use in order to exempt them from certain regulation. Common limitations that qualify for exemption include limitations on the value that may be stored on each device, on the number and type of people to whom the product is of use, and limitations as to the number of types of people to whom payments under the facility are likely to be made. The types of limited use facilities commonly exempted include closed loop products such as gift cards, road toll devices and campus cards. It is possible for an open loop product to also qualify as a limited use product where they meet the criteria determined by the regulator.
Limited use products usually attract a lower level of regulation as they have lower systemic and credit risk than larger payments systems, and requiring them to comply with the same level of regulation would result in them having a disproportionately heavy compliance burden. Two examples, stored value gift cards and mass transit cards, which are both limited use and closed-loop products, are illustrated below.
i. Stored Value Gift Cards
Stored value gift cards, also known as prepaid cards, are an alternative to credit and debit cards as a means to pay for goods and services where the issuer does not need (or choose) to conduct any credit analysis of the cardholder. Use of stored value gift cards is limited to the premises or group of premises of an identified merchant; they are a closed loop product. Examples of closed-loop products include David Jones gift cards, redeemable only at David Jones stores118 and prepaid Telstra phone cards.119 The Coles Group & Myer gift card is an example of a semi-closed product, as it may be used at any merchant that is part of the Coles Group and Myer retail network.120
118 Classic and Premium Gift Cards, David Jones, (March 2018)
ii. Mass Transit Cards
Mass transit agencies worldwide adopted the use of stored value technology in the 1970s.122 Public transport systems today increasingly use smartcard (integrated circuit) technology rather than magnetic strip technology to access stored value.123 ‘Myki’ in Melbourne and ‘Opal’ in Sydney are Australian examples of reloadable travel smartcards; their use is restricted to the state transport system by which they were issued and they cannot be used to purchase other goods or services. They are currently closed loop products, but the New South Wales government is considering making the Opal system open loop, meaning transit users could tap on and off using a non-Opal contactless card or wearable device.124
A limited use facility, such as those outlined above, may grow to become widely used, and once it has exceeded its threshold limitations, it will usually outgrow its regulatory exemption and attract a higher level of regulation. The Octopus Card is one such facility that has graduated from a limited facility to a widely used payment product. Octopus is the major stored value system of Hong Kong, one of the two comparator jurisdictions in this Thesis, and is a mass transit card that will be referred to throughout the following Chapters. Introduced in 1997, the contactless Octopus card may today be used to pay for goods and services throughout Hong Kong in addition to travel on the local mass transit system. Its use has been extended from transport to supermarkets,
121 Financial Action Task Force, ‘Prepaid Cards, Mobile Payments and Internet-Based Payment Services,’ (Guidance for a Risk-Based Approach, June 2013), 5. 122 Transport Applications, Smart Card Alliance, (2016) < http://www.smartcardalliance.org/smart-cards- applications-transportation/#smart-cards-and-transit>. 123 Ibid. 124 As the contactless payments would link to a debit or credit card, these payments would no longer be stored value payments; Catilin Fitzsimmons, ‘Payment rings will take us from the public transport network to the beach,’ Sydney Morning Herald, 26 January 2018. 35 convenience stores, restaurants, postal services, and building and school campus access.125
2.3 Fintech: Bank vs Non-Bank Issued Products
In the course of supervising stored value facilities a further distinction recognised by regulators relates to the identity of the facility provider. A product issued by a bank will usually attract a different level of regulation from one issued by a telecommunications company or by a financial technology company (fintech).126
Banks that determine to issue stored value products are already subject to significant prudential regulation, and new product issuance will usually fall within the terms of existing banking regulations. Regulators should recognise a bank’s higher levels of capital and resources, its existing risk management obligations and existing framework of prudential supervision under which it operates, and have regard to those factors when considering the more limited resources of a fintech applicant company in start- up mode whose proposed product may be novel and not covered by existing regulation. Whilst in general non-bank issued products are subject to less onerous regulatory requirements than bank-issued products, a regulator will need to consider each emerging new product on a case by case basis.
As firms outside of the financial services regulatory framework, such as retailers and telecommunications companies, issue financial-type products, the boundaries between service provider accounts and deposit-taking become blurred. The regulatory perimeter127 for stored value products needs to be examined, and a determination made of when products operating outside of the prudential and conduct framework need to be brought in.
125 Harminder Singh, ‘Octopus’ Hong Kong market dominance faces challenge from e-payment newcomers,’ South China Morning Post (online), 4 Jan 2017 http://www.scmp.com/news/hong- kong/economy/article/2059316/octopus-hong-kong-market-dominance-faces-challenge-e-payment>. 126 Fintech refers to the use of technology to deliver financial solutions: Douglas Arner, Janos Barneris, Ross Buckley, ‘Fintech and Regtech in a nutshell and the future in a sandbox,’ (2017) 3(4) CFA Institute Research Foundation 1, 2. 127 Defined in this Thesis as the boundary between products operating within the existing regulatory framework and those operating outside it. 36 I pass to consideration of three categories of stored value fintech product: open-loop prepaid cards, non-bank mobile money products and wearables issued by bank and fintech partnerships.
i. Network-branded Stored Value Cards
Network-branded cards are open loop prepaid cards that utilise a payments network (eg VISA, MasterCard). Once they have had payment transferred onto their system, they may be used as would a credit or debit card at any merchant or service provider participating in the payments network.128 The payment value may either be stored remotely and linked to the facility, or it may be stored on the card’s chip or magnetic strip.
Network-branded products often have wider use than closed-loop products. They may be reloaded using cash or electronic transfer; most may be used to access cash through the ATM network, and some permit person-to-person transfers between users. These products exhibit some features of an account, but with limitations such as loading thresholds or limited spending capacity that reduce the risk of fraud or unauthorised transactions.129
Non-banks that offer network branded prepaid cards include the Australia Post Office, which offers the ‘Load&Go’ Reloadable Visa prepaid card and STA Travel, which offers the ‘CashFLEX’ Visa card, neither of which are connected to the user’s bank account.130
Bank issued prepaid cards in Australia include ANZ’s Travel Card and Westpac’s and the Commonwealth Bank’s Travel Money Cards, all of which use the Visa network, and the NAB Traveller Card, which uses the MasterCard network. These cards are
128 Todd Zywicki, ‘The Economics and Regulation of Network Branded Prepaid Cards,’ (2013) 65(5) Florida Law Review 1477, 1486. 129 Financial Action Task Force, ‘Prepaid Cards, Mobile Payments and Internet-Based Payment Services,’ above n 121, 5. 130 Load&Go Reloadable Visa Prepaid Card, Australia Post (2018) < https://auspost.com.au/money- insurance/make-payments/explore-online-payment-alternatives/loadgo-reloadable-visa-prepaid-card>; STA CashFLEX Visa Card, STA Travel (2018) < http://www.statravel.com.au/cash-card.htm>. 37 protected with a chip and PIN and must be preloaded before use, but are not linked to a user’s bank account.
ii. Mobile Money
Prepaid mobile money products are most commonly stored value products where a telecommunications issuer provides value for the purchase goods and services that is stored outside of a bank account, usually on a mobile phone account. They may be used to facilitate mobile payments including person-to-business, person-to-person, and government-to-person transfers. Such payments can readily be made through banks, however, as mobile money products are often linked to prepaid accounts, non- banking entities have become very active in this area and a number of telecommunications providers have widened their ambit of activity to become successful mobile money issuers.131 A well known example is the ‘M-Pesa’ system, a mobile phone-based money transfer, financing and micro-financing service which was launched in 2007 in Kenya and has since spread throughout Africa, India, Afghanistan and Eastern Europe.132
Prepaid mobile money products are treated differently in different jurisdictions; some regulators have permitted development without specific regulation, some enforce specific regulatory or licensing requirements whilst others have by regulation entirely precluded their operation.133
iii. Bank and Fintech Partnerships: Contactless Wearables
A new generation of payment product, dubbed wearables, enables the making of contactless payments by approaching a device worn by a consumer into close proximity of a receiver. Value can be stored in any wearable smart devices; wristbands,
131 Financial Action Task Force, ‘Prepaid Cards, Mobile Payments and Internet-Based Payment Services,’ above n 121, 7. 132 Tom Standage, ‘Why does Kenya lead the world in mobile money? The Economist, 2 March 2015. 133 Ara Margossian, Raymond Roca, ‘Mobile Money Services in Australia: Key Trends and Legal Considerations’ (2014) Australian Media, Technology and Communications Law Bulletin. 38 watches, glasses, rings and other jewellery have found ready acceptance. Consumer electronics manufacturers and fashion industry players are each seeking a market presence in the wearable device market.134 In 2015, manufacturers produced 45.7 million wearable units worldwide, and total production volumes are forecast to reach 126.1 million units in 2019.135
The financial operation of wearables is commonly underwritten by a partnership between a bank and a fintech company. Fintech companies have the capacity to accelerate a bank’s innovation capabilities, for example by introducing capabilities missing from a technology, while banks may aid a fintech company to achieve scale by eliminating barriers around customer acquisition costs, providing capital to achieve market scale and providing the know-how to ensure compliance with relevant regulations.136
In the United Kingdom, Barclays, a British multinational bank, has developed bPay wristbands, bPay fobs and bPay stickers that enable customers to preload with funds to make purchases of up to £30 anywhere that accepts contactless payments and to gain entry into music and sporting events.137 In Australia, the ‘Power Suit,’ a prepaid wearable payment device, has been developed by Heritage Bank, a Queensland-based mutual bank, in partnership with Visa payWave.138 Tailored from a special fabric, ‘payweave,’ the suit enables the wearer to purchase items by swiping the jacket sleeve of the suit across a payment terminal.139 The funds are stored in the participant’s Heritage Bank prepaid transaction account; these are covered by existing banking
134 Wearables, Gemalto, (2016) < http://www.gemalto.com/iot/consumer-electronics/wearable>. 135 International Data Corporation, ‘Worldwide Wearables Market Forecast to Reach 45.7 Million Units Shipped in 2015 and 126.1 Million Units in 2019, According to IDC,’ (Press Release, 30 March 2015) < http://www.idc.com/getdoc.jsp?containerId=prUS25519615. 136 Kai Riemer, Ella Hafermalz, Armin Roosen et al, ‘The Fintech Advantage: Harnessing digital technology, keeping the customer in focus,’ (Publication, CapGemini, University of Sydney Business School, 2017) 18 < https://www.capgemini.com/au-en/wp- content/uploads/sites/9/2017/08/the_fintech_advantage.pdf>. 137 BPay, Barclays Bank, (2016) https://www.bpay.co.uk/home#. 138 Nate Cochrane, ‘M.J. Bale adds chips to suits: wearable technology start-up series,’ The Australian Financial Review (online), 18 June 2014 < http://www.afr.com/technology/mj-bale-adds-chips-to- suitswearable-technology-startup-series-20140618-kbg6a>. 139 Ibid. 39 regulation. In Singapore, electronics company Sony has partnered with stored value issuer EZ-Link, bank consortium NETS and mobile network operator Singtel to trial the ‘SG50 Smartband,’ a wristband with contactless reader capability that enables commuters to pay for public transport and for goods at retailers.140 The wristband credit may be topped up automatically where linked to a bank account, or manually at a top-up station, and users can check their balance through Singtel’s mWallet app.141 As the stored value for these products is held by a bank, it is usually covered by the existing banking regulations and no additional stored value regulation is required. Stored value wearables are an easy and convenient payment option likely to become increasingly popular. Wearables that provide access to a credit or debit card but do not store value themselves, Apple Watch and Samsung Gear G2 are examples, are not stored value products and are not examined in this Thesis.
Were banks to decline to form partnerships with fintech companies, it is probable that fintech institutions would develop functions traditionally provided by banks, effectively cutting financial institutions out of the market for contactless wearables.142 The strict regulatory framework that has protected market incumbents in Australia from disruption to date has played a large part in preserving the traditional banking firms’ advantage over new non-bank entrants.143 However, changing regulations in Australia and around the world encourage and support fintech development, gradually diminishing the banks’ advantage.144 Partnerships between banks and fintech companies offer considerable benefit to each type of institution, as well as to consumers and the market. It may well be that collaborations of this kind are needed by banks if they are to remain relevant in this market as the ‘techfin’ threat looms ever larger.
140 Rian Boden, ‘Singapore Commuters Trial Wristband Payments,’ NFC World (online), 1 September 2015, < http://www.nfcworld.com/2015/09/01/337402/singapore-commuters-trial-wristband- payments/> 141 Ibid. 142 Deloitte, ‘Did you wear your bank today?,’ (Wearable Banking Documents, August 2016), 6 < https://www2.deloitte.com/content/dam/Deloitte/us/Documents/process-and-operations/us-cons- wearables-in-banking.pdf>. 143 Riemer, ‘The Fintech Advantage,’ above n 136, 7. 144 Ibid. 40 2.4 Techfin: Digital Wallet Facilities
A serious disruptive force to market incumbents for contactless wearables, greater even than that posed by fintechs, is posed by the group of large global financial product companies that includes Google, Amazon and Facebook, collectively known as ‘techfin’ or ‘bigtech.’145 These companies have started with the technology and data and have added financial services to their value-chain.146 Their level of market penetration, their sheer size and ample resources and the extent to which they have become embedded in consumers’ lives makes them powerful competitors in an arena traditionally occupied by the large banks.147 These companies have access to customer data, established consumer infrastructure such as mobile phones and payments systems, and strong brand reputations.148 They are poised to become major global market players. 73% of U.S. millennials,149 (those persons born between 1980 and 1996) say they would be more excited about a new offering in financial services from Google, Amazon, PayPal or Square than from their bank, and one in three believes that in the future, they will not need a bank at all.150
Techfin companies provide internet-based stored value digital wallets within the stored value payments system. Digital wallets are electronic devices or software that facilitate payments either by using funds stored in their system, or by drawing from the customer’s linked bank account. Only those digital wallets which are capable of storing value themselves will be discussed in the following chapters. These stored value digital wallets are most commonly applications (apps) residing on a mobile
145 This Thesis has chosen the term techfin and notes that it may be used interchangeably with bigtech by other authors. ‘Big tech’ is a popular term used to refer to the largest global technology companies. ‘Techfin’ refers to new entrants with typically large, pre-existing non-financial services customer basis: Dirk Zetzsche, Ross Buckley, Douglas Arner et al, ‘From FinTech to TechFin: The Regulatory Challenges of Data-Driven Finance,’ (Working Paper Series No. 6, European Banking Institute, 25 April 2017) 1. Bigtech/Techfin includes companies such as Google, Facebook, Amazon, Microsoft and Apple. 146 Zetzsche, Buckley, Arner et al, ‘From FinTech to TechFin: The Regulatory Challenges of Data-Driven Finance,’ above n 145, 9. 147 Riemer, ‘The Fintech Advantage,’ above n 136, 7. 148 Ibid. 149 A neologism to describe the generation born between 1980 and 1996; Michael Dimock, ‘Defining Generations: Where Millennials end and post-Millennials begin,’ (1 March 2018) Pew Research Centre. 150 ‘The Millennial Disruption Index,’ (Study, Scratch Viacom, August 2015)
i. Software-Based and Hardware Digital Wallets
A digital wallet may be a software application capable of use through a computer, tablet or mobile phone, or it may exist solely on hardware such as smartphones, tablets and wearable devices. Digital wallets may also be called e-wallets or mobile payments.
Software-based digital wallets may be either client-side or server-side wallets, determined by where the digital value is stored. Wallets that function with specific vendors only and wallets that operate with a wide range of merchants are found within both client-side and server-side based wallets.151 Google Wallet, Microsoft Windows Live ID and Yahoo Wallet are widely-used software-based wallets.152
Digital wallets have evolved from a solely software base into the physical world, creating wallets apps and storing value on hardware like smartphones, tablets and wearable devices. The digital value may be linked through the hardware to value stored on an online database, or may be stored as value on the device itself.
A number of hardware-based digital wallets have been released, including Google Pay, WeChat Wallet and Alipay for use through mobile phone or tablet. Hardware-based digital wallets transfer value on command over short distances to nearby terminals using NFC technology. Tokenisation, the process whereby a card or device’s primary
151 Nathan Chandler, ‘How Digital Wallets Work,’ How Stuff Works Tech (online), 19 September 2012 < http://electronics.howstuffworks.com/gadgets/high-tech-gadgets/digital-wallet1.htm> 152 Ibid. 42 account number is replaced by a surrogate value, called a token, is employed by most digital wallet systems as their primary security feature.153 Using tokens instead of primary account numbers protects user privacy by reducing the amount of available cardholder data.154
The potential of techfin companies to disrupt the banking sector is real; these companies have customer bases that dwarf all but the largest global banks, deep engagement with existing users and a history of disruptive innovation.155 I pass to consideration of four examples of stored value digital wallets created by techfin companies: PayPal, Google, Alipay and Tencent are examined below.
ii. Four Digital Wallet Examples: PayPal, Google Pay Send, AliPay, WeChat Wallet
PayPal was until 2018, when it was overtaken by AliPay, the world’s leading digital wallet provider and payments facilitator. It has over 227 million active accounts, enabling buyers and sellers to send and receive money internationally online.156 It is regulated in Australia as a non-cash payment provider, and classified as a limited authorised deposit taking institution. PayPal permits customers to receive a payment as stored value in their PayPal account to be used to make payments to other PayPal customers or to be withdrawn through their bank account. As a condition of its licence, PayPal is not permitted to undertake traditional deposit-taking activity, such as charging for or paying interest on customer stored balances.157
153 Security Standards Council, ‘Information Supplement: PCI DSS Tokenization Guidelines,’ (PCI Security Standards Council, Version 2.0, August 2011), 3.
Google Pay is a digital wallet platform and online payment system, created by the merger of Google Wallet, a stored value peer-to-peer payment app and Android Pay, a payment app which links to the user’s credit or debit card. Google Pay Send is the stored value branch of Google Pay, used to send and receive money for commercial payments. Of Google Pay’s payment facilities, only Google Pay Send is within the scope of this Thesis.
Google Pay Send, to be launched in mid-2018, will allow users in the US and the United Kingdom (UK) to exchange money using only their mobile phone or email details.160 Value may be added to the Google Pay Balance from a linked bank account or debit card. It may remain stored in the Wallet, be cashed out, transferred to another Google Pay user instantaneously or it may be transferred without a transaction fee to a linked bank account over several business days.161
China leads the world in its embrace of digital payments. Digital payments have grown from around 4% of retail transactions in 2010 to around 17% in 2015, largely led by digital wallets Alipay Wallet and WeChat Pay.162 Alipay, launched in 2004, is a Chinese
158 John Detrixhe, Jason Karaian, ‘PayPal is now worth more than American Express,’ Quartz (online), 24 October 2017 < https://qz.com/1250876/big-tech-companies-think-they-can-make-a-lot-of-money- from-the-worlds-unbanked/>. 159 Paayal Zaveri, ‘Facebook Messenger users can now send money to each other with PayPal,’ CNBC (online), 20 October 2017, < https://www.cnbc.com/2017/10/20/facebook-messenger-send-money- with-paypal.html>. 160 Google Pay, Overview, (February 2018)
While Alipay has not yet achieved the same success in Australia as it has overseas, its use in Australia is gradually increasing. At the time of writing in 2018 online platform China Payments enables Chinese residents, migrants, students and tourists to pay obligations incurred in Australia from money stored in their Alipay digital wallet.166 Selected local merchants can accept payments through Alipay and Alipay stored value prepaid cards can be purchased at Australia Post retail outlets.167
Weixin (WeChat) is a social media mobile app developed by Chinese digital behemoth, Tencent. Launched in 2011 as a mobile messaging service, it now has around 980 million active monthly users,168 and has expanded its services to include cab-hailing, food-ordering, and money transfers of both renminbi and crypto-currencies.169 WeChat Pay, created in 2013, is the payment function of WeChat; it enables peer-to- peer transfers and purchases from stores. Users are ordinarily restricted to annual
163 AliPay, (March 2018) Alipay Website < https://intl.alipay.com/>. 164 Louise Lucas, ‘Chinese money market fund becomes world’s biggest,’ The Financial Times (online), 26 April 2017
Alipay and WeChat Pay both work by scanning codes directly online or on a device, making them an easier and cheaper method for merchants to set up when compared with methods that use NFC, which requires dedicated payments terminals.172 Alipay and WeChat Wallet use financial incentives to encourage users to take money out of their bank accounts and store it on the digital wallet platform.173 At the time of writing, users must have a Chinese bank account to use either WeChat Wallet or Alipay Wallet.174
In Australia, Google Pay, Alipay and WeChat Pay as non-bank institutions do not fall clearly within existing traditional banking legislation. Digital wallets that store value overseas are not currently regulated within Australian regulations. PayPal currently exists alone in its category of limited ADI; this may be the appropriate regulatory category for all widely-used digital wallets. I discuss in Chapter Four regulation that may apply to digital wallets and whether existing regulation is sufficient.
2.5 What do these developments mean for the Payments System?
Whilst fintech companies are certainly leading significant technological change, they are not presently the greatest threat to conventional banking system in Australia. The
170 Zennon Kapron, ‘Why it’s too early to count Apply Pay out in China,’ Forbes (online), 28 March 2016, < https://www.forbes.com/sites/zennonkapron/2016/03/28/why-its-too-early-to-count-apple-pay-out- in-china/#6b7d2d6c720b>. 171 Gabriel Wildau, ‘China unveils digital ID card linked to Tencent’s WeChat,’ The Financial Times (online), 27 December 2017. 172 ‘Apple faces tough competition in China: ‘Alipay or WeChat Pay?’ The Star (online), 22 March 2017
The first step in infiltration of the traditional banking sector by techfin companies may be in the area of payments. In India, digital wallet provider Paytm has been granted a banking licence to set up a payments bank, and in Europe digital wallet Revolut has recently applied for a banking licence.177 In 2015 UK payments provider Monzo was a digital wallet app with a linked prepaid card. The digital wallet venture was so successful that in October 2017 Monzo was granted a license by UK prudential regulator, the Financial Conduct Authority, to act as a bank and it ended its prepaid account program.178 Accenture, a global management consulting company, has estimated that competition from non-banks could erode one-third of traditional bank revenues in North America by 2020.179
The extent and outcome of competition between banks and the world’s biggest tech companies remains to be seen. At present, banks do enjoy some advantages. Research has shown that customers are more comfortable trusting banks with their money than
175 Ian Pollari, James Mabbott, ‘Australian Fintech Landscape,’ (Insights, KPMG, 1 August 2017) https://home.kpmg.com/au/en/home/insights/2017/08/australian-fintech-landscape.html. 176 Productivity Commission, ‘Competition in the Australian Financial System,’ (Final Report, No. 89, 29 July 2018) 130 < https://www.pc.gov.au/inquiries/completed/financial-system/report/financial- system.pdf>. 177 Schultz, above n 155. 178 Amelia Heathman, ‘Monzo officially ends its prepaid programme making way for its current accounts,’ Evening Standard (online), 4 April 2018, < https://www.standard.co.uk/tech/monzo-prepaid- card-current-accounts-challenger-bank-a3805761.html>. 179 ‘Banking Customer 2020: Rising Expectations Point to the Everyday Bank,’ (Survey Report, Accenture, 2015), 9 < https://www.accenture.com/t20150710T130243__w__/us- en/_acnmedia/Accenture/Conversion-Assets/DotCom/Documents/Global/PDF/Dualpub_17/Accenture- Banking-Consumer-Pulse.pdf>. 47 fintech companies,180 and the banks presently hold more valuable customer data.181 As competition in the payments sector intensifies, banks may need to lead innovation if they are to avoid being leap-frogged by non-bank institutions. However, techfins may be able to provide more efficient financial services, reducing transaction costs and improving decision making by using a more comprehensive dataset than is available to established financial institutions.182
At the time of writing, the differences are great between fintechs, techfins and traditional financial institutions. However, it is likely that, over time, their differences will diminish and these terms will fall out of use; their activities will be known simply as ‘banking’.183 This Thesis is concerned with the actions of regulators in the intervening time, and how they will respond to the changes. Whether banks, fintechs or techfin companies lead innovation, regulators need to prepare for a significant number of new entrants and payments products. Devising a regulatory regime that provides competitive neutrality for start ups and market incumbents whilst supporting market innovation and product developments is a challenge faced by supervisory authorities around the world. Some approaches commonly taken by regulators are outlined in Chapter Three, and Australia’s current regulatory regime is discussed in Chapter Four.
3. STORED VALUE FACILITIES: FINDING THEIR PLACE IN THE PAYMENTS ECOSYSTEM
This section will discuss the place of stored value products within the digital and traditional payments systems, outlining the gaps stored value facilities seek to fill, and identifying which users benefit most from these services.
180 At the time of writing, the Hayne Royal Commission into Misconduct in the Banking, Superannuation and Financial Service Industry is in the early stages of hearing evidence into the activities of organisations including Australia’s largest banks; matters have emerged that are likely to attract comment in the Royal Commissioner’s Report to the Australian Government, presently scheduled for delivery in early 2019. It would be both premature and inappropriate to comment on the effect that evidence may have before the Report is delivered. 181 Miklos Dietz et al, ‘Remaking the bank for an ecosystem world,’ (Report, McKinsey & Company, October 2017) < https://www.mckinsey.com/industries/financial-services/our-insights/remaking-the- bank-for-an-ecosystem-world>. 182 Zetzsche, Buckley, Arner et al, ‘From FinTech to TechFin: The Regulatory Challenges of Data-Driven Finance,’ above n 145, 35. 183 Ibid 15. 48 3.1 Stored Value Facilities versus Credit & Debit Services
A stored value facility holds value itself, and is not a means of accessing funds in a credit or savings account held with a bank. Although there are functional similarities between stored value products and conventional credit and debit cards, the relationship between issuer and cardholder is fundamentally different.184 The issuers of credit and debit cards are typically banks or credit unions. The issuer of a credit card underwrites an individualised line of credit to the cardholder that may be repaid without interest if paid within a fixed period following invoicing, or may be paid off with interest by pre-agreed payments.185
Debit cards or devices provide access to a demand/deposit account held with a bank. Transactions are funded from this account immediately, though if the transaction involves a sum that exceeds the available limit the bank may choose to decline the request, or may offer to authorise the transaction under an overdraft procedure.186
Stored value programs do not create either such relationship between issuer and cardholder. Transactions are funded only from the balance prepaid by the cardholder to the issuer. Should the transaction exceed the available balance, the issuer will not honour the transaction.187 Stored value facilities are a payment product only; they do not offer interest, loans or other financial services and for this reason are not usually regulated as strictly as are other banking products.
i. How do Stored Value Facilities Work?
Stored value products are loaded at inception with a fixed amount of electronic value. The consumer, within the discretions and threshold limits determined by the issuer, chooses that value. The electronic value so created may be stored either on the cards
184 Liran Haim, Ronald Mann, ‘Putting Stored-Value Cards in their Place,’ (2015) 18(4) Lewis & Clark Law Review, 989, 994. 185 Ibid. 186 Ibid. 187 Ibid 995. 49 or devices themselves, or on a centralised online server.188 Thereafter the available balance of funds is accessed through the card or device and is debited at the merchant’s point of sale terminal each time a purchase is made.
The card or device holder may spend the electronic value balance stored on the product in accordance with agreements existing between the stored value issuer and participating retailers. The relevant value data is transferred from the cardholder to the retailer in exchange for the goods or services and the product issuer reimburses the retailer.189 Some products are designed for use only until the original value has been spent; such cards or facilities are then exhausted. Other products may be reloadable by the topping up of their balances with cash or by electronic funds transfer.
From a consumer’s point of view, the mechanics of using a stored value product are no different from using a conventional credit or debit card. The consumer ascertains whether a merchant will accept a particular stored value card or device; if yes, the consumer swipes or taps the product at the merchant’s payment station. Should the transaction cost over a certain amount (presently $100 in Australia) the purchaser may be required by the issuer to enter a PIN, finger print scan or other authorisation. The point of sale terminal will initiate a connection with a remote server to ascertain the balance on the stored value card or device and the terminal will decline the transaction or debit the consumer and credit the merchant with the selected amount.190
Stored value systems differ, employing payment systems of differing complexity; the requirements of the relevant system must be met before any payment transaction is completed. In some systems, the transaction value is transferred from the customer to the merchant at the time of purchase, that value is later redeemed from the
188 Sotto and Perez, ‘Privacy Considerations for Stored Value Cards,’ above n 115, 4. 189 Ibid 57. 190 Haim and Mann, ‘Putting Stored-Value Cards in their Place,’ above n 184, 993. 50 customer’s bank account.191 In another system, the transaction value is transferred from the customer’s card or device into a reserve or general liability account held by the issuer to pay merchants and other payees.192 In a third system, electronic value is created and held by a third party, with intermediaries collecting funds from customers in exchange for the electronic value. When customers exchange funds for electronic value, the funds are held for a short time by the intermediary, and then forwarded to the third party.193
In any stored value payment program, there are a number of key participants. Typically, there are four types of service provider involved; the issuers of the stored value, the network operators, the vendors of the hardware and software, and the clearers of the e-money transactions.194 The issuer, whether a bank or non-bank institution, is responsible for distributing the stored value facility, and is the key player for policy makers and regulators, as the total of the e-money committed by the institution is a balance sheet liability of the institution.195 The network operators and vendors supply technical services only, and the clearing institutions typically are specialised companies offering a service no different from that provided for other non- cash payment products.196 In addition to the service providers, there are the user and the merchant. The user is the card or device holder who uses the payment product to acquire goods or services from the merchant, who in turn redeems the value from the issuer.
191 William F Kroener, ‘General Counsel’s Opinion No 8; Stored Value Cards and Other Electronic Payment Systems Part III,’ (Notices, Federal Deposit Insurance Corporation, 2 August 1996), 61 Federal Register 150, 40490. 192 Ibid. 193 Ibid. 194 Mohamad Al-Laham, Haroon Al-Tarawneh, Najwan Abdallat, ‘Development of Electronic Money and Its Impact on the Central Bank Role and Monetary Policy,’ (2009), 6 Issues in Informing Science and Informational Technology, 2. 195 Kroener, above 191, 40490. 196 Al-Laham, Al-Tarawneh and Abdallat, ‘Development of Electronic Money and Its Impact on the Central Bank Role and Monetary Policy,’ above n 194, 2. 51 3.2 Who are the Typical Users of Stored Value Facilities?
The incentives and willingness of issuers, merchants and users to provide, enter into and utilise stored value facilities will each be different. Each has a different motivation and goal. Incentives for issuers include revenues from fees charged to users and merchants, revenues from the investment of the stored value float, and for bank issuers, cost savings from reduced cash handling.197 A possible disincentive might be the cost of meeting any existing or expected future regulation.198
The willingness of merchants to accept stored value products will be affected by their assessment of the likely reduction in cost of cash-handling, the increase in custom, and the amount of associated fees proposed by the issuers, set-off against the cost of terminals and the additional data collection required.199 The demand by consumers for e-money products is likely to be driven by the extent to which stored value facilities compare to other payment products in terms of fees charged by issuers, their perceived security and privacy, the ease with which stored value devices may be used, and the willingness of merchants to accept them.200 These are questions in which value judgments are required and upon which opinions will differ.
The extensive usage of stored value facilities seen throughout the world has occurred because stored value use has been accompanied by major advantages over the systems that it is supplanting. In order to design an effective regulatory regime, it is important to identify the likely users of stored value facilities, so that a regulatory framework may be designed to incorporate their needs. The principal users of stored value facilities are outlined below.
197 Ibid 3. 198 Ibid. 199 Ibid. 200 Ibid. 52 i. The Unbanked and Under-banked
Stored value facilities may aid the advancement of financial inclusion in developing countries, and those in the low to middle income levels of the financial mainstream of developed countries, to whom they may provide an affordable payment option through funds that are usually immediately available at a lower cost than is available through traditional banking services such as opening a bank account or obtaining credit.201
People outside of the formal banking system, who may be poor, young, or recently immigrated, often do not have a way to save, borrow or insure themselves. They may have been overlooked by banks because it is difficult to capture these consumers using traditional business models.202 Fintech companies however, are able to scale up by accessing these consumers through their mobile phones.
Stored value products may provide immediate liquidity for consumers, commonly those on a low income, who experience difficulty of access and accommodation within the traditional banking system.203 Access to a stored value card means that businesses can employ workers who cannot be paid by direct deposit, as they have no bank account.204 The necessity for workers to wait in queues to cash cheques and worry about carrying large amounts of cash are overcome.205 Open-loop stored value facilities are accepted wherever credit cards are accepted, permitting consumers who do not otherwise have access to the credit system to make purchases such as certain plane tickets and hotel rooms that are accessible only through credit.206
201 Ibid. 202 John Detrixhe, ‘Big tech companies think they can make a lot of money from the world’s unbanked,’ Quartz (online), 13 April 2018 < https://qz.com/1250876/big-tech-companies-think-they-can-make-a- lot-of-money-from-the-worlds-unbanked/>. 203 Kim-Kwang Raymond Choo, ‘Money Laundering Risks of prepaid stored value cards,’ (Trends and Issues in Crime and Criminal Justice no 363, Australian Institute of Criminology, September 2008), 2. 204 Jessica Silver-Greenberg, Stephanie Clifford, ‘Paid via Card, Workers Feel Sting of Fees,’ The New York Times (online) 30 June 2013
Stored value facilities have particularly flourished in certain markets for high- frequency, low value transactions, such as mass transit systems.207 They are easy to arrange and use, and are a significant step along the path to paperless transactions.208 As the cash-free nature of the products obviates the need to carry coins or notes, transactions become easier, quicker and more efficient. Stored value systems can significantly reduce transaction costs; the cost of an electronic transaction often costs a fraction of that of a non-electronic transaction.209 Reducing the cost per transaction allows for faster payments and more efficient processing, improving the efficiency of public services such as public transport, road toll collection and similar coin and ticket based services.
In addition to the road toll and mass transit systems, stored value digital wallets offer greater speed and convenience than traditional payment methods. Stored value digital wallets may be downloaded without cost via an app onto a smart phone. Digital wallets give users the ability to check their account balances, track spending, send money to friends and family, split restaurant bills and pay obligations directly from their mobile device.210 This ease of use and ready accessibility makes mobile digital wallets an increasingly desirable payment method.
It is not just consumers who value the increased speed and convenience. Stored value digital wristbands are being used around the world for payments at major music festivals. Radio frequency identification wristbands can be preloaded with funds, and then used to pay for food and drinks, significantly speeding up the payments
207 Matthew Greenwood-Nimmo, ‘New Challenges for Monetary Policy in the Twenty-First Century,’ (2009) Leeds University Business School, 43. 208 Haim and Mann, ‘Putting Stored-Value Cards in their Place,’ above n 184, 992. 209 Choo, above n 203, 1. 210 Angela Ruth, ‘Digital Wallets: the reason millennials are going cashless?,’ Due (online) 18 April 2017 < https://due.com/blog/digital-wallets-reason-millennials-going-cashless/>. 54 process.211 The value is stored on the user’s digital account, not the wristband, providing security against loss or theft.212
iii. Those who require greater control and security over spending
Stored value products allow greater control over general spending. They are particularly useful when travelling, or when entrusting payments to employees or children.213 Large debts cannot be as readily created as may happen with credit cards, and the risk of overdraft is eliminated. Stored value facilities provide an option for consumers who lack the discipline to eschew the common borrowing payment cycle with its attendant interest obligations that frequently occurs with credit card use.
Stored value facilities may offer higher security for all parties; they usually do not contain personal or bank account information, and have no open line of credit.214 Value is transferred to merchants or other users electronically, enabling payments that provide security against physical theft. Digital wallets offer a variety of security features, including biometric features such as finger print or retina scan, two-factor authentication, real-time notifications and tokenisation. If the facility is lost and the wallet has been registered, there is capacity for the value to be recreated.
Electronic payments generally allow for greater transparency, leading to higher tax returns for government. In Europe, cash has been considered the ‘most important enabler of the shadow economy’ and governments are consequently trying to increase the use of electronic payments.215 For example, in 2015, in order to reduce untaxed and counterfeit money in circulation, the Indian government began a demonetisation
211 Mike Moore, ‘Cashless payments will make 2016’s festivals better than ever,’ Silicon (online), 1 March 2016 < https://www.silicon.co.uk/e-marketing/intellitix-rfid-cashless-payments-festivals- 187132?inf_by=5adfe799671db8cf708b5a19>. 212 Ibid. 213 Pros and Cons of Stored Value Cards, Financial Web < http://www.finweb.com/banking-credit/pros- and-cons-of-stored-value-cards.html#axzz494S4XHIE>. 214 ‘Cards, Cards and More Cards: The Evolution to Prepaid Cards,’ (Publications, Federal Reserve Bank of St Louis, Fall 2011) ‘Advantages and Disadvantages.’ 215 MasterCard, Submission No 2 to the Financial System Inquiry Committee, Response to the FSI Interim Report, Financial System Inquiry, (26 August 2014), 13. 55 program, requiring high denomination currency to be exchanged for low denomination currency within a short time window, following which the high denomination notes ceased to be legal tender.216 This edict had the effect of taking approximately 85% of currency by value out of circulation and it may be supposed, rendering the proceeds of crime held in hidden cash vaults valueless.217
iv. Millennials
Millennials expect their financial services provider to offer services similar to Google or Facebook. Digital wallets may offer features additional to their payments function such as digital budgeting, mobile banking and wealth management. Research has consistently shown that millennials are leading the transition away from traditional banking. 33% of millennials believe in five years they will not need a bank.218 69% of millennials are open to using non-traditional financial institutions, and 32% envisage a cashless future where currency is no longer used.219 Over 70% of millennials would bank with a company that they currently do business with that does not currently offer banking services.220
The preferences of millennials have a significant impact on the market. In 2015, 40% of the global population was under 35, and their aggregate net worth projected as US$19-24 trillion by 2020.221
216 ‘RBI to issue Rs 200 notes in coming months,’ LiveMint (online), July 4th, 2017 < https://www.livemint.com/Money/JbVlQ2pKGF6vnjYtGY13iL/RBI-to-issue-Rs-200-notes-in-coming- months.html >. 217 Heath Terry, Debra Schwartz, Tina Sun, ‘The Future of Finance: The Socialization of Finance Part Three,’ (Equity Research, Goldman Sachs, 13 March 2015) 3 < file:///Users/Sophie/Downloads/TheFutureofFinance_Part_3_03-13-15.pdf>. 218 Jeff Desjardins, ‘How affluent millennials are changing the finance industry,’ Visual Capitalist (online), 1 December 2015 < http://www.visualcapitalist.com/how-affluent-millennials-are-changing-the-finance- industry/>. 219 Ibid. 220 ‘Banking Customer 2020: Rising Expectations Point to the Everyday Bank,’ (Survey Report, Accenture, 2015), 9 < https://www.accenture.com/t20150710T130243__w__/us- en/_acnmedia/Accenture/Conversion-Assets/DotCom/Documents/Global/PDF/Dualpub_17/Accenture- Banking-Consumer-Pulse.pdf>. 221 ‘From fast follower to digital pace setter,’ (Insights, Adobe, 2017) < https://www.adobe.com/insights/accelerating-digital-transformation-in-fsi.html>. 56 v. Those who prefer anonymity
As with cash, certain stored value systems, most commonly closed loop cards, may be completely anonymous. They are usually purchased without an approval process, credit checks or the need for a bank account and many stored value facilities do not require purchaser identification.222 Anonymous stored value facilities without security features may be used by any possessor of the card or device to make purchases.223 Should the card or device be lost, the value stored will probably be irrecoverable.
The extent of anonymity may vary. A degree of privacy and absence of a readily traceable record may make a stored value facility attractive for perceived taxation consequences or illegal and dubious financial transactions. This risk is greater at non- financial outlets and has manifested more often as the product cash limits increase. Several reports have identified stored value cards as potential means to launder proceeds of crime.224
This is not the case with mobile money products or stored value digital wallets, which require user details and are often linked to an email or social media account.
4. TO WHAT EXTENT ARE STORED VALUE FACILITIES LIKELY TO BE ADOPTED IN AUSTRALIA?
In the late 1990s the Final Report of the Wallis Financial Systems Inquiry envisaged that stored value cards and devices would gradually displace cash and traditional card use in the Australian payments system.225 Some twenty years on, though some adoption in certain sectors has occurred, stored value systems have not permeated Australian society to the extent anticipated by the Wallis Committee. That said, the use of stored value cards and digital wallets is now growing in Australia, albeit slowly. The
222 Federal Reserve Bank of St Louis, above n 214; Lynden Griggs ‘Consumer Protection and Stored Value Facilities,’ (2009) 9(2) QUTLJJ 198, 205. 223 Pros and Cons of Stored Value Cards, Financial Web < http://www.finweb.com/banking-credit/pros- and-cons-of-stored-value-cards.html#axzz494S4XHIE>. 224 Choo, above n 203, 3. 225 Wallis, Beerworth, Carmichael et al, above n 38, Reserve Bank of Australia, Submission No 1 to the Financial System Inquiry Committee, Financial System Inquiry March 2014, 224. 57 2013 Annual Report of Eftpos Australia reports that more than 1.5 million proprietary prepaid cards were that year on issue in Australia, an increase of 20% over the previous year.226 In 2014, Deloitte predicted in its Financial Services Risk and Regulatory Review that digital and technology advancements may lead to stored value cards issued by retailers and telecommunications companies becoming customers’ primary transaction account.227
Stored value cards are most commonly used now as gift cards, by governments to cover emergency spending, and by businesses as expenditure-control mechanisms.228 The RBA has posited two possible reasons for the limited market success of stored value cards: First, Australia has a highly literate banking population, with most adults holding payments cards linked to bank accounts for use at point-of-sale and online. Given the extra steps required to transfer funds into a stored value account any stored value facility needs to demonstrate a clear benefit over the competing debit and credit card system if it is to persuade a user to switch payments systems.229 The second reason proposed is that the switch to smartcard-based transit systems has happened in Australia only relatively recently. Merchants and consumers are likely to feel more confident using stored value facilities as payment for goods where stored value cards are in regular use as transport cards.230 Smartcard systems for mass transit are becoming more common in Australia, but the cards are not yet capable of use for making payments outside the transit system.
Mobile money has not seen the same success in Australia as it has in other jurisdictions. In developing countries where mobile-phone penetration is high and engagement in the formal banking sector is low stored-value mobile money models have attained wide acceptance.231 This type of success is unlikely to be repeated in
226 Eftpos, ‘Collaborating for the Future,’ above n 54, 2. 227 Deloitte, ‘It’s Time,’ (Financial Services Risk and Regulatory Review, October 2014-March 2015) 7
Whilst stored value cards and mobile money products have not gained their predicted widespread adoption, regulators should not grow complacent. Digital wallets are likely to achieve success in Australia in a way that stored value cards and mobile money products have not. Australia enjoys a position ahead of most countries as the world moves away from cash and towards electronic payments.233 Australia already has the world’s highest proportion of contactless ‘tap and go’ payments,234 and one of the highest global uptake rates of smart phones.235 It has over 50 million payment cards circulating amongst its 23 million population and an average debit card penetration of close to two cards per person.236 Australia has the highest number of point-of-sale terminals per million inhabitants of all member countries of the Bank for International Settlements.237 The Reserve Bank of Australia has reported that payments by cash are declining as payments made by card and by PayPal continue to rise.238
These factors provide a healthy environment for further market penetration by digital wallets. The Australian Payments Network (AusPayNet) has reported that stored value payments are the fastest growing subset of electronic money.239 Visa has reported that emerging digital wallet providers such as PayPal, iDeal and GiroPay are growing at a
232 Ibid. 233 Blockley and Yuzon, ‘The Evolution of Cash: An Investigative Study,’ above n 15, 21. 234 Madeleine Heffernan, ‘$110bn: Australia’s contactless boom,’ Sydney Morning Herald (online) 6 August 2016 < https://www.smh.com.au/business/companies/110bn-australias-contactless-boom- 20160806-gqmg7j.html>. 235 Deloitte Australia, Media Consumer Survey 2017: The Australian cut (2017) < https://www2.deloitte.com/au/mobile-consumer-survey>. 236 Blockley and Yuzon, ‘The Evolution of Cash: An Investigative Study,’ above n 15, 33. 237 Australian Payments Network, ‘The Digital Economy,’ above n 19, 5. 238 Crystal Ossolinski, Tai Lam, David Emery, ‘The Changing Way We Pay: Trends in Consumer Payments,’ (Research Discussion Paper 2014-05, Reserve Bank of Australia, June 2014), RBA Publications < http://www.rba.gov.au/publications/rdp/2014/2014-05/>. 239 Blockley and Yuzon, ‘The Evolution of Cash: An Investigative Study,’ above n 15, 25. 59 faster rate than either Visa or MasterCard.240 Open loop contactless payments are, on a transaction basis, proving a huge success in Australia; per capita use has been reported to be the highest in the world and more popular than their domestic closed loop counterparts.241
There is no technical barrier to the entire Australian payments system becoming digital. It is true that over many years prior to the appearance of digital payments banks in Australia have developed a plenitude of market services; most Australians have long possessed credit and/or debit cards and cash remains widely used and accepted. Amongst the plethora of electronic payments devices, those made from digital wallets accessed through a mobile phone app enjoy a level of safety and ease of operation unmatched by competing products. It may confidently be supposed that issuers will offer incentives and promote the inherent advantages of the device to motivate consumers to download and transfer money into a digital wallet. Absent some new product emerging with even greater advantages, it may be predicted that digital wallets will over time become the dominant device for electronic payments in Australia, driven by techfin companies and the millennials’ preference for the latest technologies.
5. CONCLUSION
Stored value facilities emerged in the early 1990s as a payment system alternative to cash and credit. They have grown from closed system payments, originally limited to mass transit companies, to open system payments utilising the latest financial technologies. Stored value payments continue to gain acceptance throughout the world without displacing other forms of payment, doing away with the need for a bank account, fostering financial inclusion and promoting better control of consumer spending habits.
240 Visa, Submission No 2 to the Financial System Inquiry Committee, Response to the FSI Interim Report, Financial System Inquiry, 26 August 2014, 27. 241 Blockley and Yuzon, ‘The Evolution of Cash: An Investigative Study,’ above n 15, 35. 60 Today consumer preference is trending towards not just cashless but card-less payments because of the convenience and ease of use of the burgeoning range of alternatives and associated on offer incentives and benefits such as loyalty points and rewards.242 As stored value facilities develop into contactless wearables and digital wallets, the migration towards electronic payments through stored value will be driven by the demands of an increasingly tech-savvy younger generation, improved systemic reliability, the growth of stored value facilities in other jurisdictions, decreased consumer costs and increasing confidence in the global market.243 That daily transactions will become easier and quicker as increased use of stored value facilities continues apace may safely be assumed; governments too will benefit, as fewer cash payments and creation of audit trails lessens opportunity to avoid tax.244 The potential of these products to benefit consumers and markets explains the concern of governments to ensure that regulation of electronic payment products promotes consumer confidence and financial stability without stifling competition and innovation.245
Regulators must be prepared for stored value facilities to grow in popularity and significance. In order to design an adequate and proportionate regime, regulators may differentiate between products in terms of their limited capacity for value or payments, whether they operate in an open or closed system, whether they are issued by a bank or non-bank, and if they are a digital wallet only facility.
Driven by the preferences of the millennial generation, it is likely to be digital wallets that will experience the greatest growth of all the stored value products. Digital wallet have the potential to link everyone in the payments chain, purchasers, retailers, banks, credit card companies, telecommunications companies and electronic commerce
242 Gururaj Deshpande, ‘Goodbye to Plastic? The Changing Face of the Cards and Payments Industry,’ (Perspective Document, Infosys, 2017) https://www.infosys.com/industries/cards-and- payments/resources/Documents/goodbye-plastic.pdf. 243 Lynden Griggs ‘Consumer Protection and Stored Value Facilities,’ (2009) 9(2) QUTLJJ 198. 244 Mary Dowell-Jones, Ross Buckley, Submission to the Australian Payments Plan Consultation: Shaping the Future of Australian Payments, (July 2014) < http://australianpaymentscouncil.com.au/wp- content/uploads/2015/07/UNSW-Digital-Financial-Services-Research-Team.pdf>. 245 Kemp and Buckley, ‘Resolution powers over e-money providers,’ above n 109, 1543. 61 specialists.246 Commentators are not unanimous as to the long-term end of this trend. Many express the view that digital stored value will eventually replace cash;247 others opine that cash and other payment instruments will continue to hold the majority share of consumer transactions;248 still others conjecture that stored value systems may be leap-frogged entirely by newer payments technology.249 The ongoing rapid development of new technologies makes it unwise if not impossible to predict the advances in payment capacities that will emerge in the future.
This uncertainty in the future of payments is exacerbated as techfin companies enter the payments field. One possible evolutionary policy change envisages permission for large issuers to grant loans from stored value funds, effectively making non-bank institutions credit service providers.250 Such a redirection of cash flow behind the circulation of electronic money could change the amount and structure of monetary operation, impacting the wider economy.251
It is safe to predict that regulators will need considerable foresight and flexibility in their response to future developments in the global payments environment. Chapter Three discusses the possible approaches available to regulators in regulating stored value payments, including the position of Australian regulators, and Chapter Four outlines the current Australian stored value regulatory regime.
246 Elisabeth Sexton, ‘Digital wallets wave in new era: Smartphone technology seeks to revolutionise the way we live and pay’ Sydney Morning Herald (online), 4 August 2012 < http://www.smh.com.au/business/digital-wallets-wave-in-new-era-20120803-23l0f.html> 247 David Birch, Before Babylon, Beyond Bitcoin: From Money That We Understand to Money That Understands Us,’ (London Publishing Partnership, 2017). 248 Gemma Tetlow, ‘Cash is still king despite rise of contactless payments,’ The Financial Times (online), 14 June 2017
1. RISKS CONCERNING REGULATORS 63 2. THEORETICAL APPROACHES TO THE REGULATION OF ELECTRONIC 64 MONEY 3. REGULATING THE AUSTRALIAN PAYMENTS SYSTEM 78 4. CONCLUSION 88
There exist several differing theories regarding which regulatory approach is best for supervising stored value facilities. In Section One of this Chapter I identify the main risks considered by regulators overseeing stored value facilities. In Section Two I discuss theoretical approaches to the regulation of electronic money and examine the approaches taken by major regulators around the world, ultimately deciding upon co- regulation as the most suitable regulatory approach for stored value facilities. In Section Three I outline the system of stored value regulation in Australia and the roles of the relevant regulators, and examine to what extent they have accepted a co- regulatory approach.
1. RISKS CONCERNING REGULATORS
Electronic money issuers are under an obligation to redeem the stored value as its equivalent in cash, upon demand by the stored value facility holder. The aggregate of funds received by an e-money issuer from customers in exchange for the stored value is the ‘float.’252 The funds in the stored value float should at all times equal the stored value in circulation, so that all requests for stored value can be honoured.253 According to Greenacre and Buckley, there are three main threats to the e-money float and the security of customers’ funds.254 These are, that the issuer may have insufficient liquid
252 Committee on Payments and Market Infrastructures and Bank for International Settlements, ‘Payment Aspects of Financial Inclusion,’ above n 56, 65. 253 Kemp and Buckley, ‘Resolution powers over e-money providers,’ above n 109, 1544. 254 Jonathan Greenacre, Ross Buckley, ‘Using Trusts to Protect Mobile Money Customers’ (2014) Singapore Journal of Legal Studies 59. 63 assets to meet customers’ demands for cash (‘illiquidity risk’); that the issuer may become insolvent and customers will be unable to redeem their stored value at all or in full (‘insolvency risk’); and that customer’s funds may be lost through fraud, theft or negligence (‘operational risk’).255
These risks are exacerbated by two inherent characteristics of stored value facilities. The first is the possibility of their issuance by non-bank providers who are not subject to the same level of financial and prudential supervision as banks and other financial institutions.256 The second is that the stored value received by the issuer from the customer is not classified as a ‘deposit’ and is therefore not usually covered by deposit insurance schemes.257
These issues should be considered by regulators as they take steps to increase consumer confidence in stored value facilities, improve the likelihood of their adoption and preserve the stability of the payments system. While their systemic risk may be less than other payments products, the failure of an issuer may be significant for individual households, and would likely undermine consumer confidence in electronic money and possibly in the financial system generally, as well as damage the reputation of the regulator.258
2. THEORETICAL APPROACHES TO THE REGULATION OF ELECTRONIC MONEY
Central bankers around the world have taken differing views as to the optimal form of financial market regulation; there is no less divergence of view on the desirability of regulatory intervention on the issuance and usage of electronic money.259 The extent to which governments should intervene in the payments market and the extent to
255 Ibid; Kemp and Buckley, ‘Resolution powers over e-money providers,’ above n 109, 1544. 256 Jonathan Greenacre and Ross P Buckley, ‘Using Trusts to Protect Mobile Money Customers’ (2014) Singapore Journal of Legal Studies 59; Michael Tarazi and Paul Breloff, ‘Nonbank E-Money Issuers: Regulatory Approaches to Protecting Customer Funds’ (Focus Note No 63, CGAP, July 2010) 1. 257 Kemp and Buckley, ‘Resolution powers over e-money providers,’ above n 109, 1544. 258 Ibid 1551. 259 Thomas Rohling, Mark Tapley, ‘Optimal Regulation of Electronic Money: Lessons from the “Free Banking” Era in Australia,’ (1998) 17 Economic Papers: A Journal of Applied Economics and Policy 4, 8. 64 which electronic money ought be regulated is widely debated by legal commentators.260 In this section I outline three approaches: the wait-and-see approach, in-advance regulation, and responsive regulation and consider which is the approach most suitable for the regulation of electronic money and stored value facilities in particular.
In its simplest form, regulation refers to a set of authoritative rules accompanied by a mechanism, usually a public agency, for monitoring and promoting compliance with those rules.261 A broader interpretation of regulation includes government measures beyond the making and enforcement of rules, and includes taxation, incentives, disclosure requirements and similar measures, which may be carried out by non- government actors including corporations, professional firms and community groups.262 In this broader interpretation of regulation, the state is decentred so that it no longer dominates regulatory processes, but shares regulatory processes with other sub-centres of control.263 It is this wider interpretation of regulation that will be used in the following sections and throughout this Thesis.
2.1 The Wait-and-See Approach
The wait-and-see approach requires regulators to take no action when new products or technologies first appear, but to observe the market as it operates under existing regulations. The reasoning behind this approach is to allow businesses to develop without burdening them with additional regulation that may prove to be a barrier to market entry, thereby limiting competition by slowing the introduction of new technologies.264 In this Thesis a barrier to entry is ‘anything that stops a competitor or
260 For example, see Stephen Aikins, ‘Political Economy of Government Intervention in the Free Market System,’ (2009) 31 Administrative Theory and Praxis 3, 403; Giulio Gallarotti, ‘The advent of the prosperous society: The rise of the guardian state and structural change in the world economy,’ (2000) 7 Review of International Political Economy, 1; Richard Lehne, Government and Business: American political economy in comparative perspective (CQ Press, 2006). 261 Robert Baldwin, Colin Scott, Christopher Hood, A Reader on Regulation (Oxford University Press, 1998), 3-4. 262 Ibid. 263 Lorraine Mazerolle, Janet Ransley, Third Party Policing (Cambridge University Press, 2006). 264 Mmaphuti David Tuba, ‘The Regulation of Electronic Money Institutions in the SADC Region: Some Lessons from the EU,’ (2014) 17 Potchefstroom Electronic Law Journal 6, 2276. 65 new entrant from competing away excess profit of the incumbent,’ including regulatory requirements.265
Governments that are concerned that enforcing parameters such as product characteristics, security features and threshold limits may stifle growth will not regulate growing technologies heavily. In the case of stored value facilities, a wait-and- see approach would mean that the regulators would not interfere with the issuance or design of the product, but rather leave it to existing regulation and market forces to determine which products best meet the needs of consumers. Such an approach is evident in the regulatory framework of the United States, the South African Development Community and many other countries.266 China is often commended for adopting a wait-and-see approach before designing a comprehensive regulatory approach for the new regulatory environment, allowing market participants to test their products without immediate repercussions from the regulator.267 However, it was due to this approach by Chinese regulators that Alibaba Group’s Yu’e Bao, now the world’s largest money market fund, was able to grow into the fourth largest money market fund in the world in only nine months.268 This lack of initial visibility by regulators has pushed China to develop a comprehensive new regulatory approach.269
The government of the United States, one of the countries widely embracing electronic money facilities, has opted to leave regulation of this growing market largely out of the scope of federal legislation, choosing to allow market forces to determine the development of the payment system.270 The US has taken the strong view that
265 Productivity Commission, ‘Competition in the Australian Financial System,’ (Final Report, No. 89, 29 July 2018) 84 < https://www.pc.gov.au/inquiries/completed/financial-system/report/financial- system.pdf>. 266 Tuba, above n 264, 2275. 267 Dirk Zetzsche, Ross Buckley, Douglas Arner et al, ‘Regulating a Revolution: From Regulatory Sandboxes to Smart Regulation,’ (Law Working Paper Series No. 6, European Banking Institute, 14 August 2017) 15
One reason for choosing this approach is it is still unclear whether or not stored value products will achieve widespread popularity. An attempt to control their development through regulation may disable their success before it is achieved. Where there is a strong regulatory framework, products are likely to be designed primarily around the relevant regulatory gaps or requirements, rather than around the needs of the market. Products that do not prioritise the specific needs of the market or the consumer are not likely to be widely adopted.
Another benefit is this approach is less restrictive of e-money issuers, who are often not subjected to banking regulations. As the regulatory provisions that do exist are much broader, they harmonise not only e-money regulation but other non-bank payment activities also.274
A danger of the wait-and-see approach is that, in contrast to the objective of allowing the industry to develop unfettered by regulation, the lack of a strong legal framework may in practice inhibit the growth of the payments products. Market entry of new technologies may be slow as new issuers and products try to navigate regulations that were not designed with them in mind. Legal uncertainty may make it difficult to issuers to identify and minimise associated risk.
271 In the 1970s, US regulators strongly regulated the then emergent payments automation technology, and it is believed that this had a role in discouraging private sector initiatives that may have resulted in alternative technologies; Olujoke Akindemowo, ‘Electronic Money regulation: a comparative survey of policy influences in Australia, the European Union and the United States of America,’ (2001) 11 Journal of Law and Information Science 1, 73. 272 Mehmet S Yurtcicek, ‘The Legal Nature of Electronic Money and the Effects of the EU Regulations Concerning the Electronic Money Market,’ (2013) 4 Law and Justice Review 1, 291. 273 Ibid. 274 Ibid 292. 67 A legal framework may act as a safety net to reduce the likelihood and impact of these risks. Possible systemic risks may arise from the operation or failure of institutions that provide these products. Consumers who access only lightly regulated products may be exposed to risks of fraud, theft, and unfair trade practices.275 A danger of leaving it to the market to determine such issues as consumer protection and systemic stability is that the market, concerned primarily with profit, will not manage these issues appropriately.276
Another weakness is that failure to adopt a legal framework may render impossible or jeopardise the creation of competitive neutrality between existing financial institutions and new market entrants.277 For example, bank issuers have natural advantages of market share, existing customer base, and financial and other resources. Tailored regulation which recognises the disadvantages of non-bank issuers will be essential for new entrants to be able to survive in a market dominated by the large bank incumbents.
Considering the wait-and-see approach more broadly, it is my view that the substantial benefits inherent in the widening use of electronic money justify implementation of policies that foster their spread. However, considering the risks of adopting a wait and see approach, it is worthwhile to consider alternative regulatory approaches.
2.2 The In-Advance Approach
An alternative approach to regulating stored value facilities is taking the in-advance approach. The in-advance approach advocates putting in place a regulatory framework for emerging payment technologies as they are being developed and before they have been widely adopted. It pre-empts the regulatory challenge of trying to remedy
275 Tuba, above n 264, 2276; ‘Electronic Money: Consumer Protection Law, Law Enforcement, Supervisory and Cross Border Issues,’ (Report of the working party on electronic money, Bank for International Settlements: Group of Ten, 1 September 1997). 276 Akindemowo, above n 271, 63. 277 Tuba, above n 264, 2276. 68 undesirable situations once e-money schemes are introduced, in place and widely used.278
An increasing number of jurisdictions have developed new regulatory frameworks to address fintech innovation. The Financial Stability Board (FSB)279 has stated that
While many FinTech activities are covered within existing regulatory frameworks, the FSB stocktake of regulatory approaches to FinTech finds that a majority of jurisdictions (20 of 26) have already taken or plan to take regulatory measures to respond to FinTech, but the scope and scale of changes or planned changes vary substantially.280
The primary reasoning underlying this approach is that if non-banks are allowed to issue e-money services they must be carefully regulated to ensure consumer protection, orderly development of e-commerce, and the creation of legal certainty.281 This approach accepts that developing e-money payment systems may be under the same general regulatory regime as traditional payment systems, but holds that this is appropriate as there is some regulatory and definitional uncertainty attending electronic money products.282
In contrast to the US, the European Union (EU) thoroughly prescribed the use and issuance of electronic money when it created its electronic money regulations in 1998. The European Central Bank’s (ECB) first draft of regulatory recommendations raised many policy concerns relating to electronic money, including concerns about fundamental monetary policy, efficient functioning of payment systems, protection of customers and merchants, stability of financial markets, protection against criminal
278 Ibid. 279 The Financial Stability Board, created in 2009 is an international body that monitors and makes recommendations about the global financial system – Financial Stability Board, About the FSB (March 2018) < http://www.fsb.org/about/>. 280 Financial Stability Board, ‘Financial Stability Implications from FinTech,’ (Supervisory and Regulatory Issues that Merit Authorities’ Attention, 27 June 2017) 4 < http://www.fsb.org/wp- content/uploads/R270617.pdf>. 281 Ibid 2277. 282 Ibid. 69 abuse and concerns related to market failures.283 In its Directive 2000/46/EC the ECB concluded that the best way to minimise risk was to limit the issuance of e-money to credit institutions.284 It imposed detailed requirements for electronic money institutions, including prohibiting such institutions from undertaking any business activity unrelated to their operation as electronic money institutions and included a minimum initial capital requirement of one million euros.
In 2005 the European Commission reviewed the original electronic money directive, finding that e-money had not to that time delivered the anticipated benefits.285 It attributed the disappointing uptake of e-money to the legal framework regulating its use, consumer attitudes and the technology adopted.286 Companies thus avoided investing in this field, and in 2006 there were only nine electronic money institutions in Europe.287
The European Commission reported that the original initial capital requirements represented a significant barrier to market entry which proved a significant deterrent to new entrants in the market, and failed to ensure a level playing field between credit institutions and e-money institutions, contrary to the objectives of the regulatory framework.288 The EU’s regulatory framework allows Member States to use their discretion to waive some or all of the authorisation requirements for small e-money issuers to facilitate their market entry and innovation289 and the Commission found
283 Malte Krueger, ‘E-money Regulation in the EU,’ in Robert Pringle, Matthew Robinson (eds), E-Money and Payments System Review, (Central Banking Publisher, 2002) 239-251. 284 Sandun Hapugoda, Champa Hewagamage, ‘Analysis of the Regulatory Framework for Electronic Money in Sri Lanka: Suggestions for Future Sustainability and Governance,’ (Paper presented at the 12th International Conference on Business Management (ICBM), Colombo, 8 December 2015) 8. 285 Ruth Halpin, Roksana Moore, ‘Developments in electronic money regulation – the Electronic Money Directive: A better deal for e-money issuers?’ (2009) 25 Consumer Law and Security Review 563. 286 Ibid. 287 The European Commission, ‘Evaluation of the E-Money Directive (2000/46/EC)’ (Final Report, 17 February 2006) 4. 288 Tuba, above n 264, 2297. 289 Commission of the European Communities, ‘Impact Assessment,’ (Accompanying Document to the proposal for a Directive of the European Parliament and of the Council amending Directive 2000/46/EC on the taking up, pursuit of and prudential supervision of the business of electronic money institutions, 2008) 16. 70 that the strict regulations had forced many smaller, primarily non-bank e-money issuers to choose the waiver scheme rather than compete with the larger issuers.290
In 2009, the Council of the European Union abolished 2000/46/EC and adopted a new directive on electronic money, E-money Directive 2009/110/EC.291 2009/110/EC relaxed restrictions, permitting electronic money issuers to conduct business activities other than issuing e-money.292 It also widened the scope of payment services that electronic money issuers are permitted to provide to include the specific payment services listed.293
The European Commission anticipated (correctly, as time established) that allowing the issue of e-money alongside the core business activity would remove significant costs for new participants entering the market.294 The Commission concluded that the high level of initial capital required was the principal obstacle to the establishment of smaller electronic money issuers, and was what preventing exempted low value institutions from upgrading from the waiver scheme to full electronic money issuer status.295 Article 4 of 2009/110/EC reduced the initial capital requirement of one million euros to 350,000 euros, reflecting the lower level of risk posed by e-money institutions.296
The European Commission concluded that some of its regulatory provisions under Directive 2000/46/EC hindered the emergence of a true single market for electronic money services and the development of user-friendly services.297 Since it has been repealed there are fewer restrictions on electronic money institutions, and an
290 Halpin and Moore, above n 285, 564. 291 Council of the European Union, ‘Financial services: new rules on credit rating agencies, bank capital requirements, cross-border payments and e-money, and a programme to support the effectiveness of EU policies’ (Press Release, 12380/09, 27 July 2009) < http://register.consilium.europa.eu/doc/srv?l=EN&f=ST%2012380%202009%20INIT>. 292 Halpin and Moore, above n 285, 565. 293 Annex to Directive 2009/110/EC of the European Parliament and of the Council (European Union, 2009). 294 Halpin and Moore, above n 285, 565. 295 Ibid. 296 Tuba, above n 264, 2297. 297 Directive 2009/110/EC of the European Parliament and of the Council (European Union, 2009), 2. 71 increased number of electronic money issuers and products have emerged in the EU. Recent research has shows that the number of e-money providers registered in the UK with the Financial Conduct Authority has more than doubled between 2013 and 2017.298
It is likely that it is the success of the European waiver scheme that has facilitated the growth of the e-money market, enabling innovation to be tested in the marketplace by businesses that would otherwise have been unable to attain electronic money issuer status.299 Article 9 of 2009/110/EC continues to support market development by simplifying the criteria against which a waiver can be granted, requiring only that the total outstanding e-money does not exceed five million euros, and that the persons responsible for the issuer have not been convicted of any offences relating to money laundering, terrorist financing or other financial crimes.300
Proponents of the in-advance regulatory approach claim that the role of government is to use regulation to mitigate such undesirable market consequences as market failure and recession, without losing the benefits of a competitive economy.301 The provision of a map for the development of new products may reduce the uncertainty that could make it difficult for issuers to ascertain and manage certain risks, such as issuer failure or consumer protection. A comprehensive framework for electronic money generally and digital stored value in particular may ensure system stability, consumer protection and foster healthy competition. Considering that consumer trust is essential for the success of any payments system, a framework that ensures a minimal level of consumer protection may increase the adoption and overall success of new stored value products.
298 Jens Bader, ‘E-money – the Unsung Hero of Payment Innovation,’ (4 March 2016) Global Finance & Banking Review (online)
While the provision of legal certainty and consumer protection are considerable benefits of this approach, these must be balanced with the risk that compliance with early regulation may dissuade the development of new products or the entry of new issuers. The following section outlines an approach that attempts to find a middle ground between the wait-and-see approach and the in-advance approach, amplifying their inherent benefits while minimising their limitations.
2.3 Reconciling the Two Extremes: Responsive Regulation
While at opposite ends of the regulatory spectrum, each system has considerable merits, and those merits are not necessarily irreconcilable. The wait-and-see approach and in-advance approach each has its own benefits and limitations, and it may be that a combination of both approaches is necessary for a healthy payments system.
In many cases, regulators should not rely exclusively on one regulatory technique, but should choose an approach that employs a mix of techniques.303 Responsive regulation is a middle ground approach that has largely been adopted by Australian regulators seeking to provide legal certainty within a regulatory framework but providing many
302 A sandbox is a regulatory ‘safe space’ where firms can experiment with new technology as it applies to financial services and test products with less risk of being ‘punished’ by the regulator - Zetzsche, Buckley, Arner et al, ‘Regulating a Revolution: From Regulatory Sandboxes to Smart Regulation,’ above n 267, 13. 303 Richard Johnstone and Rick Sarre, ‘Regulation: Enforcement and Compliance,’ 2004, Australian Institute of Criminology Research and Public Policy Series 57, 7; Lorraine Mazerolle and Janet Ransley, Third Party Policing (Cambridge University Press, 2006). 73 exceptions, particularly for low value facilities, in order to permit them to develop.304 Responsive regulation is a theory advanced by Ian Ayres and John Braithwaite which seeks to ‘bridge the abyss between deregulatory and pro-regulatory rhetoric,’ finding a balance between in-advance government control and deregulation.305 The theory has gained worldwide influence, adopted by a wide range of regulators and applied and developed by academics.306
Responsive regulation advocates that in order to be effective, efficient and legitimate, regulatory policy should take neither a solely deterrent nor a solely cooperative approach.307 ‘Responsiveness’ may be defined as ‘the ability of a regulator to respond purposively and effectively to the particular context of regulation, and persuade the regulated firm to do so too.’308 This Thesis adopts the position that this combination approach is particularly advantageous for stored value facilities, as they are products that require regulatory space for growth and development in addition to a regulatory buffer to protect against the risks that they pose to consumers and the wider economy.
Decentred regulation is where a range of state and non-state actors within a regulatory area engage in the drawing up of regulation together.309 Responsive regulation proposes that regulators listen to those whom they are regulating, before choosing a course of action to correct the deficiency observed.310 Its key concept is
304 Responsive regulation is also known as ‘strategic regulation theory’ and the terms are often used interchangeably. See Vicky Comino, ‘Towards better corporate regulation in Australia,’ (2011) 26 Australian Journal of Corporate Law 1, 7. 305 Ian Ayres, John Braithwaite, Responsive Regulation: Transcending the Deregulation Debate (Oxford University Press, 1992) 15. 306 Eg Robert Baldwin, Julia Black, ‘Really Responsive Regulation,’ (2008) 71(1) Modern Law Review 59; Valerie Braithwaite (ed) ‘Special Issue on Responsive Regulation and Taxation,’ (2007) 29(1) Law and Policy 3; Neil Gunningham, Robert Kagan, ‘Regulation and Business Behaviour,’ (2005) 27 Law and Policy 213. 307 Vibecke Lehmann Nielsen, ‘Testing Responsive Regulation in Regulatory Enforcement,’ (2009) 3(4) Regulation and Governance 376, 379. 308 Dimity Kingsford Smith, ‘A Harder Nut to Crack? Responsive Regulation in the Financial Services Sector,’ (2011) 44(3) University of British Columbia Law Review 711, 711. 309 Ann Wardrop, ‘Co-regulation, responsive regulation and the reform of Australia’s retail electronic payment systems,’ (2014) 30(1) Law in Context 197, 201. 310 Mary Ivec, Valerie Braithwaite, ‘Applications of Responsive Regulatory Theory in Australia and Overseas: Update,’ (Occasional Paper 23, Regulatory Institutions Network, Australian National University, 2008) 5. 74 that regulation should be responsive to the industry being regulated, with regulators engaging in consultation with consumer groups and other stakeholders in order to identify and adopt best strategy for particular industries.311
Responsive regulation advocates the use of co-regulation and self-regulation, two terms often used synonymously by commentators.312 Co-regulation is a regulatory technique often used in public administrative law, defined by Ayres and Braithwaite as ‘rule-making by industry with government oversight.’313 It may be understood as a combination of government regulation and industry regulation, for example an industry may develop a code of practice in consultation with government.
Responsive regulation is regulation reflecting a dynamic interaction between state and market, with co-regulation emphasising the joint responsibilities of market actors and the state.314 Government depends upon business for investment, production, employment and government revenues while the market depends on government for a competitive operating environment to ensure a level playing field.315 Thus, government and market need to coexist and work together toward a sustainable and dynamic economy.316
Regulators around the world, including those in the European Union, the United States and Australia are embracing co-regulation.317 In the European Community, co- regulation is defined as a combination of ‘binding legislative and regulatory action’ together with stakeholder involvement.318 In general, it promotes greater flexibility
311 Wardrop, above n 309, 200. 312 Ibid 202-3. 313 Ibid. 314 Christopher Marsden, ‘Co- and Self-regulation in European Media and Internet Sectors: The Results of Oxford University’s Study,’ in Moller, Amouroux (eds) OSCE Representative on Freedom of the Media (Vienna, 2006) quoting G Teubner, ‘The Transformation of Law in the Welfare State, in G. Teubner (ed), Dilemmas of Law in the Welfare State (W. de Gruyter, 1986) 8. 315 Stephen Aikins, ‘Political Economy of Government Intervention in the Free Market System,’ 2009 31(3) Administrative Theory and Praxis 403, 407. 316 Ibid. 317 Wardrop, above n 309, 198. 318 Wardrop, above n 309, 202 quoting European Governance: A White Paper (White Paper, Commission of the European Committees, 2001) 21. 75 and adaptability and provides an ability to harness industry knowledge and expertise to address industry-specific and consumer issues directly.319
Co-regulation may vary in degree; it may for example, range from a legislative framework that permits specific regulatory goals to be achieved voluntarily by industry with state oversight, to frameworks wherein the state provides policy input by way of industry codes of conduct and provides for periodic review by a relevant government agency.320 The theory relies upon a premise that the actions of individual actors are motivated by different factors. It follows that a successful regulatory agency needs to formulate a range of regulatory options designed to address the different motivational factors involved.321 The current regime in Australia employs a range of regulatory options, from industry codes of conduct, to conditional and full banking licences.
Responsive regulation through co-regulation advocates appropriate relations between regulator and the regulated, and that enforcement should be directed to a more cooperative future attitude where those regulated work to achieve compliance with the goals of the law.322 Responsive regulation results in ‘more positive attitudes towards the regulator and compliance, and crucially, better compliance behaviour.’323 I propose that responsive regulation is the most appropriate regulatory model for stored value facilities in Australia, however one must be aware of its limitations and shortcomings.
2.4 Weaknesses of Responsive Regulation
There exists some doubt whether or not responsive regulatory theory can effectively be applied to financial markets, as they usually have
319 Glen Hepburn, ‘Alternatives to Traditional Regulation’ (Report, OECD, 2009) 6. 320 Wardrop, above n 309, 204. 321 Michelle Welsh, ‘Civil Penalties and Responsive Regulation: The Gap between Theory and Practice,’ (2009) 33(3) Melbourne University Law Review 908, 910. 322 Lehmann Nielsen, above n 307, 6. 323 Ibid 4. 76 …large populations of regulatees and insufficient resources for visits, inspections, or other regular checks, and where detection of non-compliance is difficult. Here the regulatory circumstances do not provide the bridge for contact between regulator and the firm, which allows a relationship to develop which can support responsive action.324
A relevant factor worthy of note is the external environment within which a regulatory regime operates. Political and economic contexts can constrain regulatory efforts to promote compliance, especially where firms are subject to different regulatory regimes that promote different aims and requirements.325
A criticism of co-regulation is that it in order for it to be effective, private structures must be integrated effectively within a larger institutional setting.326 Co-regulation needs to assist the law and the regulator’s policies, or there is the danger of repeating or confusing requirements.
Another weakness of this approach is giving regulation to industry-based bodies will come at the cost of regulatory non-neutrality. Drawbacks include the potential of raising barriers to entry within an industry, and unintended monopoly power gained by participants that could restrict competition.327
Despite these weaknesses, this Thesis advocates that co-regulation remains the best approach for regulating stored value facilities in Australia. In the following section, I outline Australian payments system regulation and examine to what extent responsive regulation, and co-regulation in particular, has been adopted by the regulators of Australian stored value facilities. In Chapter Five I outline the varying political,
324 Kingsford Smith, above n 308, 711. 325 Fiona Haines and David Gurney, ‘Section 1: Regulatory conflict and regulatory compliance: the problems and possibilities in generic models of regulation,’ in Richard Johnstone and Rick Sarre (eds), ‘Regulation: Enforcement and Compliance,’ (Research and Public Policy Series No 57, Australian Institute of Criminology, 2004) 11. 326 Edward Balleisen, Marc Eisner, ‘The Promise and Pitfalls of Co-Regulation: How Governments Can Draw on Private Governance for Public Purpose,’ 129, in David Moss, John Cisternino (eds), New Perspectives on Regulation, (Cambridge University Press, 2009) 127-151. 327 Australian Communications and Media Authority, ‘Optimal Conditions for effective self- and co- regulatory arrangements,’ (Occasional Paper, September 2011) 5. 77 economic and cultural contexts of the comparator jurisdictions, and discuss the likely impact of these contexts on their regulatory regimes.
3. REGULATING THE AUSTRALIAN PAYMENTS SYSTEM
3.1 The Regulators and the Twin Peaks Model
The Australian Government has represented itself as in favour of an open, market- based economy with a pro-competition approach to the financial services industry.328 Its role has largely been directed to the facilitation of an effective and fair market place in which businesses will compete in serving the needs of the consumer.329
Regulators have determined that where regulation is appropriate it is to be as light- handed as possible:
It is a basic principle of industry efficiency and public welfare that the degree of intervention should be the minimum necessary to achieve the identified objectives. The manner of intervention should be that which imposes the least cost of compliance consistent with achieving the identified objectives.330
The Final Report of the 2014 FSI aimed to ‘lay out a blueprint for the financial system over the next decade,’ and was charged with updating the ‘philosophy, principles and objectives underpinning the development of a well-functioning financial system.’331 The Report found that prevention of market failure provides the general case for government intervention.332 Market failure occurs when an efficient market is not present, resulting in an imbalance between supply and demand.333
328 Bollen, ‘Best Practice is the Regulation of Payment Services,’ (2010) above n 2, 26. 329 Ibid. 330 ‘Industry Self-Regulation in Consumer Markets,’ (Report, Taskforce on Industry Self-Regulation (‘the Colllier Report’), August 2000). 331 Murray, David, Dunn et al, above n 26, viii. 332 Wallis, Beerworth, Carmichael et al, above n 38. 333 Bollen, ‘Best Practice is the Regulation of Payment Services,’ above n 2, 28. 78 The financial system in Australia has resulted from a unique process of development, making its regulation quite different to that of other countries.334 Following the 1997 Wallis Inquiry, regulation in Australia has been divided between three separate agencies, each assigned the objective of addressing one of the main sources of market failure. The RBA is responsible for monetary policy, the payments system and financial stability. APRA has responsibility for the prudential soundness of all deposit taking institutions, insurance companies and superannuation funds. ASIC is responsible for conduct regulation of all financial institutions, markets and market participants. Prudential regulation focuses on ensuring that individual financial institutions are able to withstand external shocks and can continue to meet their obligations to depositors, supporting the resilience of the system as a whole.335 Conduct regulation focuses on reducing the risk that consumers will be harmed through their interactions with the financial system, and provides for remedies in cases of misconduct.336
APRA and ASIC are the ‘twin peaks’ that have characterised the Australian regulatory model, now being emulated around the world. Australia was the first country to bring all prudentially regulated entities under one regulator and group all market conduct matters under another.337
The Australian financial regulatory structure ensures effective coordination and cooperation between the three regulators. The separate regulators are coordinated by the Council of Financial Regulators (CFR), another creation of the Wallis Inquiry. The CFR website emphasises facilitating regulatory cooperation and collaboration, contributing to the efficiency and effectiveness of regulation and promoting stability of the Australian financial system.338 Cooperation agreements have been set out in three
334 Alex Erskine, ‘Regulating the Australian Financial System,’ (Funding Australia’s Future Project, Australian Centre for Financial Studies, July 2014), 11 < https://australiancentre.com.au/wp- content/uploads/2016/04/FAF2-Regulation.pdf>. 335 Productivity Commission, ‘Competition in the Australian Financial System Final Report’ above n 176, 63. 336 Ibid 64. 337 Andy Schmulow, ‘Doing it the Australian Way, “Twin Peaks” and the Pitfalls in between,’ (31 March 2016) Columbia Law School (online) < http://clsbluesky.law.columbia.edu/2016/03/31/doing-it-the- australian-way-twin-peaks-and-the-pitfalls-in-between-2/>. 338 Council of Financial Regulators, About the CFR, (2018) < https://www.cfr.gov.au/about- cfr/index.html>. 79 Memoranda of Understanding signed between the RBA and APRA, between APRA and ASIC, and between the RBA and ASIC.
The strengths of this model is that it encourages regulatory neutrality by avoiding regulatory bias for example where there are multiple regulators for similar types of institutions.339 It minimises cultural classes between different institutions, which may happen where market conduct regulation and prudential regulation are within one institution. This model is also designed to minimise regulatory gaps and overlaps, although, as will be demonstrated in Chapter Four, gaps and overlaps in the regulation of stored value facilities remain.
Weaknesses of this model include conflict of interest between the regulators, arising from differences in their governing objectives.
The twin peaks model places the most experienced and well-equipped organisations in charge of establishing and administering regulations. It is not based on co-regulation, but on cooperation between the regulators, who each have a fundamentally different mandate. The objectives of each regulator, and the extent of co-regulation between each regulator and their regulated industry bodies is outlined in the following section.
3.2 An Australian Co-Regulatory Approach
Although there was no specific mention of co-regulation in the 2014 FSI Final Report, there is already in existence a high level of it in the financial system, with co-regulation being explicitly incorporated into the consumer protection regulatory framework.340
339 Jeffrey Carmichael, ‘The Australian Model of Integrated Regulation,’ (Speech delivered at the 25th IOSCO Annual Conference, Sydney, 17 May 2000) < https://www.iosco.org/library/annual_conferences/pdf/ac25-11.pdf>. 340 Nicola J Howell, ‘Revisiting the Australian Code of Banking Regulation: Is Self-Regulation still relevant for improving consumer protection standards?’ (2015) 38(2) University of New South Wales Law Journal 544. 80 The Australian Government has encouraged the use of self- and co-regulatory mechanisms as part of its best practice regulation agenda.341
The Australian payments framework itself is largely co-regulatory, and since 2003 the informal co-regulatory model has been overlaid with specific government interventions such as access regimes and standards under the Payments System (Regulation) Act 1998 (Cth) (PSRA).342
Co-regulation between regulators and industry through voluntary codes is a key concept in the Australian regulation of electronic money. These arrangements, agreements and understandings require industry participants to assume some responsibility; this is underpinned by legislative obligations, with the regulators retaining ultimate authority.
Electronic payments have evolved largely in the absence of heavy-handed regulation, which has contributed to many of their benefits, including low transaction fees and fast processing times, but left unaddressed many of the risks that they pose. When considering the future of payments, the primary concern should not be with its technology, but with the legal frameworks in which it operates. Governments may choose to only lightly regulate stored value facilities, in order not to stifle their growth, or they may choose to use regulation to influence the direction in which they wish such facilities to grow.
The Australian Government has cooperative and/or self-regulatory arrangements with a number of non-government bodies across various industries. Responsive regulation has informed the regulatory style of the RBA, APRA , ASIC as well as AusPayNet.343 The role of each regulator, and the degree to which it adopts a co-regulatory approach, will be examined below.
341 ‘Best Practice Regulation Handbook’ (Handbook, Australian Government, Department of Finance and Deregulation, Office of Best Practice Regulation, June 2010) 33–34. 342 Australian Payments Clearing Association, Submission to the Treasury, Financial System Inquiry, March 2014, 8. 343 Haines and Gurney, above n 325, 199. 81 i. The Reserve Bank of Australia
The RBA, Australia’s independent central bank is responsible for the fundamental stability of the Australian financial system through monetary policy and regulation of its payment systems. Its role in the regulation of the payments system was extended following recommendations of the 1997 Financial Systems Inquiry.344 It consists of two Boards; the Reserve Bank Board which monitors and regulates monetary policy, and the Payments System Board, which is responsible for policy relating to the operation of the payments system.345
The RBA adopts a strong form of co-regulation. In general it will consult extensively with industry, present its analysis and conclusions, then meet with industry participants in order to promote voluntary reform.346 The Payment Systems (Regulation) Act generally allows the Bank to regulate where it considers it in the public interest to do so.347 The preamble to the Payments System (Regulation) Bill puts co-regulation at the centre of the intended payments system regulatory framework:
…the philosophy of the Bill is…co-regulatory. Industry will continue to operate by self- regulation in so far as such regulation promotes an efficient, competitive and stable payments system.
The Explanatory Memorandum for the Payments Systems (Regulation) Bill further recommends that any intervention by regulator only occur ‘after substantial consultation with participants and after consideration of alternative regulatory approaches and voluntary arrangements have been exhausted.’348 While the Payments System (Regulation) Act does not mandate a co-regulatory approach, the RBA has
344 Wallis, Beerworth, Carmichael et al, above n 38, 386. 345 Reserve Bank Act 1959 (Cth); Reserve Bank of Australia, Payments System Board (2016) < https://www.rba.gov.au/about-rba/boards/psb-board.html>. 346 Wardrop, above n 309, 207. 347 Reserve Bank of Australia, Approach to Regulation (2017) < https://www.rba.gov.au/payments-and- infrastructure/payments-system-regulation/approach-to-regulation.html>. 348 Payments System (Regulation) Bill 1998 (Cth), [11]. 82 made it clear in a number of statements that it has adopted the co-regulatory method:349
…the Reserve Bank is a reluctant regulator and we would much rather see an industry, than a regulatory, response to public-policy concerns…the Board is interested in the scope for the private sector to develop arrangements that address public-policy concerns about competition and efficiency.350
Whilst the intent of the Act is explicitly co-regulatory, the RBA’s obligations may arise sequentially.351 For example, the RBA has no formal role in stored value payments unless it ‘designates’ a payment system under Section 11.352 Once it has determined to designate, the RBA has under Section 10 almost unlimited powers to act in the public interest. It may determine rules for participation in the payments system, including access rules for new participants, set standards for safety and efficiency of the system, direct participants to comply with a standard or access regime, and arbitrate on disputes in the system on matters relating to access, financial safety, competitiveness and financial stability.353 The RBA’s decisions under the Payments System (Regulation) Act (unlike the decisions of the Australian Competition and Consumer Commission (ACCC)) are not subject to merits review.354
Whilst the RBA’s powers are broad, they are in practice used sparingly, and the Government has stated that self-regulatory measures are preferred as long as they operate satisfactorily.355 When the RBA refers to ‘self-regulation’ it appears to mean
349 Wardrop, above n 309, 207; Reserve Bank of Australia, ‘Payments System Board’ (Annual Report, 2 October 2003), 2. 350 Philip Lowe, ‘Reform of Australia’s Payments System: The 2007/08 Review,’ (Speech delivered at the 4th International Consumer Credit Card Summit, Sydney, 27 June 2007) < https://www.rba.gov.au/speeches/2007/sp-ag-270607.html>. 351 Australian Payments Clearing Association, Submission to the RBA, Reform of Australia’s Payments System: Issues for the 2007/8 Review (August 2007), 11. 352 A further discussion on RBA designations and how they have been utilised in stored value regulations is contained in Chapter Four. 353 Reserve Bank of Australia, Payments System Board (2016) < https://www.rba.gov.au/about- rba/boards/psb-board.html>. 354 ‘Payments System Board’ (Annual Report, Reserve Bank of Australia, September 2006), 21
ii. The Australian Prudential Regulation Authority
APRA is a statutory authority of the Australian government, and the prudential regulator of the financial services industry. It was established following the recommendations of the Final Report of the 1997 FSI by the Australian Prudential Regulation Authority Act 1998 (Cth). Prior to 1998, the RBA was responsible for the prudential oversight of companies in the financial sector,358 but the creation of APRA allowed the RBA to focus on macroeconomic management and monetary policy.359 This has aided in removing the impression that the RBA is a ‘lender of last resort;’ an ultimate guarantor of any individual bank.360
APRA oversees banks, credit unions and other financial institutions and is funded largely by the institutions it supervises.361 Under Subsection 8(2) of the Australian Prudential Regulatory Authority Act 1998 (Cth), APRA’s supervision must ‘balance the objectives of financial safety and efficiency, competition, contestability and competitive neutrality.’ Its primary role is to ensure that organisations in the financial services industry are able to manage their risk appropriately, to minimise their threat to the financial system.362 APRA’s tasks include creating and enforcing standards in the industry, advising the Commonwealth Government of regulatory policy, and protecting
356 Wardrop, above n 309, 207. 357 Australian Payments Clearing Association, Submission to the RBA, above n 351, 10. 358 The Insurance and Superannuation Commission supervised insurance and superannuation companies and was replaced by APRA. 359 ‘The origins of APRA’ (Factsheet No. 2, Australian Prudential Regulation Authority, June 2015 < http://www.apra.gov.au/AboutAPRA/Publications/Documents/APRA-FS2-062015.pdf>. 360 King & Wood Mallesons, Australian Financial Law, (Thomson Reuters, 7th ed, 2016) 7. 361 Australian Prudential Regulation Authority, About APRA, (February 2018) < https://www.apra.gov.au/about-apra>. 362 King & Wood Mallesons, above n 360, 4. 84 the financial system from fraudulent or negligent behaviour of companies that provide financial services.363
APRA works closely with the other regulatory agencies, and has standing committees with both ASIC and the RBA.364 It has generally demonstrated a co-regulatory approach to regulation. APRA has announced their intent to work closely with industry, with the then-chief executive officer of the newly formed APRA stating that ‘genuinely open, two-way communication with industry will be a very high priority.’365 It has emphasised that its preferred approach to manage issues is to work with regulated entities to resolve problems and improve risk management.366
iii. The Australian Securities and Investment Commission
ASIC is an independent Commonwealth government body that acts as Australia’s corporate, markets and financial services regulator, set up by the Australian Securities and Investment Commission Act 2001 (Cth).367 ASIC is responsible for disclosure standards, dispute resolution and general consumer protection issues relating to all financial services providers.
The legislative sanctions available to ASIC and the enforcement policy developed and published by ASIC reflect many aspects of responsive regulation.368 ASIC’s law enforcement pyramid includes punitive action, protective action (such as disqualifying orders), preservative action (such as court injunctions), corrective action (such as
363 Ibid. 364 Graeme Thompson, ‘APRA and the New World of Financial Regulation,’ (Speech delivered to the Committee for Economic Development of Australia, Sydney, 27 August 1998) < http://www- test.apra.gov.au/Speeches/Pages/98_03.aspx>. 365 King & Wood Mallesons, above n 360. 366 ‘The APRA Supervision Blueprint,’ (Report, Australian Prudential Regulation Authority, May 2015), 7, < https://www.apra.gov.au/sites/default/files/APRA-Supervision-Blueprint-FINAL.pdf >. 367 Australian Securities and Investment Commission, About ASIC (23 March 2016) < https://asic.gov.au/about-asic/>. 368 ‘Performance of the Australian Securities and Investments Commission,’ (Final Report, Australian Senate, Economic References Committee, 26 June 2014) 29, < https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/ASIC/Final_Report/in dex>. 85 corrective advertising), compensation action and negotiated resolution.369 Since 2001, ASIC has had power to approve industry codes and industry dispute resolution schemes in the financial services sector.370
ASIC has recognised the benefits of a co-regulatory approach, observing that when compared to government regulators, industry may have greater knowledge of industry participants and be able to respond to emerging regulator problems in a more timely and flexible manner.371 According to ASIC, a ‘well-designed system of co-regulation could improve outcomes for consumers through greater flexibility, responsiveness and oversight.’372 ASIC has indicated that it is of the view that industry self-regulation can play a valuable role in conjunction with legislation and other regulatory mechanisms.373 ASIC regulates the consumer protection provisions of stored value facilities through the ePayments Code, a voluntary industry Code of Conduct. It has stated that it sees Codes as ‘a means of “fleshing out” existing, but perhaps uncertain, legislative obligations and establishing guidelines for “best practice.”’374
ASIC has demonstrated a willingness to work with other regulators. ASIC and APRA have close interests, and have co-operated closely on joint investigation programs, information sharing and enforcement, including the creation of joint ASIC-APRA enforcement task forces.375
369 Ibid 30. 370 Howell, above n 340, 544. 371 John Price, ‘Our markets: A regulatory update,’ (Speech delivered at G100 Dinner, Melbourne, 25 September 2014) < http://download.asic.gov.au/media/1901735/speech-g100-dinner-published-25- september-2014.pdf>. 372 Australian Securities and Investment Commission, Submission to the Treasury in Response to the Interim Report, Financial System Inquiry (August 2014), 92. 373 Jillian Segal, ‘Institutional self-regulation: what should be the role of the regulator?’ (Speech delivered to National Institute for Governance Twilight Seminar, Canberra, 8 November 2001), 4. 374 Ibid 10. 375 Reserve Bank of Australia, ‘Australia’s Financial Regulatory Framework,’ (Annual Report, Council of Financial Regulators, 1999) < http://www.rba.gov.au/publications/annual-reports/cfr/1999/aus-fin-reg- frmwk.html>. 86 iv. The Australian Payments Network & The Payments Council
The Australian Payments Network (AusPayNet), formerly the Australian Payments Clearing Association is the Australian payment industry’s principal self-regulatory body, established to administer the technical and operational rules and standards between banks, credit unions, and other payments associations.376 Its role includes managing and developing regulations, procedures, policies and standards governing payments clearing and settlement.377 AusPayNet has advocated for co-regulation, with industry and regulator working together to improve the efficiency and competitiveness of the overall payments system.378
AusPayNet works closely with government, regulators, payments stakeholders and individuals to improve the payments system.379 It manages five clearing systems, which clear more than 98% of Australia’s non-cash retail payment values.380 AusPayNet does not regulate stored value payments directly, but coordinates the rules and processes of electronic payments and provides valuable commentary on their regulation in its reports and submissions.
AusPayNet has advocated that the ‘co-regulatory approach of setting high-level policy objectives, supported by co-ordination and self-regulation by payment system participants to achieve these objectives, is the best way to meet future challenges.’381 It has argued that in a rapidly changing and technologically-complex environment, it is not possible to regulate for each new entrant or payment method, but at the same time, leaving regulation to market forces is likely to result in sub-optimal outcomes.382
376 Australian Payments Clearing Association, Submission to the RBA, above n 351, 4. 377 Ibid. 378 Ibid 2. 379 Australian Payments Clearing Association, What we do, (2016)
AusPayNet and the RBA have together established the Australian Payments Council to promote industry collaboration in order to foster the development of the payments industry.384 The Payments Council directly engages with the Payments System Board (PSB) of the RBA to facilitate alignment between regulator and industry on significant payments issues and initiatives.385 AusPayNet has stated that the co-regulatory approach taken by the PSB and industry has worked well.386
4. CONCLUSION
While the wait-and-see approach and in-advance approach each have their merits, for the regulation of stored value facilities, a mixed approach is the most suitable in terms of providing some protection against risk, while allowing products to develop organically. For example, low value or developing products may be regulated with a wait-and-see approach, while larger, more widely-used products could be captured by in-advance regulation. Responsive regulation through co-regulation is one type of mixed approach, as it allows for industry contribution within a government framework.
Each of the RBA, APRA, ASIC and AusPayNet, working through the twin-peaks model of co-ordinated regulation, have publically indicated their support for co-regulation with the payments industry, and have demonstrated their willingness to cooperate with each other. Taking into account the risk that regulation is likely to stifle to some extent the development of digital stored value and assessing the many benefits stemming from the use of electronic money, the Thesis accepts that the risks inherent in keeping early light-touch regulation at this stage of development are justified.
383 Australian Payments Clearing Association, Submission to the Treasury, above n 381. 384 Australian Payments Council, About Us (2017) < http://australianpaymentscouncil.com.au/about- us/>. 385 Ibid. 386 Australian Payments Clearing Association, Submission to the Treasury in Response to the Interim Report, above n 382, 4. 88 It is essential that co-ordinated regulation is adopted for the management of stored value facilities, in Australia and around the world. Stored value facilities are growing rapidly, providing consumers with a non-cash product without the need for a bank account. They represent new risks to the consumer and the payments market generally, and these risks must be effectively managed to further confidence and trust in the stored value system.
The RBA has reported that Australia’s financial regulatory structure has strong mechanisms to ensure effective co-ordination and co-operation between regulatory agencies, particularly among RBA, ASIC and APRA.387 The Payments System Board overlaps the agencies, and there are regular inter-agency senior meetings. The weakness of this approach is an Australian stored value facility may be subject to multiple regulatory regimes, which may have different and potentially conflicting regulatory goals, and having to comply with three different regulators may prove to be an unnecessarily heavy regulatory burden for smaller issuers. However, it is my opinion that these regulators possess the requisite experience and insight into payments systems to be in the best position to administer the most effective regulatory scheme for stored value payments.
In the following Chapter, the specific regulations of each regulator relevant to stored value facilities and whether or not they have a co-ordinated and/or co-regulatory approach will be examined. Alternative roles for the regulators will be proposed, and recommendations made for adjusting the current regulatory framework.
387 Reserve Bank of Australia, ‘Australia’s Financial Regulatory Framework,’ (Annual Report, Council of Financial Regulators, 1999) < http://www.rba.gov.au/publications/annual-reports/cfr/1999/aus-fin-reg- frmwk.html>. 89 CHAPTER FOUR: AUSTRALIA’S CURRENT REGULATORY FRAMEWORK
1. AUSTRALIA’S E-MONEY REGULATIONS 90 2. REGULATION BY THE AUSTRALIAN PRDUENTIAL REGULATION AUTHORITY 92 3. REGULATION BY THE RESERVE BANK OF AUSTRALIA 101 4. REGULATION BY THE AUSTRALIAN SECURITIES AND INVESTMENTS 105 COMMISSION 5. MAIN ISSUES WITH THE EXSTING REGULATORY FRAMEWORK 110 6. CONCLUSION: PREPARING FOR A DIGITAL ECONOMY 116
In Section One of this Chapter I outline the current regulatory regime for stored value facilities in Australia and examine the interrelation of Australia’s regulators. Sections Two, Three and Four examine the regulatory regimes, as they relate to stored value facilities, of APRA, the RBA and ASIC respectively. I afford particular attention to identifying which stored value products are captured by the existing regulations, and which are not. Section Five discusses the primary weaknesses of the existing regulatory regime. The analysis in this Chapter forms the basis of the recommendations for a new stored value regime that provides greater flexibility for existing products and captures emerging technologies, found in Chapters Six, Seven and Eight.
1. AUSTRALIA’S E-MONEY REGULATIONS
The achievement of a well-functioning payments system is an attribute essential for the well-being of a nation’s economy. An effective regulatory regime for stored value facilities is one that provides clarity for all participants, an appropriate level of competitive neutrality between issuers of similar products, is open to the innovation and development of new and existing products, and provides an adequate level of client protection.
A payments system must be efficient and reliable. Participants must have a high level of confidence in the payments system; in the absence of that they would not be
90 prepared to use it. As the payments system underpins most transactions in the economy it is a critical component of the broader financial system and must be accepted by its users to be dynamic and efficient.388 It has the ability to create or amplify economic shocks due to its complexity and its interconnectedness with the rest of the economy.389 Accordingly, it is apparent that the payments system demands carefully considered regulation to reduce the likelihood and consequence of any adverse impact of the broader economy.
E-money products pose significantly less systemic risk than other payments products and financial services, as even where they are widely used, they account for only a small portion of total funds in electronic payments in a country.390 Even so, the failure of a large e-money issuer could cause major disruption to a nation’s economy, including financial losses, the disruption of trade and payments, and reputational risk of the regulators.391 This would likely undermine consumer confidence in e-money products and possibly the financial system generally.
For stored value products in particular, careful and proportionate regulation is essential to ensure the integrity of the electronic money payments system. Integrity of the system and the products depends upon the security and reliability of its underlying technology and the creditworthiness and liquidity of the issuers. As with other financial products, the need for adequate security of stored value products is essential for these products to gain acceptability amongst retailers and consumers. The 2014 FSI Final Report has added that while consumers should generally bear responsibility for their financial decisions, they are entitled to expect financial products and services to perform in the way they have been led to believe they will.392
388 Murray, David, Dunn et al, above n 26, 36. 389 Ibid 10. 390 Kemp and Buckley, ‘Resolution powers over e-money providers,’ above n 109, 1541. 391 Ibid. 392 Murray, David, Dunn et al, above n 26, 12. 91 2. REGULATION BY THE AUSTRALIAN PRDUENTIAL REGULATION AUTHORITY
In the 1990s, highly publicised trials of products such as the electronic purse (a smartcard based stored value system) and internet-based electronic cash caught the attention of the public and of regulators.393 In 1997 the Final Report of the Wallis Inquiry concluded that these new electronic payment facilities, dubbed purchased payment facilities (PPFs) had the potential to become an important element of the Australian payment system.394 As a result of the Wallis Inquiry, the Australian Government decided that holders of stored value should be subject to government regulation to ensure the safety and integrity of the payments system.395 In particular, it decided that open-loop systems must be subjected to regulation, because the volumes of money they involve are sufficiently large as potentially to disturb the wider payments system.396 The Government decided that closed-loop products posed little systemic risk, and accordingly required little formal regulation.397
Following the Inquiry, the Payments System (Regulation) Act 1998 (Cth) was enacted. The PSRA requires all holders of stored value to be authorised by the Reserve Bank, unless within certain exemptions.398 The Explanatory Memorandum to the PSRA explains that this is because such facilities
…operating in closed systems for the purposes of a single merchant or small group of merchants (such as telephone cards) pose little systemic risk and require no special prudential regulation. However, smart cards operating in open systems, or intended for widespread use as a means of payment at many merchants, pose different risks
393 Reserve Bank of Australia, Regulation of Purchased Payment Facilities: Proposed Exemptions under the Payments System (Regulation) Act 1998, (Discussion Paper, 15 September 2003) 1
Under Section 22 of the PSRA, a corporation may not be the holder of the stored value of a purchased payment facility unless it is an authorised deposit-taking institution or has an exemption granted by the RBA under s23 or s25.400 ADIs include banks, building societies, credit unions and similar institutions that accept deposits.401 In order for a corporation to describe itself as a ‘bank’, ‘building society’ or ‘credit union’, it must meet certain additional criteria.402
The Government subsequently decided that in order to ensure consistency of regulatory treatment, all purchased payment facilities akin to a deposit, whether offered by an ADI or not, should be regulated by APRA under a common regime.403 APRA authorises institutions that carry on banking business under the Banking Act 1959 (Cth). In order to bring such entities under APRA’s supervision the government enacted a regulation that defined carrying on banking business to include the provision of PPFs with deposit-like characteristics. Under section 5 of the Banking Act, ‘banking business’ is defined as:
Section 5, Interpretation:
a. A business that consists of banking within the meaning of paragraph 51(xiii) of the Constitution; or b. A business that is carried on by a corporation to which paragraph 51(xx) of the Constitution applies and that consists, to any extent, of: i. Both taking money on deposit (otherwise than as part-payment for identified goods or services) and making advances of money; or
399 Payment Systems (Regulation) Bill 1998 (Cth), [3.8]. 400 This is addressed in Section 2, Regulations of the RBA, below. 401 Reserve Bank of Australia, Main Types of Financial Institutions, (June 2017) < https://www.rba.gov.au/fin-stability/fin-inst/main-types-of-financial-institutions.html>. 402 Australian Prudential Regulatory Authority, Authorised Deposit-taking Institutions, (2016) < http://www.apra.gov.au/adi/Pages/default.aspx>. 403 Reserve Bank of Australia, Regulation of Purchased Payment Facilities: Proposed Exemptions under the Payments System (Regulation) Act 1998, above n 394, 1. 93 ii. Other financial activities prescribed by the regulations for the purposes of this definition.
The criteria for supervision by APRA include: the product is widely available for purchase and use as a means of payment, and, the stored value is redeemable by the user in Australian currency on demand.404 Overseas digital wallets are redeemable on demand, however as wallets such as AliPay and WeChat wallet require a Chinese bank account to operate, their stored value is not redeemable for Australian currency and consequently they are not caught by APRA’s regulation.405
No minimum stored value threshold is defined in the legislation, but APRA has interpreted the RBA exemptions for small stored value facilities (see below) as also exempting them from regulation by APRA, although this is not explicitly published.406
2.1 Regulating PPFs under the ADI Regime: Conditional Licences
APRA has determined that, while it may be ideal to have a harmonised supervisory approach to all ADIs, it is not appropriate to apply the existing ADI regime to PPF providers for reasons of incompatibility and unreasonable regulatory burden.407 APRA has advised that the costs of complying with the full ADI regime would likely ‘be prohibitive to any but the largest PPF providers, even factoring in the lower credit risk’ and has reasoned that this would result in fewer PPF providers entering the market, restriction of the development of e-money and alternative forms of payment in Australia, and higher costs being passed on to consumers by those PPF providers that
404 Reserve Bank of Australia, Australian Prudential Regulation Authority ‘Regulation of Purchased Payment Facilities,’ (Joint Media Release, 15 June 2000)
Fundamental differences exist between PPF providers and traditional ADIs in their balance sheets, risks generated, and the underlying nature of their business. The receipt of deposits for the purpose of making advances of money is not the primary business of PPF providers; rather the stored value is ‘largely a residue of the services provided by these facilities.’410 APRA has clarified: ‘PPFs are specifically designed as a means of payment rather than storing wealth, and they typically hold relatively small amounts of money for short periods as a residue of the services provided.’411 As PPF providers do not fund their business operations through their PPF liabilities, they are not as highly leveraged, and their balance sheets and types and levels of risk are different from ADIs engaged in typical banking business.412
APRA has identified credit risk413 as the fundamental risk arising from an ADIs banking business, but determined that PPF providers appear to be more exposed to liquidity, market, operational, reputational and legal risks, rather than credit risk.414 PPF providers need to hold assets against their liabilities (the stored value float) and market risk is ‘the risk of adverse movements in the mark-to-market value of these assets.’415 Liquidity risks are of special concern to PPF providers as redemption rates are expected to be high and potentially volatile.416
408 Ibid. 409 Australian Prudential Regulation Authority, Guidelines on Authorisation of Providers of Purchased Payment Facilities, (Guidelines, August 2010), 4. 410 Australian Prudential Regulation Authority, Regulation Impact Statement, above n 406, 2. 411 Ibid. 412 Ibid. 413 Credit risk is defined as ‘the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms: Basel Committee, ‘Principles for the Management of Credit Risk,’ (Publication, Risk Management Group of the Basel Committee on Banking Supervision, September 2000) < https://www.bis.org/publ/bcbs75.pdf>. 414 Australian Prudential Regulation Authority, Regulation Impact Statement, above n 406, 3. 415 Ibid. 416 Ibid. 95 The Basel Committee on Banking Supervision highlighted in its risk management principles for electronic banking that operational, legal and reputational risk are important to PPF providers as they are engaged in electronic banking.417 Systems failure, business continuity and security risks are particular operational risk relevant for PPF providers.418 Legal risk usually arises in relation to information disclosure and protection of consumer data; reputational risk may arise from issues such as operations failure or failure to comply with legal requirements.419 Legal and reputational risks fall within the regulatory responsibility of ASIC and are addressed by the requirement for non-cash payment facilities to be licensed as a financial product under the Corporations Act 2001 (Cth).420
The complex business models of PPF providers, that often involve a number of entities when compared with other ADIs, illustrate a further relevant difference between them.
APRA illustrates this with an example:
…one entity may be responsible for making payments to consumers, another physically holds the stored value, while another may be the party that entered into the contractual relationship with the consumer.421
APRA has determined that the prudential framework thus needs to be sufficiently flexible to regulate individually the component parts of a PPF while recognising the differences in risk profile of each part.422 APRA has for that reason created two categories of PPF provider, one for those providers that hold stored value at risk and one for those that do not.
417 Basel Committee on Banking Supervision, ‘Risk management Principles for Electronic Banking’ (Publication, July 2003) 7 < https://www.bis.org/publ/bcbs98.pdf>. 418 Australian Prudential Regulation Authority, Regulation Impact Statement, above n 406, 3. 419 Ibid. 420 For further discussion, see Section 3, ASIC Regulations, below. 421 Australian Prudential Regulation Authority, Regulation Impact Statement, above n 406, 5. 422 Ibid. 96 These differences impact the regulatory treatment of PPF providers. Conditions of a conditional licence on PPF providers include:423
1. A restriction from accepting deposits for the purpose of making advances of money; 2. The provider must not represent that it is authorised to carry on the general business of taking deposits; 3. The business activities of the PPF provider are restricted to PPF business operations and closely related services; 4. In most cases the PPF provider must be incorporated in Australia; 5. PPF provider must provide financial data to APRA on a periodic basis.
APRA imposes additional authorisation criteria on a case-by-case basis. An institution with conditions on its licence may continue to operate indefinitely within the bounds of those conditions.424
2.2 Two Categories of PPF Provider: Stored Value at Risk
If a PPF provider can demonstrate that it has no stored value at risk, its prudential framework is limited to meeting existing ADI prudential standards on auditing requirements, business continuity management, outsourcing, governance, fitness and propriety.425
APRA’s Prudential Standard APS 610 (hereafter, APS 610) provides:
A purchased payment facility provider is deemed not to have stored value at risk if the purchased payment facility provider can satisfy APRA that: a. the PPF provider itself does not have any stored value liabilities; or b. the PPF provider has stored value liabilities but:
423 Australian Prudential Regulation Authority, Guidelines on Authorisation of Providers of Purchased Payment Facilities, above 409, 6. 424 Australian Prudential Regulatory Authority, ‘Licensing: A phased approach to authorising new entrants to the banking industry,’ above n 53, 11. 425 Australian Prudential Regulation Authority, Regulation Impact Statement, above n 406, 5. 97 I. the funds received in exchange for stored value on PPF devices or in PPF accounts are deposited in an account held with an ADI until settlement to payees occurs; and II. the PPF provider has no operational control of this account; and III. no creditors aside from the beneficiaries or payees of the stored value can have legal recourse to the assets held in this account in the event the PPF provider becomes insolvent or is wound-up. (Emphasis added).
The benefit of keeping customers’ funds safe and separate from the provider’s own funds is that it creates a legally recognised segregation of property, imposing obligations on the provider to use the stored value float for the benefit of the customers alone, as well as removing the risk that the float will be subject to claims by other creditors should the provider become insolvent.426
APRA has observed ‘it is important that all regulated entities that take on trust other people’s money meet appropriate standards of behaviour, which can be facilitated by prudential requirements on auditing, fitness and propriety and governance.’427 PPF providers that do not hold stored value at risk have complete relief from the need to hold capital.
For PPF providers that hold stored value at risk, the following additional APS 610 requirements apply:
1. A requirement to hold at all times Tier One statutory capital, the amount of which will be the higher of five per cent of total outstanding stored value liabilities, or the minimum start-up capital figure, determined by APRA on a case-by-case basis.428
426 Kemp and Buckley, ‘Resolution powers over e-money providers,’ above n 109, 1545. 427 Australian Prudential Regulation Authority, Regulation Impact Statement, above n 406, 8. 428 Australian Prudential Regulation Authority, Prudential Requirements for Providers of Purchased Payment Facility (Prudential Standard APS 610, January 2015) 4 < https://www.apra.gov.au/sites/default/files/Consequential-changes- APS_%2520610_January_2015.pdf>. 98 2. A requirement to have at all times high quality liquid assets equal to 100 per cent of its outstanding stored value liabilities;429 and 3. Additional operational risk requirements including the development, implementation and maintenance of a risk management framework. 430
Reasoning that capital ‘engenders confidence among liability holders that their claims will be repaid,’ APRA requires that each PPF provider hold sufficient capital to enable it to trade if unanticipated losses or other problems occur in its business operations.431 APRA imposes a further mandatory requirement on PPF providers that, aside from their PPF liabilities, PPF providers have sufficient internal resources to establish and operate the necessary infrastructure for PPFs.432 It states that
…these have been designed to minimise compliance costs, for example by formalising common market practice, and avoid creating barriers for new entrants, while ensuring the objectives of prudential supervision are met.433
To ensure that small entities seeking PPF authorisation are not automatically rejected APRA has chosen not to impose a minimum figure for start-up capital.434 APRA has further stated that in order to reduce compliance costs it has chosen a very simple methodology for calculating the necessary capital.435
PayPal is currently the only ADI that holds a conditional license as a purchased payment facility.436 It has been granted an Australian Financial Services Licence (AFSL) by ASIC to operate as a non-cash facility. Its conditions do not permit it to undertake deposit-taking activities such as charging and/or paying interest on any customer
429 Ibid 4.14. 430 Ibid 5.15. 431 Australian Prudential Regulation Authority, Regulation Impact Statement, above n 406, 6. 432 Ibid. 433 Ibid 8. 434 Ibid. 435 Ibid. 436 Australian Prudential Regulation Authority, List of Authorised Deposit-taking Institutions, (March 2016) < http://www.apra.gov.au/adi/Pages/adilist.aspx#PPPF>. 99 stored balances.437 For anti-money laundering and counter-terrorism financial measures it is also regulated by the Australian Transaction Reports and Analysis Centre as a Reporting Entity.
2.3 Restricted ADI Licences
APRA is proposing to introduce a phased approach to licensing new entrants, which includes the introduction of a temporary restricted ADI licence. APRA has stated that the new approach is to support increased competition by reducing barriers for new entrants being granted authorisation to conduct banking business, including those with innovative and non-traditional business models and those leveraging new technologies.438 The temporary licence will be granted for up to two years, following which the institution would either graduate to a ‘full’ ADI licence (with or without conditions) or exit the banking industry.439
APRA has advised that the purpose of a restricted ADI is to allow applicants to obtain a licence while they are still developing the resources and capabilities necessary to meet the prudential standards.440 It has stated that applicants will need a minimum of $3 million plus wind-up costs in start-up capital.441 The current requirement to obtaining a full ADI licence is $50 million in Tier One capital.442
Restricted licences are unlikely to be relevant for PPF providers that do not hold stored value at risk, as they are currently able to operate without start-up capital. It may be that certain PPF providers that hold stored value at risk will take advantage of the restricted licence where their conditional licence requirements of having to hold five per cent of their outstanding stored value liabilities exceeds $3 million. However, as
437 Australian Prudential Regulation Authority, Regulation Impact Statement, above n 406, 4. 438 Australian Prudential Regulatory Authority, ‘Licensing: A phased approach to authorising new entrants to the banking industry,’ above n 53, 5. 439 Ibid 18. 440 Ibid 5. 441 Ibid. 442 James Eyers, ‘APRA to adopt ‘phased’ licensing for start-up banks,’ The Financial Review (online), 15 August 2017 < http://www.afr.com/business/banking-and-finance/financial-services/apra-to-adopt- phased-licensing-for-startup-banks-20170815-gxwk5m>. 100 the proposed restricted licence has a two-year time limit before the licensed entity must enter the full ADI scheme, it is unlikely that any PPF provider will take advantage of this proposed license scheme.
3. REGULATION BY THE RESERVE BANK OF AUSTRALIA
3.1 Section 9 Declarations: Limited Facilities
As the PSRA is drafted quite broadly, it may be read as requiring authorisation by the RBA of special-purpose systems such as prepayment cards and other closed-loop payment products that have operated outside financial regulation successfully for decades.443 To remove any regulatory uncertainty and potential compliance burden, Section 9 of the PSRA gives the RBA the discretion to determine by declaration those facilities to which the PSRA applies.
Section 9(3) provides
The Reserve Bank may, by notice in writing published in the Gazette, declare that this Act does not apply to a specified facility, or to facilities included in a specified class of facilities, if the Reserve Bank considers that it is not appropriate for this Act to apply to the facility, or to each facility of that class, having regard to:
a. any restrictions that limit the number or types of people who may purchase the facility; or b. any restrictions that limit the number or types of people to whom payments may be made using the facility.
In exercising that discretion, the RBA is empowered to have regard to other matters that it considers relevant, but is not required to do so.444
443 Reserve Bank of Australia, ‘Regulation of Purchased Payment Facilities: Proposed Exemptions under the Payments System (Regulation) Act 1998,’ above n 394. 444 Payments System (Regulation) Act 1998 (Cth) s9(3). 101 The RBA has declared that small-scale facilities with total issued outstanding payments value not exceeding $10 million and facilities with 50 or fewer payees are not subject to the PSRA provisions on PPFs.445 It has by declaration exempted gift card facilities, loyalty schemes, electronic road toll devices and prepaid mobile phone accounts.446 In 2005, the Payments System Board granted an exemption to Westfield for their electronic gift cards on the basis that it is a limited payments facility regulated under existing corporations law and consumer protection legislation.447 Declarations may provide exemption for new entrants in trial phase and those operating in a relatively closed environment.
The consequence of a declaration is that the PSRA does not apply to the declared facility; it does not determine the legal nature of the facility, nor affect other applicable regulation.448 The RBA monitors developments in declared facilities, as it is envisaged that such facilities, once unfettered by the ADI restrictions, may grow significantly larger. Should they take on characteristics of ‘open’ payment systems, the RBA may need to review their exclusion.449
3.2 Reserve Bank of Australia: Authorities and Exemptions
i. Section 23 Authorisations
In addition to the RBA’s system of declarations, a stored value facility may become a purchased payment facility without first becoming an ADI, via an authority or an exemption granted by the RBA.
445 Reserve Bank of Australia, Declaration Regarding Purchased Payment Facilities, No. 2, April 2006. 446 Ibid. 447 Reserve Bank of Australia, ‘Changes in the Regulation of Purchased Payment Facilities,’ (Advice, April 2006)
4. A constitutional corporation commits an offence if: a. It is the holder of the stored value of a purchased payment facility; and b. It is not an authorised deposit-taking institution, within the meaning of the Banking Act 1959; and c. there is no authority or exemption in force under section 22 or 25 that applies to the corporation and the purchased payment facility.
Under Section 23 of the PSRA the RBA may by way of authorisation grant a corporation the status of a purchased payment facility to act as a holder of stored value without it being classified as an ADI. The RBA may impose conditions, add new conditions and revoke or vary existing conditions to ensure a corporation meets its obligations as a holder of stored value.450 A class of corporations that are not ADIs may be granted permission by the RBA to be holders of stored value for a type of specified purchased payment facility, for example providers of travellers’ cheques.451
ii. Section 25 Exemptions: Guaranteed Facilities
To clarify the regulatory regime governing PPFs and alleviate unnecessary regulatory burden the RBA may exempt certain classes of facility or an associated holder of stored value from regulation.452 Subsection 25(1) of the PSRA provides:
The Reserve Bank may grant a corporation, or corporations included in a class of corporations, an exemption allowing the corporation, or each corporation in the class, to be the holder of the stored value in respect of purchased payment facilities in a particular class even though the corporation is not an authorised deposit-taking institution, within the meaning of the Banking Act 1959, and does not have an
450 Payments System (Regulation) Act 1998 (Cth) s22, 23. 451 Australian Prudential Regulation Authority, Authorisation and Prudential Supervision of Providers of Purchased Payment Facilities, (Discussion Paper, May 2005), 2. 452 Reserve Bank of Australia, ‘Regulation of Purchased Payment Facilities: Proposed Exemptions under the Payments System (Regulation) Act 1998,’ above n 394. 103 authority under section 23 of this Act that covers those facilities.
An exemption conferred under Section 25 may apply to a corporation, or a class of corporations. No provision is made for the imposition of any condition on exemptions. The RBA has granted a general exemption to facilities or corporations in circumstances where an ADI or a Commonwealth, State or local government has guaranteed the stored value.453
Exemptions may be granted by the RBA acting on its own initiative or in response to an application.454 The RBA has received enquiries from organisations in the process of developing or offering PPFs in a pilot or test phase.455 In response the RBA has stated
…there would seem to be little public benefit in requiring companies to undergo a potentially lengthy and costly prudential authorisation process early in their business development process, where systemic risk does not exist and any risk to the user of the facility is negligible.456
Thus there are three options available to the RBA in regulating purchased payment facilities.
By requiring facilities to apply for authorisation on a case-by-case basis under Section 23 of the PSRA it may apply the full scope of the regulatory regime to purchased payment facilities. Alternatively, the RBA may under Section 25 of the PSRA provide exemptions to PPFs from the need to be authorised under Section 23. Third, the RBA may under Section 9(3) of the PSRA issue an exemption from the provisions of the PSRA to either a facility or a class of facilities, limiting the number or types of people who may purchase or be paid by the facility, or generally to corporations which act as
453 Reserve Bank of Australia, ‘Exemption Notice for Certain Guaranteed Holders of Stored Value Under Section 25: Payments System (Regulation) Act,’ (Media Release 2004–04, 4 March 2004). 454 Payments System (Regulation) Act 1998 (Cth) s25(2). 455 Reserve Bank of Australia, ‘Regulation of Purchased Payment Facilities: Proposed Exemptions under the Payments System (Regulation) Act 1998,’ above n 394. 456 Ibid. 104 holders of stored value if satisfied that the corporation will be able to meet its obligations as the holder of stored value.457
The differing mechanisms of authorisation and exemption allow a non-ADI to be a holder of stored value. No reason is given in the legislation for the different approaches; the only apparent difference is that an authority may be subjected to conditions. Professor Alan Tyree observes, (correctly, it is submitted with respect) that as there is no obligation for the RBA to impose conditions, the exemption provisions appear to be redundant.458
4. REGULATION BY THE AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION
PPFs not supervised by APRA may be required to undergo separate licensing processes with both the RBA and ASIC, with potentially overlapping requirements.459 Additional regulation governing non-cash payment facilities that include prepaid cards and other purchased payment facilities is provided by the Australian Securities and Investment Commission under the Corporations Act 2001 (Cth) and the Financial Services Reform Act 2001 (Cth).
The Financial Services Reform Act established a new licensing regime under the responsibility of ASIC for all providers of financial services, including providers of non- cash payment instruments. Providers of PPFs are explicitly covered and are required to be licensed by ASIC, unless issued an ASIC exemption. Holders of stored value, as providers of financial services need to have an Australian Financial Services Licence under the Financial Services Reform Act; they may also need to hold an Australian Credit Licence, also issued by ASIC.
457 Reserve Bank of Australia, Payment Systems (Regulation) Act 1998: Exemptions for Limited Facilities and Certain Guaranteed Holders of Stored Value, (Regulation Impact Statement, 10 March 2004), 2. 458 Tyree, The Australian Payments System, above n 448. 459 Reserve Bank of Australia, ‘Regulation of Purchased Payment Facilities: Proposed Exemptions under the Payments System (Regulation) Act 1998,’ above n 394. 105 In March 2016, ASIC created the ASIC Corporations (Non-Cash Payment Facilities) Instrument 2016/211 and updated RG 185. RG 185 defines an eligible non-cash payment facility in Section 5 as:
S. 5 In this Instrument ……. Eligible non-cash payment facility means a non-cash payment facility that: a. is issued by a financial services licensee; or b. is issued by a participant in a designated payment system, within the meaning of section 7 of the Payments System (Regulation) Act 1988, and that relates to that system.
ASIC may grant class orders to purchased payment facility issuers according relief and individual exemptions from the requirement to hold these licences.460 In considering such applications, ASIC will take into account the nature, scale and complexity of the facility, whether the facility is subject to adequate alternative regulation and the likelihood of significant developments in the nature or use of the facility.461 Relief accorded may be conditional or unconditional.462
ASIC has determined that it will employ a ‘flexible approach’ to non-cash payment facilities, recognising that they are a ‘developing area’ that includes a ‘broad spectrum of facilities.’463 The RBA and ASIC adopt a co-ordinated approach to regulating non- cash facilities; RBA exemptions generally work with ASIC class orders that exempt certain purchased payment facility providers from certain provisions of the Corporations Act.464 Most of these forms of payment involve payment to fewer than
460 Corporations Act 2001 (Cth) Ch 7. 461 Australian Securities and Investments Commission, Regulatory Guide 185: Non-Cash Payment Facilities (15 November 2005), RG 185.8. 462 Ibid RG 185.9. 463 Ibid RG 185.5. 464 Reserve Bank of Australia, Submission No 1 to the Financial System Inquiry Committee, Financial System Inquiry, March 2014, 8.5.2 < http://www.rba.gov.au/publications/submissions/financial- sector/financial-system-inquiry-2014-03/developments-and-innovation.html>. 106 50 people; they are already excluded from the Payments Services (Regulation) Act under the RBA’s existing limited facilities criteria.465
In ASIC Corporations (Non-cash Payment Facilities) Instrument 2016/211 ASIC has granted conditional relief to low value facilities that may not at any one time hold more than $1000 in any one account, and the total value held in all accounts does not exceed $10,000,000.466 It has granted unconditional class order relief to persons providing financial services in relation to gift cards and prepaid mobile phone accounts so that they do not have to meet the licensing, conduct and disclosure obligations of the Corporations Act.467 ASIC has declared that loyalty schemes and electronic road toll devices are not financial products for the purposes of the Corporations Act.468 The ASIC Corporations (Non-cash Payment Facilities) Instrument 2016/211 replaces previous class orders which were to expire, and extends these exemptions for a further three years. It is likely that this is an interim measure awaiting review of the Australian payments regulatory framework.
In addition to its licensing regime powers, ASIC regulates stored value facilities through the ePayments Code.
4.1 Self-Regulation and the ePayments Code
The payments industry is regulated through a mix of formal regulation, and industry self-regulation. AusPayNet has proposed that cooperative engagement of public and private regulators needs to commence at the earliest possible stage of establishing policy objectives, and should continue through to compliance.469
465 Reserve Bank of Australia, Declaration Regarding Purchased Payment Facilities, No. 2, April 2006. 466 Australian Securities and Investments Commission, Corporations (Non-cash Payment Facilities) Instrument, 2016/211, 18 March 2016, 1.5. 467 Australian Securities and Investments Commission, Regulatory Guide 185: Non-Cash Payment Facilities (15 November 2005), RG 185.9. 468 Ibid RG 185.9. 469 Australian Payments Clearing Association, Submission to the Reserve Bank of Australia, Reform of Australia’s Payments System: Issues for the 2007/8 Review, August 2007, 14. 107 To harmonise government objectives with market efficiency, responsive regulation requires the delegation of regulatory functions to private actors; these may include public interest groups, trade unions and industry associations.470 By legislating self- regulation through various industry codes of conduct governments transfer some of the risks of regulation from regulatory authorities to industry. Industry codes of conduct engage the reputation of the whole industry, and delegate the resolution of complaints and consumer disputes to industry-based bodies.471 Industry standards set by Codes are voluntary and not enforceable; they have enforceability only following the voluntary choice to be so bound by relevant individual industry-based bodies.
ASIC has described industry codes of conduct as sitting ‘at the apex of industry self- regulatory initiatives’; it reserves the term code for self-regulatory instruments that have binding and enforceable rules, transparent processes for developing and reviewing the rules, and instruments that effect monitoring and compliance arrangements.472 According to ASIC, by raising standards and complementing legislative requirements such codes improve consumer confidence and result in measurable consumer benefits in industry.473
Many financial services providers, having so elected, are under no legislative obligation requiring subscription to an ASIC-approved code or indeed, to any code at all.474 Industry cooperation is required for codes to be successful; the payments industry has generally expressed its support for self-regulation.475 ASIC has promulgated a code directed specifically at the payments industry, the ePayments Code.
470 Richard Johnstone, ‘Rethinking Responsive Regulation,’ Video Transcript, Safe Work Australia, 23 October 2015, 2 < http://www.safeworkaustralia.gov.au/sites/swa/australian- strategy/vss/pages/richard-johnstone>. 471 Howell, above n 340, 544. 472 Ibid; Australian Securities and Investments Commission, Regulatory Guide 183 – Approval of Financial Services Sector Codes of Conduct (1 March 2013) RG 183.2. 473 Australian Securities and Investments Commission, Regulatory Guide 183 – Approval of Financial Services Sector Codes of Conduct (1 March 2013) RG 183.2. 474 Howell, above n 340, 544; Holders of an Australian Financials Services Licence must belong to an ASIC-approved industry-approved external dispute resolution scheme if providing services to retail clients, Corporations Act 2001 (Cth) ss 912A(1)(g), 912A(2)(b)(i). 475 Australian Securities and Investments Commission, ePayments Code Regulation Impact Statement, September 2011, 10 < http://ris.dpmc.gov.au/files/2011/09/03-ePayments-Code-RIS.pdf>. 108
ASIC’s ePayments Code, published in 2011 and amended in March 2016 is an example (where adopted) of industry self-regulation relating to stored value facilities. The Code has an important role in regulating electronic payment services; it complements other regulatory requirements and adds additional consumer protections.476 The ePayments Code regulates consumer electronic payments including online payments, internet and mobile banking. It requires stored value facility providers to provide consumers with terms and conditions, statements and receipts related to their payment facilities. It contains provisions relating to unauthorised and mistaken payments, and avenues for customer complaint and appeal.
At the time of this writing in 2018 the ePayments Code is voluntary. This has led to a divergence of views between bank and non-bank providers of financial services, to which subject I return later in this Thesis.477 The Australian Government in its response to the FSI Final Report in 2015 announced that ASIC will mandate the ePayments Code to ensure baseline consumer protections, however this is yet to be undertaken.478
Despite their voluntary nature self-regulation through codes is well established in the regulatory framework for financial services.479 Prior to publication of the ePayments Code in 2011, the Electronic Funds Transfer Code of Conduct (EFT Code) provided a voluntary code with application to card and PIN transactions and all forms of electronic banking.480 Importantly, the EFT Code addressed allocation of loss in the event of a dispute. Although it played an important role in the development of the electronic payments market it received criticism as not drafted in a technologically neutral manner and being limiting its application.481 Re-drafted and re-named the ePayments
476 Ibid 9. 477 See Chapter Eight. 478 Australian Government, ‘Improving Australia’s financial system’ (Government Response to the Financial System Inquiry, Australian Government, 2015), 15. 479 Howell above n 340, 552. 480 Financial Ombudsman, ‘E-Payments Code,’ (Service Circular, Issue 9, Autumn 2012) < https://www.fos.org.au/the-circular-9-home/epayments-code/>. 481 Australian Securities and Investments Commission, ePayments Code Regulation Impact Statement, above n 475, 6. 109 Code, it is now expressed in less technical language.482 Its provisions are similar to the EFT Code, but instead of repeating the separate provisions for stored value facilities that were contained in the EFT Code, the ePayments Code provides a set of requirements tailored for low value facilities that are restricted to balances of no more than $500 at a time.483
5. MAIN ISSUES WITH THE EXSTING REGULATORY FRAMEWORK
The current stored value regime in Australia is a modified version of the authorised deposit-taking institution regime, and its relevant provisions are scattered throughout the numerous acts, regulations and instruments that are administered by ASIC, APRA and the Payments System Board of the RBA. Stored value facilities in the payments system today are potentially regulated by five pieces of commonwealth legislation484 and the regulatory architecture upon which the stored value system is built is characterised principally by exemptions. All stored value cards are regulated by the APRA and the RBA, with closed loop prepaid cards, electronic toll devices and public transport ticketing products also covered by the ASIC’s ePayments Code.485 ASIC regulates gift cards as non-cash payments; a licence is required to issue and distribute them.
The majority of stored value facilities fall within exemptions of the current regulatory system, creating considerable doubt as to the extent if at all to which they are currently regulated. For example, the current regulatory framework does not adequately incorporate emerging products such as digital wallets.486 A system so based promotes the creation of products designed to fit into one or more of those exemptions, influencing design and leading to uncertainty for industry participants.
482 Financial Ombudsman, ‘E-Payments Code,’ above n 480. 483 Australian Securities and Investments Commission, ePayments Code Regulation Impact Statement, above n 475, 2. 484 The Payments System (Regulation) Act 1998 (Cth), The Banking Act 1959 (Cth), Competition and Consumer Act 2010 (Cth), Corporations Act 2001 (Cth), Financial Services Reform Act 2001 (Cth). 485 2011. 486 Australian Payments Clearing Association, Submission No 1 to the Financial System Inquiry Committee, Financial System Inquiry, April 2014, 10. 110 Such an approach undermines the predominant objective of such legislation that new product design should reflect that which best serves the needs of the market.487 Shortcomings of this type led the 2014 FSI to recommend a review of the present inadequate reach of the regulatory framework.
This Thesis agrees with the findings of the 2018 Productivity Commission Report that ‘stored value payment methods have the potential to be a significant source of competition to traditional payment methods, but face a complex set of regulations that may limit their incentive to grow.’488 Drafting of the existing stored value legislation took place after the Wallis Report had concluded that ‘the potential efficiency gains offered by smart cards are tangible’489 and that ‘stored value or other smart cards should be subject to regulation’.490 That conclusion has not been borne out to the degree anticipated; the bulk of the products in operation have been card- based payment instruments used in closed environments such as universities, or for purchases of specific goods and services.491 Since the enacting of the regulations mentioned, electronic cash, stored value facilities, and other similar payment instruments have underperformed the expectations of the Wallis Inquiry.492
The current legislation was appropriate for the situation in which it was created, but time, innovation and the emergence of firms in the field requires revision of old legislation and in some cases new legislation needs to be created. Three significant problems with the current legislative regime as it relates to stored value facilities exist. The first is that its system of declarations and exemptions has proven overly complex, occasioning significant consumer and provider confusion as to the application of regulatory protections. The second is its significant compliance costs for products that
487 Interview conducted by the author in Sydney, May 2017. 488 Productivity Commission, ‘Competition in the Australian Financial System Final Report’ above n 176, 465. 489 Wallis, Beerworth, Carmichael et al, above n 38, 404. 490 Ibid 406. 491 Reserve Bank of Australia, ‘Regulation of Purchased Payment Facilities: Proposed Exemptions under the Payments System (Regulation) Act 1998,’ above n 394. 492 Ibid. 111 do not fall within an exemption. The third is that certain stored value products are currently falling outside of the regulatory perimeter.
In general, gift cards are only lightly regulated. They provide little systemic risk, are not readily capable of exploitation for money laundering or terrorism financing purposes and are not interconnected with the wider financial system. Usually holding only small amounts the protection of consumer funds is not of major regulatory concern, nonetheless consumers may lose their stored value funds should the merchant becomes insolvent, as happened when Australian retailer Dick Smith Electronics entered receivership in 2016.493
The payments system has undergone rapid transformation during the years following the Wallis Report, with digital technologies becoming increasingly widespread and customers gaining access to an ever-expanding array of options for making online and mobile payments. Non-traditional business models have emerged, and new purchased payment facility products and providers have entered the market at an increasing rate.494 The current regulatory framework does not take full account of all of these new entrants; in consequence some marketed stored value products are only partially regulated or not regulated at all. This shortcoming applies with particular force to digital wallets.
In Australia, a digital wallet may be characterised as a PPF if it has three characteristics. These are that: it is a facility purchased by the customer from another person; it can be used to make payments; it involves payments being made by the provider of the facility or a third party acting under an arrangement with the provider.495 Any stored value digital wallets that is widely-used and therefore poses a potential risk to the financial system falls under APRA’s supervisory authority. Currently, PayPal is the only PPF that is regulated by APRA.
493 Misa Han, ‘Customers with Dick Smith gift vouchers advised to call their banks,’ (6 Jan 2016) Australian Financial Review (online); Catie Low, ‘Electrical storm: how Dick Smith went from a $520m sensation to the bargain bin,’ (9 Jan 2016) Sydney Morning Herald (online). 494 Murray, David, Dunn et al, above n 26, 163. 495 Under the Payments System (Regulation) Act 1998 (Cth). 112
However, certain stored value facilities having the three characteristics are not considered PPFs and are not required to meet the requirements of the PSRA. Some services with a limited value or range of goods issue electronic money solely for the purpose of purchasing goods or services directly from the electronic money issuer.496 Such services are comparable to closed loop stored value cards, and fall within the limited facility regulatory exemptions. An example of this is the iTunes online account, which allows customers to purchase music or other products only from the iTunes store.
Stored value facility providers currently have an incentive to utilise an ADI to act as the holder of stored value to avoid the need for the provider itself to become an ADI. ASIC has recognised that the current framework is flawed insofar as
…it may encourage providers to engage in complex white labelling arrangements in an effort to sustain existing business models and to potentially avoid exceeding the low- value threshold and therefore attracting RBA and APRA regulation.497
This arrangement would not trigger ASIC’s $10 million threshold for full regulation of the provider as a non-cash payment facility, and unless APRA determines that this activity constitutes banking business, it appears that the provisions of the Banking Act do not apply to the stored value held in those facilities.498
Uncertainty arises regarding the regulatory framework for facilities that are neither supervised by APRA nor classified as limited or guaranteed facilities.499 Regulatory uncertainty arises for those facilities that hold more than $10 million in capital and that do not fall within an RBA exemption. The Productivity Commission has
496 The Financial Action Task Force, ‘Guidance for a Risk-Based Approach: Prepaid Cards, Mobile Payments and Internet-Based Payment Services,’ (Guidance Paper, June 2013), 10 < http://www.fatf- gafi.org/media/fatf/documents/recommendations/Guidance-RBA-NPPS.pdf>. 497 Australian Securities and Investments Commission, Submission No 1 to the Financial System Inquiry Committee in Response to the Interim Report, Financial System Inquiry, August 2014, 89. 498 Ibid. 499 Reserve Bank of Australia, ‘Regulation of Purchased Payment Facilities: Proposed Exemptions under the Payments System (Regulation) Act 1998,’ above n 394. 113 recommended that these facilities should be either authorised as an ADI by APRA or authorised by the RBA.500 However, at the time of writing, only PayPal has been authorised as an ADI, and the RBA has not authorised any stored value facilities.501 PayPal, which is a subscriber to the Code has expressed concern that ‘there are a number of digital-wallet-only providers who are not regulated from a consumer perspective’ and has called for the ePayments Code to be extended to digital wallets.502 The current regulatory framework does not make provision for such facilities as Google Pay or WeChat Wallet. PPFs originating from and storing value overseas, such as AliPay and WeChat Wallet, are generally not regulated in Australia.503
i. Calls for Reform and Preliminary Recommendations
AusPayNet has suggested a thorough review of what it terms ‘the APRA/RBA purchased payment facility regime and the related ASIC non-cash payment facility regime’ is necessary.504 AusPayNet has criticised the current Australian retail payments system for being fragmented, complex and lacking in clarity.505 It is unclear whether stored value facilities provided by techfins are subject to regulation. Under existing regulation, there is an uneven regulatory playing field as authorised institutions lose business to techfins, the level of regulatory compliance is undermined, and potential systemic risk may gradually build up, with the next global financial crisis being caused by techfins rather than authorised financial institutions.506 Digital wallets that act as holders of stored value, that is they enable customers to store funds in the wallet for the purpose of making and receiving payments, should be regulated as a non-cash
500 Productivity Commission, Business Set-up, Transfer and Closure, above n 405, 231. 501 Interview conducted by the author in Sydney, March 2017. 502 Shaun Drummond, ‘Apple, Google must sign fraud code for e-payments, says PayPal,’ (30 March 2015) Sydney Morning Herald (online)
The ePayments Code appears to provide a reasonably fair way of dealing with consumer protection issues, but it applies only when the transaction falls within the scope of the code. I recommend that the operation of the ePayments Code be made mandatory for all stored value facility issuers – discussed further in Chapter Six. This will ensure a minimum level of consumer protection for all payment products without their being subject to onerous regulatory requirements.
The Final Report of the FSI recommends that compliance with the ePayments Code be made mandatory; mandating the Code, a matter for the Australian Government, is not within the scope of ASIC’s current powers.508 By creating rules on responsibility for losses, the Code is directed to increasing consumer confidence in electronic payments, leading to their mainstream adoption.509 The chair of the Australian Bankers Association observed
Our …ambition should be to maximise intelligent self-regulation and minimise government regulation…to demonstrate through our behaviour that, wherever it is practicable, self- regulation is better than government regulation.510
Amongst the plethora of electronic payment devices, those made from digital wallets accessed through a mobile phone application enjoy a level of safety and ease of operation unmatched by competing products. Stored value wallets effect payments at a lower cost than those conducted through current networks such as MasterCard and VISA.
507 Interview conducted by the author in Sydney in March 2017. 508 Australian Securities and Investments Commission, ePayments Code Regulation Impact Statement, above n 475, 6. 509 David Murray, Kevin Davis, Craig Dunn et al, ‘Financial System Inquiry Interim Report’ (Interim Report, Australian Government, 15 July 2014) 4-43. 510 Australian Payments Clearing Association, Submission No 1 to the Reserve Bank of Australia, Reform of Australia’s Payment System: Issues for the 2007/08 Review, August 2007 quoting David Morgan, Opening Plenary to SIBOS 2006, 9 October 2006. 115 Digital wallets are likely to evolve around markets’ dominant retailers (eg Coles, Woolworths), companies that have highly cost-effective proprietary payments networks in place. As new retail entrants such as Costco and Aldi expand within the market the pressure of competition in both product price and the costs of conducting business may be expected to increase; the popularity of the lower-cost wallet option may be expected to widen. I opine that, absent the emergence of some new product that offers even greater advantages, digital wallets will over time become the dominant device for electronic payments in Australia.
6. CONCLUSION: PREPARING FOR A DIGITAL ECONOMY
The four primary areas of analysis511 that I have determined require review are the overall clarity of the regime; whether the regulations provide competitive neutrality for issuers with similar risk-weighted products; how regulators have balanced openness to innovation and enabled market entry of new products with ensuring market stability; and the stringency and efficacy of their client money protection rules.
The current Australian regime does not capture all stored value facilities, and as the regime is based on a number of exemptions and declarations its application to facilities seemingly captured is unclear. The regulations do not clearly differentiate between stored value products, nor do they provide a clear definition of what constitutes a stored value facility. Many emerging digital stored value facilities are not captured by the regime at all.
The current regulatory framework envisages that the holder of stored value will be either an ADI or hold an exemption or authority. If the holder of stored value is an ADI it is supervised by APRA. If it is a non-ADI with an exemption or an authority it is supervised by the RBA, save in respect of consumer protection issues, for which ASIC is responsible. The RBA and ASIC each issue regulatory exemptions for certain purchased
511 Identified in ‘Functional Comparative Methodology’ in Chapter One. 116 payment facilities to permit them to develop. The resulting system is overly complex, with confusing technical definitions of stored value.
Regulatory discretion through conditions-based regulatory exemptions is a solution that will help regulators to keep pace with market developments in the short term, while making time and space for regulators to develop better long-term solutions. The danger with this short-term approach is that governments may continue to use this approach, developing regulation on a case-by-case basis, responding to each particular business model and its inherent characteristics, rather than developing a long-term regulatory framework. If regulations are constantly challenged, or presenting market barriers to businesses with new innovations, then that regulation is in need of review.
The Australian government has an important choice to make regarding the regulation of stored value facilities. On one hand, stored value products have only just begun to take their place in the Australian payments system. The products themselves have not reached their full development and they do not currently represent a substantial systemic threat. As such, the wait-and-see approach to the ‘grey area’ between low value facilities and limited ADI issued products may be appropriate. On the other hand, this Thesis argues that we are approaching the critical stage where the Australian Government must regulate the emerging stored value products in order to limit the increasingly significant risks posed by stored value products.
As in many countries, Australia is in the midst of a technology revolution that is changing its financial system. Historically, when the only PPFs were phone cards, university library cards, gift cards and transport cards, it made sense for these products be exempted from regulation. Issuers of these products did not need to be regulated at the same level as ADIs, and the products themselves did not need to be regulated as part of the card payments system. These products have now evolved to hold high values and reach a wide range of consumers. They include international travel cards with access to the global ATM network, and digital wallets which allow for online purchases or peer to peer transfers.
117 In July 2014 AusPayNet released a report highlighting that as cash is declining in use, regulators should prepare for a digital economy.512 The increased availability of digital wallets from major global issuers such as Apple, Google and PayPal has increased the importance of regulating facilities that have the potential to disrupt the wider payments system.513
In 2014 the RBA submitted to the Wallis Inquiry that ‘retail payment systems are currently the subject of substantial customer-facing innovation as well…If managed appropriately, these changes also have the potential to deliver greater security and increased competition.’514 Electronic payments, continually increasing throughout the world, may well eventually replace cash completely. Regulators globally must prepare a political and legal framework within which they can operate. In 2016 the Australian Government observed that ‘as financial services become more globalised and technological disruption more relevant, we need to keep pace with innovation and banking and finance to stay competitive.’515
Appropriate regulation will support the introduction of products better suited to consumer and market needs, thereby enhancing capital productivity and economic growth.516 The creation of an effective, co-ordinated and proportionate regulatory regime for stored value products would promote reduction of the overall cost of the payments system. Reduction in usage costs throughout the payments system should assist Australia to become more competitive and to achieve higher domestic economic growth.
The following Chapters will analyse the stored value payment system in terms of the four areas that I have identified for review, and make recommendations for a best
512 Australian Payments Clearing Association, Towards the Digital Economy, (Milestones Report, Third Report, July 2014). 513 The Financial Action Task Force, ‘Guidance for a Risk-Based Approach: Prepaid Cards, Mobile Payments and Internet-Based Payment Services,’ above n 496, 13. 514 Reserve Bank of Australia, Submission No 1 to the Financial System Inquiry Committee, March 2014, above n 464. 515 Australian Government, ‘Supporting Australia’s FinTech future,’ above n 107. 516 Lumpkin, ‘Regulatory Issues related to Financial Innovation,’ above n 108, 1. 118 practice model for Australia. Chapter Five presents case studies of the regulatory systems of Hong Kong and Singapore, which have two of the most widely used stored value systems in the world, and examines how the four identified areas have been approached in those jurisdictions. Definitional and legal certainty in regulatory regimes and the adequacy of current consumer protection provisions is discussed in Chapter Six. Chapter Seven discusses how regulation may best support innovation and achieve appropriate competitive neutrality. The Thesis Conclusion in Chapter Eight draws upon the previous Chapters in order to recommend a regulatory approach for Australia which addresses current and expected issues, and summarises the recommendations for Australia’s stored value products made throughout the Thesis.
119 CHAPTER FIVE: COMPARATIVE INSIGHTS
1. INTRODUCTION 120 2. A COMPARISON OF THE REGULATORY REGIMES 121 3. A COMPARISON OF REGULATORY ISSUES 129 4. CONCLUSION 157
1. INTRODUCTION
Payments systems throughout the world have increasingly become electronic and interconnected, driven largely by the ubiquity of smartphones and the ability of banks and payments networks to effect instantaneous transfers worldwide.517 It is unsurprising that this phenomenon is most apparent in the richer countries of the world but it is by no means restricted to them. People in rural and developing areas can connect to the internet and make purchases online using a stored value facility or digital wallet, even where they do not have access to a bank account.
Comparative study of various legal systems may demonstrate how different regulations for the same problem function in practice. The Australian financial system is ‘part of a global economy increasingly influenced by Asia’ and is affected by the increasing scope of cross-border financial regulation and broader economic changes.518 Australia, Hong Kong and Singapore have been chosen as comparators for this Thesis as they are major trading partners, each making extensive use of stored value payment technologies, within legal systems based on English common law.
To underline the importance of comparative study to discussion of the regulation of stored value systems, in this Chapter I examine the manner in which international financial systems interconnect. I draw from interviews conducted with regulators and with payments systems professionals in the three comparator jurisdictions, in addition to government and industry reports. Part One contains an introduction and overview
517 Faraaz Ali, ‘Are payments nearing a tapping point?’ (Blue Notes, ANZ, 25 January 2016) https://bluenotes.anz.com/posts/2016/01/are-payments-nearing-a-tapping-point/. 518 Murray, David, Dunn et al, above n 26, 8. 120 of the Chapter. Part Two outlines the contextual differences of the three comparators and provides an overview of the regimes of Hong Kong and Singapore (Australia’s regime having been described and examined in Chapter Four). Part Three examines and compares the different approaches of Australia, Hong Kong and Singapore to the chosen regulatory issues. I examine the laws chosen to govern stored value facilities, the process by which these rules are applied and the outcomes of these decisions.519
The primary issues that this comparison seeks to address are drawn from the earlier Chapters, and are: the clarity of the regulations; whether the regulations provide sufficient competitive neutrality between issuers; how regulators have balanced openness to innovation and enabled market entry of new products with ensuring market stability, and; the stringency and efficacy of their client money protection rules. The normative criteria chosen for assessing the regulations will be different for each of the issues, and will be outlined as the evaluation is made.
The Chapter concludes in Part Four with my views as to the combination of approaches appearing best suited to the needs of Australia’s stored value market.
2. THE REGULATORY REGIMES
This section outlines some of the fundamental differences between Australia, Hong Kong and Singapore, and addresses the question of whether the differences in the adoption of stored value payments between the jurisdictions have emerged as a result of the differences in regulatory approach, or whether the different regulatory approaches are a result of the differing levels of adoption of stored value products. In other words, is the uptake of stored value payments the cause or the consequence of the different regulatory regimes.
519 For a full methodology, see Chapter One. 121 2.1 Jurisdictional Differences
In Hong Kong, stored value facilities are a popular payment method, with around 67% of the population regularly using a stored value card or device.520 The Hong Kong Monetary Authority (HKMA) is the central bank for the Hong Kong Special Administrative Region; it is responsible for the maintenance of monetary and banking stability.521
Hong Kong has a strong regulatory infrastructure for stored value facilities based upon clear and well-defined licencing requirements for holders of stored value. The current regulatory regime for stored value facilities was created in 2015 with the Payments Systems and Stored Value Facilities Ordinance (the Ordinance). Under the Ordinance, the HKMA implemented a mandatory licensing system for multi-purpose stored value facilities, making it illegal for any holder of stored value to issue or operate a stored value facility without holding a licence or the benefit of an exemption.522 As with Australia’s regime, it has general requirements for stored value facilities, with single purpose low value facilities exempted from the regime.
To obtain a stored value facility licence from the HKMA, a company must hold a minimum of HK$25 million in paid-up capital (or the equivalent amount in another currency).523 The HKMA may impose a higher requirement taking into consideration the issuer’s size, operations, number of users, business model and type of product to be launched in the market.524 According to the Hong Kong government the purpose of
520 Retail Finance intelligence, ‘The payments industry is set for disruption but how far is too far?’ (Insights Paper, Global Retail Banker, 1 February 2016) http://www.rfintelligence.com/_blog/RFi_Media_Centre/post/the-payments-industry-is-set-for- disruption-but-how-far-is-too-far/>. 521 Hong Kong Monetary Authority, About the HKMA, (2016) < http://www.hkma.gov.hk/eng/about-the- hkma/hkma/about-hkma.shtml>. 522 Hong Kong Monetary Authority, ‘Regulatory regime for SVFs and retail payments systems commences operation,’ (Press Release, 13 November 2015). 523 Payment Systems and SVF Ordinance, Cap 584, Schedule 3, Part 2 s2; Hong Kong Monetary Authority, ‘Explanatory Note on Licencing for SVFs,’ (November 2015), 18 < http://www.hkma.gov.hk/media/eng/doc/key-functions/finanical-infrastructure/infrastructure/retail- payment-initiatives/Explanatory_note_on_licensing_for_SVF.pdf>; 524 Hong Kong Monetary Authority, ‘Explanatory Note on Licencing for SVFs,’ (November 2015), 18 < http://www.hkma.gov.hk/media/eng/doc/key-functions/finanical-infrastructure/infrastructure/retail- payment-initiatives/Explanatory_note_on_licensing_for_SVF.pdf>; Mark Parsons, Tommy Liu, ‘Hong 122 the minimum capital requirement is to avoid possible contagion by offshore business, and serve as an additional financial buffer on top of the float protection requirements.525
Licensees must be a Hong Kong incorporated company with the issue of stored value as its principal business.526 The HKMA states this is to encourage the stored value business to be as robust as possible, and to prevent the stored value industry from being impacted by the failure of a related business.527 The directors and management of the stored value facility licensee must meet fit and proper requirements, including bankruptcy and criminal record tests.528 The Chief Executive must be and remain ordinarily resident in Hong Kong, and other senior management team members and key personnel be based in Hong Kong.529 The regulatory concern of the HKMA is that senior management of an stored value facility licensee must be reachable, responsive and contactable by the HKMA in the case of any urgent stored value facility related matters.530
The Octopus card is Hong Kong’s most well established stored value facility. Adults can purchase the card for HK$50 (around AUD $8) and it may hold up to HK$1000 reloadable value.531 Its use has spread from the city of Hong Kong to the neighbouring Chinese cities of Shenzhen, Guangdong and Macau, where it may be used on the transport systems serving these cities, their major fast food chains, all major supermarkets and most convenience stores, as well as their hospitals, schools and
Kong Monetary Authority grants first round of SVFs Licensees,’ (Publication, Hogan Lovells, 30 August 2016). 525 Mark Parsons, ‘Hong Kong Concludes Payments Regulation Consultation,’ (2015) The Hong Kong Lawyer,
Octopus is available as a smart sticker for a mobile phone, as a mini-card key ring and may be embedded in an Octopus collection watch.534 Using an Octopus Mobile SIM enables a phone to function both as an Octopus and telecommunications device.535 An option permits the Octopus account to link to a credit card, assuring an automatic reload when the account’s credit drops to a given amount, it is automatically reloaded. It has proved useful to authorities engaged in tracking the movements of criminal suspects, and with nearly 32 million cards in circulation, (close to four and a half times the population of Hong Kong) it is one of the world’s most widely used stored value facilities.536 Octopus has been so successful that Hong Kong has recalled coins back to the national Mint for re-melting.537
In April 2016, Octopus launched a smartphone app, O!ePay, a peer-to-peer payment system that enables a consumer to use a mobile phone number to transfer to another consumer the value stored on the transferor’s Octopus account.538 O!ePay has higher maximum threshold limits than the Octopus card, ranging from HK$3,000 to HK$10,000, and accounts may be topped up from 21 participating banks, and all 7- eleven stores.539
532 Octopus, Where can I use it, (2018), < http://www.octopus.com.hk/get-your-octopus/where-can-i- use-it/en/index.html>. 533 Ibid. 534 Octopus product licensees include Genetics and Citykeys: Octopus, Choose your Octopus, (2018) < http://www.octopus.com.hk/get-your-octopus/choose-your-octopus/licensed-octopus- products/en/index.html>. 535 Ibid. 536 Ibid; Octopus, Octopus Company Profile, (23 September 2016), 9, < http://www.octopus.com.hk/web09_include/_document/en/company_profile.pdf>. 537 Blockley and Yuzon, ‘The Evolution of Cash: An Investigative Study,’ above n 15, 56. 538 Octopus, Mobile Payment, (2018) < https://www.octopus.com.hk/en/consumer/mobile- payment/oepay/services/index.html > 539 Singh, ‘Octopus’ Hong Kong market dominance faces challenge from e-payment newcomers,’ above n 125. 124 Singapore’s payments market has a high volume of stored value cards and a strong non-cash payment system, with 3.8 billion non-cash transactions in 2013, 80% of which were made with a stored value card.540 The majority of consumer transactions in Singapore are performed using a stored value facility; they account for 59% of total payments and are used predominantly for public transportation.541
Singapore has a higher stored value facility penetration than either Australia or Hong Kong. Residents hold an average of eight cards per person; 4.3 stored value cards, 2 debit cards, and 1.7 credit cards.542 In 2014, there were approximately 29.4 million multipurpose stored value cards in circulation, a 27.2% increase on the previous year.543 However, despite the plethora of stored value options, cashless payments for non-transport purchases are not as popular in Singapore as they are in Hong Kong.544 Analysts have theorised that it is the confusing number of e-payment options as the reason that cashless payments have not been as successful as anticipated.545
The Monetary Authority of Singapore (MAS) is the national central bank, the prudential regulator, and the market conduct regulator.546 It oversees all financial institutions in Singapore, and works closely with other government agencies to develop and promote Singapore as a regional and international financial centre.547
In contrast to Hong Kong’s regime, Singapore allows stored value facilities to be established without capital or qualification requirements. The Singaporean stored value systems may offer online accounts and/or card services to clients worldwide
540 CapGemimi, Royal Bank of Scotland, World Payments Report (6 October 2015). 541 KPMG, ‘Enabling the Future of Payments: 2020 and Beyond,’ (Singapore Payments Roadmap, August 2016) 13
All holders of stored value in Singapore are encouraged to comply with the MAS’s Guideline on Stored Value Facilities (the Guidelines).552 The Guidelines, while a recommendation for all stored value facilities in Singapore, provide a mandatory minimum standard for WASVFs.553 They provide that users must be able to redeem their stored value in a timely manner, and the holder must have at all times sufficient assets to meet full redemption of the total stored value.554 Holders of WASVF must also comply with the Corruption, Drug Trafficking and Other Serious Crimes (Confiscation of Benefits) Act, and Terrorism (Suppression of Financing) Act. The MAS may impose additional conditions on the WASVF before granting its approval to operate, although these conditions are not published.555
548 Monetary Authority of Singapore, Stored Value Facilities: Overview and Regulations (Jan 2016), < http://www.mas.gov.sg/singapore-financial-centre/payment-and-settlement-systems/payment- media/stored-value-facilities.aspx>. 549 Payments System Oversight Act 2006 s35. 550 Monetary Authority of Singapore, Stored Value Facilities: Overview and Regulations, above n 548. 551 HSBC, ‘Treasury Management Profile 2016: Singapore,’ above n 543, 16. 552 Monetary Authority of Singapore, Stored Value Facility Guidelines, June 2006 < http://www.mas.gov.sg/regulations-and-financial-stability/regulations-guidance-and- licensing/payment-and-settlement-systems/guidelines/payment-systems-oversight-act- 2006/2006/stored-value-facility-guidelines.aspx>; Committee on Payments and Market Infrastructures, ‘Non-banks in Retail Payments,’ (CPMI Paper No. 118, Bank for International Settlements, 9 September 2014) 30. 553 Monetary Authority of Singapore, Stored Value Facility Guidelines, June 2006, 4. 554 Ibid 5. 555 Payments System Oversight Act 2006 s36. 126 Stored value facilities in Hong Kong and Singapore have a greater share of their national payments market than those in Australia. In Australia in 2016, prepaid cards accounted for just 2% of consumer payments, and PayPal accounted for 3%.556 The report does not distinguish between PayPal’s stored value function and its ability to enable payments from a linked bank account or credit card (which are not stored value payments), and thus the percentage of actual stored value payments in Australia will be lower than 5%.
Significant differences between the three jurisdictions deserve mention. Hong Kong and Singapore are both much smaller geographical regions than Australia, covering an area of 2,754 km2 and 719 km2 respectively, compared with Australia’s 7.692 million km2. In terms of population, Hong Kong has a population of around 7.3 million, Singapore 5.7 million; Australia has around 24.5 million residents.557
Australia is a federation of six states and a number of territories. Each state has its own constitution within the framework of the Australian Constitution, which is paramount, and their own respective constitutions; territories are subject to laws passed by the Commonwealth. Two mainland territories, the Australian Capital Territory and the Northern Territory have been granted a limited right of self-government by the federal government. Seven external territories remain governed only by Commonwealth law, usually through an Australian Government-appointed Administrator.
Hong Kong and Singapore have simpler government structures than Australia. Singapore is a sovereign city-state, with one major governing body under the long- term political control of one party, the People’s Action Party.558 Hong Kong, though an autonomous territory, is a Special Administrative Region of China, and is influenced by
556 Doyle, Fisher, Tellez and Yadav, above n 17, 60. 557 Worldometer, 2017 World Population Statistics, (2018) < worldometers.info/world-population>. 558 Singapore Prime Minister’s Office, The Government, (1 May 2018) Singapore Government < http://www.pmo.gov.sg/the-government>; Garry Rodan, Singapore’s Elected Presidency Under Fire (19 April 2017) Australian Institute of International Affairs < http://www.internationalaffairs.org.au/australianoutlook/singapore-elected-presidency-under-fire/>. 127 the government in Beijing.559 The Hong Kong Legislative Council, though elected, is composed of candidates approved by the Chinese Government in Beijing.560
Hong Kong and Singapore each has a strong history of stored value facility usage. Singapore introduced the world’s first stored value card for interchangeable use on bus and rail travel in 1990,561 and has been using contactless smart cards for mass transit fare payments since 2002. Hong Kong has been using the Octopus system for its mass transit tickets since 1997, and with 42 million cards in circulation, nearly five and a half times the population of Hong Kong562 it is one of the world’s most successful stored value systems. Australia’s first mass transit smartcard system was not introduced until 2007;563 each major city operates its own transit system and associated smartcard. As the revenue and costs of operation of the transit system have direct impact on state finances, there is little likelihood of interaction between the states in this area.
Regulation alone cannot account for the rapid growth of stored value products in certain countries and not in others. Business strategy, infrastructure and policy, as well as payment culture and socio-economic factors all have important influences. Singapore, a small nation with limited natural resources, relies upon innovative macroeconomic approaches for economic growth.564 The World Bank regularly ranks Singapore as one of the easiest economies in the world within which to do business; it is currently ranked at number two, behind only New Zealand.565 The Singaporean government offers grants and related programs to help entrepreneurs develop their
559 Hong Kong Government, Government Structure (February 2018) < https://www.gov.hk/en/about/govdirectory/govstructure.htm>. 560 Eleanor Albert, Democracy in Hong Kong, (22 June 2017) Council on Foreign Relations < https://www.cfr.org/backgrounder/democracy-hong-kong>. 561 Robert Cevero, The Transit Metropolis, (Island Press, 1998) 165. 562 Around 7.3 million: Worldometers, Hong Kong Population (18 June 2018) < http://www.worldometers.info/world-population/china-hong-kong-sar-population/>. 563 SmartRider was progressively introduced in Perth from January 2007. 564 Scott Anthony, ‘How Singapore became an Entrepreneurial Hub,’ (2015) Harvard Business Review (online). 565 The World Bank, Doing Business: Economy Rankings, (2017)
Hong Kong and Singapore are useful comparative jurisdictions because they each have a mature stored value market and their regulatory regimes sit at opposing ends of the regulatory spectrum. Hong Kong’s regulatory regime is more rigorous and comprehensive than that of Australia, while Singapore’s is in general more liberal.
3. A COMPARISON OF REGULATORY ISSUES
This section compares how each of Hong Kong, Singapore and Australia have fared in terms of the clarity of their regulation, the competitive neutrality between different stored value facility issuers for similar products, their openness and commitment to innovation and how they have balanced this with market stability, and their management of consumer funds.
566 Including the Early Stage Venture Investment Fund program and the Technology Incubation Scheme. 567 Mark Parsons, ‘RegTech in Hong Kong: the current state of play’ (Publication, Hogan Lovells, December 2016). 568 Basic Law of the Hong Kong Special Administrative Region of the People’s Republic of China 1997, Article 109. 569 Andrew Schmulow, ‘Approaches to Financial System Regulation: An International Comparative Study,’ (Working Paper 053/2015, Centre for International Finance and Regulation, 2015) 3. 570 Interview conducted by the author in Hong Kong, 24th October 2017. 129 3.1 Clarity of Regulation
i. The Problem
Regulating stored value facilities is made more difficult by confusion around what constitutes an electronic payment, or how stored value may be defined. Chapter Four has described the difficulty that Australian regulators have faced in deciding whether stored value facilities are purchased payment facilities, non-cash payment facilities or epayments and the resulting regulatory and legal confusion. This section evaluates the clarity of each regime based upon its governing legislation and regulator(s), how stored value is defined, and which products and issuers are captured.
ii. The Law, Regulations and Guidelines
As Australian stored value facilities are captured by multiple definitions and legislative provisions, they fall under the remit of three regulators, ASIC, APRA and the RBA. In both Hong Kong and Singapore, one regulator, the nation’s central bank, oversees regulation of stored value facilities. Each central bank is tasked with oversight and administration of one primary piece of legislation specific to stored value. In Hong Kong, the HKMA is responsible for the maintenance and stability of Hong Kong’s financial system, and regulates stored value facilities under the Payments Systems and Stored Value Facilities Ordinance 2015.571 In Singapore, the MAS is the national central bank, the prudential regulator and the market conduct regulator, and regulates the nation’s stored value facilities under the Payments System (Oversight) Act, 2006 (the PSOA).
In the spectrum of the HKMA’s payments regulation, stored value facilities are considered to be at the high end of regulation, behind only banks.572 The Ordinance requires both device-based and non-device based multi-purpose stored value facilities
571 Cap 584. 572 Interview conducted by the author in Hong Kong, 23rd October 2017. 130 to be licenced.573 The previous regulatory regime applied only to device-based multi- purpose stored value facilities and had Octopus as its sole active licensee.574 The HKMA has publically stated that the purpose of the licencing regime is to better enable the HKMA to supervise and enforce actions which ensure the fitness and propriety of issuers, the protection of the float stored in the facilities, and the reliable operation of these facilities.575 Mr Henry Cheng, Executive Director (Monetary Management) of the HKMA has stated that depositing money into a stored value account is ‘similar to depositing money into banks. Therefore, it is important to ensure the safety of the float and the soundness of the operators.’576
Hong Kong’s stored value licensing regime is comprehensive in its detail and often takes around twelve months of negotiation before a licence is granted.577 In 2016, the HKMA issued the Guideline on Supervision of Stored Value Facility Licensees (the Guideline) which sets out the supervisory principles used to assess the fitness and propriety of stored value facility licensees. Although the process of obtaining a licence is negotiated between the HKMA and the potential licensee, the system is quite transparent, with the Guidelines providing information about what is required, and guidance as to whether or not a provider is likely to satisfy the HKMA’s requirements.578
In Singapore, the issuance and management of stored value facilities is governed by the PSOA and its related regulations. Stored value payments are not regulated in
573 Device-based SVFs store value on an electronic chip on a card, or physical device such as a watch or wallet. Non-device based SVFs store value on a network-based account, accessible through the internet or a mobile network; Hong Kong Monetary Authority, ‘Explanatory Note on Licensing for SVFs,’ (November 2015), 9; Hannah Leung, ‘Will new regulations affect fintech startups in Hong Kong?’ e27 (online), 23 November 2015. 574 Parsons and Liu, ‘Hong Kong Monetary Authority grants first round of SVFs Licensees,’ above n 530. 575 Hong Kong Monetary Authority, ‘Regulatory regime for SVFs and retail payments systems commences operation,’ above n 522. 576 Hong Kong Monetary Authority, ‘InSight – Part 1: Smart tips on using stored value facilities,’ (Key Information Article, 24 August 2016) < http://www.hkma.gov.hk/eng/key- information/insight/20160823.shtml>. 577 Interview conducted by the author in Hong Kong 26th October 2017. 578 Interview conducted by the author in Hong Kong 23rd October 2017. 131 Singapore under the same regime as bank activity.579 In contrast to Hong Kong, the MAS distinguishes stored value funds from deposits:
There is a clear distinction in the functionality of stored value facilities versus deposits. Values are stored on stored value facilities with the specific intent to purchase a predetermined range of goods or services while deposit accounts are not referable to any particular type or class of good or service. Values stored on stored value facilities are also generally limited in amount as operators of stored value facilities often voluntarily enforce limits on the stored value facilities that they issue due to safety concerns. This is in contrast to deposit accounts where banks accept limited funds.580
Australian legislation does not contain a clear definition of stored value products – discussed further in Chapters Four and Six - however ASIC has taken the view ‘that money paid to these products is not a deposit.’581
All three jurisdictions exempt single-purpose facilities from their regulation. Hong Kong and Singapore use the same definition, that is, a single-purpose facility is a facility which can only be used for payment of goods and services provided by the issuer of the facility.582 The HKMA grants a licence exemption to multi-purpose stored value facilities used for purchasing certain digital products on online store platform, loyalty and bonus point schemes, and stored value facilities with limited usage, such as facilities used within a limited group of goods or service providers, or within a certain premises), provided their aggregate float does not exceed HK$1,000,000.583
579 A holder of stored value must comply with the Payments System (Oversight) Act 2006 and all related regulations: Monetary Authority of Singapore, Stored Value Facility Guidelines, June 2006, 4, 1.3.1. 580 Monetary Authority of Singapore, ‘Response to Feedback Received: Consultation on Draft Payment Systems Oversight Bill’ (Publication, 21 November 2005) < http://www.mas.gov.sg/~/media/resource/publications/consult_papers/2004/MAS_%20Response%20t o%20Feedback%20Received%20%20Consultation%20on%20Draft%20Payment%20Systems%20Oversigh t%20Bill.pdf>. 581 Australian Securities and Investments Commission, Submission No 1 to the Financial System Inquiry Committee in Response to the Interim Report, above n 497, 89. 582 Payments Systems and Stored Value Facilities Ordinance 2015, 2A (5); Payments Systems (Oversight) (Exclusion of Single Purpose Stored Value Facilities) (Amendment) Order 2007, 2. 583 Payment Systems and Stored Value Facilities Ordinance (Cap 584) Schedule 8; Hong Kong Monetary Authority, ‘Implementation of the Stored Value Facilities Regulatory Regime,’ (Quarterly Bulletin, September 2016), 3 < http://www.hkma.gov.hk/media/eng/publication-and-research/quarterly- bulletin/qb201609/fa2.pdf>. 132
In Singapore, single purpose stored value facilities are not required to have a bank undertake liability for their stored value funds, even where they exceed the $30 million threshold.584 The MAS exempts from anti-money laundering and know-your-customer measures stored value facilities with maximum account limits of S$1,000, or maximum bulk-loads of S$20,000.585 For example, if a holder of a stored value facility loads it with $1,000, it can only sell up to twenty such facilities to any user at any one time.586 In Australia, gift cards, loyalty schemes and road toll devices have been exempted from regulation, as have limited value facilities. A limited value facility is one that has total obligations not exceeding $10 million and is used by fewer than 50 people.587
iii. The Outcome; an Evaluation
Hong Kong, Singapore and Australia all provide some exemptions for low value facilities where the public benefit in making the product available is adjudged to outweigh the cost of requiring compliance. Because of their lower level of risk, all three jurisdictions exempt single purpose stored value facilities from the full extent of payments regulation. Hong Kong and Singapore have far simpler regulatory models than the multiple-regulator approach taken by Australia.
The regulatory regime in Hong Kong for the issuance and management of stored value facilities is clear and well-defined, and the HKMA’s perspective of the stored value float as being similar to a bank deposit accounts for the more stringent regulations for stored value facilities that are present in Hong Kong. Stored value payments activities have existed in Hong Kong since the 1990s, and the new stored value licensing regime provides rules that define what may and may not be done in the course of those activities.
584 Payment Systems (Oversight) Act 2006, Ch 222A, s33(2), Payment Systems (Oversight) (Exclusion of Single Purpose Stored Value Facilities) Order, 2007. 585 Monetary Authority of Singapore, Stored Value Facility Guidelines, June 2006, 2.5.3. 586 Ibid 2.5.3. 587 Payments System (Regulation) Act 1998 - Declaration No. 1 of 2006 regarding Purchased Payment Facilities; Payments System (Regulation) Act 1998 - Declaration No. 2 of 2006 regarding Purchased Payment Facilities. 133 Hong Kong’s 2015 regulations contained in the Ordinance leave no room for confusion over whether an issuer or product is captured. The regulations are technology-neutral, and eliminate a regulatory gap that previously existed for non-card based facilities.588 Large players such as PayPal had been operating in the non-device based payment field, and until the 2015 Ordinance, were largely unregulated.589 The new regulations ensure that the HKMA is being proactive rather than reactive to developments in the payments system, and the licensing regime is considered an important updating of the regulation reflecting the advances in payments products made possible by new technologies.590
Singapore’s liberal regulatory regime puts it amongst the most attractive jurisdictions in the world to set up an online payments business.591 Singapore’s regulation clearly separates those stored value facilities which the MAS considers to be systemically important (WASVFs) from all others, using the amount held in its float as the determining factor. All other stored value facilities are allowed to operate with minimal supervision, reflecting the MAS’s perspective that the money stored in a stored value float is not akin to a bank deposit, and therefore does not need to be regulated as such. The MAS has been described as a ‘one-stop shop,’ where both incumbents and start-ups may obtain all the information necessary to the set up and running of their businesses.592 However, the fact that there is no centralised Singaporean body responsible for overseeing payments and coordinating improvements has been criticised for causing confusion at the point-of-sale, excess infrastructure, and limited adoption of more efficient payment methods.593 KPMG has recommended that a single government structure, the Singapore Payments Council, be
588 Mark Parsons, Tommy Liu, ‘The Clock is now ticking on Hong Kong’s new SVF Regime: Do you need a licence?’ (Publication, Hogan Lovells, 25 November 2015) < http://www.hoganlovells.com/files/Uploads/Documents/HKGLIB01_1527207_v1_The_clock_is_now_tic king_on_Hong_Kong_s_new_Stored_Value_Facility_regime__Do_you_need_a_licence_.pdf>. 589 Hannah Leung, ‘Will new regulations affect fintech startups in Hong Kong?’ e27 (online), 23 November 2015. 590 Interview conducted by the author in Hong Kong, 24th October 2017. 591 Bankers Press, ‘Start your own “PayPal” or E-Money banking business,’ (2015) < http://bankerspress.com/start-your-own-paypal-or-e-money-banking-business/>. 592 Interview conducted by the author in Singapore, 14th November 2017. 593 KPMG, ‘Enabling the Future of Payments: 2020 and Beyond,’ above n 541, 8. 134 created to enable more rapid and complete adoption of payments innovations and foster competition in the payments landscape.594
Hong Kong and Singapore each have clear stored value guidelines, although there are differences as to the extent that these guidelines apply. Of the three jurisdictions, Australia’s stored value rules are the most uncertain, as they are found in different legislative instruments, each of which has limited application. Australia’s stored value payments has been described as an alphabet soup of regulation,595 with its three potential supervisors. However, all payment and financial products in Australia are regulated in this fashion, not just stored value payments. It would not be in keeping with the existing system to create a ‘stored value regulator,’ and leave the regulation of other financial products to be shared amongst the other regulators.
Commentators have suggested that it is Australia’s system of multiple regulators that contributed to its avoidance of many of the problems that arose elsewhere during the global financial crisis of 2007-8.596 The United Kingdom, the Netherlands, Belgium and South Africa are amongst the countries that have followed Australia in adopting ‘twin peaks’ styles of regulation.597 The benefits of this style of regulation, particularly its ability to better adapt to technological change, are likely to outweigh any disadvantages of complexity and increased regulatory burden.
It may be possible to preserve the benefits of this style of regulation, while still simplifying the current system. Were regulation to be shared between just two regulators, say, for example APRA and ASIC, the burden on regulated entities would be lessened, and no other major changes to the current structure would be required. As another possibility, regulation could remain as at present, but be coordinated by one government-industry body. Such a body would also act as a contact point for industry
594 Ibid. 595 Interview conducted by the author in Singapore, 16 November 2017. 596 For example, Elizabeth Brown, ‘A Comparison of the Handling of the Financial Crisis in the United States, the United Kingdom, and Australia,’ (2010) 55(3) Villanova Law Review 509. 597 Andrew Godwin, Timothy Howse, Ian Ramsey, ‘A Jurisdictional Comparison of the Twin Peaks Model of Financial Regulation,’ (2017) 18 Journal of Banking Regulation 103, 104. 135 and could provide information to aspiring new entrants into the market. The nature of such a postulated body and the potential scope of its duties is discussed in Chapter Seven.
3.2 Competitive Neutrality: Bank vs Non-Bank Issuers
i. The Problem
A country’s regulatory environment impacts the extent to which non-banks may operate within its payments system, and issues around differing levels of regulation may arise between banks and non-banks.598 Regulation of non-banks may be needed to reinforce consumer confidence in payment providers. Consumer protection laws may reassure the public that their funds and data are protected.599 Non-banks may need to meet certain capital or data security requirements, or meet minimum operational standards before they are able to provide payments services to the public.
Non-banks now have a significant role in the provision of payments services as developments in technology such as mobile banking and internet payments allow non- banks to compete in areas traditionally dominated by banks.600 Regulators may choose not to allow non-banks to enter the payments system, or may limit their involvement to collaboration with banks. Alternatively, the entry of non-banks into the payments sector may be completely unrestricted. This section evaluates the competitive neutrality between issuers of each regime based upon how it differentiates and regulates different issuers, and whether or not this results in an unduly uneven playing field for regulated facilities of similar size and influence.
598 Committee on Payments and Market Infrastructures, ‘Non-banks in Retail Payments,’ (CPMI Paper No. 118, Bank for International Settlements, 9 September 2014) 7. 599 Ibid 17. 600 Ibid 16. 136 ii. The Law, Regulations and Guidelines
Australia, Hong Kong and Singapore all allow non-banks to issue and operate stored value facilities; this is not the case in every jurisdiction.601 Allowing non-banks to compete directly with banks improves the efficiency of the retail payments system by increasing competition, introducing new or improved payment options and reaching sectors of the population that do not otherwise have access to payment services.602 For example, payment services that use mobile phones are growing at a particularly fast rate in countries where banks have been unable to provide payment services to certain segments of the population.603
In Australia any institution that carries on banking business, whether a bank or not, must be authorised as an ADI.604 To receive authorisation the institution must meet requirements relating to capital, ownership, governance, risk management and internal control, compliance, information and accounting systems, external and internal audit, supervision by home supervisor, and it must meet these requirements on an on-going basis.605 ADIs which have an authorisation to carry on banking business are deemed to have authorisation to carry on business as a Purchased Payment Facility; Australian banks are not required to obtain further authorisation or meet additional requirements in order to become PPF providers.606
PPFs, while exempted from the capital-based framework that applies to other classes of ADI, are subject to the same regulatory and prudential requirements as well as reporting requirements, as other ADIs, unless they have received an exemption from
601 For example, Pakistan and Mexico do not allow non-banks to issue payments products: Denise Dias, Stefan Staschen, Wameek Noor, ‘Supervision of Banks and Nonbanks Operating through Agents,’ (Working Paper, CGAP, August 2015). 602 Committee on Payments and Market Infrastructures, ‘Non-banks in Retail Payments,’ above n 598, 19. 603 Committee on Payments and Market Infrastructures, ‘Innovations in retail payments,’ (CPMI Paper No. 102, Bank for International Settlements, 29 May 2012) 4 < https://www.bis.org/cpmi/publ/d102.htm>. 604 Banking Act 1959 (Cth), Part II. 605 Australian Prudential Regulation Authority, Guidelines on Authorisation of Providers of Purchased Payment Facilities, above 409, 4. 606 Ibid. 137 APRA. However, the RBA may allow a corporation to act as PPF provider without being classified as an ADI. Most SVFs in Australia have been exempted from being classified as a PPF, and thus avoid ADI requirements (PayPal is the exception). APRA may and often does impose conditions on the PPF provider licence; the rationale being, as PPF providers are exempt from the prudential standards that apply to other ADIs under the APS 610, APRA may need to add further conditions in order to maintain an even playing field between PPF providers and other ADIs. Thus, some non-bank stored value facilities in Australia are subject to the ADI-PPF regime, while others are not.607
As they are held to a lower regulatory standard, PPF providers may not call themselves a ‘bank,’ or use suggestive terms precluded by s66 of the Banking Act. It is a condition of authorisation as a PPF provider that the provider may only conduct banking business as specified in Regulation 3. This restriction prevents PPF providers from accepting deposits for the purposes of making money advances. It is a condition of authorisation that the PPF provider may not represent that it is authorised to take deposits.608 If it holds out to the public that it is an authorised deposit-taking institution, it must qualify this with a clear statement that it is only authorised to provide PPFs and not carry on a general business of taking deposits.609
The HKMA allows a range of issuers to enter the market, with licensees offering retail payments and stored value products, business-to-business channels or collaboration under credit card schemes, and there is a diversity of business models that have been granted a stored value licence by the HKMA.610 The list of current licensees include technology giants Tencent and PayPal, telecommunications provider HKT, public transport fare operator Octopus, and road toll system operator Autotoll, all of whom are familiar names in the Hong Kong market.611 It also includes emerging companies
607 This is discussed in more detail in Chapter Seven. 608 Ibid. 609 Ibid. 610 Mark Parsons, Tommy Liu, ‘Hong Kong’s fintech surge: HKMA grants second round of SVFs licences,’ (Publication, Hogan Lovells, November 2016) 1 < https://www.hoganlovells.com/~/media/hogan- lovells/pdf/publication/2016/hong-kongs-fintech-surgehkma-grants-second-round-of-stored-value- facil.pdf>. 611 Ibid. 138 such as virtual card issuer Optal, China UnionPay card issuer K&R International, local e- wallet issuer TNG and traveller card issuer Transforex.612
Licenced banks do not have to apply for an additional licence in order to operate stored value facilities, as they have undergone stringent licencing requirements under the Banking Ordinance, and any existing stored value facility is already under the supervision of the HKMA.613 Two licensed banks, Bank of Communications and Dah Sing Bank are stored value facility operators under section 8G of the Ordinance.
In Hong Kong, bank issuers are required to meet the same float safeguarding principles as non-bank issuers; discussed further in Part Four. This is an attempt to even the playing field by reducing the banks’ competitive advantage in the payments space.614 However, banks also have to comply with provisions under the Banking Ordinance which require them to maintain liquidity and capital adequacy, to submit periodic returns to the HKMA, to adhere to loan limitations, and to seek approval for the appointment of directors and chief executives, amongst other requirements, in addition to the stored value facility requirements should they choose to issue stored value products.615 Non-bank issues are subject to less stringent regulations than banks, as they only have one set of regulations with which to comply, allowing non-bank providers a regulatory advantage and the potential to issue more competitive products.616
Singapore’s stored value arena appears to have greater competitive neutrality than Hong Kong, as it is not differentiated by whether the issuer is a bank or not, but by the total value of the issuer’s float, and whether it is a multi-purpose or single purpose
612 Ibid. 613 Payment Systems and SVF Ordinance Cap 584 s8G; Financial Services and the Treasury Bureau, ‘The Proposed Regulatory Regime for SVFs and Retail Payments in Hong Kong’ (Consultation Conclusions, Hong Kong Monetary Authority, 31 October 2014) < http://www.hkma.gov.hk/media/eng/doc/key- information/press-release/2014/20141031e4a1.pdf>. 614 Mark Parsons, ‘Hong Kong Concludes Payments Regulation Consultation,’ above n 525. 615 Hong Kong Monetary Authority, Banking and Supervision Policy – Regulator Framework, (27 January 2017) < http://www.hkma.gov.hk/eng/key-functions/banking-stability/banking-policy-and- supervision/regulatory-framework.shtml>. 616 Interview conducted by the author in Hong Kong on 25th October, 2017. 139 facility. The PSOA divides stored value facilities into single purpose and multi-purpose products, and as in Hong Kong and Australia, exempts single purpose facilities from most regulation.617 It also divides stored value facilities into WASVFs, which are subject to the full extent of the regulation, and exempts the other facilities from the PSOA. Multi-purpose stored value facilities are classified as either widely-accepted, or not, and this is the main determinant of the level of their regulation.
Bank-issued stored value facilities must comply with the anti-money laundering/counter-terrorism (AML/CTF) financing requirements in Notice 626, which do not apply to non-banks.618 From November 2015 all holders of stored value must comply with PSOA-N02: Notice to Holders of Stored Value Facilities on Prevention of Money Laundering and Countering the Financing of Terrorism.619 For all issuers of widely-accepted stored value facilities (WASVFs), a bank, approved by the MAS, is required to have undertaken full liability for the stored value.620
The MAS does not require non-WASVFs to disclose even basic information to consumers, such as whether terms and conditions may be varied, the extent of consumer liability for lost or stolen cards and the existence of expiration dates. This information gap imposes a greater regulatory burden for WASVFs; the only requirement imposed upon non-widely accepted stored value issuers is that they notify users that they are not subject to MAS approval.621
617 Monetary Authority of Singapore, Stored Value Facilities: Overview and Regulations, above n 548. 618 Monetary Authority of Singapore, ‘Proposed Amendments to MAS Notice PSOA – N02 on Prevention of Money Laundering and Countering the Financing of Terrorism – Holders of Stored Value,’ (Response to Feedback Received, 2 November 2015), 2 < http://www.mas.gov.sg/~/media/MAS/News%20and%20Publications/Consultation%20Papers/Respons e%20to%20Feedback%20Received%20%20PSOAN02%20%20Nov%202015.pdf>. 619 Monetary Authority of Singapore, ‘Notice to Holders of Stored Value Facilities PSOA-N02,’ (Notice, 30 November 2015) < http://www.mas.gov.sg/~/media/MAS/Regulations%20and%20Financial%20Stability/Regulatory%20and %20Supervisory%20Framework/Anti_Money%20Laundering_Countering%20the%20Financing%20of%2 0Terrorism/Nov2015/MAS%20Notice%20PSOAN02%20%20November%202015.pdf>. 620 Payments System (Oversight) Act 2006 ss34, 35. 621 Singapore Government, ‘Government’s Responses to the Follow-up Actions Arising from the Discussion at the Meeting held on 2 March 2015,’ (Report, CB(1)656/14-15(10), Bills Committee, March 2015) Annex 4 < http://www.legco.gov.hk/yr14-15/english/bc/bc03/papers/bc0320150323cb1-656-10- e.pdf>. 140 iii. The Outcome; an Evaluation
Regulation can have a direct impact on the services that an issuer can offer by restricting the products available for issue by certain providers, and may advantage some issuers over others; banks or larger issuers may be advantaged over non-banks or smaller providers, or vice-versa. In Hong Kong, a banking licence is required to offer particular types of service, market entry and maintenance involves significant outlay of funds, and due to having to comply with two sets of regulation, banks and traditional issuers may be at a disadvantage.622 Similarly, in Singapore, where non-banks and smaller providers are subject to less stringent regulatory requirements than banks, they may be advantaged, particularly for non-WASVFs.
Like Hong Kong and Singapore, the existing stored value regulations in Australia do not provide an adequate level of competitive neutrality for different issuers of similar products. This has been identified by the Final Report of the 2014 FSI, which concluded that the current PPF regime is in many respects unclear, involves significant compliance costs, and does not provide competitive neutrality for PPF issuers with other ADIs.623 The exemptions to the PPF regime available to non-bank issuers lessen their regulatory burden; whether they afford a balance with the natural competitive advantages of banks derived from their greater capital and personnel resources, market penetration, consumer trust etc remains a question for debate. PPFs captured by the ADI regime have simpler capital requirements than do other ADIs, but are subject to more onerous liquidity requirements, which may dissuade smaller providers from expanding and becoming subject to the PPF regime.624 However, there are non- bank stored value issuers which are not captured by the APRA’s prudential regime and operate outside of the regulatory framework, thus retaining the greatest competitive advantage. This situation, along with recommendations on how it may be addressed, is discussed in Chapter Seven.
622 Interview with Scott Thiel in Allan Tan, ‘Hong Kong’s rush to SVF gold,’ (4th June 2017) Fintech Innovation (online)
This outlay of start-up funds and cost of maintaining the licence may not be a large financial burden for a large bank or company to bear, but smaller potential entrants have complained that the uniform fee and licence are not in the best interests of competition.628 Aurélian Menan, Co-Founder and CEO at Gatecoin, a regulated digital currency exchange based in Hong Kong, put it this way:
…In Hong Kong, no matter your volume or business, you need to have HK$25 million (US$3.2 million) in equity [to get a license]. But other places, like Europe, have more progressive schemes. This is especially helpful if you consider the hardship of raising funds.629
The difficult conditions for new non-bank entrants to the stored value payments system in Hong Kong’s could inhibit Hong Kong’s aspiration to become a major competitive fintech centre.630 Stored value start-ups may prefer to leave the Hong Kong market and base themselves in China, which has an established stored value
625 Financial Services and the Treasury Bureau, ‘The Proposed Regulatory Regime for SVFs and Retail Payments in Hong Kong’ (Consultation Conclusions, Hong Kong Monetary Authority, 31 October 2014) 4. 626 Interview conducted by the author in Hong Kong, 25th October 2016. 627 Payments Systems and SVFs Ordinance Section 8B; Scott Thiel, Heng Loong Cheong, A Kong et al, ‘Payment Regulations in Flux, Recent Changes in Hong Kong, China and Singapore,’ Lexology (online) 8 March 2016 < http://www.lexology.com/library/detail.aspx?g=aa361236-e189-49f8-a3bd- 2246be304950>. 628 Hannah Leung, ‘Will new regulations affect fintech startups in Hong Kong?’ above n 589. 629 Ibid. 630 Ibid. 142 market with systems such as Alipay and WeChat Wallet, or Singapore, with its open- access market.
In Singapore concerns have also been expressed in submissions to the MAS that differing requirements for different providers have created an uneven playing field.631 The MAS has responded that the 2015 amendments to the stored value AML/CTF requirements are intended to clarify the obligations of all holders, whether bank or non-bank, and no effect on the relative positions of competing institutions is intended, and that it will monitor the single purpose stored value facility market as part of its ongoing review.632 The MAS has also stated that imposing additional requirements for non-widely accepted payments facilities may result in a high regulatory burden for these issuers.633
3.3 Regulatory Support for Innovation of Stored Value Facilities
i. The Problem
Regulators are tasked with ensuring the stability of a market and protection of consumers, without inhibiting beneficial innovations. Innovation is essential for the development of payments products and markets, especially in the areas of improved efficiency and improved security.634 Regulations affect both entrepreneurial plans for payments innovation and production costs, and can act as either a driver for or a barrier to market entry.635 As consumers need to have confidence and certainty of operation in their payments products, regulators may restrict innovation to ensure that the market is secure and stable, or encourage innovation to increase efficiency through competition.636 When a country’s regulations stifle innovation, potentially
631 Monetary Authority of Singapore, ‘Proposed Payment Services Bill,’ (Consultation Paper P012, November 2017) 44, 45. 632 Ibid. 633 Monetary Authority of Singapore, ‘Response to Feedback Received: Consultation on Draft Payment Systems Oversight Bill’ above n 580, 9.2. 634 Committee on Payments and Market Infrastructures, ‘Innovations in retail payments,’ above n 603, 15. 635 Ibid 33. 636 Ibid 37. 143 useful technology may be ignored, placing that country at a competitive disadvantage to its global competitors. This section compares and evaluates the different approaches that regulators in each jurisdiction have taken to balance financial stability, consumer protection and innovation.
ii. The Law, Regulations and Guidelines
The current regulatory regime in Australia should improve its support for innovation and development of stored value facilities – Chapter Seven contains a detailed analysis. An aspiring new PPF entrant in Australia must apply for a financial services licence, or be so small as to fit in with the low value exemptions, that is, where the amount outstanding to a single client may not exceed AU$1000, and the total amount outstanding under the facility may not exceed AU$10 million.637 Should the business become significantly sizable, it will become regulated as an ADI. The need to comply with regulatory requirements is likely to deter some aspirants from entering the market, and influence others to design their product to fit into legislative exemptions, rather then by a determination of what is best for the market and consumers. ASIC has demonstrated a commitment to supporting innovation, launching an Innovation Hub to foster innovation by helping new entrants navigate ASIC’s regulatory framework,638 creating a Digital Finance Advisory Committee and establishing a regulatory sandbox,639 however these initiatives have not impacted the existing regulatory requirements.
The Hong Kong government has committed to making Hong Kong a fintech leader in the Asia-Pacific region. Government allocations towards fintech in the 2016-17 budget have been made, including the setting aside of HK$2 billion for an Innovation and Technology Co-investment Fund.640 The HKMA has created a Fintech Facilitation Office and the Securities and Futures Commission has established a Fintech Contact Point –
637 Payments System (Regulation) Act 1998 - Declaration No. 2 of 2006 regarding Purchased Payment Facilities. 638 Australian Securities and Investments Commission, Innovation Hub (2018)
…great challenge…is to provide adequate protection for FinTech consumers, while retaining appropriate flexibility so as not to hinder the development of FinTech. Our job is to find a good balance between market development and user protection.643
In 2016, the HKMA launched a FinTech Supervisory Sandbox for pilot fintech initiatives for banks, but not non-banks.644 The sandbox excludes stored value facility operators, although they may collaborate with a bank and participate indirectly in the HKMA sandbox.645 From this it can be surmised that Hong Kong’s commitment to innovation is targeted towards bank-issued products, or at least those products with a bank sponsorship.
The HKMA envisages that Hong Kong’s new stored value legislative regime will ‘strengthen the public's confidence in the use of these products and services, and foster the development and innovation of the payment industry.’646 Law firm Hogan Lovells has described Hong Kong’s stored value regime as ‘the most significant regulatory development in relation to Hong Kong fintech to date, bringing regulatory oversight to all businesses to enable payments to merchants and amongst peers
641 Ibid. 642 The Hub was launched by the FinTech Facilitation Office in collaboration with the Hong Kong Applied Science and Technology Research Institute. 643 Nelson Chow, ‘Is Hong Kong ready for a FinTech Revolution?’ (27 June 2017) South China Morning Post. 644 Hong Kong Monetary Authority, ‘HKMA-ASTRI Innovation Hub,’ (Letter Sent to all SVF Licensees, G12/228C, 6 September 2016) < http://www.hkma.gov.hk/media/eng/doc/key-functions/finanical- infrastructure/20160906e1-svf.pdf>. 645 John Casanova, Yuet Ming Tham, Josephine Law, et al, ‘Fintech and Regulatory Sandboxes in the UK, Hong Kong and Singapore,’ (Banking & Financial Services Update, Sidley, 6 September 2017) 4 < https://www.sidley.com/-/media/update-pdfs/2017/09/20170901--banking-and-financial-services- update.pdf>. 646 Hong Kong Monetary Authority, ‘Regulatory regime for stored value facilities and retail payments systems commences operation,’ (Press Release, 13 November 2015) < http://www.info.gov.hk/gia/general/201511/13/P201511130423.htm>. 145 through any manner of stored value facility.’647 The new regulations are designed to provide a roadmap for companies like Alipay to move into Hong Kong. In 2016, about 30% of all licence applicants were new operators.648 The HKMA has granted eight digital wallet providers stored value licences, bringing the number of total licensees to 13.649
Singapore has a liberal stored value regime that strongly encourages new entrants into the payments system, promoting innovation and competition amongst providers and drawing in fintech start-ups from around the world.650 Financial institutions do not need MAS permission to experiment with new technologies. That responsibility lies with the board which assesses risks and devises appropriate safeguards.651 The regulatory burden for start-up companies is not great; the MAS’s $30 million exemption threshold was chosen to balance the protection of funds-at-risk with the developmental objective of promoting innovation in the smaller stored value market.652
The MAS launched its FinTech Sandbox in 2016, and is open to all types of firms, including financial institutions, fintech firms, or any interested firm.653 It is aimed at new financial products or services where there may be uncertainty over whether the innovation meets regulatory requirements.654 The Singapore government has
647 Parsons and Liu, ‘Hong Kong Monetary Authority grants first round of SVFs Licensees,’ above n 530. 648 Nikki Sun, ‘Over 20 companies apply for Hong Kong licences to operate stored-value systems like Octopus,’ (2016) South China Morning Post (online) < http://www.scmp.com/news/hong- kong/economy/article/1933860/over-20-companies-apply-hong-kong-licences-operate-stored>. 649 AliPay Wallet, Tap&Go, Tencent’s WeChat Pay, TNG Wallet, Octopus O! ePay. PayPal, Autotoll, Optal, 33 Financial, UniCard, ePaylinks, TransForex, and K&R International; Singh, ‘Why Hong Kong going cashless is no small change,’ above n 8. 650 Bhavan Jaipragas, ‘Fintech – the next frontier for Hong Kong’s battle with Singapore,’ (19 September 2016) This Week in Asia (online) < http://www.scmp.com/week-asia/business/article/2020094/fintech- next-frontier-hong-kongs-battle-singapore>. 651 Ravi Menon, ‘FinTech – Harnessing its Power, Managing its Risks,’ (Speech delivered at Singapore Forum, Singapore, 2 April 2016) < http://www.mas.gov.sg/News-and-Publications/Speeches-and- Monetary-Policy-Statements/Speeches/2016/FinTech-Harnessing-its-Power-Managing-its-Risks.aspx>. 652 Monetary Authority of Singapore, ‘Consultation on Draft Payment Systems (Oversight) Bill,’ above n 580. 653 Monetary Authority of Singapore, ‘Fintech Regulatory Sandbox Guidelines,’ (November 2016) 2.2, 4.1. 654 Monetary Authority of Singapore, Fintech Regulatory Sandbox, (1 September 2017)
iii. The Outcome; an Evaluation
Singapore appears to be winning the race to promote itself as Asia’s principal fintech hub - around 200 fintech firms have opened in Singapore between 2014 and 2016, the fastest growth in Asia.657 The high threshold captures existing stored value facilities that operate nationwide while leaving regulatory space for innovation on the part of potential market entrants, allowing market flexibility to meet consumers’ needs and encouraging competition and innovation amongst providers.658
In marked distinction to those of Hong Kong and Australia, Singapore’s regime strongly encourages new non-bank entrants, providing very few barriers to entry and few regulatory burdens for new start-ups. It is not until a company holds stored value of S$30million (around US$22 million) that full regulatory requirements apply. In Hong Kong, only stored value facilities with a float size of less than $1 million (around US$130,000), and in Australia, only stored value facilities with a float size of less than $10 million, (around US$7.5 million) and up to $1,000 per user, qualify for an exemption to the regulation. The higher threshold in Singapore allows issuers to become medium-sized institutions before imposing the full regulation. Whilst this open-market background is proving attractive to potential start-ups seeking a sympathetic base, it may be that in time in Singapore this proves to be at the expense of market stability and consumer protection.659
655 Ravi Menon, ‘Singapore’s FinTech Journey – Where we Are, What is Next?’ (Speech delivered at Singapore FinTech Festival, Singapore, 16 November 2016). 656 Faraaz Ali, ‘Are payments nearing a tapping point?’ above n 517. 657 Saeed Azhar, Marius Zaharia, ‘In race to be Asia’s fintech hub, Singapore leads Hong Kong,’ (4 July 2016) Sydney Morning Herald. 658 Ibid. 659 Interview conducted by the author in Singapore, 16th November 2017. 147 One downside to Singapore’s regime is that the variety of payments providers has meant that merchants may accept one card or facility, and not another, confusing consumers.660 For example, considering the two most widely-used cards, ez-link and CashCard, ez-link is accepted for public transport payments, but not at all car parks, and thus motorists need to carry both cards.661 Critics have stated that ‘Singapore missed the opportunity to go cashless much earlier by (not) standardising the ez-link card as the universal payment card, as Hong Kong did with the Octopus card.’662
Whilst the HKMA is committed to supporting innovation, their regulations may inhibit innovation and development. Hong Kong has fewer than 100 fintech firms, despite receiving fintech funding grants valued at nearly US$300 million.663 Hong Kong’s strict licensing requirements is a barrier to market entry, particularly for smaller non-bank issuers. The HK$25 million paid-up capital requirement in particular has generated concerns amongst start-ups seeking stored value licences.664 Once the potential licensee has raised the adequate capital requirement, they must also find a bank willing to store the client value, and to act as a trustee for the stored value facility.665 Smaller businesses in Hong Kong may be forced to choose between finding an exemption from the licensing regime or forming a collaborative partnership with a stored value facility licensee or financial institution.666 Similarly, stored value operators cannot enter the sandbox without first collaborating with a bank.
By providing legal clarity, the HKMA aims to foster development of stored value facilities and maintain Hong Kong’s status as an international financial centre.667 Exemption to the licence requirements may be granted by the HKMA if the risks posed by the stored value facility to the consumer or financial system are immaterial, for example where there is a limited float amount, and the parent companies of the
660 Interview conducted by the author in Singapore, 15th November 2017. 661 Irene Tham, ‘Can Singapore catch up in race to go cashless?’, (Aug 24, 2017) The Straits Times. 662 Ibid. 663 Azhar, Zaharia, above n 657. 664 Parsons and Liu, ‘Hong Kong Monetary Authority grants first round of SVFs Licensees,’ above n 530. 665 Interview conducted by the author in Hong Kong, 23rd October 2017. 666 Parsons and Liu, ‘Hong Kong Monetary Authority grants first round of SVFs Licensees,’ above n 530. 667 Hong Kong Monetary Authority, ‘Explanatory Note on Licencing for SVFs,’ above n 527, 4. 148 issuers are financially sound.668 This exemption may be conditional, for example by placing limits on float or number of users,669 but if this has occurred, it has not been published. Exercise of that discretion may lessen some of the inhibitory factors and provide some relief for smaller start-up companies.
The HKMA requirement that stored value facility licensees be a Hong Kong registered business prevents issuers from setting up their products in neighbouring jurisdictions and accessing the Hong Kong market through cross-border services.670 Payments companies may choose not to develop into the stored value area because of its high financial and resource cost of compliance. For example, Chinese peer-to-peer lender Jimubox abandoned Hong Kong after spending nearly a year setting up, as strict rules on account openings made it hard to take on customers.671 MatchPay Move, a mobile payments company, chose Singapore over Hong Kong as its base because of its ‘highly- skilled professionals, access to regional markets and the regulatory environment.’672 Mr Joe Seunghyun Cho, whose Marvelstone group is developing a mobile payments platform, chose Singapore over Hong Kong as the headquarters for his six financial technology companies because of the Singaporean Government agencies, which introduced him to tax advantages and connected his firm to potential partners.673
Australia’s PPF regime was introduced following the Wallis Inquiry to encourage growth and support for innovation in the payments field, but it is the PPF regime itself which is proving a major barrier to the growth of stored value facilities in Australia. The RBA and ASIC have issued regulatory exemptions for certain PPF to permit them to develop, but as the system is overly complex, the resulting stored value product is often shaped by the need to fulfil regulatory requirements rather than by the entrepreneur’s vision of an innovative product designed to meet consumer needs.
668 Payment Systems and SVF Ordinance, Cap 584 s8ZZZ. 669 Ibid. 670 Interview conducted by the author in Hong Kong, 23rd October 2017. 671 Azhar and Zaharia, ‘In race to be Asia’s fintech hub, Singapore leads Hong Kong,’ above n 657. 672 ‘With fintech, Hong Kong-Singapore rivalry gets a new twist,’ (8 December 2016) Singapore Business Times (online). 673 Ibid. 149 The Australian government has announced that it will launch an enhanced regulatory sandbox for new and innovative financial products, and will extend ASIC’s powers to grant an exemption from the Australian Financial Services Licence for the purpose of entering this sandbox.674 The new sandbox is currently in consultation phase with industry, and it remains to be seen how this enhanced sandbox will affect stored value facility issuers.
The approaches of Australia and Hong Kong allow for the possibility of regulatory relief for smaller companies and new products. The HKMA may grant exemptions to allow small companies to develop without a large capital requirement. To like effect, ASIC’s non-cash payment facility regime exempts low value products and provides a regulatory sandbox for new entrants. This laudable approach in principle is not without disadvantages.
There is a question as to the extent to which a system incorporating numerous exemptions encourages fintech start-ups to enter the stored value market. By exempting products from the standard regulatory framework, the regulator(s) may be creating a second-class group of institutions, who are not seen as serious players by users or competitors.675 It is possible that potential clients and business partners may choose not to engage with products that operate within the exemptions, particularly if the number of consumers and total value the product can store is limited.676
Market development may be limited as products are designed to fit within exemptions rather than meeting the needs of the market. Fintech start-ups seeking to scale up in Hong Kong’s already limited retail market may find it difficult to find a business model that works within these constraints.677 As in Australia, once the product reaches significant growth, it falls to be regulated under the full regime: the product or the business model may need to be re-designed in order to comply with the widened
674 The Treasury, Enhanced Regulatory Sandbox, Australian Government (1 December 2017) < https://treasury.gov.au/consultation/c2017-t230052/>. 675 Interview conducted by the author in Sydney, 31st March 2017. 676 Interview conducted by the author in Sydney, 31st March 2017. 677 Ibid. 150 requirements. Also like Australia, the exemptions under the stored value regime have attracted criticism as being narrowly crafted and limited to tightly defined user bases and specific types of products, encouraging some business models to develop by avoiding full regulation.678
Despite Hong Kong’s commitment to innovation, its stored value regime prioritises the security of consumers’ money and the maintenance of Hong Kong’s reputation as a well-run financial services hub, with consequent trade-offs that limit growth in certain parts of the market.679 As the HKMA gains experience in regulating the new stored value facility licenses, it may be expected to make adjustments to the regulatory regime over time. One may assume that Hong Kong’s cautious approach to legislative regulation is influenced by its desire to maintain its reputation as a prudent regulator of financial services. A cultural factor has been described:
…a deep-rooted cash culture , an older population reluctant to adopt new technologies, and the fear of “Big Brother” snooping on transactions are some of the obstacles stopping Hong Kong from becoming truly cashless.680
These factors too may be taken to have relevance to the minds of legislators. Hong Kong’s road to becoming a cashless society is likely to be achieved through a small number of highly regulated and widely accepted stored value facilities, rather than through the adoption of the latest techfin innovations.
Singapore’s stored value regulations, while not as comprehensive as those of Hong Kong, provide more opportunity for innovation and growth. Singapore’s regulations contain tiers that operate according to ascending float values, a regime with regulations similar to the ASIC non-cash payments regime in Australia, though its thresholds are much higher.
678 Parsons and Liu, ‘Hong Kong Monetary Authority grants first round of SVFs Licensees,’ above n 530. 679 Ibid. 680 Singh, ‘Why Hong Kong going cashless is no small change,’ above n 8. 151 3.4 Client Money and Float Protection
i. The Problem
This section outlines the measures imposed upon issuers to protect client money held in stored value facilities. It compares the rules found in each jurisdiction pertaining to how a client may redeem their money, whether this money may be invested, if this money is protected by trust or bank guarantee and liability in cases of fraud.
ii. The Law, Regulations and Guidelines
In Hong Kong, the stored value facility licence conditions include measures to ensure that the stored value float remains secure and used only in accordance with users’ instructions.681 The float and stored value deposit must at all times be kept separate from other funds paid to or maintained by the business, and protected against claims from the issuer’s other creditors.682 Bank issuers are required to meet the same float safeguarding principles as non-bank issuers; they are each required to keep their stored value float separate from other funds, and must have in place float protection measures that adequately protect customers’ funds.683 The particulars of the float safeguarding principles will be assessed on a case-by-case basis, taking into account the licensee’s government structure, financial strength, scale of business, risk management procedures and internal control environment. Conditions imposed remain a feature of the institution’s stored value facility licence.684
The Ordinance requires that the stored value provider redeem the full total of the stored value as soon as practicable once requested by the user to do so, and users should be provided with easy channels for redemption.685
681 Parsons and Liu, ‘Hong Kong’s fintech surge: HKMA grants second round of SVFs licences,’ above n 610, 2. 682 Payment Systems and SVF Ordinance, Cap 584, Schedule 3, Part 2, s7. 683 Hong Kong Monetary Authority, ‘SVFs and retail payments systems in Hong Kong: a proposed regulatory regime,’ (Quarterly Bulletin, June 2013). 684 Ibid. 685 Payment Systems and SVF Ordinance, Cap 584, Schedule 3, Part 2, s8. 152 Guideline 8.3.5 states that:
…a licensee should be solely responsible for the robustness of its stored value facility scheme and as such it should bear the full loss of the value stored in a user account where there is no fault on the part of the user.686
A licensee is expected to observe this Guideline, unless it can be demonstrated that a user has acted fraudulently, with gross negligence (for example if they failed to safeguard his or her card, device and/or secret code), or failed to inform the licensee as soon as reasonably practicable of any possibility that their account may have been compromised, lost or stolen, or of the presence of any unauthorised transactions.687 The licensee must also have in place appropriate procedures to ensure that funds are protected against the risk of misappropriation by any means.688 Under exceptional circumstances, the HKMA may grant the licensee permission to put expiry dates on the stored value, but this must be stated clearly and prominently in the contract with the user.689
The HKMA requires that a trust arrangement with a licensed bank be in place, usually with a bank guarantee or custodian appointed to monitor the flow of funds to and from a dedicated customer account holding the stored value float.690 In regulating licensees, the HKMA will use on-site examinations, off-site reviews, independent assessments, auditors’ reports and meetings with the licensee’s management.691
686 Hong Kong Monetary Authority, ‘Payment Systems and Stored Value Facilities Ordinance: Guideline on Supervision of Stored Value Facility Licensees,’ (Guideline, September 2016) 8.3.5 < http://www.hkma.gov.hk/media/eng/doc/key-functions/finanical-infrastructure/Guidelines-on- supervision-of-SVF-licensees_Eng.pdf>. 687 Hong Kong Monetary Authority, ‘Practice Note on Supervision of SVF Licensees,’ (Publication, September 2016) < http://www.hkma.gov.hk/media/eng/doc/key-functions/finanical- infrastructure/PN_on_supervision_of_SVF_licensees_eng.pdf>. 688 Payment Systems and SVF Ordinance, Cap 584, Schedule 3, Part 2, s5,7. 689 Ibid s8; Hong Kong Monetary Authority, ‘Practice Note on Supervision of SVF Licensees,’ above n 687. 690 Parsons and Liu, ‘Hong Kong’s fintech surge: HKMA grants second round of SVFs licences,’ above n 599, 2. 691 Hong Kong Monetary Authority, ‘Explanatory Note on Licensing for SVFs,’ (Explanatory Note, November 2015), 5. 153 In Singapore, the MAS Guidelines, mandatory only for WASVFs, outline a relatively high level of protection for consumer funds. They state that a user should be able to redeem the stored value in two ways; in exchange for goods or services, or by obtaining a refund from the holder in respect of the stored value.692 The Guidelines add that refunds should be allowed unless the holder is able to prove that the stored value facility is a counterfeit, the stored value in the facility has been illegally updated, or the stored value has not been updated in accordance with the procedure stated in the terms and conditions that govern the use of the facility.693
The Guidelines state that holder should have sufficient assets to meet the full redemption of a user’s stored value in a timely manner, and accordingly, on a daily basis should maintain an amount of cash and liquid assets which is commensurate with the redemption, or projected redemption patterns of the stored value.694 To ensure the preservation of the stored value, the Guidelines recommend that the stored value is held in a bank account that is separate from the working capital funds, or held in trust for the users.695 If the holder chooses to invest the stored value, then it should be invested in liquid and low-risk assets such as fixed deposits or government treasury bills.696
All stored value holders are required to submit annual statistical reports to the MAS, and must undertake customer due diligence measures for any transaction exceeding S$5000.697 Exceptions are made for pre-defined classes of stored value facility which have low money laundering and terrorism financing risk.698
692 Monetary Authority of Singapore, Stored Value Facility Guidelines, June 2006, Principle 2.1.1. 693 Ibid Principle 2.1.2. 694 Ibid Principle 2.1.4. 695 Ibid Principle 2.1.7. 696 Ibid Principle 2.1.8. 697 Scott Thiel, Heng Loong Cheong, A Kong et al, ‘Payment Regulations in Flux, Recent Changes in Hong Kong, China and Singapore,’ Lexology (online) 8 March 2016. 698 These are SVF which cannot contain value of more than S$1000, do not allow cash withdrawals, allow refunds of S$80 or more only with customer identification documents, and satisfy two of the following conditions: do not allow cross-border funds transfer or withdrawal; can only be used as means of payment of goods or services; or the stored value is funded from an identifiable source. Monetary Authority of Singapore, ‘Prevention of Money Laundering and Countering the Financing of Terrorism – Holders of Stored Value Facilities,’ (Notice PSOA-NO2, November 2015) s2.1. 154
In Australia, APRA’s Prudential Standard APS 610 outlines that PPFs with stored value at risk must hold, at all times, high quality liquid assets of equal value to their stored- value liabilities, and meet specific minimum Tier One capital requirements.699 It outlines that PPFs are not allowed to behave like deposit-taking institutions, that is, they may not charge and/or pay interest on customer balances. However, if the stored value provider has been authorised or exempted from the ADI-PPF system by the RBA then APS 610 does not apply. APS 610 only applies to ADIs that have obtained an authorisation to provide PPFs, and thus, at the time of writing, applies to only one stored value provider (PayPal Australia).700
Regardless of whether they fall under the APRA or RBA system, stored value facilities should also be captured by ASIC’s non-cash payment facility regime, with exemptions made for low value facilities.701 Stored value facilities as non-cash payment facilities are subject to the provisions of the Corporations Act, unless exempt by an RBA exemption or ASIC class order. However, there is uncertainty over whether the client money handling provisions under Part 7.8 apply to stored value products, as there is a question of whether the stored value is classified as an increased interest in the product or not.702 Client money under the Corporations Act is money that is paid to a financial services licensee in connection with a financial service that has been provided, or that will or may be provided, to the client.703 It does not, however, include money that has been paid to reimburse the licensee for payments made to acquire an increased interest in a financial product from the licensee.704 It is unclear whether value held in a purchased payment facility is classified as an increased interest or not.
699 Australian Prudential Regulation Authority, Prudential Requirements for Providers of Purchased Payment Facility, above n 428, 9, 12. 700 Interview conducted by the author in Sydney, 25th July 2017. 701 Interview conducted by the author in Sydney, 31st March 2017. 702 Corporations Act 2001 (Cth), Part 7.8, Sect 981A (2); Interview conducted by the author in Sydney 31st March 2017. 703 Corporations Act 2001 (Cth), Part 7.8, Sect 981A. 704 Ibid. 155 Low value facilities exempted from APS 610 and ASIC’s non-cash facility regime may find operational guidelines in the ASIC ePayments Code. The ePayments Code applies to transactions that are initiated using electronic equipment, and is therefore relevant to all stored value facilities. It has particular tailored provisions for low value facilities that can hold a balance of no more than $500 at a time. It contains some client money provisions, including when a holder is and is not liable for the loss of clients’ money, but the Code is voluntary and only applies if the provider chooses to be bound.705 PayPal and the major Australian banks have subscribed to the ePayments Code.706
iii. The Outcome: an Evaluation
The extent that regulatory differences exist between jurisdictions reflects national perceptions of the trade-off between the efficiency of the financial sector, and the level of risk assumed by the public sector.
Hong Kong has the most comprehensive client protections for the stored value float of the three jurisdictions, requiring all stored value facilities that are not low-value or single-purpose to be subject to the stringent protection provisions.
Singapore’s client money protections are less stringent than Hong Kong’s, but more clear than Australia’s. Like Hong Kong, Singapore’s client money handling provisions are clear and comprehensive, but while Hong Kong’s Guidelines apply to almost all multi-purpose stored value facilities, the Guidelines in Singapore are mandatory only for WASVFs, and merely a recommendation for the other facilities. Thus the majority of Singaporean stored value facilities do not need to comply with the Guidelines, they may operate without the approval of the Monetary Authority of Singapore, and there is no alternative regulation to act as a minimum standard.
705 S10 & 11; It must be noted that ASIC does have the power to declare that the Code applies or does not apply to a type of transaction. 706 For a full list of subscribers, see Australian Securities and Investments Commission, ePayments Code Subscribers (3 January 2018) < http://asic.gov.au/for-consumers/codes-of-conduct/epayments- code/epayments-code-subscribers/>. 156 ‘MoneySense,’ Singapore’s national financial education program, advises consumers that if they lose their money with an ordinary (non-widely accepted) stored value facility, then they need to consider whether it is worthwhile to take action against the issuer.707 The Singaporean government also advises consumers to minimise potential losses by taking the precautionary measure of not storing large amounts in any stored value facility.708
Australia’s client protections are the weakest of the three jurisdictions, as unlike Hong Kong and Singapore, there is no single set of Guidelines for stored value facilities in Australia and the extent to which regulatory protections apply to the money held by stored value products under the current regulations occasions confusion and uncertainty. The regulations concerning what a stored value provider can and cannot do with the money stored in its facility are varied and often uncertain. The rules and regulations determining how a stored value facility may manage its clients’ funds are found in different legislative instruments, which have different levels of applicability.
4. CONCLUSION
In this section I evaluate the outcomes drawn from the previous section, and offer a view as to the combination of approaches that appear to best suit the needs of Australia’s stored value market.
In terms of clarity, both the regimes of Hong Kong and Singapore clearly define what does and what does not constitute a stored value facility, and whether it is subject to regulation. Australia’s regime is the least clear of the three, as stored value facilities may be captured by several parallel regimes, and may also fall within the exemptions to any or all of these regimes. Hong Kong’s regulators consider stored value to be analogous to a deposit, accounting for its stringent licensing requirements, whereas
707 MoneySense, Stored Value Facilities, Singapore Government (26 November 2016) < http://www.moneysense.gov.sg/Understanding-Financial-Products/Banking-and-Cash/Types-of- Products-and-Services/Stored-Value-Facilities.aspx>. 708 SVFs FAQs, Monetary Authority of Singapore (2018) < http://www.ifaq.gov.sg/MAS/TOPICS/STORED_VALUE_FACILITIES/579#FAQ_2734>. 157 regulators in Singapore and Australia do not. Accordingly, neither regime is as rigorous as that of Hong Kong.
In general, the stored value regulatory regimes of Hong Kong and Singapore represent each extreme of the regulatory spectrum, with Australia’s regime falling somewhere in the middle. On the one hand, in Hong Kong, all stored value facilities, whether device- based or non-device based, are subject to a mandatory licensing regime with stringent float protection requirements and a large capital buffer. In order to qualify for a licence, a facility must be operated by a Hong Kong incorporated business, which has the stored value facility as its primary business, (unless a bank). In Australia, there is a similar condition of authorisation as a purchased payment facility, where the business activities of an authorised issuer are restricted to purchase payment facility operation and closely related services.
On the other hand, Singapore has a very liberal regulatory regime, allowing stored value facilities to be established without capital or qualification requirements, provided the total stored value is less than S$30 million. Singapore’s stored value regulatory system is a lighter touch regime (when compared to other financial products) that runs alongside the traditional banking system, reflecting the lower risk of these products when compared to traditional payments products. It is only WASVFs that need gain the approval of the MAS to operate, and require a bank to be fully liable for their float. Most Singaporean stored value facilities are not currently subject to risk management requirements.
All three jurisdictions allow banks and non-banks to issue products, but fare differently in terms of competitive neutrality. Singapore and Australia have lesser requirements for non-bank issuers, to balance the natural competitive advantages of banks, but allow banks to issue stored value facilities without additional approval. Hong Kong requires that banks fulfil the same regulatory criteria as non-bank issuers in addition to their obligations under the banking regulations. This is likely to be an attempt to level the playing field as banks are advantaged by the large ongoing capital requirements, as
158 well as reflective of the HKMA’s classification of the stored value float as equal to a bank deposit.
Hong Kong’s chosen regulatory regime is reflective of a stored value system that provides certainty to issuers and consumers and has a clear regulatory path for the entry and advancement of new products. Although the HKMA does have the authority to exempt small stored value operators from the licensing regime in order to allow them to develop,709 the high capital and operational requirements would seem to indicate that Hong Kong’s regime is not particularly open to innovation and the entry of new providers. However, in the last two years, there has been ‘something of a gold rush’ of stored value facility licence applications to the HKMA, most of which have not yet been approved.710 It appears that Hong Kong’s stricter licensing regime has not discouraged new stored value applicants.
Singapore’s regime is very open to new participants and products, posing virtually no barriers to market entry. Australia’s regime is neither so liberal as Singapore’s regime, nor as stringent as Hong Kong’s regime. In implementing regulation, Australia should build on the experience of global regulators while reflecting features of the Australian system. This Thesis proposes that an alternative approach to the system of exemptions found in Hong Kong and Australia is a system of graduations, similar to that in Singapore. However, unlike Singapore, where regulation does not apply until a product reaches the top tier, a flexible, light-touch regulatory regime can be applied to new products, and can be gradually increased as the product grows. This would increase the clarity of Australia’s regime, and provide a clear roadmap for the growth of these products, while minimising the risk to market and consumers of being exposed to unregulated products. Products can develop through the stages of graduation, and the steps between the levels will be less extreme than moving from an exemption to full regulation. It may be that the best system for Australia is to have a clearly defined set of regulations as Hong Kong does, in order to minimise regulatory confusion and to
709 Payment Systems and SVF Ordinance, Cap 584, Schedule 8. 710 Interview with Scott Thiel in Allan Tan, ‘Hong Kong’s rush to SVF gold,’ (4th June 2017) Fintech Innovation (online). 159 provide a clear path for entry of new products, and to lessen the regulation applicable to new entrants as Singapore does, so that each product attracts a level of regulation which is proportionate to its level of risk. A system of this nature is described in more detail in Chapter Eight.
160 CHAPTER SIX: CLARITY AND CONSUMER PROTECTION
1. DEFINITIONAL AND LEGAL UNCERTAINTY 162 2. DEFINITION OF STORED VALUE FACILITIES IN AUSTRALIAN REGULATIONS 168 3. TECHNOLOGICAL NEUTRALIY IN STORED VALUE FACILITY REGULATION 179 4. ASIC’S CONSUMER PROTECTION PROVISIONS 184 5. RECOMMENDATIONS TO IMPROVE THE EXISTING STORED VALUE 185 REGULATORY REGIME 6. CONCLUSION 199
The clarity and transparency of the existing regulatory regime in Australia for stored value facilities should be improved and its consumer protection provisions strengthened. Overlapping regulatory provisions, a multitude of exemptions and a consumer protection code that is voluntary create uncertainty. That uncertainty is exacerbated by the RBA’s designation provision, which operates on regulator discretion rather than fixed criteria. Further, to capture emerging products, minimise risk to consumer funds and to stabilise the financial system generally, regulation needs to be technologically neutral. Consumer protection provisions for stored value facilities of sufficient scale should be made mandatory.
This Chapter examines the current regulatory regime’s definitional uncertainty, the clarity of its provisions, the extent to which it is technologically neutral and the adequacy of its consumer protection provisions. Section One provides a comparison of regulatory definitions of stored value facilities around the world. Section Two examines the definitional clarity of stored value facilities and their applicable regulations in Australia. Section Three outlines the importance of technological neutrality in payments regulation, and considers to what extent it has been achieved in Australia. Section Four examines the consumer protection provisions contained in the current regulatory regime. Section Five considers recommendations made by Government, regulators and industry to improve existing stored value regulation
161 relating to the clarity, technological neutrality, consumer protection and the roles of the regulators.
1. DEFINITIONAL AND LEGAL UNCERTAINTY
1.1 Definitional Challenges are Present around the World
This Section will outline the different definitions of stored value facilities in key jurisdictions around the world. In Chapter Four I outlined the difficulty that Australian regulators face in deciding whether stored value facilities are purchased payment facilities, non-cash payment facilities or e-payments, and I pointed to the resulting regulatory and legal confusion.
Clear regulatory definitions of stored value facilities are imperative as they determine which payment instruments, institutions and services fall within the scope of relevant legislation.711 Regulators should pay particular attention to the scope of definitions of stored value systems in legislation to ensure that they are neither too narrow nor too broad so that products determined to hold significant risk are appropriately regulated.712
Electronic money does not have a universally accepted definition, largely because most legal frameworks now regulating it are still in a developmental stage. The terms used to describe electronic money often differ between jurisdictions and even within the same jurisdiction, leading to difficulties in interpretation, legal uncertainty and regulatory confusion. Different classifications between jurisdictions hamper international coordination and may lead to regulatory inconsistencies.
Uncertainty is not limited to Australian regulators; electronic money poses a definitional challenge to regulators around the world. In order best to analyse the definition chosen by Australian regulators it is necessary first to identify and examine
711 Gonenc Gurkaynak, Ilay Yilmaz, ‘Regulating payment services and electronic money: A comparative regulatory approach with a specific focus on Turkish legislation,’ (2015) 31(1) Computer Law and Security Review 404. 712 The primary risks associated with stored value facilities are outlined in Chapter Three, Section One. 162 the definitions given to electronic money by commentators and by regulators in other jurisdictions. The following section compares the clarity and technological neutrality of definitions of electronic money in comparable jurisdictions. A technologically neutral approach requires that regulations that govern technological activities do not assume a particular unchanging technology is used by a product or service, hindering the use or development of other technologies in the future.713
i. European Union
E-money Directive 2000/46/EC, the first regulatory framework in the European Union for electronic money institutions, defined e-money as ‘monetary value represented by a claim on the issuer which is stored on an electronic device.’714 This definition identified electronic money stored on card-based products, but did not encompass other prepaid products, for example server-based products such as PayPal.
In 2009, as it had not achieved its objective of harmonising legal framework within the European Community, E-money Directive 2000/46/EC was replaced by E-money Directive 2009/110/EC.715 The European Commission now defines e-money in terms of that Directive as
…electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions…, and which is accepted by a natural or legal person other than the electronic money issuer.716
This definition broadens the definition of electronic money that may be stored to include electronically and magnetically stored value, thereby extending the range of products captured by the regulation. E-money Directive 2009/110/EC widened the compass of server-based stored value by removing the earlier reference to ‘defined
713 Tuba, above n 264, 2292. 714 E-money Directive 2000/46/EC [2000] OJEC L275, Article 1(3)(b). 715 Tuba, above n 264, 2288. 716 E-money Directive 2009/110/EC [2009] OJEU L267, Article 2(2). 163 storage mediums;’ so amended, ‘electronic money’ now includes magnetically stored money, thus extending e-money technology to include magnetic, non-smart cards.
The definition of electronic money in 2009/110/EC has opened up the EU market to new entrants, including mobile operators, increasing the number of market participants and the value of electronic money in circulation.717
Under EC Directives prepaid cards are not considered to be digital stored value, and are exempted from the legislation. Electronic-money Directive 2009/110/EC maintains an exclusion for prepaid instruments that operate in a limited network, those that can be used only for purchase of a limited range of goods and services - store cards, petrol cards, public transport smart cards and the like, or of goods and services from a specific retailer or chain of participating retailers.718
ii. United States
The concept and definition of electronic money in the United States differs significantly from the approach in Europe. In the US, the individual states have varying definitions (or none) of electronic money; there is no uniform definition of what constitutes electronic money.
The National Conference of Commissioners on Uniform State Laws has developed the Uniform Money Services Act (UMSA), and under it, electronic money is ‘stored value,’ if it meets the definitional requirements ‘monetary value that is evidenced by an electronic record.’ ‘Monetary value’ is itself defined as ‘a medium of exchange, whether or not redeemable in money.’719 This flexible definition of monetary value
717 Commission of the European Communities, ‘Impact Assessment,’ (Accompanying Document to the proposal for a Directive of the European Parliament and of the Council amending Directive 2000/46/EC on the taking up, pursuit of and prudential supervision of the business of electronic money institutions, 2008) 12. 718 Halpin and Moore, above n 285, 565. 719 Uniform Money Services Act (2004) 17 < http://www.uniformlaws.org/shared/docs/money%20services/umsa_final04.pdf>. 164 allows regulators to capture emerging forms of money on a case-by-case basis.720 The definition of stored value is simplified by omission of any reference to the instrument or medium in which the stored value is embedded.721
UMSA has been enacted only in certain states and territories,722 leaving other states to enact other stored value laws. In California, the Californian Financial Code defines stored value as
…monetary value representing a claim against the issuer that is stored on an electronic or digital medium and evidenced by an electronic or digital record, and that is intended and accepted for use as a means of redemption for money or monetary value or payment for goods or services.723
This definition is similar to the definition of electronic money under the European Directive 2009/110/EC; both present a technologically neutral approach.
The US Code of Federal Regulations includes in its General Definitions the term ‘prepaid access,’ defined as
…access to funds or the value of funds that have been paid in advance and can be retrieved or transferred at some point in the future through an electronic device or vehicle, such as a card, code, electronic serial number, mobile identification number, or personal identification number.724
Unlike the European Union, the United States does not have a uniform definition of electronic money, nor does it have uniform regulation. A stored value instrument may be regulated by state regulation; at the same time, it may also fall within the definition of ‘prepaid access’ at federal level. In the US, a ‘stored value card’ is defined as a different type of card from a ‘prepaid card,’ and yet the value for both types of card is
720 Ibid 20. 721 Ibid 22. 722 Alaksa, Iowa, Puerto Rico, Texas, US Virgin Islands, Vermont and Washington. 723 California Financial Code 2013 s2003(1) (v). 724 Code of Federal Regulations Title 31, Part 1010.100. 165 referred to as ‘stored value,’ which may lead to confusion as prepaid phone or gift cards may also be considered stored value cards.725
iii. Hong Kong
In Hong Kong, the Hong Kong Monetary Authority has issued an Explanatory Note on Licensing for Stored Value Facilities that contains a clear definition of such facilities.726 Section One of Chapter Two states that for the purposes of the Payment Systems and Stored Value Facilities Ordinance727 a facility is a stored value facility if:
a. It may be used for storing the value of an amount of money that – i. Is paid into the facility from time to time; and ii. May be stored on the facility under the rules of the facility; and
b. It may be used for either or both of the following purposes – i. As a means of making payments for goods or services under an undertaking (whether express or implied) given by the issuer… ii. As a means of making payments to another person (other than payments mentioned in subparagraph (i) above) under an undertaking (whether express or implied) given by the issuer.
Section Two of Chapter Two provides that the definition above applies to both device- based and non-device based stored value facilities. These two sections provide a clear and technologically neutral definition of ‘stored value facility.’
iv. Singapore
In Singapore, the Payments Systems (Oversight) Act 2006 defines a stored value facility as:
725 Gurkaynak and Yilmaz, ‘Regulating payment services and electronic money,’ above n 711, 407. 726 Hong Kong Monetary Authority, ‘Explanatory Note on Licencing for SVFs,’ above n 527, 8. 727 2004 (Amended 2015). 166 (a) a facility (other than cash), whether in physical or electronic form, which is purchased or otherwise acquired by a person (referred to in this Act as the user) to be used as a means of making payment for goods or services up to the amount of the stored value that is available for use under the terms and conditions applying to the facility, and payment for the goods or services is made by the holder of the stored value in respect of the facility (rather than by the user); or
(b) all the facilities referred to in paragraph (a) provided under the same terms and conditions.
This definition is reproduced in the Stored Value Facility Guidelines issued by the Monetary Authority of Singapore.728 The Guidelines provide further clarity by describing the operation of a stored value facility (SVF):
A person who wishes to use an SVF (“user”) will purchase the SVF containing a certain stored value. This stored value amount is paid in advance to the stored value holder of an SVF scheme (“holder”). Thereafter, the user will be able to use the SVF to purchase goods or services from merchants who accept the stored value in the SVF as payment (“merchants”). These merchants will redeem from the holder the stored value that they have accepted from users. SVFs can be provided in different forms, such as smart cards, contact-less cards, paper vouchers, micro-chips and internet accounts. Certain forms of SVFs allow for the “topping up” of additional stored value in consideration of cash or other means of payment. 729
Singapore’s regulations operate to provide a clear, uniform definition of what constitutes a stored value facility, phrased in technologically neutral terms.
728 The Guidelines provide a minimum standard for widely-accepted stored value facilities: s1.3.3. 729 Monetary Authority of Singapore, ‘Stored Value Facility Guidelines,’ (Consultation Paper P003-2006, March 2006) 1
In Australia, different legislative instruments arguably purport to regulate the same products, sometimes in different ways. This introduces considerable regulatory uncertainty as to which regulation applies, and if more than one regulation appears to apply, which is to be applied? There is some definitional confusion attending the concept of a stored value product. Stored value facilities such as prepaid cards and digital wallets purport to be regulated by the Payments System (Regulation) Act as ‘purchased payment facilities.’730
The Payments System (Regulation) Act 1998 defines ‘purchased payment facilities’ in section 9(1) as:
…a facility (other than cash) in relation to which the following conditions are satisfied: a. the facility is purchased by a person from another person; and b. the facility is able to be used as a means of making payments up to the amount that, from time to time, is available for use under the conditions applying to the facility; and c. those payments are to be made by the provider of the facility or by a person acting under an arrangement with the provider (rather than by the user of the facility). (Emphasis added).
A facility covered by a Reserve Bank declaration under subsection 9(3) is not a purchased payment facility for the purposes of the Payments System (Regulation) Act.731
730 Payments System (Regulation) Act 1998 (Cth) s9(1). 731 The Reserve Bank may declare that the PSRA does not apply to a specified facility, or to facilities included in a specified class of facilities, if it considers that it is not appropriate for the Act to apply to the facility, or to each facility of that class, having regard to the number or types of people who may purchase the facility, or to whom payments may be made: Payments System (Regulation) Act 1998 (Cth) s9(3). 168 Subsections (b) and (c) of subsection 9(1) of the Payments System (Regulation) Act appear to apply to almost all payment systems; the concept of ‘purchased’ in subsection 9(1)(a) is vague and uncertain, and could also apply to all payment systems.732 The requirement for the facility to have been ‘purchased,’ creates confusion and uncertainty, for example, where a reloadable stored value card has an express clause stating that the card remains the property of the issuer, or where the digital wallet has been downloaded without cost onto a smart phone or device.
The RBA has itself observed that it finds the definition of purchased payment facilities contained in the Payments System (Regulation) Act to be unclear, adding further weight to the argument that the definition should be revisited and clarified.733
Subsection 9(4) provides for the purposes of that section:
a. a reference to a facility includes a reference to a right to use a facility; and b. a reference to the purchase of a facility includes a reference to the payment of an amount for a right to use a facility.
The word ‘facility’ is not defined in the Payments System (Regulation) Act. From this section, and the Explanatory Memorandum to the Payments System (Regulation) Act, it seems that these sections were intended to apply to new payment system developments in stored value and digital payments.734
In Prudential Standard APS 610 APRA defines ‘stored value’ as ‘the balance of funds represented on purchased payment facility devices or purchased payment facility accounts held by beneficiaries for purposes of making payments.’735 So defined this restricts stored value’s definition to the funds underlying the e-money, not to the facility itself.
732 Tyree, The Australian Payments System, above n 448. 733 Ibid. 734 Ibid. 735 Australian Prudential Regulatory Authority, Prudential Standard APS 610 Prudential Requirements for Providers of Purchased Payment Facilities (2005), 4. 169
Legislative uncertainty involving overlapping and inconsistent regulatory requirements occasions industry uncertainty and confusion as to what products are subject to which provision.
2.1 Provision of Purchased Payment Facilities as ‘Banking Business’
The federal Banking Regulations 1966 have been extended to include purchased payment facilities, adding to the complexity of their regulation. Purchased payment facilities such as stored value cards, internet-based payment systems and travellers’ cheques are regulated through the authorisation and prudential supervision of purchased payment facility providers under the Banking Act 1959 (Cth).736
A provider of a purchased payment facility is defined under the Payments System (Regulation) Act as either:737
a. A person providing a purchased facility (PPF) that has been determined to be banking business under Regulation 3 of the Banking Regulations 1966; or b. A holder of stored value (HSV) as defined by the Payments System (Regulation) Act 1988 that makes payments (as mentioned in paragraph 9(1)(c) of that Act) in relation to a PPF that has been determined to be banking business under Regulation 3. (Emphasis added).
Section 8 of the Banking Act provides ‘only the Reserve Bank and bodies corporate that are authorised deposit taking institutions (ADIs) may carry on banking business.’ Section 5 of that Act defines ‘banking business’ as:
736 Australian Prudential Regulation Authority, Authorisation and Prudential Supervision of Providers of Purchased Payment Facilities, above 451. 737 Payments System (Regulation) Act 1998 – Declaration No. 2 of 2006 regarding Purchased Payment Facilities. 170 a. a business that consists of banking within the meaning of paragraph 51 (xiii) of the Constitution; or b. a business that is carried on by a corporation to which paragraph 51 (xx) of the Constitution applies and that consists, to any extent, of: I. both taking money on deposit…and making advances of money; or II. other financial activities prescribed by the regulations for the purposes of this definition.
These regulations do not apply to all purchased payment facilities. Under Section 9(2A) of the Act, ‘APRA may, by legislative instrument, set criteria for the granting of an authority to carry on banking business in Australia.’ A purchased payment facility is subject to APRA regulation. Section 6 of the Banking Regulation 2016 (Cth) provides that a purchased payment facility is banking business if:
APRA determines that the facility (a) is of a type for which the purchaser of the facility is able to demand payment, in Australian currency, of all, or any part, of the balance of the amount held in the facility that is held by the holder of stored value (within the meaning of the Payments System (Regulation) Act 1998; and
(b) is available, on a wide basis, as a means of payment, having regard to: (i) any restrictions that limit the number or types of people who may purchase the facility; and (ii) any restrictions that limit the number or types of people to whom payments may be made using the facility.
The effect of paragraph (a) is to include payments that are akin to a deposit. In paragraph (b), single purpose facilities are excluded by the introductory words of (b), but limited issue products under (b)(i) and (b)(ii) are not necessarily excluded. Thus, under the existing regulatory framework, there is no clear definition of stored value facilities, and regulations that apply to stored value facilities vary in scope. This may be contrasted with the regulatory regimes of Hong Kong and Singapore, which each have
171 a primary piece of legislation that governs stored value facilities.738
2.2 Definitional Exclusions
The legal position of Purchased Payment Facilities in Australia requires additional consideration; the definition of a non-cash payment facility under the Corporations Act 2001 (Cth) is very broad, applying to payments made ‘otherwise than by the physical delivery of Australian or foreign currency in the form of notes and/or coins.’739 Payments made ‘otherwise’ include cheque accounts, travellers’ cheques, stored value cards, electronic cash, direct debit services, and funds transfer services, but exclude payments made by payment facilities where there is only one person to whom payments can be made and by certain electronic funds transfer systems.740 Non-cash payments subject to restrictions relating to the number of people who can make payments, or to whom payments may be made, are also excluded from the definition.741
Where all definitional conditions are met, the Payments System (Regulation) Act by Section 9(1) provides ‘…a facility covered by a declaration under subsection (3) is not a purchased payment facility for the purposes of this Act.’ Section 9(3) identifies facilities in respect of which the RBA has declared, after considerations of restrictions that limit the number or types of people who may either purchase the facility or to whom payments may be made, that the Act does not apply.742
Issuers and aspiring issuers have limited resources and little desire to navigate legal complexities; unclear regulation may prove a barrier both to market entry and market growth and to product development. Clarity in regulation provides certainty for the regulator and issuer as well as merchants and consumers. It is often difficult from the
738 The Payments Systems and Stored Value Facilities Ordinance 2015 (the Ordinance) and the Payments System (Oversight) Act, 2006 (the PSOA) respectively. See Chapter Five, ‘Clarity of Regulation’ for more information. 739 Corporations Act 2001 (Cth) s763D. 740 Corporations Regulations 2001, regs 7.1.0F and 7.1.0G. 741 Corporations Act 2001 (Cth) s763D(d)(2)(a). 742 Payments System (Regulation) Act 1998 (Cth) s9(3). 172 definitions to determine which stored value products are captured by which scheme, and unclear which products might qualify for an exemption. This situation of multiple definitions does not arise under the regulatory schemes of Hong Kong and Singapore, as all stored value facilities are captured by the one primary piece of legislation, which includes the single purpose exemptions.743
2.3 Application of other Legislation
This opacity in definition and the number of exemptions available to stored value facilities in Australia raises numerous other questions of legislative application, including whether the provisions of the client money handling rules in the Corporations Act744 and the unclaimed money provisions of the Banking Act745 apply to stored value products. This is not the case for stored value facilities under the regulatory regimes of Hong Kong and Singapore.746 In Hong Kong, the stored value facility licence conditions include measures to ensure that the stored value float remains secure and used only in accordance with users’ instructions.747 In Singapore, the MAS Guidelines outline a relatively high level of protection for consumer funds, however they are mandatory only for widely-accepted stored value facilities.748
Current general consumer expectations are likely to be that funds held with stored value facilities are monies held on their behalf, akin to a deposit.749 Under the present legislative framework, providers of these products do not appear to hold the money on trust for the consumer.750 ASIC has stated that
743 Payments Systems and Stored Value Facilities Ordinance 2015, 2A (5); Payments Systems (Oversight) (Exclusion of Single Purpose Stored Value Facilities) (Amendment) Order 2007, 2. 744 Corporations Act 2001 (Cth). 745 Banking Act 1959 (Cth) s69. 746 See Chapter Five, ‘Client Money & Float Protection’ for more detail. 747 Parsons and Liu, ‘Hong Kong’s fintech surge: HKMA grants second round of SVFs licences,’ above n 610, 2. 748 Monetary Authority of Singapore, Stored Value Facility Guidelines, June 2006, Principle 2.1.1. 749 Interview conducted by the author in Sydney, May 2017; Lynden Griggs, ‘Consumer Protection and Stored Value Facilities,’ 9(2) Queensland University of Technology Law and Justice Journal 198, 204. 750 Australian Securities and Investments Commission, Submission No 2 to the Financial System Inquiry Committee in Response to the Interim Report, Financial Systems Inquiry, August 2014, 90. 173 Consumer expectations are likely to be that value held in these products is ‘their’ money and is treated like a deposit with an ADI. However, we understand that providers of these products, including ADIs, do not hold the money on trust for the consumer. We also note that, in general, ADIs take the view that money paid to these products is not a deposit, and that provisions in the Banking Act dealing with unclaimed money and the Financial Claims Scheme do not apply.751
If ASIC’s view that monies held are not held in trust, and its stated understanding of the view of ADI’s as to whether monies paid are a deposit are legally correct, stored value funds are not a deposit, and the provisions of the Banking Act that deal with unclaimed money, the Financial Claims Scheme therein and general unclaimed money legislation have no application.752
i. Calls for Clarity
The absence of clarity has been recognised by regulators and industry. Minter Ellison has recommended that the ‘complex interaction between the provisions of Chapter 7 of the Corporations Act, overlapping provisions of the ASIC act, exemptions and modifications in regulations and ASIC class orders, and ASIC’s quasi-prudential and quasi-legislative guidance’ be simplified, as the current situation impedes efficiency and regulatory certainty, and reduces confidence in the regulatory system by both participants and consumers.753
The RBA submitted to the 2014 Financial Systems Inquiry that the definitions of ‘purchased payment facility’ and ‘holder of stored value’ in the Payments System (Regulation) Act are technical, with interpretation affected by consideration of the nature of the entity under the obligation to make payments through the facility; it has indicated its support for the creation of a new stored value facility framework and has
751 Ibid 89. 752 Interview conducted by the author in Sydney, March 2017. 753 Minter Ellison, Submission No 1 to the Financial System Inquiry Committee in Response to the Interim Report, Financial Systems Inquiry, August 2014, 10. 174 submitted that the definition of Purchased Payment Facility should be clarified.754 ASIC has noted that the ‘entity,’ as the holder of stored value may not be the entity of the actual provider that operates the facility and has direct obligations to the consumer.755 ASIC has noted that even where purchased payment facilities have ‘deposit-like’ features, it remains unclear whether the product is offered as part of the ADI’s banking business under the Banking Act 1959.756
The existing stored value regulatory regime is complicated, inconsistent and does not operate to cover new entrants adequately. Lack of clarity in any payments regime raises concerns surrounding issues of systemic risk and liability. It is unclear in Australia who ultimately is to bear liability should a new entrant fail, and uncertainty as to how funds that customers hold in stored value facilities are to be protected.757 In Hong Kong, issuers are required to keep their stored value float separate from other funds, and must have in place float protection measures that adequately protect customers’ funds.758 Issuers must also have in place appropriate procedures to ensure that funds are protected against the risk of misappropriation by any means.759 In Singapore, to ensure the preservation of the stored value, widely accepted stored value facilities must hold consumer funds in a bank account that is separate from the working capital funds, or held in trust for the users.760
AusPayNet, in a reply to the Draft Report of the 2014 Financial Systems Inquiry submitted that consideration of the following issues should be included in any review:
754 Reserve Bank of Australia, Submission No 2 to the Financial System Inquiry Committee, Financial Systems Inquiry, August 2014, 9 < https://www.rba.gov.au/publications/submissions/financial- sector/financial-system-inquiry-2014-08/>. 755 Australian Securities and Investments Commission, Submission No 2 to the Financial System Inquiry Committee in Response to the Interim Report, above n 750, 89. 756 Australian Securities and Investments Commission, Submission No 2 to the Financial System Inquiry Committee in Response to the Interim Report, above n 750, 88. 757 AusPayNet, Submission No 2 to the Productivity Commission: Response to Draft Report, Competition in Australia’s Financial System Inquiry, 7 < https://www.pc.gov.au/__data/assets/pdf_file/0019/226135/subdr075-financial-system.pdf>. 758 Hong Kong Monetary Authority, ‘SVFs and retail payments systems in Hong Kong: a proposed regulatory regime,’ (Quarterly Bulletin, June 2013). 759 Payment Systems and SVF Ordinance, Cap 584, Schedule 3, Part 2, s5,7. 760 Monetary Authority of Singapore, Stored Value Facility Guidelines, June 2006, Principle 2.1.7. 175 • Appropriate safeguards to protect consumer funds. • PPFs should be required to become signatories to the ePayments Code; • The establishment of clearly defined lines of regulator responsibility; • The need for ongoing or semi-regular assessments of the regime, to take into account evolving business models and offerings.761
ASIC recommends that in order to provide certainty as to whether these products form part of an ADI’s banking business, attracting the consequent deposit product protections available, the regulatory status of payment products offered by ADIs ought be clarified.762 AusPayNet agrees with the need for clarity in this area.763
ASIC has further recommended that if the current regulatory framework is to remain, the client money handling provisions under Pt 7.8 of the Corporations Act should be significantly strengthened to ensure that client funds held in stored value facilities are ‘ring-fenced’ and protected in the event of insolvency of the product provider.764 It is uncertain whether these provisions presently apply to stored value products.
This Thesis supports implementation of both the AusPayNet submissions and ASIC’s recommendations, as outlined in Chapter Eight.
In its Response to the Final Report of the 2014 Financial Systems Inquiry, the Government agreed to develop legislative amendments to amend the definition of a basic deposit product in the Corporations Act.765 To date this has not occurred. Whether or not a new definition will clarify the position of stored value facilities remains to be seen.
761 AusPayNet, Submission No 2 to the Productivity Commission: Response to Draft Report, above n 757, 7. 762 Australian Securities and Investments Commission, Submission No 2 to the Financial System Inquiry Committee in Response to the Interim Report, above n 750, 90. 763 AusPayNet, Submission No 2 to the Productivity Commission: Response to Draft Report, above 757, 7. 764 Australian Securities and Investments Commission, Submission No 2 to the Financial System Inquiry Committee in Response to the Interim Report, above n 750, 89. 765 Australian Government, ‘Improving Australia’s financial system,’ above n 478, 26. 176 2.4 International Regulatory Coordination and Control
A clear definition for stored value facilities is needed for Australia to harmonise with payments products in other jurisdictions.
The international use of electronic money is changing the nature of cross-border trade. With that change, electronic money has become a factor relevant to foreign currency exchange rates.766 Stored value cross-border payments may occur when consumers travel overseas and utilise stored value payment facilities, for example when preloaded travel cards are employed to purchase goods or services and digital wallets provide the means of payment for international products and services acquired online.
Technological advances used by smartphones and e-wallets have made it much easier for payment providers to engage in regulatory arbitrage. If financial regulation in one jurisdiction is seen as too restrictive, companies may seek advantage by basing themselves in another country where relevant laws are perceived to be more favourable, sometimes referred to as forum shopping.767 Companies choosing to incorporate in this manner may offer payment services cross-border. A country or state may decide to enact laws that are advantageous to a particular type of company, in order to entice more companies of that type to incorporate within their jurisdiction, or it may choose to avoid adopting regulations that might be perceived as excessively restrictive for fear of discouraging the setting up or investment in systems within their jurisdiction.768 Many new electronic payments providers have chosen to locate their head offices in Singapore, confirming its reputation as a favourable stored value regulatory environment.
Digital wallets in particular, are able to easily expand across borders. Alipay has expanded into 70 countries and honours 14 major currencies, enabling consumers
766 Al-Laham, Al-Tarawneh and Abdallat, ‘Development of Electronic Money and Its Impact on the Central Bank Role and Monetary Policy,’ above n 194, 346. 767 Rosa Maria Lastra, ‘Do we need a World Financial Organisation,’ in Antonio Segura Serrano (ed), The Reform of International Economic Governance (Routledge, 2016) 41. 768 Risen Jayaseelan, ‘The e-wallet race hots up,’ The Star (online), 29 July 2017 < https://www.thestar.com.my/business/business-news/2017/07/29/the-ewallet-race-hots-up/>. 177 with Alipay accounts to make both online and in-store purchases worldwide.769 The global nature of such payments systems has a consequence that competition for market share of payment vehicles is not restricted to national markets.770 US-based Apple Pay is competing in China with Chinese services Alipay and WeChat Pay for consumer payments.771 In Malaysia, WeChat Pay is competing for market share with Samsung Pay, a South Korea-based provider.772
As demand for cross-border payments increases and providers seek out the most favourable set of national regulations, it becomes increasingly important for the different jurisdictions to coordinate and harmonise their regulatory policies. This is to avoid not just the risks inherent in competitive deregulation, but also to minimise the likelihood of lax regulation in one country affecting another country’s enforcement of financial regulations and management of fraudulent transactions. This has been achieved for stored value products to some extent with anti-money laundering and counter-terrorism financing measures, but there is currently no international coordination on other aspects of stored value regulation, including universal definitions and technical integration.
On the other hand, some commentators caution against ceding too much power to certain influential (usually large, developed) jurisdictions.773 These jurisdictions may seek to formulate and enact regulations and policy with the intent that their provisions may serve as a de facto international minimum standard.774 For example, the European Union has been a frontrunner in the regulation of stored value products, and by Directive 2009/110/EC promulgated a definition of electronic money for the EU
769 Bien Perez, ‘Alipay steps up mobile payments expansion in Australian stores,’ South China Morning Post, 7 December 2016
Differences in definition can make it hard to determine which regulations apply to which products, as well with cross-border transactions as with local operations. Without definitional certainty there cannot be legal certainty, and whether products fall within the scope of regulations will remain ambiguous and uncertain. In order to encourage and increase the number of market entrants and available products, Australian regulators should provide clear definitions of which stored value facilities are captured by applicable regulations.
3. TECHNOLOGICAL NEUTRALITY IN STORED VALUE FACILITY REGULATION
As stored value facilities are used increasingly in electronic commerce and online transactions it has become generally accepted that when designing regulations, regulators should aim for technological neutrality.776 Focusing on the behaviour of the payments system rather than on an existing mechanism or some technology involved would improve the regulatory regime and extend its longevity. A principles-based approach as opposed to a differential technology-based approach would ensure that there is a broader application of the intent of a rule or change, and that the regulatory stance will be maintained in the longer term.777
3.1 What is a ‘Technologically Neutral’ Approach?
Technological neutrality in legislation means that regulatory provisions do not dictate, assume or require the use of particular forms of technology. In the context of stored value products, specifying electronic delivery methods is likely to create confusion and argument as to whether and when certain provisions apply, particularly as new
775 Gurkaynak and Yilmaz, ‘Regulating payment services and electronic money,’ above n 711, 405. 776 Bollen, ‘Best Practice is the Regulation of Payment Services,’ above n 2, 404. 777 Australian Financial Markets Association, Submission No 2 to the Financial System Inquiry Committee in Response to the Interim Report, Financial Systems Inquiry, 26 August 2014, 54 < https://afma.com.au/policy/submissions/AFMA_FSI_Interim_Report_Submission.pdf>. 179 technologies emerge. Adopting a technologically neutral approach to regulation reduces the risk of changes in technology rendering current regulations anachronistic and uncertain in their meaning and authority and reduces the risk of stifling needed innovation.778
3.2 Why should Payments Regulation be in Technologically Neutral Terms?
A regulatory regime not expressed in technologically neutral terms may encourage the designing of products specifically to fit within the parameters of that regulation, risking distortion of the market and the favouring of one business model or product over another. The most favoured product on the market should be the one that best meets the consumers’ needs, not one that has best navigated its regulatory regime. Regulation should be flexible enough to apply to future product developments and avoid new products falling through regulatory loopholes, distorting the market and failing to protect consumers.
Technologically neutral regulation supports innovation and competition by encouraging new products, innovations and technology to be absorbed into the payments system. By enabling any form of technology to be used for payment, competition between issuers and products is supported.779 Technologically specific regulation may impede innovation by preventing or delaying adoption of better technology, for example, regulation may entrench the use of paper-based disclosure documentation, creating inefficient outcomes.780 Regulation that specifies the content of the product may hinder market development by legislating particular product attributes that may not be optimal for all consumers.781 On the other hand a regulatory instrument that does not specify whether or not a particular technology falls under its scope may give rise to issues of interpretation.
778 Chris Reed, Making Laws for Cyberspace, (Oxford University Press, Oxford, 2012) 190-191. 779 Deloitte Access Economics, ‘Regulatory Treatment of PayPal Australia, Submission No. 3 to the Financial Systems Inquiry in Response to the Final Report,’ above n 157, 17. 780 Ibid. 781 Haim and Mann, ‘Putting Stored Value Cards in their Place,’ above n 184, 1009. 180 A technologically neutral approach should be adopted in order not to benefit one type of payment medium over another, as the choice between electronic devices as to which is to be subjected to regulation should not be left to the regulating authorities: ‘Governments are not good at picking winners; that should be left to the market.’782
3.3 Considering the Situation in Australia
In Australia, the Payments System (Regulation) Act uses technologically neutral language and is framed to operate in conjunction with existing regulatory systems in which financial institutions play a role. To encompass different types of stored value devices, the PSRA provides that all holders of stored value must be an ADI, or have an authority or an exemption granted by the RBA.783 The Act does not define types of device or technology involved in creation and utilisation of stored value products.
It is appropriate to recognise that to reflect changes since its passage as the EFT Code of Conduct in 1986, the ePayments Code (described in Chapter Four) was redrafted in 2011 in broad and technologically neutral terms that extend its scope to all electronic payments products and are flexible enough to accommodate subsequent payments technologies.
Nonetheless, many other current regulations continue not phrased in technologically neutral terms, potentially distorting competition. Under current law, application of current regulatory provisions to digital wallets awaits an initial jurisdictional determination of whether a digital wallet is a ‘financial product’ and whether the issuers are ‘providing a financial service.’ If both those matters are not determined in the affirmative, the Payments System (Regulation) Act has no application and the product is seemingly not regulated at all. Assuming the product is determined to meet the jurisdictional imperatives and the factual questions of whether it is a facility purchased by the customer, the product may be used to make payments. The further
782 Christian Azar, Bjorn Sanden, ‘The elusive quest for technology –neutral policies,’ (2011) 1(1) Environmental Innovation and Societal Transitions, 135. 783 Payments System (Regulation) Act 1998 (Cth) ss 22, 23, 25. 181 question arising is whether the use of the facility involves payments being made by the provider of the facility (or a third party acting under an arrangement with the provider). If answered affirmatively, the product is likely to be a classified as a purchased payment facility and the relevant provision will provide the applicable law. These questions frequently give rise to considerable uncertainty as to whether particular facilities fall within the regulatory classification of a purchased payment facility, and are required to meet the regulated requirements.
The principal remaining applicable Australian stored value regulations, the provisions under the Banking Act and APRA’s Prudential Standard APS 610, are generally in technologically neutral terms. The definition of purchased payment facility in Australian regulation is very broad, capturing both open and closed loop products. As the medium of payment device is not stated or defined, it does generally provide technological neutrality.
3.4 Attaining a Balance
Technological neutrality should provide the flexibility to adapt to change, but it may also result in ambiguity and interpretation difficulties.784 For example, the definitions of ‘financial product’ and ‘financial service’ under the Corporations Act 2001 are broad and technologically neutral, designed to apply to different business models; as a result, ASIC has regularly to deal with questions of interpretation and to issue regulatory exemptions for some classes of product.785
Regulations are often expressed in language that, taken without context, is technologically neutral, but in practice is technologically specific.786 One technology may be preferred to others in the regulatory process, and existing technology may benchmark and condition the way regulators think.787 As a result, absolute techno-
784 Murray, Davis, Dunn et al, ‘Financial System Inquiry Interim Report’ above n 509, 4-43. 785 Ibid; ASIC has issued exemptions for low value products, gift vouchers and cards, prepaid mobile phone accounts, loyalty schemes and electronic road toll devices under Regulatory Guide 185. 786 Tuba, above n 264, 2293. 787 Ibid 2293. 182 neutrality may not be viable; instead, regulators in order to achieve specified objectives, should aim to strike a balance between techno-neutral and techno-specific regulation.788 For example, E-money Directive 2000/46/EC contains a provision requiring all electronic money be stored on an electric device. The scope of the regulation includes all devices that are based on electronic technologies, but does not specify whether the provision applies to money stored through technologies such as cloud computing. E-money Directive 2009/110/EC has not added any substantial provisions to the definition addressing its scope, despite advocating a techno-neutral definition to overcome definitional problems.789 Here, the problem lies in the implementation of the regulation, not the interpretation.
AusPayNet has identified that certain government agencies and services allow for payment by cash and cheques only, and has highlighted the need to prepare for a society which uses less cash, and makes more electronic payments.790 AusPayNet has recommended that the Attorney-General’s Department prepare an omnibus bill to remove specific reference to cheques in federal legislation.791 In like vein, the Australian Bankers’ Association has recommended that whilst all reference to cheques should ultimately be removed from existing regulation, a pro tem opt-out provision should be included to provide access for those to whom online access is not readily available.792 While absolute technological neutrality may not be feasible, regulators should regularly survey the payments market to ensure that all appropriate products are within the regulatory perimeter, and if not, these products should be brought within the regulatory framework either by an update in legislation, or a declaration by the RBA. Only products which have been granted a regulatory exemption should be operating outside of the regulatory perimeter.
788 Ibid 2294. 789 Tuba, above n 264, 2296. 790 Australian Payments Clearing Association, Submission No. 2 to the Financial System Inquiry in Response to the Interim Report, Financial System Inquiry, August 2014, 14. 791 Ibid 3. 792 Australian Bankers’ Association, Submission No. 2 to the Financial System Inquiry in Response to the Interim Report, Financial System Inquiry, August 2014, 79 < http://fsi.gov.au/files/2014/08/Australian_Bankers_Association_2.pdf>. 183 One risk to take into consideration when implementing technologically neutral regulation is the possibility of inhibiting or failing to reach some segments of the community, for example those without internet access, precluding those segments from engagement with the financial system.793 To address this, regulation should sanction existing alternative methods of access to services, such as paper-based delivery, particularly during periods of transition.794
It is acknowledged that technology-specific regulation may be beneficial in other circumstances, for example where the adoption of a common industry standard would improve overall system efficiency.795 However, technology-specific regulation should be formulated on an exceptions basis, with future review mechanisms in place to ensure that particular technology-specific regulations do not impede innovation.796
4. ASIC’S CONSUMER PROTECTION PROVISIONS
The consumer protection problems of stored value systems are not in principle very different from those posed by electronic funds transfer generally. Issues revolve around what happens when cards are lost, what happens when a transaction goes wrong, how costs and charges are to be distributed among all participants and protection of consumers’ funds and data.
A regulatory approach not based upon a system of exemptions and the discretion of regulators would provide greater transparency and certainty for all participants operating within the payments system. This Thesis supports a proposal by Visa that to remove the present necessity for a discretionary decision by the RBA designating a payments system, the Payments System (Regulation) Act should be amended to include a wider, clearer definition of ‘payments system,’ one that requires all such
793 National Seniors Australia, Submission No. 2 in Response to the Interim Report of the Financial System Inquiry, Financial Systems Inquiry, August 2014, 29 < http://fsi.gov.au/files/2014/09/National_Seniors_Australia.pdf>. 794 Ibid. 795 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 270. 796 Ibid. 184 systems to apply for a licence before commencing operations.797 The RBA’s designation power should only be required as a regulatory safety net in cases of unusual or unexpected emerging technologies to ensure they are subject to appropriate regulation.
The extent to which regulatory protections apply to money held by stored value products under the current regulations engenders confusion amongst consumers.798 The FSI Final Report recommends that Government make basic consumer protection mandatory for all service providers under the currently voluntary ASIC ePayments Code.799 Only if consumers have the confidence to use the systems will stored value facilities succeed as a payment technology. The FSI Report concludes that the current framework is not sufficient to ensure fair treatment for consumers.800 Consumer protection provisions are not comprehensive; consumers may lose their funds in the event of issuer bankruptcy. Unused funds may risk reversion to the issuer if not utilised within a certain timeframe, creating use-it-or-lose-it pressure. Legislated consumer protection is particularly inadequate where the product issuer is not a financial institution.801 The Government has recognised that if consumers are overcharged or treated unfairly, the losses they incur adversely affect the whole community.802
5. RECOMMENDATIONS TO IMPROVE THE EXISTING STORED VALUE REGULATORY REGIME
The range of available stored value facilities is broad and each facility has varying characteristics. The applicable legislation is complex, applying to some products and not to others.
797 Visa, Submission No 2 to the Financial System Inquiry Committee in Response to the Interim Report, above n 240, 14. 798 Australian Securities and Investments Commission, Submission No 2 to the Financial Systems Inquiry Committee in Response to the Interim Report, above n 750, 89. 799 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 161. 800 Ibid 269. 801 Haim and Mann, ‘Putting Stored-Value Cards in their Place,’ above n 184, 990. 802 Australian Government, ‘Improving Australia’s financial system,’ above n 478, 3. 185 This Thesis agrees with the observation of the Productivity Commission that
…(there exists) a need to improve the clarity of requirements for new stored value systems, provide greater transparency around regulator processes and decision- making on access and designation of payment systems, and strengthen the focus on competition in the financial system more generally.803
The present regulatory regime lacks clarity, does not ensure competitive neutrality between issuers nor facilitate market entry for new products and providers. I return to discussion of competitive neutrality and innovation in Chapter Seven.
5.1 Purchased Payment Facility or Stored Value Facility?
This Thesis recommends that government consider employing in legislative instruments the phrase stored value facility in lieu of purchased payment facility, for the reasons that follow.
First, the term purchased payment facility does not always accurately describe the products in question, adding to uncertainty in identifying those products captured by regulation. Nor is the label purchased payment facility appropriate for all of the current generation of products. Digital wallets such as Google Wallet are not purchased prior to use, but downloaded as a free application onto a computer or phone. Regulation of these products could be assisted by emphasising their function as holders of stored value rather than their payments function. These products are not used for payments alone; they provide storage for value and function as a facility for peer-to-peer transfers. Were this function-emphasis approach to be adopted the name stored value facility would more comfortably describe them than does purchased payment facility.
Second, the phrase stored value facility is in keeping with global usage, a factor particularly relevant in respect of products that pass across national borders.
803 Productivity Commission, Business Set-up, Transfer and Closure, above n 405, 7. 186
It is true that in the European Union, such facilities are termed electronic money facilities, but those countries with which Australia has significant trade, primarily Singapore and Hong Kong, label equivalent products stored value facilities. Australia’s adoption of this phrase would decrease regulatory confusion and uncertainty within both domestic and international markets.
Clarification of the entities having regulatory responsibilities within the Australian market provides a third reason for the suggested change of nomenclature. Currently, different agencies in Australia use different terms to describe the same product. Purchased payment facilities under APRA regulations may or may not be non-cash payment facilities under ASIC’s regulations. Some products are regulated by two sets of regulations, and currently have to comply with both. This has the potential to discourage aspiring new entrants and may dissuade or delay some from attempting market entry. Were the uniform definition of stored value facility to be adopted by the various regulators, significant improvement of congruency between regulators would be achieved and the present confusion surrounding regulatory compliance reduced.
5.2 Providing Clarity through a Graduated Regulatory Regime
Recommendation 16 of the 2014 FSI Final Report proposes that APRA join existing regulators ASIC and the RBA to develop a two-tier prudential payments regime for purchased payment facilities, separate from the ADI regime, to replace the existing regime. Recommendation 16 invites the Australian Government to:
…enhance graduation of retail payments regulation by clarifying thresholds for regulation by ASIC and APRA; strengthen consumer protection by mandating the ePayments Code; and introduce a separate prudential regime with two tiers for purchased payment facilities.804
804 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 161. 187 In September 2015, the Productivity Commission released its ‘Business Set-up, Transfer and Closure’ Report, which contained the following recommendation:
The Australian Securities and Investments Commission, the Australian Prudential Regulation Authority and the Reserve Bank of Australia should, with appropriate industry consultation, develop an enhanced graduated framework and determine appropriate thresholds and prudential requirements for stored value facilities. The framework should be published to provide clarity to new stored value systems.805
It further recommended that,
…there should also be an ongoing review process or indexation of thresholds to ensure that prudential regulation continues to be limited to ‘large and widely used’ facilities that pose a substantial risk to the wider payment system and/or consumers.806
In like vein, the 2014 FSI Report proposes that the thresholds of a graduated regime should be defined to cover only PPFs of sufficient scale and suggests the following thresholds:
APRA regulation would only apply to stored value facilities that hold more than $50 million in stored value and that allow individual customers to hold more than $1000.807
In its August 2018 Final Report, the Productivity Commission recommended:
The Council of Financial Regulators should review the current regulation of Purchased Payment Facilities (PPFs)…and design a tiered regulatory structure for PPFs, including one tier that does not attract prudential regulation.808
805 Productivity Commission, Business Set-up, Transfer and Closure, above n 405, 31. 806 Ibid 234. 807 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 161. 808 Productivity Commission, ‘Competition in the Australian Financial System Final Report,’ above n 176, 49, Recommendation 17.5. 188 This Thesis agrees with the proposal that there should be a graduated prudential regulatory regime for stored value facilities and adds that there should be a third, non- prudential tier of regulation. Three regulatory tiers in addition to the existing limited use and low value exemptions will provide a definitional and legal clarity, as well as clear regulatory path for product development. A discussion of how the tiers of regulation may be defined, and how a graduated regime can support innovation is contained in Chapter Seven.
A primary weakness of the current system is that it is so confusing as to constitute a barrier to market entry, inevitably dissuading some potential new entrants from seeking to enter the market. This barrier has seemingly inhibited the growth of the stored value market, which is today far smaller than anticipated.809 Recommendation 16 of the FSI Final Report recommends publication by regulators for industry participants of a clear guide to a new regulatory system.810 That guide, designed particularly with new entrants in mind would set thresholds and regulatory requirements.811
5.3 Regulatory Review
While regulations need to be designed in a way that is both product and technology neutral and leave no doubt that their provisions apply to a new product or market entrant, they must in addition manage associated risk and should be so framed that they support innovation and the uptake of new technologies.
Existing regulations should be regularly reviewed to ensure they are in fact operating in a technologically neutral manner by surveying the payments landscape and ensuring relevant legislative provisions are phrased in terms that operate on all relevant products and technologies. Due to the diversity of stored value schemes, regulation should be based not upon the card or device used to effect the payment but on the
809 Interview conducted by the author in Sydney in June 2017. 810 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 161. 811 Ibid. 189 nature of the stored value product. This approach however requires the legislator to guess at the types of e-money products that may be developed in the future.812 Regulators should be prepared to assess future developments in the payments industry including convergence of payments products and allow for innovation that does not undermine competition, or the security, stability, reliability and integrity of payments.813
The FSI’s Final Report recommends that to facilitate innovation and to enable development of alternative methods of financial service and promotes competition amongst providers, unnecessarily technologically-specific regulation be amended and superfluous regulation be removed.814 Recommendation 39 states the Australian Government should:
Identify, in consultation with the financial sector, and amend priority areas of regulation to be technology neutral.
Embed consideration of the principle of technology neutrality into development processes for future regulation.
Ensure regulation allows individuals to select alternative methods to access services to maintain fair treatment for all consumer segments.815
The Final Report advises regulators to review the extent to which their powers enable them to regulate system and service providers that are using alternative media of exchange, such as digital currencies.816 It concludes that the Reserve Bank of Australia should review the definitions contained in the Payments System (Regulation) Act to ensure that all products are sufficiently within the ambit of their remit.817
812 Tuba, above n 264, 2293. 813 Eftpos, Submission No. 2 to the Financial System Inquiry in Response to the Interim Report, Financial System Inquiry, August 2014, 5. 814 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 145. 815 Ibid 269. 816 Ibid 162. 817 Ibid 163. 190
This Thesis proposes that the Payment Systems (Regulation) Act should also be amended to require a transparent process for the assessment of applications to designate payment systems. I agree with the proposal of the Productivity Commission that changes should include a formal application process, the publication of determinations and the reasons for each determination and a review process through the Australian Competition Tribunal.818
Industry participants are likely to support this recommendation. BPay has asserted that technology neutrality facilitates competition, innovation and efficiency by allowing financial institutions to integrate their services onto a platform in a flexible way, tailoring the end-user experience for their customers and adding value over and above their base service.819 ANZ submitted that regulation should not entrench existing products and distribution channels.820 Regulating some payment types and not others may engender disparate compliance costs and access to technology, pricing approaches and standards of functionality, all of which may adversely affect competition and lead to inefficiency.821
Eftpos has submitted that the RBA’s system of designating payments for technology type, identifying card-based payments for example, not only prevents regulation from keeping pace with technology, but inhibits it from allowing adequately for convergence in mobile products and online payments methods, which while consumer retail payments, are not necessarily card-based.822 The submission continues that technology specific regulation may be based on monopolistic protections contrary to the open access aim of the Payments System (Regulation) Act and may support technology lock-out, leading to a loss of competition and efficiency.823 Eftpos also has
818 Productivity Commission, Business Set-up, Transfer and Closure, above n 405, 32. 819 BPay, Submission No. 3 to the Financial Systems Inquiry in Response to the Final Report,’ Financial Systems Inquiry, March 2015. 820 ANZ, Submission No. 2 to the Financial System Inquiry in Response to the Interim Report, Financial System Inquiry, August 2014. 821 Eftpos, Submission No. 2 to the Financial System Inquiry in Response to the Interim Report, above n 813, 4. 822 Ibid. 823 Ibid. 191 warned also that amending regulation to achieve technology-neutrality may be perceived as being at the expense of security, reliability and integrity of payments in the short-term.824 To address this, eftpos has in its submission requested a clarification of the roles of the RBA and the ACCC to ensure more consistent application of competition regulation in payments for similar conduct.825 A discussion of the roles of regulators in Australia is contained below.
In its Response to the FSI, the Government accepted that it should amend priority areas of legislation and regulation to make them technology neutral and that it should embed the principle into future legislation and regulation making.826 It acknowledged that technology-specific regulation may impede innovation and competition by hindering the adoption of best-practice technology and the introduction of innovative business models.827 The Government has announced that it will consult with the financial sector on those priority areas of existing legislation and regulation that present regulatory impediments to innovation before commencing work on contemplated amendments, which amendments it expects will when implemented, have a major deregulatory impact.828
5.4 Considering the Australian Financial Services Licence
Digital wallets act as holders of stored value, that is they enable customers to store funds in the wallet for the purpose of making and receiving payments. To provide a basic level of consumer protection and greater competitive neutrality between issuers (discussed in the following Chapter) digital wallets should be subject to some form of regulation. One option is for wallets containing funds exceeding a threshold amount, for example $1000, to be required to hold an Australian Financial Service Licence and regulated as a non-cash payment facility.829
824 Ibid. 825 Ibid. 826 Australian Government, ‘Improving Australia’s financial system,’ above n 478, 18. 827 Ibid. 828 Ibid. 829 Interview conducted by the author in Sydney in March 2017. 192
Another option supported by this Thesis is contained in FSI Recommendation 16 which recommends that the AFSL regime for non-cash payment facilities should be narrowed so that only service providers providing access to ‘large, widely-used payment systems’ would be required to obtain an AFSL.830 It proposes that under a new regime, ‘the only non-cash facilities that would be required to hold an AFSL with ASIC would be those with annual transaction of over $100 million and more than 50 payee groups; or annual transactions of over $500 million and more than 5 payee groups.’831 The FSI recommends that the definition of a ‘payee group’ be designed from a customer’s perspective; a system that provides access to several merchants would be considered to provide access to a single payee group where the customer associates the merchants with a single merchant brand.832 This threshold would remove the need to exempt from the regime smaller service providers such as public transport cards and road toll devices.833 The AFSL regime would continue to regulate the payments function of non-cash payments products.
If adopted, this would simplify the existing regime and remove the need for ASIC to make exemptions for small payment providers. The application of the current regime is complex and costly, and because the current regime automatically captures entities that do not necessarily need an AFSL, ASIC has had to grant multiple class orders and individual exemptions.834
The Final Report recommends that APRA remove exemptions for service providers that do not allow deposits to be redeemed in Australian currency. 835 Removal of these exemptions would apply prudential regulation to such service providers including those who provide prepaid cards available on widely-used systems that are commonly not redeemable for cash.836 However, most prepaid cards would be unlikely to fall
830 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 161. 831 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 161. 832 Ibid. 833 Ibid. 834 Ibid 165. 835 Ibid 162. 836 Ibid. 193 within the definition of a ‘large, widely-used payment system’ and were the recommended system to be adopted, they would be unlikely to require an AFSL.
The ASIC regulatory sandbox introduced in December 2016 allows eligible businesses to test defined financial services for up to 12 months without needing to apply for an AFSL.837 Only businesses that distribute payments products that are ADI-issued with a maximum balance of $10,000 are eligible for that trial sandbox.838 The sandbox is likely to have relevance only for those stored value facilities that are issued in partnership with a bank.
5.5 Mandatory Operation of the ePayments Code
Application of the ASIC ePayments Code to all providers of stored value facilities should be made mandatory.
In addition to graduating the regulation and narrowing the application of the AFSL regime, Recommendation 16 of the FSI Final Report proposes that the ePayments Code be made mandatory in order to provide greater consumer protection. An updated version of the ePayments Code was issued in March 2016; it remains voluntary.
The current ePayments Code provides that issuers of electronic payments that choose to subscribe to the Code are to provide consumers with clear terms and conditions and are to stipulate how any changes to these terms, conditions, receipts and statements will be made. The Code establishes rules as to the burden of loss in cases of unauthorised transactions and in respect of loss arising through mistaken internet payments.839 At the time of writing, for these protections to apply to a particular
837 Australian Government, ‘Backing innovation and FinTech’ (Budget Factsheet, 2017-18). 838 Australian Securities and Investments Commission, ‘Licensing Exemption for Fintech Testing,’ (Infographic, Innovation Hub, 2017) < http://download.asic.gov.au/media/4112096/licensing- exemption-for-fintech-testing-infographic.pdf>. 839 Deloitte Access Economics, ‘Regulatory Treatment of PayPal Australia, Submission No. 3 to the Financial Systems Inquiry in Response to the Final Report,’ above n 157, 16. 194 product the issuer needs to have voluntarily subscribed to the Code; the consumer protections therein are not otherwise guaranteed.
The ASIC Enforcement Review Panel has submitted that the ePayments Code should be given legislative effect; its Recommendation 19, proposes that ‘entities should be required to subscribe to the approved codes relevant to the activities in which they are engaged.’840 The Australian Government has indicated its agreement with these recommendations, but has deferred action pending the findings of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry; one of its Terms of Reference is investigation of the adequacy of the financial industry’s self-regulation.841 That Royal Commission is current at the time of writing.
The Productivity Commission’s 2018 Final Report has added its support for a mandatory ePayments Code. Recommendation 17.6 proposed that ‘the Australian Government should give ASIC the power, by end-2018, to make the ePayments Code mandatory for any organisation that sends or receives electronic payments.’842 It further recommended that ‘ASIC should more clearly define the liability provisions for unauthorised transactions when third parties are involved, including participation in financial dispute resolution schemes. ASIC should update the ePayments Code by end- 2019 and commit to 3-yearly reviews.’843
AusPayNet has indicated its support for a mandatory ePayments Code for any entity that intends to send or receive electronic payments, stating that ‘the ePayments Code has not been substantially reviewed for more than five years and urgently requires review, in order to bring it up to date with developments in technology and new payment operating models.’844
840 Australian Government, ‘ASIC Enforcement Review,’ (Taskforce Report, December 2017), 34. 841 Australian Government, ‘Response to the ASIC Enforcement Review Taskforce Report,’ (Report, Australian Government, April 2018) 5. 842 Productivity Commission, ‘Competition in the Australian Financial System Final Report,’ above n 176 49. 843 Ibid. 844 Australian Payments Network, Submission No 2 to the Productivity Commission: Response to Draft Report, Competition in Australia’s Financial System Inquiry 7. 195 The Australian Government has since responded to the FSI Final Report, foreshadowing that it will mandate the baseline consumer protections contained in the ePayments Code, subject to the Code proving fit for purpose and technologically neutral.845 The Government has committed extra funding to ASIC to accelerate the implementation of certain measures, including the strengthening of consumer protections in the ePayments Code.846
5.6 Rethinking the Roles of the Regulators
The existence in Australia of multiple regulators for all financial products, including payments, insurance and superannuation, is entrenched. While this system has proven to have many benefits, there remains in the case of stored value facilities some confusion and overlap. Each regulator has its own aims accorded to it by mandate, and as there is no apparent overarching sense of purpose between them in the overall framework, there is no clear directional sense. A number of submissions by industry to the FSI propose that regulators be given a clear and well-targeted mandate actively to pursue better coordination to make the regulatory framework clearer and more streamlined.847 Other submissions recognise the overlap and inconsistencies between regulatory regimes.848
The Australian Payments Network submitted that a co-regulatory approach between government and industry is the best way to address challenges. It proposes that the RBA should be the primary regulator with an ability to arbitrate should the co- regulatory approach not achieve the desired outcomes.849 If this option were to be adopted, the RBA could retain its declaratory power850 and use it to determine which
845 Australian Government, ‘Improving Australia’s financial system,’ above n 478, 15. 846 Kelly O’Dwyer, Scott Morrison, ‘Turnbull Government bolsters ASIC to protect Australian consumers,’ (Joint Media Release, The Treasury, 20 April 2016). 847 Australian Payments Clearing Association, Submission No. 2 to the Financial System Inquiry in Response the Interim Report, above n 504, 2, 13; Australian Securities Exchange, Submission No. 2 to the Financial System Inquiry in Response the Interim Report, Financial System Inquiry, August 2014, 16. 848 Australian Securities Exchange, Submission No. 2 to the Financial System Inquiry in Response the Interim Report, Financial System Inquiry, August 2014, 16. 849 Australian Payments Clearing Association, Submission No. 2 to the Financial System Inquiry in Response the Interim Report, above n 504, 2. 850 Under Payments System (Regulation) Act 1998 (Cth) Section 9. 196 entities should be captured by regulation. AusPayNet has also recommended that the RBA’s jurisdictional reach under the Payments System (Regulation) Act be reviewed to ensure that it can effectively respond to new entrants.851 It has further recommended that inter-regulatory protocols be reviewed to minimise the burden on regulated entities of having to deal with multiple regulators.852
Key participants suggested to the FSI that bringing all stored value facilities under the remit of a single regulator would lessen the complexity of the current regime.853 The RBA was among those that identified this option, and in its Supplementary Submission to the FSI submits that one authority should be given supervision of all purchased payment facilities.854 In order to lessen the burden on regulated entities, particularly smaller organisations, of having to deal with multiple regulators the Australian Payments Network recommended a review of the APRA / RBA purchased payment facility regime and the related ASIC non-cash payment facility regime.855 AusPayNet recommended that inter-regulatory coordination be reviewed in order to minimise the burden of a regulated entity from having to deal with multiple regulators.856 In each of Hong Kong and Singapore there is one supervisory authority only for all payment systems. In both jurisdictions there is a single primary supervisory authority overseeing all the stored value facilities in each jurisdiction, the Hong Kong Monetary Authority and the Monetary Authority of Singapore respectively.
Critics have questioned why the RBA is involved in the payments system at all, claiming that there is no strong case to support its involvement, beyond that it has done so
851 Australian Payments Clearing Association, Submission No. 2 to the Financial System Inquiry in Response the Interim Report, above n 504, 2, 12. 852 Ibid 13. 853 For example, Reserve Bank of Australia, Submission No 2 to the Financial System Inquiry Committee, Financial Systems Inquiry, August 2014, above n 754; Australian Payments Clearing Association, Submission No 2 to the Financial System Inquiry in Response the Interim Report, above n 504, 2. 854 August 2014 < http://www.rba.gov.au/publications/submissions/>. 855 Australian Payments Clearing Association, Submission No. 2 to the Financial System Inquiry in Response the Interim Report, above n 504, 2. 856 Ibid 2, 13. 197 since 1959.857 The primary argument against the RBA acting as payments regulator is that its important function is monetary policy; adding responsibility for the payments system industry is a distraction and not the RBA’s main area of competence.858 Sinclair Davidson and Jason Potts have argued that the economics of industry regulation are very different from monetary economics, the primary specialisation of the RBA.859 They propose that regulation of the payments system be removed from the RBA and reposed within a transparent specialist agency experienced in the regulation of competition and industrial organisation, such as the ACCC,860 or APRA.861 In similar vein, former Senator Dastyari, then a member of the Payments System Board stated that the RBA’s payments regulation functions fit more appropriately within ASIC or APRA.862
This Thesis agrees that the number of regulators involved in the supervision of stored value payments should be reduced, but to preserve the benefits of Australia’s twin- peaks style of regulation, it recommends that stored value payments regulation primarily be shared between APRA, as the prudential regulator, and ASIC, as the conduct regulator. It proposes that APRA should be the primary supervisor for products operating in the top two tiers of regulation, and ASIC should be the primary supervisor for products operating with this third tier and the regulatory exemptions. It further recommends that while the RBA’s involvement in stored value payment should
857 See Sinclair Davidson, Jason Potts, ‘Why the Reserve Bank isn’t the right regulator for our payments system,’ (14 October 2015) The Conversation (online)
6. CONCLUSION
The existing regulatory regime for stored value facilities in Australia is unclear as some definitions fail to make clear what stored value products are captured by which scheme, others fail to specify which products qualify for an exemption. Overlapping regulatory provisions and a multitude of possible exemptions create uncertainty, exacerbated by the RBA’s designation provision that introduces regulator discretion rather than stated criteria. Specificity in regulations provides certainty for regulators, issuers and courts, as well as merchants and consumers. Unclear regulations may prove to be barriers to market growth and product development and a disincentive to new market aspirants, particularly given the significant cost of allocating their resources to challenge complexity and ambiguity of the variety of relevant legislative provisions. The need for definitional and legal clarity is becoming increasingly important with the growing use of multi-currency digital wallets in Australia and overseas.
All present stored value legislation should be reviewed to achieve technologically neutrality and phrasing in terms that capture emerging products, thereby obviating the risk that inadequately regulated products currently pose to consumer funds and the general stability of Australia’s financial system. While absolute technological neutrality may not be viable, regulators should regularly survey the payments market to ensure that all appropriate products are within the regulatory perimeter, and if not, these products should be brought within the regulatory framework either by an update in legislation, or a declaration by the RBA.
199 Changing the name ‘purchased payment facilities’ to ‘stored value facilities’ would clarify the regime for issuers in Australia and those overseas dealing with them. The Payment Systems (Regulation) Act should be amended to prescribe a transparent process for determining the level of regulation appropriate for different products. A three-tiered regulatory regime for stored value facilities should be introduced, with clear criteria determining the different tiers.
To strengthen and clarify consumer protection provisions, the AFSL regime should be reviewed to only capture large and widely used payments systems. If adopted, this would simplify the existing regime and remove the need for ASIC to make exemptions for small payment providers. To ensure a basic level of consumer protection, the ePayments Code should be made mandatory for all providers of stored value facilities. Supervision of stored value facilities could be primarily undertaken by APRA and ASIC, with the RBA retaining its declaratory powers.
The following Chapter considers the degree of competitive neutrality between issuers and support for innovation within the existing stored value regulatory regime in Australia. It considers recommendations of various industry stakeholders for improving the existing system before making its own recommendations.
200 CHAPTER SEVEN: INNOVATION AND COMPETITIVE NEUTRALITY
1. ‘BANKING IS NECESSARY, BANKS ARE NOT’ 202 2. THE BENEFITS OF A LEVEL PLAYING FIELD FOR ISSUERS 204 3. AN ANALYSIS OF COMPETITIVE NEUTRALITY BETWEEN STORED VALUE 209 ISSUERS AND PRODUCTS IN AUSTRALIA 4. DESIGNING A NEW SYSTEM 219 5. GOVERNMENT RESPONSE TO A GRADUATED REGIME 232 6. GOVERNMENT-INDUSTRY INITIATIVES 234 7. CONCLUSION 237
The emergence in Australia of new business models within the stored value payments market presents a complex regulatory challenge, as many new stored value payments products do not fit within the existing regulatory structure. The blurred distinctions between different types of financial products has led to the need to revise supervisor coverage to avoid regulatory gaps and to achieve better competitive neutrality between issuers with similar products.863 Absolute competitive neutrality between issuers is not achievable in the payments system, nor should it be the aim of regulators. The Australian financial system is regulated to maintain systemic stability and improve community outcomes, and thus most markets, including the payments system market, will never be perfectly competitive.864 The question this Chapter seeks to address is how regulation can better balance competition between issuers with similar risk-weighted products and encourage new entrants to the payments system while maintaining systemic stability and consumer confidence.
Regulators must consider to what extent support for the entry of these new products into the market is appropriate, how best to maximise potential consumer benefits and how best to minimise any risk to which consumers and the payments system are
863 Michel Flamée, Paul Windels, ‘Restructuring Financial Sector Supervision: Creating a Level Playing Field,’ (2009) 34(1) The Geneva Papers on Risk and Insurance – Issues and Practice 9, 13. 864 Productivity Commission, ‘Competition in the Australian Financial System Final Report,’ above n 173, 70. 201 exposed. The importance of technological neutrality within regulation has been outlined in Chapter Seven; this Chapter will focus on issues of competitive neutrality between different types of issuers.
This Chapter discusses the need and ability of regulators to prevent the regulatory playing field between issuers from being unduly uneven and favouring one type of issuer, and how competitively neutral regulation should support innovation and development within stored value payments. In this Chapter I propose changes to the regulatory system specific to stored value facilities to reflect the developments occurring within Australia’s payments system since the existing legislation was passed in 1998. I draw on submissions to and recommendations of the 2014 FSI and on the regulatory approaches adopted in Hong Kong and Singapore. In the following Chapter I discuss how each of my recommendations might be incorporated into the current system and their likely effects.
Part One of this Chapter discusses the relationship between innovation and competitive neutrality. Part Two examines the role and influence of the regulators. An analysis of how the current regime in Australia fares in terms of its openness to innovation is contained in Part Three, and whether it has achieved sufficient competitive neutrality is contained in Part Four. Parts Five, Six and Seven advance recommendations as to how Australia might improve its current regime for stored value facilities.
1. ‘BANKING IS NECESSARY, BANKS ARE NOT’865
In Australia stored value products may be issued not only by banks and financial institutions, but also by certain non-banks, such as telecommunications companies. There has been strong growth in payments services provided by organisations that are not traditional financial firms, such as Cuscal, Tyro and Indue, as well as new providers
865 Richard Kovacevich quoted in Joseph Nocera, ‘Banking is necessary, banks are not,’ 137(9) Fortune 84. The quote is often erroneously attributed to Bill Gates – see Patrick Schueffel, Doing Away with an Urban Myth, (2016) Fintech < http://schueffel.biz/away-urban-myth>. 202 such as Adyen, First Data and Pin Payments.866 New technology has facilitated the emergence of these new entrant non-bank institutions and of new mechanisms for accessing finance, such as peer-to-peer transfers and lending.867
As the global retail payments landscape changes and non-cash payments increase, it is the non-bank issuers rather than the traditional banks that are driving innovation in payments.868 Non-banks have an increasingly significant role in the innovation of payments services, primarily due to the development and adoption of technology such as mobile banking and Internet payments, which developments enable non-banks to compete in areas not dominated by banks.869 As there are often no physical products to manage, and the system involves recording, analysing and interpreting transactions and managing associated information flows, the processes readily lend themselves to improvements through the incorporation of digital technologies.870
In this Thesis I define non-banks as institutions that provide financial services but do not have full banking licences, and are not supervised as banks by their national regulatory authorities; telecommunications companies, retailers and tech companies are familiar examples.
The evolution of information networks has led to competition within proprietary systems; card companies, banks, mobile network operators and service providers, Internet companies and retailers are all competing for a share of the growing payment processing market.871 The changing payment needs, the marked shift from paper to
866 Productivity Commission, ‘Competition in the Australian Financial System Draft Report,’ above n 1, 278. 867 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 143. 868 Committee on Payments and Market Infrastructures, ‘Non-banks in Retail Payments,’ above n 598, 3; Claire Alexandre, Ignacio Mas, Daniel Radcliffe, ‘Regulating New Banking Models to Bring Financial Services to All’ (2011) 54(3) Challenge 116, 116. 869 Committee on Payments and Market Infrastructures, ‘Innovations in retail payments,’ above n 603, 16. 870 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 143. 871 Simon Millet, ‘Technology Trends and Future Predictions 2013,’ (White Paper, Australian Information Industry Association, 2012) 8 < https://www.aiia.com.au/documents/thought-leadership/financial- services-thought-leadership/2012/thougth_leadership_papers_technology_trends_-And- _predictions_for_2013_Simon_Millett_2012.pdf>. 203 electronic payments, and the increasing number of online and mobile payments has presented significant new opportunities for non-banks.
Non-banks are better able to make use of economies of scale to reduce the size of the critical mass needed to take advantage of cost savings than are banks, which enables them to provide back-end services at a lower cost than banks.872 By providing a wider scope of services cost savings may be passed on to the end-user; that cost advantage increases with any increase in non-banks’ specialisation. Non-banks may also provide front-end or end-to-end services, increasing available alternatives to consumers and merchants and thereby competing directly with banks for end-users. Such increased competition introduces pressures on banks to lower bank fees and processing charges.
To compete with banks non-bank providers have designed new payments products that provide a wider array of payment options to meet the needs of the market. These new business models pose novel oversight and regulatory challenges. Additional issues arise as non-banks provide more international cross-border services, as differing regulatory approaches may result in different treatment of the same non-bank in different jurisdictions. As stored value products may be issued by either banks or non- banks, one challenge faced by regulators is how to manage the effect of applying the same set of regulations to issuers of very different natures.
2. THE BENEFITS OF A LEVEL PLAYING FIELD FOR ISSUERS
Although posing challenges for regulators, the inclusion in the payments system of new entrants and non-banks brings benefits to the economy. The primary argument in support of providing a more level playing field for issuers of similar products is that it improves welfare, as different institutions can compete on an equal footing, and therefore more efficient institutions gain a larger market share.873 New stored value
872 Committee on Payments and Market Infrastructures, ‘Innovations in retail payments,’ above n 603, 41. 873 Alan Morrison, Lucy White, ‘Level Playing Fields in International Financial Regulation,’ (2009) 64(3) Journal of Finance 1099. 204 businesses introduce new products and services, increasing consumer choice and improving the operation of existing products. Non-bank organisations, unhindered by out-of-date technology, compete directly with banks and are often better able to meet consumer demand. Competition from new providers forces existing providers to become more efficient, thereby contributing to productivity and healthy development of a dynamic and growth-oriented economy. Expansion of the number of market participants leads to improvements in the range, price and quality of products and services.874
Financial innovation has been defined as an innovation that allows either a cost reduction or an improvement of service.875 Innovation is essential for the development of payments products and markets, improving efficiency and security.876 Competition between banks and non-bank providers benefits the market through improvements in traditional payment systems, including faster transaction processing times, and lower costs for end users. Both the Australian Bankers’ Association and the Australian Bureau of Statistics have attributed the increase in productivity of financial services in Australia to the adoption of new technologies.877
Innovation in stored value systems’ payments technology is reducing the fixed costs of banking business, as the use of e-money is cheaper than printing, distributing and retrieving banknotes through banking systems.878 In the words of Tyro Payments, an Australian fintech institution, ‘prosperity in the new digital century will come to a large extent from start-ups and fast growth companies building the technologies and business models of the future.’879 A country that stifles innovation in its payments
874 Productivity Commission, Business Set-up, Transfer and Closure, above n 405, 46. 875 W Scott Frame, Lawrence White, ‘Empirical studies of financial innovation: lots of talk, little action?’ (2004) 42(1) Journal of Economic Literature, 116. 876 Committee on Payments and Market Infrastructures, ‘Innovations in retail payments,’ above n 603, 15. 877 Ibid. 878 Yuksel Gormez, Christopher Houghton Budd, ‘Electronic Money Free Banking and Some Implications for Central Banking,’ (2004) 1 Central Banking Review 67, 101. 879 Tyro Payments Ltd, Submission No. 2 to the Financial Systems Inquiry Committee in Response to the Interim Report, Financial Systems Inquiry, 26 August 2014, 2 < http://fsi.gov.au/files/2014/09/Tyro_Payments.pdf>. 205 systems will soon find itself at a competitive disadvantage with global competitors.
2.1 The Role of Government in Creating a Level Playing Field and Supporting Innovation
Governments and regulators are in a position to co-create the shift from traditional banking to digital payments by actively supporting innovation and competition in their payments systems. Competitive neutrality has been defined by the Organisation for Economic Co-operation and Development as ‘where no entity operating in an economic market is subject to undue competitive advantages or disadvantages.’880 Issues of competitive inequality arise when some issuers are subject to more onerous regulatory requirements, or where certain issuers bear a heavier regulatory burden than do others. This Thesis acknowledges that issuers should be subject to different regulatory burdens depending on factors that affect their overall risk level, such as their size, influence and whether they are governed by other legislation, but proposes that issuers of products that are adjudged to have similar risk-weightings should be subject to a similar regulatory burden. I propose that a three-tiered graduated system is the best regulatory regime to achieve this.
A country’s regulatory environment may impact the level of competitive neutrality between issuers in two main ways. Firstly, it may affect competition between existing issuers where one type of provider must bear a heavier regulatory burden than do others. Regulations may be designed to support or hinder one type of institution over another. For example, regulation that fails to capture non-bank institutions and subject them to existing provisions such as minimal capital or disclosure requirements may place bank issued products at a competitive disadvantage.881 Alternatively, regulation may apply equally to all types of provider, failing to take into account or ignoring their differences and potentially strengthening the position of existing market
880 Organisation for Economic Co-operation and Development, ‘Competitive Neutrality: Maintaining a level playing field between public and private business,’ (Report, 30 August 2012) 17; Productivity Commission, ‘Competition in the Australian Financial System Final Report,’ above n 176, 71. 881 Akindemowo, above n 271, 64. 206 incumbents which have greater resources, including financial, customer base, data and personnel.
Secondly, regulation may present a market entry barrier and can determine whether new issuers and their technologies and products reach the market. A regulatory environment in which new entrants can thrive requires support for product and issuer innovation and the lowering of barriers to market entry and product development. Legislation that subjects new entrants to a heavy burden of regulatory compliance is a common disincentive to market entry. Unless regulation is designed to support new entrants, new products if they reach the market at all may be tailored to fit existing regulations.
A major difficulty for regulators is how to provide in one set of regulations for both financial and non-financial institutions, particularly when each is offering a similar product, and thus provide competitive neutrality between issuers and products. This has been observed by commentators. Davis has stated that ‘appropriately delineating the prudentially regulated sector and politically and socially managing the consequences of risk taking outside of that sector remain major unsolved regulatory and political challenges.’882 Maddock and Munckton have reflected that
…(r)egulators face a difficult transition. The current approach has been to define key institutions, like banks and other aspects of the financial system (including payments), and to regulate them more tightly. This creates a natural tendency for more risk to be taken outside the regulated boundaries.883
As financial products have evolved, the differences between different types of product and provider have become less distinct, and this has led to the situation where similar types of products are receiving different regulatory treatment. It is through these
882 Kevin Davis, ‘From Where Do We Begin?’, (Funding Australia’s Future Project Paper, Australian Centre for Financial Studies, April 2016) 52 < https://australiancentre.com.au/wp- content/uploads/2016/04/FAF1-begin.pdf>. 883 Rodney Maddock, Peter Munckton, ‘The Future Demand and Supply of Finance’ (Funding Australia’s Future Project Paper, Australian Centre for Financial Studies, April 2016) 59 < https://australiancentre.com.au/wp-content/uploads/2016/04/FAF1-future.pdf>. 207 differences that some financial service providers may obtain an unfair advantage, while others may engage in regulatory arbitrage.884 Products or institutions may be designed to minimise supervisory oversight.
Regulation should not undermine competition, but should aim to balance the characteristics of each type of institution. It should not seek to remove the inherent advantages of one type of issuer, such as financial resources and customer base that established banks have in competing with newer entrants. However, the cost of regulatory compliance is large; the Productivity Commission reported in August 2018 that the annual expenditure of ADIs on APRA and ASIC reporting and compliance increased by nearly 60% between 2008 and 2016.885 Regulators may need to minimise the regulatory burden of certain issuers where it is so heavy that if these issuers were to be compliant, they would be unable to survive in the payments market. A balance needs to be reached to establish regulatory certainty in respect of existing products while remaining open, technologically neutral and flexible enough to incorporate emerging products.
Creating a playing field for issuers that is not unduly uneven does not necessarily mean subjecting all products to the same regulatory regime – smaller issuers are unlikely to be able to shoulder the same regulatory cost as larger bank issuers, nor should they be required to as they pose different levels of risk. A regime that provides a more even regulatory playing field for all issuers encourages competition and innovation by adjusting the regulatory requirements for smaller entrants that have less systemic influence. It may seek to increase competitive neutrality between issuers by lowering barriers to entry for new non-bank firms, but these lower regulatory requirements must be balanced against increased consumer protection and market stability risks that new and less experienced firms may pose.
884 Michel Flamée, Paul Windels, ‘Restructuring Financial Sector Supervision: Creating a Level Playing Field,’ (2009) 34(1) The Geneva Papers on Risk and Insurance – Issues and Practice 9, 15. 885 Productivity Commission, ‘Competition in the Australian Financial System Final Report,’ above n 176, 64. 208 The following section examines the present situation in Australia and discusses the approach that Australian regulators have taken to innovation and competitive neutrality in stored value payments.
3. AN ANALYSIS OF COMPETITIVE NEUTRALITY BETWEEN STORED VALUE ISSUERS AND PRODUCTS IN AUSTRALIA
The stored value regulatory regime that followed the Wallis Inquiry Report was introduced to encourage growth and innovation in new payment methods, yet ironically, that regulatory regime is today a major impediment to the growth of these products in Australia.886 For stored value facilities in Australia, it is the differing regulatory treatment of similar products issued by bank and non-banks issuers that raises concerns of competitive neutrality. The balancing act required to ensure a sufficiently level playing field between banks and non-bank issuers must take into account the inherent characteristics of different types of institution.
Regulation of payments systems in Australia was separated in 1998 from the prudential regulation of banks so that the growing number of non-banks participating in the payments system would be regulated effectively. The Payments System (Regulation) Act 1998 (Cth) applies mainly to non-bank providers, as banks and other financial institutions are subjected otherwise to high prudential standards. The following section examines how the existing stored value regulatory regime applies to different classes of product.
886 Centre for Law, Markets and Regulation, Submission No. 2 to Financial Systems Inquiry Committee in Response to the Final Report, Financial Systems Inquiry, 23 March 2015) 1 < https://clmr.unsw.edu.au/sites/default/files/attached_files/fsi_consultation_submission_march_23_su bmit_vers-1.pdf>. 209 3.1 Regulation of the Different Types of Stored Value Product
i. Purchased Payment Facilities without Stored Value-At-Risk
Purchased Payment Facility providers that do not hold stored value at risk are not required to meet any capital or liquidity requirements under APRA’s Prudential Standard APS 610. PPFs whose stored value liabilities are held in an account owned by an Authorised Deposit-taking Institution are deemed not to hold stored value at risk.887 APRA has explained that ‘it has chosen not to have a minimum figure for start-up capital to ensure that small entities seeking PPF authorisation are not automatically rejected.’888 The majority of PPF providers fall within this provision. APRA has explained that this provision ‘balances the need to protect beneficiaries with the need to allow the market for PPFs to continue to develop, innovate and mature.’889
The APS 610 provision encourages fintechs to partner with banks. Those fintechs that choose to collaborate with a bank are not required by APRA to meet capital or liquidity requirements. Those fintechs who do not store their value with an ADI are subjected to onerous capital requirements, and will likely not be able to compete with banks or global non-bank techfin companies.
The RBA has issued a declaration that small-scale facilities with issued outstanding payments value not exceeding $10 million and facilities with fifty or fewer payees are not subject to the Payments System (Regulation) Act provisions on PPFs.890 This provision applies to PPFs whether or not the stored value is held with an ADI. There is an unintended incentive for stored value payment providers to limit growth of their products so as to remain within the RBA declaration and to avoid becoming subject to the purchased payment facility regulatory regime and becoming regulated as a conditional or full ADI.891
887 Australian Prudential Regulation Authority, Prudential Requirements for Providers of Purchased Payment Facility, above n 428, 4. 888 Australian Prudential Regulation Authority, Regulation Impact Statement, above n 406, 8. 889 Ibid 10. 890 Reserve Bank of Australia, Declaration Regarding Purchased Payment Facilities, No. 2, April 2006. 891 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 165. 210 ii. Purchased Payment Facilities with Stored Value-At-Risk
For providers that elect to hold their own stored value, the current regime involves significant compliance costs that are likely to place such providers at a competitive disadvantage when compared with other ADIs. Institutions may be authorised to operate PPFs under a conditional ADI licence but are mandated to meet strict operational risk and liquidity requirements, including holding a minimum level of Tier One capital and 100% liquidity investment.892 All PPF providers with stored value at risk are required to hold high-quality liquid assets of value equal to their stored-value liabilities; other ADIs have lower liquidity requirements.893
APRA has advised that its rationale for imposing conditions on PPF provider licences is that as PPF providers are exempt from full ADI requirements, APRA, in order to maintain an even regulatory playing field between PPF providers and other ADIs would otherwise have to apply the current ADI framework in its entirety.894 ADIs authorised to carry on general banking business are not required to obtain any further authorisation to issue PPF products.895
PPF providers operating at the lower regulatory standard are precluded by s66 of the Banking Act 1959 (Cth) from calling themselves a ‘bank,’ and from using terms that suggest that they are banks. As a condition of authorisation as conditional ADIs, PPF providers are prohibited from accepting deposits for the purpose of making money advances.896 Should a PPF provider hold out to the public that it is an ADI, it must make a clear statement that it is authorised only to provide PPFs and is not authorised to carry on a general business of taking deposits.897 At the time of writing, PayPal is the only provider that holds a conditional ADI licence.
892 Australian Prudential Regulation Authority, Prudential Requirements for Providers of Purchased Payment Facility, above n 428, 3, 4. 893 Ibid 2. 894 Australian Prudential Regulation Authority, Guidelines on Authorisation of Providers of Purchased Payment Facilities, above 409, 5. 895 Ibid 4. 896 Ibid. 897 Ibid. 211 iii. Becoming a Fully Licensed ADI
A stored value issuer wishing to obtain a full ADI licence is unlikely to achieve that objective without difficulty. The lengthy authorisation process and high capital requirements act as a barrier to market entry that will constitute a disincentive to making an application. Stored value providers are required to meet the same prudential standards on governance, fitness and propriety, outsourcing, business continuity management and auditing requirements as other ADIs, but do not usually have the same resources as do traditional bank ADIs.
Value stored within fully licensed ADI issued products is held by a prudentially regulated organisation, unlikely to experience issuer insolvency. Value stored by products not issued by an ADI do not have this protection. The loss of protection advantage in the event of issuer insolvency is to be weighed against the difficulties in meeting the requisite regulatory requirements to become an ADI.
PPFs classified as conditional ADIs appear to carry a heavier regulatory burden than do their full ADI counterparts. PPFs, though with simpler capital requirements than full ADIs are subject to more onerous liquidity requirements. As bank issuers are subject to the ADI regime, the PPF regime applies only to PPF providers that are non-bank issuers, and this will likely place them at a competitive disadvantage when compared with their traditional bank counterparts.898 This perceived disadvantage may dissuade providers within the low value and stored value not-at-risk exemptions to the PPF regime from expanding and becoming subject to it. The advantage of simpler capital requirements is unlikely to afford a sufficient compensatory balance offset to the natural competitive advantage of bank status with its inherent access to greater capital and personnel resources, greater market penetration and consumer trust.
898 Interview conducted by the author in Sydney, May 2017. 212 iv. Digital Wallet Providers
The range of products that may be classified as stored value facilities or non-cash payment products is now much broader than was the case when the legislation was passed in 1998. PayPal is currently the only purchased payment facility whose activity APRA has determined to constitute banking business, and it is authorised as a conditional ADI. All other PPFs and stored value facilities either fall within the present exemptions to the ADI regime or are not captured at all, and are accordingly outside APRA’s supervisory ambit.899 The exemptions to the PPF regime available to non-bank issuers lessen their regulatory burden; these products have in this respect a competitive advantage over banks and PPF providers with conditional licences. This is particularly apparent where large non-bank providers have ample resources and do not need to operate within the regulatory exemptions to allow them to achieve scale.
The current Australian system does not catch all participants automatically. In particular, it does not capture new entrants whose business is facilitation of non- traditional payments. Digital wallet only facilities do not presently fall comfortably within APRA’s ADI regime. New international competitors have emerged that operate payments leveraging account-to-account transfers that do not require the use of a card. Such companies include PayPal, AliPay and Google Send: each of these payments networks is growing at a faster rate than Visa and MasterCard.900 While many digital wallets are not yet available in Australia, their approach is nearing. Facebook has introduced free peer-to-peer transfers between its users in the US, Britain and France, and has indicated it will introduce this service in Australia in 2018.901 In 2017, Apple Pay Cash became available in the US, allowing users to make payments using stored
899 If it is a non-ADI with an exemption or an authority it is supervised by the RBA, save in respect of consumer protection issues, for which ASIC is responsible. Stored value facilities as non-cash payment products may need to have an AFSL or an exemption from ASIC – see Chapter Four, above. 900 Visa, Submission No 2 to the Financial System Inquiry Committee in Response to the Interim Report, above n 240, 27; Information Technology Faculty, ‘The Future of payments,’ (Report, 2016) 33 < https://www.icaew.com/-/media/corporate/files/technical/information-technology/technology/185- the-future-of-payments.ashx>. 901 Productivity Commission, ‘Competition in the Australian Financial System Draft Report,’ above n 1, 284. 213 value;902 regulation should be readied to accommodate these international heavyweight providers. It is likely that the lack of certainty in Australia’s present stored value regulatory regime has contributed to the decisions of these large international providers to choose jurisdictions other than Australia in which to introduce their products.
APRA has stated its reasoning for not regulating new entrants is that ‘while beneficiaries are provided with a high level of protection, this will not come at the expense of restricted competition due to high entry barriers, or increased costs due to high ongoing regulatory requirements.’903 Onerous regulation for new entrants tends to inhibit development of new payment providers and technologies and stifle their entry to the market. Specific and detailed laws that impose complex requirements risk the possibility that uncertainty of the law may lead to potential participants avoiding what is perceived as overly regulated activity.904
v. APRA’S Proposed Phased Licensing System
In the United Kingdom fourteen new banks have been approved following the introduction in 2014 by its prudential authority of a phased licensing system.905
In August 2017 APRA produced a discussion paper on the subject of new entrants to the banking industry that proposed that a phased licensing regime might, without overly burdening developing facilities, fill the regulatory gap affecting those PPF facilities that were ready to graduate to full ADI status. A restricted ADI licence, it continued, would allow applicants to begin limited operations while developing the full
902 Jason Cipriani, ‘Apple Pay Cash: How to use your iPhone’s new Venmo-like feature,’ Cnet (online), 5 December 2017
APRA’s proposal is supported by Xinja, a fintech start-up digital bank, which said that the phased licensing would ‘remove a significant commercial barrier to entry and enable the banking sector to enjoy the growth in technology and innovation already embraced by other sectors without such significant capital barriers to entry.’908
APRA’s proposal envisages that an applicant will acquire a restricted licence for up to two years. Following the APRA submission, the Australian Banking Association submitted that
APRA should ensure the phased licence remains an interim step in moving to a full ADI licence, rather than creating a two-tier and uneven regulatory regime in which both markets and consumers are not afforded the same protections.909
To date, the Australian government has not acted on APRA’s proposal and has passed no legislation directed to phased licensing. If implemented, restricted licences would be appropriate only for those PPF providers that, in order to expand outside stored value payment activities, wish to move from a permanent conditional PPF licence to a full licence. Were the proposed phased temporary licence regime to be introduced, the prudential regulatory gap between exempted facilities and facilities that hold a limited ADI licence would remain. Thus the proposal for a phased licencing regime does not adequately address the current regulatory grey area for stored value facilities
906 Australian Prudential Regulatory Authority, ‘Licensing: A phased approach to authorising new entrants to the banking industry,’ above n 53, 7. 907 Ibid. 908 James Eyers, ‘Start-up bank says drop $50m capital requirement,’ The Financial Review (online), 30 July 2017 < http://www.afr.com/business/banking-and-finance/financial-services/startup-bank-says- drop-50m-capital-requirement-20170729-gxlii8>. 909 Australian Bankers Association, ‘Licensing: A phased approach to authorising new entrants to the banking industry,’ Submission No. 1 to the Australian Prudential Regulation Authority, 4 December 2017, 2. 215 in Australia.
3.2 Consequence of Exemptions and Regulatory Grey Areas
The current regulatory regime for stored value facilities has led to an uneven regulatory playing field for issuers. The existence of various exemptions to this regime and an unclear regulatory perimeter means that certain facilities are not regulated at all.
While absolute competitive neutrality should not be the aim of regulators, current regulations should apply in a more competitively neutral way; the existing exemptions that provide regulatory relief to some payment methods benefit those employing those payment methods at the expense of those that do not qualify for exemption. Relief from regulatory obligations arises from the exercise of the RBA’s discretionary declaratory powers instead of a system that automatically captures all relevant entities and from APRA’s system of granting ADI exemptions. That payment systems are designated by RBA discretion as ADIs rather than by application of an objective and non-discriminatory classification system based on operating patterns of payment systems has led to a ‘regulatory free ride for non-designated participants’.910 This has resulted in unregulated payment systems having the potential to grow disproportionately at the expense of regulated payment systems. Operating outside the regulatory framework creates an unfair advantage for non-designated providers, who do not have to bear the cost of regulatory compliance.
New business models in stored value payments are particularly challenging for the existing regulatory structure. There are complete regulatory gaps in respect of products not established at the time of drafting, such as digital wallet facilities. Market incumbents and industry representatives have voiced concerns about this issue. Visa for example, has submitted that ‘there must be some form of licensing in the Australian system for players who have established accounts and transactions outside
910 MasterCard, Submission No 2 to the Financial System Inquiry Committee, Response to the FSI Interim Report, above n 215, 6. 216 traditional payments systems.’911 The Australian Retailers Association has noted that the playing field is not even, as not all payment providers are treated equally by the regulatory system.912 Eftpos has asked rhetorically why large scale providers that are likely to have achieved scale through experience, capability and capacity should be required to adhere to onerous and expensive regulation whilst small scale participants, more likely to introduce risk in terms of stability, security, integrity and reliability to payment systems, should not be so regulated.913 In addition to the problem of unequal treatment of larger institutions, it is unclear whether stored value businesses that operate within regulatory exemptions are subject to consumer protection provisions.
Existing regulation that plainly applies in particular circumstances is in practice not always applied on the basis of the function of payment instruments, but on other criteria such as the characteristics of its issuer, and may or may not be construed as applicable to innovation that has emerged since passage of that legislation.
The Final Report of the Wallis Inquiry and that of the Murray Inquiry each recommends that in order to provide entities performing similar functions with competitive neutrality, a functional regulatory framework be developed that ensures that risks emanating from similar economic functions are regulated in substantially the same way.914
3.3 Should all Providers Be Subject to the Same Core Regulations?
Claims by incumbent providers that all providers should be subject to the same level of regulation – a one-size-fits-all regime - should be carefully evaluated to ensure that the regulatory regime is not being used to create a market entry barrier that protects existing providers from an increased level of competition from new entrants.
911 Visa, Submission No 2 to the Financial System Inquiry Committee in Response to the Interim Report, above n 240, 27. 912 Australian Retailers Association, Submission No 1 to the Financial System Inquiry Committee, Financial System Inquiry, (March 2014), 4. 913 Eftpos, Submission No 2 to the Financial System Inquiry Committee, Response to the FSI Interim Report, above n 813, 5. 914 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 144. 217
Subjecting all providers to the same regulatory requirements without consideration of their differing characteristics does not of itself create a level playing field. Policies mandating that all participating stored value issuers are subject to the same core restrictions have been criticised as being blatant measures aimed at preserving the status quo.915 Rather, better competitive neutrality should be achieved through the absence of unduly high barriers to market entry for new products when compared with the position of market incumbents, and a three-tiered regime with different levels of regulation for different products that allows for and supports product development.
A PPF provider must be either a conditional or full ADI, or have its stored value guaranteed by an ADI. APRA’s current regime differentiates providers only on whether or not they hold stored value at risk. This has created an expectation that non-bank issuers will choose between subjecting themselves to the core prudential requirements applicable to financial institutions or entering into an arrangement with a financial institution willing to provide the stored value component of their business. Such regulations may readily be perceived as thinly disguised measures aimed at preservation of the traditionally central role of banks in payment systems, or at least as consolidating the banks’ present position by avoiding any undermining of their influence within payment systems.916
A more even regulatory playing field between incumbents, primarily banks, and new entrants, often non-banks, is the regulatory environment that best ensures that the benefits of innovation reach the market. It is not in the interest of the community for either banks or non-bank institutions to be at a competitive disadvantage. More issuers mean greater innovation, choice and competition between products with technologically up-to-date issuers focused on the needs of the market. If aspiring issuers are inhibited in seeking to access the market, potential new entrants generally will be discouraged. If existing issuers have no incentive to disturb the status quo they
915 Akindemowo, above n 271, 2.7. 916 Ibid. 218 may choose not to expand operations whilst the disadvantages of new entrants remain unaddressed.
4. DESIGNING A NEW SYSTEM
In any rapidly changing environment regulators must determine whether to compose a new regulatory framework tailored specifically to the needs of the changed environment, or whether it is sufficient to amend existing payments regulation.
Whether Australia should aim to create a fail-safe system or a system balanced between risk and stability is a key question posed for a federal government considering payments system reform. If balanced is the appropriate system, how might that be achieved in a manner protecting tax payers and keeping financial system costs down?917 Making the case for change in Australia is not easy; superficially there is little that is not working, particularly as the 2008 global financial crisis experience did not affect Australia as adversely as it did other countries.918 However, early findings from the 2018 Hayne Royal Commission into Misconduct, Superannuation and the Financial Services Industry are demonstrating that regulatory update and reform is important for the future stability and integrity of Australia’s financial system.919
The existing stored value regulatory framework in Australia, largely unamended, has lagged behind the evolution of digital payments. Shortcomings in the current legislation followed the original attempt to deal with disparate products within one all- encompassing legislative scheme, the consequent complexity of the regulations, the awkward seeking to categorise all products falling within the ambit of the legislation as either ADIs or exemptions to ADIs, and the increasing inability of the provisions to remain relevant in the face of rapid technological change. Current regulation is not
917 Erskine, above n 334, 9. 918 Ibid. 919 See for example, Karen Maley, ‘Hayne Royal Commission and the banking crisis: insiders reveal when the rot set in,’ (4 May 2018) Australian Financial Review < https://www.afr.com/news/australian- banking-crisis-insiders-reveal-when-the-rot-set-in-20180503-h0zmec>; Virginia Mansell, Mehul Joshi, ‘The 5 stages of Hayne royal commission grief,’ (21 May 2018) Australian Financial Review < http://www.afr.com/leadership/the-5-stages-of-hayne-royal-commission-grief-20180521-h10bns>. 219 tailored to the different range of stored value products and the resulting system is overly complex, difficult to apply, and not targeted to any particular risk inherent in a stored value system. In August 2018, the Productivity Commission found that ‘PPFs face complex and potentially stunting regulation that can deter entry and expansion.’920
Optimum balance between stability in the domestic economy and the development of the payments industry is best achieved by a regulatory framework that supports new entrants and products and maintains security and confidence in the Australian payments system. A clear, graduated approach that reflects the differing risks created by smaller stored value providers, larger bank incumbents and middle-ground digital wallet providers would best support innovation and development. Competition between issuers benefits the community through lower prices, greater product variety, higher product quality and greater innovation.921 Where competition is curtailed, established firms may use their market power to raise prices, lower quality for consumers and block entry by new firms.
The existing regulatory regime for stored value facilities should be re-designed. A number of aspects of current legislation inhibit aspiring new entrants to the current stored value system. As the introduction of regulations at an early stage may affect the direction taken by an industry, the shaping of development should be an objective of regulation. The lowering of barriers to market entry and the promotion of competition with existing providers are the principal actions required to support new entrants. The favourable response from Government and regulators to emerging new business models is critical to their success. In dealing with stored value products for example, regulation may encourage merchant acceptance of novel payment devices and
920 Productivity Commission, ‘Competition in the Australian Financial System Final Report’ above n 176, 498. 921 Council of Economic Advisers, ‘Benefits of Competition and Indicators of Market Power,’ (Issue Brief, May 2016) 2 < https://obamawhitehouse.archives.gov/sites/default/files/page/files/20160502_competition_issue_bri ef_updated_cea.pdf>. 220 methods, or may exclude the participation of certain types of payment provider altogether.
4.1 Government Support for Innovation
This section looks at regulatory and industry recommendations for a new regulatory regime for stored value facilities.
The Final Report of the Financial System Inquiry led by David Murray defines a well functioning financial system as one that is efficient, resilient and fair, promotes economic growth, and meets the financial needs of its participants.922 It recommends that policy makers aim to reduce unnecessary regulatory burdens and seek to encourage competition by removing unnecessary barriers to competition in the domestic and international markets.923 After removing regulatory burdens, policy makers, it advises, should seek to prevent a build-up of systemic risk, for example by establishing systems to manage failing financial institutions in a manner that protects the financial system and maintains financial stability, while minimising risk to taxpayers.924
The Final Report identified as a key area for reform technology-driven innovation, particularly in the area of payments.925 It recommended review of policy settings to ensure facilitation of innovation for the benefit of consumers, business and government, but cautioned that regulatory intervention should be considered only where it would improve efficiency, resilience or fairness of the financial system, and intervention benefit outweighs the costs to the economy overall.926 It recommended also that Australia emulate the deliberately pro-innovation policy settings found in
922 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 6. 923 Ibid 12. 924 Ibid. 925 Ibid 143. 926 Ibid 238. 221 other countries where governments have cultivated dynamic, vibrant financial sectors.927
The Government in its response to the Final Report identified as a strategic priority for its financial system program innovation measures that unlock new sources of finance for the wider community and support competition.928 It agrees that properly harnessed, new payment methods, better use of customer information and deeper cross-border linkages promise enormous opportunity. It accepts that its policy settings must facilitate the entry of new payment methods, rather than act as a barrier.929
The pace of technology-driven market developments particularly challenges existing regulatory frameworks. In times of rapid development, it is difficult for regulators to respond in timely fashion. Failure to manage emerging risks is prone to result in system-wide impacts and/or adverse consumer outcomes, amplified in their effects as developments in technology increase network speeds, broaden distribution networks and heighten levels of interconnectivity.930 Mr Ravi Menon, managing director of the Monetary Authority of Singapore, asserts ‘while regulation must not front-run innovation, regulators must run alongside innovation.’931 In February 2018 a national infrastructure for low-value payments, Australia’s New Payments Platform was launched. It is designed to enable fast, flexible and data-rich payments, further encouraging the use of electronic payments and enlivening the concomitant need for their regulation.
One aspect of the challenge facing regulators is the need to adapt existing regulations to a rapidly changing environment. A flexible regime that is able to respond to new developments in payments practice is required. I propose a regime comprised of three different tiers separate from existing ADI regulation.
927 Ibid 149. 928 Australian Government, ‘Improving Australia’s financial system’ above n 478, 4. 929 Ibid 6. 930 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 144. 931 Ravi Menon, ‘FinTech – Harnessing its Power, Managing its Risks,’ above n 651. 222 4.2 A Tiered Regime: Defining the Thresholds
As regulation tends to lag behind market developments and changing payments practices, governments and regulators need to adopt an adaptive approach to regulation. A flexible graduated regime is the best regulatory model for a payments system that is in the process of developing. A tiered system of regulation tailored to particular risk levels of individual facilities should be introduced. This need was recognised in both the 2014 Final Report of the FSI and the 2018 Final Report of the Productivity Commission.932 In its August 2018 Final Report, the Productivity Commission recommended
The Council of Financial Regulators should review the current regulation of Purchased Payment Facilities (PPFs). The review should develop an approach to simplify the regime, develop clear thresholds for regulatory responsibility and reduce barriers to growth in this sector. The review should consult on and design a tiered regulatory structure for PPFs, including one tier that does not attract prudential regulation. The review should be completed by end-2018 at the latest and provide a path forward for regulators by mid-2019.933
To protect consumer funds and the stability of the financial system, products used by large numbers of consumers or which have the capacity to hold high values should be placed within a top tier and subjected to strong prudential and consumer protection regulation. Products with a smaller customer base with lesser value stored by individual customers and lower values in aggregate should be subject to less stringent prudential regulation, thereby reducing regulatory burden and encouraging development of business. Products holding lower value again should operate in a third tier of regulation and not be subject APRA’s prudential regulation but be required to adhere to ASIC’s ePayments Code. The existing system of exemptions for limited use products could remain below the three tiers.
932 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 161; Productivity Commission, ‘Competition in the Australian Financial System Final Report,’ above n 176, 49. 933 Productivity Commission, ‘Competition in the Australian Financial System Final Report,’ above n 176, 49, Recommendation 17.5. 223
The higher tier might reduce the present liquidity requirements with other prudential requirements strengthened. The middle tier should maintain the 100% liquidity ratio requirement but should lessen overall compliance costs by lowering other prudential requirements. A third tier without prudential requirements would reduce barriers to new market entry, providing opportunity for aspiring entrants; as new providers and more products enter the market, improved competition, choice and efficiency are likely to follow.934
The appropriate threshold for regulatory capture of substantial facilities into the top tier purchased payment facilities regime would identify those entities that are classified as ‘widely-used payment systems.’ This Thesis adopts the thresholds suggested in the 2014 FSI Final Report for widely-used non-cash payment systems that should require an AFSL935 as the threshold appropriate for the top tier of prudential regulation. That is, widely-used payment systems should be defined as those with annual transaction values over $100 million and more than 50 payee groups, and those with annual transaction values over $500 million and more than five payee groups.936 The middle tier of prudential regulation could capture those entities of ‘sufficient scale.’ This Thesis considers appropriate the threshold proposed by the 2014 FSI Final Report for PPFs of sufficient scale being those that hold more than $50 million of stored value and/or which enable individual customers to hold more than $1000.937 Entities which hold less than $50 million would not be subject to prudential regulation, but would be subject to ASIC’s ePayments Code. Those entities that hold less than $10 million would continue to operate within the existing low value exemption, and be subject only to the provisions of the ePayments Code tailored to low value facilities.
Questions that regulators need to address when updating the stored value regulatory regime include whether or not issuers in the middle tier will need a licence, and if so,
934 Deloitte Access Economics, ‘Regulatory Treatment of PayPal Australia,’ Submission No. 3 to the Financial Systems Inquiry in Response to the Final Report,’ above n 157, 15. 935 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 161. 936 Ibid. 937 Ibid 162. 224 what the appropriate requirements are for obtaining the licence. A determination of the ongoing capital requirements and how to ensure the sum determined is appropriate to their level of development will need to be formulated. As outlined in Chapter Six, this Thesis proposes that only products in the top prudential tier be required to obtain an AFSL.
Tier Threshold APRA ASIC
Conditional ADI Products with 50 or more licence or new payee groups and annual equivalent transaction values over
$100 million Reduce present ePayments Code
Top liquidity OR requirement AFSL required
5 or more payee groups and Strengthen other transactions values over prudential $500 million requirements
Products that have between $50 million and $100 million 100% liquidity in annual transaction values requirement
Middle ePayments Code AND / OR Lower other prudential Allow customers to hold requirements $1000 or more per device
Products with less than $50 Lower million in annual No ePayments Code transaction value
Products that hold less than ePayments Code $10 million in aggregate (tailored Exemptions stored value No requirements for low value Limited Use Products facilities)
Table 7.1: Table Outlining Proposed Regulatory Tiers for Stored Value Facilities
225 A graduated regime would encourage facilities to expand, subjecting them to a level of regulation whilst not requiring that they be classified as an ADI. Thresholds that separate the tiers of regulation should act to remove the need for RBA declarations. A regime of this nature, based on the objectives of the regulation rather than the specific characteristics of each facility should provide a model able to accommodate future developments. A graduated regime could offer service providers a choice between three tiers. This approach would reduce regulatory gaming, where providers tailor their products to avoid inclusion in a regulatory class appropriate to their character. Even were gaming to occur between the tiers, products would still be caught by some degree of regulation, which is currently not the case for products that fall between the exemptions and the full ADI-PPF regime.
A potential drawback to adoption of a tiered scheme is the risk of perception by competitors and potential partners that a product which falls into the lower tier is a second-class product, not a serious market contender. This may result in lower tier products not being promoted or marketed enthusiastically, thereby restricting those products’ ability to compete with the higher tier products. Despite this drawback, a regulatory approach that establishes a balance between preserving the safety of the payments system and allowing institutions and markets to develop is ideal.938 To meet changes in payments products as they emerge, Australian payments system regulation will need to accommodate potential new stored value products as they appear within a framework that guards consumers and the payments market against foreseeable risk.
Should changes to the current regulatory system be made, regulators should publish a guide for industry participants so that more providers are encouraged into the stored value arena. ASIC’s Innovation Hub appears to be well-placed to take on this role.
938 Ibid. 226 4.3 Lowering Barriers to Market Entry
Regulators are in a position to co-create with industry the culture shift from traditional banking into the digital age. The financial services paradigm has traditionally been focused on compliance, and this risk-adverse mindset has acted as a protective mechanism for market incumbents.939 Critics have warned that this regulatory mindset may prove to be a barrier to the openness to innovation that is needed to survive and thrive in the digital age.940
Shortcomings in the present regulatory scheme include unintended difficulties entering the market and uncertainty for new and existing issuers as to whether proposed new products will fit within present regulatory definitions. Confident entry of new products into the market fosters innovation and competition, and as technology-enabled innovation reaches the payments system and its participants, its benefits become increasingly important.
Stakeholders have reported that due to the complexity of regulation and regulatory mandates, having no single point of entry for innovators and start-ups poses a significant challenge.941 A clear method and point of entry to the payments market is essential for new businesses and products. The monetary authorities of Hong Kong and Singapore have statutory mandates to promote financial sector development that include the provision of streamlined entry points for new entrants.942
In Australia, the Report of the 2015 Productivity Commission Inquiry recommends that ‘the default position of governments should be to allow entry of innovative new business models, not restrict them or protect incumbents.’943 Smaller stored value businesses should be able to operate outside of APRA’s prudential regime. This non-
939 Riemer, Hafermalz, Roosen et al, ‘The Fintech Advantage: Harnessing digital technology, keeping the customer in focus,’ above n 136, 23. 940 Ibid. 941 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 149. 942 Ibid. 943 Productivity Commission, Business Set-up, Transfer and Closure, above n 405, 2. 227 prudential tier of regulation could be made conditional; to ensure that a basic level of consumer protection is met it could for example include a compulsory undertaking to comply with the full provisions of ASIC’s ePayments Code. The creation of innovation collaboration committees would greatly assist emergent providers to access the market and to navigate the regulatory framework.
The current regime offers various exemptions for low value and limited purpose facilities whose stored value is held by an ADI. It does not provide a regulatory tier into which these facilities could develop, other than via the conditional ADI-PPF licence path. The present piecemeal regime is a result of exemptions being created in response to the particular characteristics of different types of facility, rather than upon a principled attempt to implement formulated desired objectives. It is not the best practice regulatory model for an industry that is developing quickly; it does not take account of the necessity to have a rules-based order in place before the inevitable advent of new types of payment service, nor does it create incentives for existing facilities to grow.
4.4 Supporting Non-Banks through Competitive Neutrality
Stored value regulation should be constructed so as to ensure that all stored value facilities fall within the regime’s ambit and the regulatory burden created is not unduly heavy for certain issuers. Current stored value regulatory arrangements appear to have been drawn with an expectation that non-bank providers would operate only on a small scale and under the $10 million limited facility threshold set by the RBA, or would arrange for ADIs to act as holders of their stored value. In their present form the regulations do not support independent growth of non-bank facilities.
The current regulatory burden is too high for non-bank issuers. A non-bank issuer has to choose between accepting the core prudential requirements applicable to financial institutions or entering into an arrangement with a financial institution willing to provide the stored value. In Australia the majority of stored value issuers, in order to avoid being regulated as a PPF, partner with traditional banks.
228
New non-bank issuers face the difficulty of attracting users in the numbers needed to take advantage of cost savings. The inability to achieve economies of scale may prove to be an insuperable hurdle, resulting in failure of the venture in some cases. The ability to grow and retain an active customer base with the necessary funding will often dictate success or failure for fintechs, with some reports suggesting that over 95% of fintechs fail when they reach the scale-up phase.944
Collaboration with traditional banks may provide the capital needed for a fintech to survive, driving its growth and improving the quality of its services. Partnership with a bank may aid a fintech in overcoming existing hurdles relating to customer acquisitions costs and access to capital. A bank may provide solutions to scalability and compliance with existing regulations difficulties.945 Fintechs may capitalise on existing customer bases of traditional banking institutions and may improve their service quality and visibility by observation and imitation. Knowledge of the existence of financial backing by a bank may provide the customer trust and confidence that new fintech companies may lack. In 2016 in Australia, the fintech customer adoption rate, which is the percentage of the surveyed population that are regular users of fintech services, was 61.2% but the level of trust amongst these customers towards fintech firms was only 24.8%.946 For their part, fintechs may offer traditional banks new skills and innovative ways of working with new technologies.947
The entry of large companies such as Google and Alibaba into the payments system has encouraged incumbents to take a leading role in innovation, rather than becoming the ‘backbone’ provider for other suppliers.948 Techfin companies with resources such as customer data, established consumer infrastructure and strong brand reputations
944 Riemer, Hafermalz, Roosen et al, ‘The Fintech Advantage: Harnessing digital technology, keeping the customer in focus,’ above n 136, 22. 945 Ibid. 946 ‘World Retail Banking Report 2016’ (Report, CapGemini, Efma, 18 April 2016); ‘Customer adoption rate’ refers to the number of members of a society that start using a new technology during a specific period of time. 947 Riemer, Hafermalz, Roosen et al, ‘The Fintech Advantage: Harnessing digital technology, keeping the customer in focus,’ above n 136, 23. 948 Ibid 19. 229 are or are poised to become major players in the payments services market. Unless regulators with revised regulatory framework, this increased competition in the payments market is likely to make market success for fintechs more difficult.
Regulators must consider to what extent they are prepared to support the entry of techfin companies, and whether this is to come at the expense of fintechs or other market incumbents. In the words of Keith Noreika, Acting Head of the US Office of the Comptroller of Currency ‘if a commercial company can deliver banking services better than existing banks, we hurt consumers by making it hard for them to do so.’949 Regulation may be used to encourage potential new non-bank market entrants, by creating, for example, certainty in the regulatory environment, and by stimulating competition between banks and non-bank issuers.
Regulations and new security measures must develop alongside payments technology as cardless payments replace traditional card-based payments. In order to provide competitive neutrality legislation must capture effectively all entrants in the system. To provide greater regulatory parity between bank and non-bank issuers stored value facilities that are neither a limited-purpose ADI nor within the low value exemption ought to be subjected to clearly defined regulation. The Payment Systems (Regulation) Act should be reviewed and re-drafted to capture all existing and emerging products. APRA’s regime should be graduated to include a middle prudential tier, and a lower non-prudential tier administered by ASIC should be introduced for stored value providers operating between the low value exemptions and conditional ADIs. Competitive neutrality will be improved through the existence of a graduated regime as all products within each regulatory tier will be treated in an equal manner.
Whilst it is important to capture all facilities not subject to an exemption, overly strict regulation will inhibit innovation and advantage incumbents. Regulation that shields incumbent firms from competition provides opportunity to incumbents to raise profit
949 Schultz, above n 155. 230 yields, imposing higher costs on consumers, discouraging innovation and reducing economic growth.950
4.5 Clarifying the Regulatory Grey Area
Legal uncertainty attending the applicability of regulations is another disincentive to innovation. Regulations should preferably be designed to be both product and technology neutral, and be drawn in terms that leave no room for doubt as to whether a new product or a new market entrant is subject to the terms of a particular legislative provision.
Regulatory uncertainty currently exists in respect of facilities that grow to hold over $10 million in stored value and are not covered by an RBA limited use exemption. PayPal is currently the only stored value facility authorised as an ADI by APRA, and the RBA has not yet declared any facilities to be subject to the purchased payment facility regime. Accordingly, stored value facilities that hold over $10 million and are not covered by an RBA exemption seem to be subject to no regulation, but if determined to be ‘banking business,’ ought to be authorised as an ADI. This regulatory grey area is a disincentive for stored value facilities operating within an exemption to grow, in order to avoid the requirement to be authorised as an ADI. Industry participants have long identified this situation; in 2014, Australian retailer Coles submitted to the Financial System Inquiry that the complexity of existing regulations affecting non-cash payments and other payment facilities such as purchased payment facilities is such that new participants are discouraged from developing innovative payment facilities that benefit consumers, such as digital wallets.951 PayPal has called for a lower tier of regulation for those with conditional banking licences, on the basis that digital wallet competitors, including MasterCard’s MasterPass, Visa Checkout, Apple Pay and Samsung Pay are not regulated at all under existing regulations when taking deposits or store value.952
950 Productivity Commission, Business Set-up, Transfer and Closure, above n 405, 6. 951 Coles, Submission No. 2 to the Financial Systems Inquiry Committee in Response to the Interim Report, Financial Systems Inquiry,’ (August 2014), 5. 952 Shaun Drummond, ‘Fintech split on lower regulatory hurdles,’ (6 April 2015) Sydney Morning Herald. 231 In Chapter Four, I noted that an Australian stored value facility presently may be subject to regulation by three different entities, ASIC, APRA and the RBA, each with its own regulatory regime, or may not be covered by legislation at all. Stored value facilities where the stored value held by the operator is less than $10 million, a class that includes many retail payment systems and providers, are regulated by ASIC, but not by APRA or the RBA.953 Retail payment systems that hold stored value of $10 million or more are regulated by both ASIC and, if the product is determined by APRA to be ‘banking business,’ by APRA and/or the RBA. ASIC has exempted gift-cards, low value payment facilities, road toll devices, pre-paid mobile facilities and certain other stored value products from the Financial Services Licence regime. Some facilities not falling within the exemptions, not caught by APRA’s PPF regime nor designated as a payments system by the RBA appear not to be covered by any regulation.
5. GOVERNMENT RESPONSE TO A GRADUATED REGIME
Government and regulators have expressed differing views in response to industry and regulator recommendations for a graduated regime.
AusPayNet has indicated its support for the graduated framework approach.954 APRA also has indicated its support, but has added the warning that a graduated approach must take care that it does not raise a perception of a ‘second-class’ group of institutions, leading to an overall weakening of ADI prudential requirements.955 This concern raises the question of whether products with fewer regulatory requirements are in fact seen generally as less serious players in the payments market.
In 2014 ASIC submitted to the FSI that a graduated approach already exists, as under the Payments System (Regulation) Act 1998, smaller scale facilities (those with stored value less than $10 million) are excluded from the definition of purchased payment
953 Australian Securities and Investments Commission, Submission No 2 to the Financial System Inquiry in Response to the Interim Report, above n 750, 88. 954 Australian Payments Clearing Association, Submission No. 2 to the Financial System Inquiry in Response the Interim Report, above n 504, 2. 955 Australian Prudential Regulatory Authority, Submission No 2 to the Financial System Inquiry in Response to the Interim Report, Financial Systems Inquiry, August 2014, 61. 232 facility.956 However, the ASIC submission appears to view the exemption provisions as a tier of regulation; the ASIC submission to the FSI does not address the circumstance that if a user holds more than $1000 on their card or device, the product does not fall within the low-value relief and is subject to full regulation. This Thesis proposes that three levels of regulation should be applied in conjunction with existing exemptions.
In its 2015 Response to the FSI Final Report the Australian Government agreed that a graduated regulatory regime will support innovation, and announced that APRA, ASIC and the RBA will review the framework for payments system regulation and will develop clear guidance.957 Government indicated further that it will clarify the powers held by ASIC and the RBA to ensure that regulators have the power to regulate new payment systems such as digital currencies and new payment systems in a graduated way.958
In 2016, the Australian Government announced that it
…wants to offer home-grown and offshore FinTech innovators an opportunity to develop and refine new products and services in the Australian market through a regulatory system that allows them to be frictionless through their scale journey while still becoming regulatory match fit for deployment into domestic and global markets.959
This announcement signals a desire to formulate a regulatory regime suited to activity in domestic and overseas market places unburdened with existing bureaucratic obstacles. No detail has as yet emerged publicly as to interpretation and the manner in which the governmental desire might be implemented.
956 Australian Securities and Investments Commission, Submission No 2 to the Financial Systems Inquiry Committee in Response to the Interim Report, above n 750, 88. 957 Australian Government, ‘Improving Australia’s financial system’ above n 478, 15. 958 Ibid. 959 Scott Morrison, ‘Backing Australian FinTech,’ (Treasury Statement, 21 March 2016)
Changes in technology and emerging new developments occur faster than regulations can adapt, challenging existing regulatory frameworks. Innovation in payments methods should not be met with heavier regulation, but with greater government- industry support, actively facilitated by government. Recommendation 14 of the 2014 FSI Final Report is to ‘establish a permanent public–private sector collaborative committee, the ‘Innovation Collaboration’, to facilitate financial system innovation and enable timely and coordinated policy and regulatory responses.’ Extensive interaction between regulators and market participants can provide an appropriate background for experimentation with, and regulation of innovation.960
Following the 1996 financial system inquiry, the Wallis Inquiry, all bank regulation was separated and put under the care of the RBA. All prudential regulation was entrusted to APRA and all market conduct regulation was entrusted to ASIC. Reform after the Wallis Inquiry sought to expand access to the payments system, and the Government, recognising that this could involve non-bank entities holding funds equivalent to deposits, introduced a purchased payment facility regime.961 Australia’s financial system is now more complex; systemic risks and regulatory gaps are emerging, and some commentators contend that delay in updating the current financial regulatory regime is hastening the arrival of the next crisis.962 The FSI Final Report considered the roles of the three major financial regulators to be appropriate, while acknowledging that there is room for improvement.963
Since the latest FSI Final Report was published in 2014, several coordinating bodies have been created. In February 2016 a Government Fintech Advisory Group (GFAC) was created. Its members are drawn primarily from financial institutions and fintech
960 Zetzsche, Buckley, Arner et al, ‘Regulating a Revolution: From Regulatory Sandboxes to Smart Regulation,’ above n 267, 14. 961 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 165. 962 Erskine, above n 334, 5. 963 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 29. 234 bodies. Its remit includes identifying areas of potential future reform and advising the Federal Treasurer directly on issues relevant to Australia’s fintech industry.964
ASIC has demonstrated its commitment to facilitating public-private collaboration for fintech through four initiatives. ASIC’s Innovation Hub, established in 2015 is well placed to guide new fintech entrants through the regulatory framework. Recognising that new entrants may lack resources and experience with the regulatory framework, it supports new providers seeking market entry and providing regulatory guidance.965
The second initiative is ASIC’s Digital Finance Advisory Committee, which first met in August 2015 and is one component of the Innovation Hub. It is composed of primarily fintech members and initially had some small membership overlap with the GFAC. 966 It focuses on building lines of communication and developing relationships with fintech start-ups and associations.967
The third initiative was introduced in December 2016. ASIC established a regulatory sandbox that allows eligible fintech businesses to test approved services for up to 12 months without holding an Australian financial services licence or credit licence. The only payment products currently eligible for the sandbox are products issued by an ADI with a maximum balance of $10,000.968 As it stands, this sandbox is not relevant to any stored value facilities, as those with a balance of less than $10,000 will already fall within ASIC’s low value exemptions from regulation. However, it does demonstrate ASIC’s willingness to waive regulation for some emerging fintech products, which may benefit some stored value facilities in the future.
964 Australian Government, The Treasury, Working with Australia’s FinTech Industry, (2017) < https://fintech.treasury.gov.au/working-with-australias-fintech-industry/>. 965 Greg Medcraft, ‘The future of fintech and regulation,’ (Speech deliver to the British Australian Fintech Forum, London, United Kingdom, 20 April 2017). 966 Kevin Davis, ‘Innovation and fintech policy: Post-Murray developments,’ (Australian Centre for Financial Studies, May 2018) 7. 967 Ibid. 968 ASIC’s Innovation Hub, Licensing Exemption for Fintech Testing, (2017) < http://download.asic.gov.au/media/4112096/licensing-exemption-for-fintech-testing-infographic.pdf>. 235 ASIC’s fourth initiative is the reaching of a number of agreements between ASIC and regulators in other jurisdictions, agreements that are aimed at widening cross-border expansion and regulation of valuable fintech innovations.969 ASIC has signed cooperation agreements with the Hong Kong Monetary Authority and with the Monetary Authority of Singapore aimed at assisting fintech companies in those markets to expand into each other.970
A further initiative to ASIC’s initiatives is the role played by the Australian Payments Council, which role has been expanded to coordinate different entities and to monitor market developments. The Australian Payments Council is the ‘strategic coordination body for the Australian payments industry.’971 It provides a forum for key stakeholders from financial institutions, merchants and new entrants to engage directly with the Payments System Board of the RBA. The role of the Council includes identification and removal through collaboration of barriers to innovation and through constant scanning of the payments environment, and identification of issues and trends.972
This Thesis supports the introduction of a supervisory authority to oversee the regulation of stored value facilities to support both innovation and competitive neutrality. A permanent public-private committee, granted a remit to facilitate financial system innovation and the promotion of timely coordinated policy and regulatory responses, would facilitate innovators contributing directly to the development of policy. A permanent committee may better identify innovation opportunities and emerging network benefits, while building understanding of the likely impact on consumers and providers. A coordinating body could coordinate and liaise with regulators, acting as an access point for consumers and companies interested in launching new payments products, including stored value facilities.
969 Kevin Davis, ‘Innovation and fintech policy: Post-Murray developments,’ above n 963, 8. 970 Gina Baldasarre, ‘ASIC signs cooperation agreement with Hong Kong regulator to help fintechs explore expansion,’ Startup Daily (online), 14 June 2017, < http://www.startupdaily.net/2017/06/asic- signs-cooperation-agreement-hong-kong-regulator-help-fintechs-explore-expansion/>. 971 Australian Payments Council, About Us, (2017) < http://australianpaymentscouncil.com.au/>. 972 Australian Payments Council, How we operate, (2017). 236 A single supervisor that oversees the regulators is able to monitor the market to ensure that similar products receive comparable regulatory treatment. Institutionalised communication between regulators and industry means that regulators remain connected in an ever-changing innovative marketplace and can adjust their approaches on a case-by-case basis.973 This approach also addresses a primary weakness of the multiple-regulator approach - the danger of repeating or confusing requirements – by appointing a body separate from the regulators to oversee each of their regimes and act as a single point of contact for industry.
A collaborative committee such as the Payments Council or Council of Financial Regulators (CFR) composed of regulators and members of industry is in the best position to coordinate actions of the existing regulators, to streamline existing regulation, avoiding loopholes and regulatory overlap and reducing unnecessary burden on both regulators and regulated entities. The Productivity Commission has also identified the Council of Financial Regulators as the body best suited to oversee existing stored value regulation, recommending that ‘the CFR should review, consult on and re-design regulation of PPFs to encourage entry and expansion, with regard to necessary safeguards to protect consumer funds.’974 A system with a supervisor well- placed to monitor the facilities and market developments should ensure regulatory space for small fintech companies to develop, while still managing risk effectively.
7. CONCLUSION
Australians now have more payment options than ever before, and technology continues to evolve at a rapid pace. Regulation has not always kept pace with the rate of change, and this can have negative consequences for competition in future.975 Australia’s payment system is at a crucial turning point and government and regulators
973 Zetzsche, Buckley, Arner et al, ‘Regulating a Revolution: From Regulatory Sandboxes to Smart Regulation,’ above n 267, 14. 974 Productivity Commission, ‘Competition in the Australian Financial System Final Report,’ above n 176, 500. 975 Ibid 29. 237 have an opportunity to set up regulatory arrangements that will support substantial competition in electronic payments, before incumbency becomes cemented.
To ensure consumer protection and financial system stability as payment systems develop, regulation needs to keep pace with and be relevant to emerging products and systems. Ideal policy settings should facilitate innovation and accommodate market developments by providing a clear path of development without burdening small issuers with unnecessarily onerous regulatory requirements. Equally, regulators must identify and manage attendant and future risks. Failure of a stored value provider not subject to appropriate regulation may result in unforeseen adverse consumer outcomes and system-wide impacts that might include consumers losing access points for products or losing stored funds entirely. Balance must be preserved between ease of introduction to market of new products and preservation of the stability of the payments system.
The payments industry, driven by emergent technologies, is changing too fast for regulators to adapt their regimes in a proportionate and competitively neutral way. The existing stored value regime in Australia includes loopholes and grey areas and does not apply impartially to all issuers. New legislation specific to stored value legislation should be drafted with greater technological and competitive neutrality that addresses both emerging and existing products. The new regime should have clear definitions and apply generically to all stored value products and issuers.
Governments and industry are in a position to co-create the emerging payments landscape. Governments should actively support innovation and development in payments facilities by lowering existing barriers to new market entry, creating a regulatory playing field that is more even and removing unnecessary obstacles and disincentives to product development, which are often subject to heavy regulatory burden. Regulation that applies a light touch, considering and contrasting the different resources and inherent characteristics of new entrants and market incumbents is best suited to provide competitive neutrality between issuers.
238 Stored value facilities present challenges that stem from their rapid evolution, from their issuance by non-bank providers, and from their ability to be used and transferred outside the traditional banking system. These challenges are distinct from the challenges associated with traditional payments systems. In Australia, APRA’s current regime differentiates between providers primarily on the basis of whether they hold or do not hold stored value at risk. This has created a situation where a potential provider seemingly must choose between partnering with an ADI or itself becoming an ADI.
PPF providers that hold conditional ADI licences, i.e. providers not holding a low value exemption and not in partnership with a bank have an unduly heavy regulatory burden. In contrast, some issuers, neither entitled to the low value exemption nor required to obtain a conditional ADI licence are falling within a regulatory grey area and are not within APRA’s prudential regime at all.
The current regime acts as a disincentive for providers to evolve as with modest growth they will be reclassified as an ADI and thereby become subject to the heavy regulation that that status attracts. The Australian government should support the entry of new payments providers to the market through a three-tier graduated regime with the option to suspend particular regulatory requirements for a limited time, such as within a regulatory sandbox, with the support of a private-public collaboration body such as ASIC’s Innovation Hub. That graduated regime should have more nuance to address the imbalance in regulatory application between issuers, and be designed to provide a clear growth path for facilities. APRA’s remit should be revised to introduce a lower prudential tier for stored value providers for whom conditional ADI prudential supervision in not appropriate. ASIC should be the primary supervisor for those products that do not require prudential supervision, that are positioned between the low value and limited-use exemptions and the two tiers supervised by APRA.
239 CHAPTER EIGHT: RECOMMENDATIONS AND A PROPOSAL FOR A GRADUATED REGIME
1. ADDRESS UNCERTAINTY WITHIN THE EXISTING REGIME 242 2. REVIEW THE REGULATORY PERIMETER 244 3. INTRODUCE A GRADUATED SYSTEM 246 4. SEPARATE STORED VALUE REGULATION FROM THE ADI REGIME 248 5. INCREASE CONSUMER PROTECTION 250 6. ADDRESS COMPETITIVE NEUTRALITY AND INNOVATION 251 7. RETHINK THE ROLES OF THE REGULATORS 252 8. CONCLUSION 254 7.
To conclude this Thesis, I return to the primary and secondary research questions identified in Chapter One.
1. How effective is Australia’s Regulatory Regime for Stored Value Facilities?
Current legislation governing stored value facilities in Australia requires review and amendment. As stored value facilities expand to embrace wider use of contactless wearables and digital wallets, migration towards electronic payments through stored value will be driven by the demands of an increasingly tech-savvy younger generation, improved systemic reliability, the growth of stored value facilities in other jurisdictions, decreased consumer costs and increasing confidence in the global market. Driven by the preferences of the millennial generation, digital wallets are likely to experience the greatest growth of all the stored value products. Though current legislation was adequate for the times in which it was created, subsequent innovation and the emergence of variegated firms in the field requires revision of old legislation and the passage of some new legislation.
Three significant problems exist with the current legislative regime as it relates to stored value facilities. The first is that its system of declarations and exemptions has
240 become overly complex. Second, other than for products that fall within an exemption, it generates significant compliance costs. Third, application of the current regulatory requirements has occasioned significant confusion in both consumers and providers, with the result that many products appear to be operating outside the regulatory framework. Existing regulations often create market barriers and disincentives to businesses contemplating or seeking to introduce innovations, occasioning constant challenge.
The Australian government has important choices to make regarding regulation of stored value facilities which have recently begun to take a place in the Australian payments system. The products themselves are in course of continuing development and do not yet represent a substantial systemic threat. A wait-and-see approach to the ‘grey area’ between low value facilities and conditional ADI-PPF issued products may be thought appropriate. On the other hand, this Thesis argues that we are approaching a critical stage where in order to limit increasingly significant risks posed by stored value products, the Australian Government must regulate the stored value products now in the market.
Before answering my primary research question regarding the effectiveness of Australia’s stored value regulatory regime, I turn to consideration of my secondary research questions, viz.
2. Does existing Australian regulation of stored value facilities capture all relevant products? 3. How does Australian regulation fare in terms of clarity, competitive neutrality, openness to innovation and client protection? 4. Are similar problems better or differently addressed in other jurisdictions? 5. Should Australia modify its current regulatory regime to address possible benefits derived from comparison with comparable jurisdictions, and if yes, how?
241 I answer these questions seriatim. A number of emerging products do not fall within the ambit of current Australian regulation; a further number may or may not be affected by regulatory reach. Existing regulations lack clarity, there is little competitive neutrality between bank and non-bank issuers for similar risk-weighted products, innovation and product development is not well supported and consumer protection provisions that exist are often not mandatory.
In comparison with Singapore and Hong Kong, Australian regulation does not fare particularly well. In implementing regulation Australia should build on the experience of global regulators, while reflecting features of the Australian system. This Thesis proposes that in order to minimise regulatory confusion and to provide a clear path for entry of new products, the best system for Australia is to have a clearly defined set of regulations as does Hong Kong, and to lessen the regulation applicable to new entrants so that each product attracts a level of regulation proportionate to its level of risk, as does Singapore. Unlike Singapore however, where regulation does not apply until a product reaches a top tier, a light-touch regulatory regime should be applied to all new products, which touch should be gradually increased as use of the product grows. This approach would increase the clarity of Australia’s regime, providing a clear and predictable roadmap for the growth of products while minimising the risk of exposure to unregulated products to market and consumers. Products should develop through stages of gradation with the steps between levels set to be less extreme than moving from exemption status to full PPF-ADI regulation.
I propose the introduction of a new system for regulating stored value facilities, summarised in the following recommendations.
1. ADDRESS UNCERTAINTY WITHIN THE EXISTING REGIME – CLARIFY NAME AND DEFINITION
I recommend that the phrase stored value facility be employed in lieu of purchased payment facility in legislative instruments. The phrase stored value facility is in keeping with global usage, a factor particularly relevant in respect of products that pass across
242 national borders. Australia’s adoption of this phrase would avoid regulatory confusion and uncertainty within both domestic and international markets. Considering the function of the products in question which store value and may or may not be purchased by the consumer, the various regulators adopting a uniform definition of stored value facility should lead to significant improvement of congruency between regulators and reduce the present confusion surrounding regulatory compliance. The name stored value facility provides a better product description than does purchased payment facility.
The range of emerging products and uptake by consumers of technological advances is likely to increase and may well accelerate. Whatever type of technology is used to deliver the stored value payments product, regulations should so far as possible extend to regulate all participants and future providers in the field.976 Technology develops quickly and without regard to whether legal regulation relevant to it is or is not in existence. It is not possible to predict with any certainty the ways in which present and future electronic money systems will develop; regulators should strive to maximise technological neutrality in their regulatory instruments. Technologically neutral regulation would better enable regulators to react to developments and to manage emergent risks. By removing unnecessary regulatory impediments, such regulation would reduce compliance costs and would improve the durability of the regulation and decisions made thereunder. It would assist regulators to manage risk more effectively and limit definitional uncertainty.
To take into account evolving business models and offerings there is a need for ongoing or semi-regular assessments of the regime. Existing regulations should be regularly reviewed to ensure they are operating in a technologically neutral manner and are phrased in terms that operate on developing types of all relevant products. Payments system regulation must be developed with support for future changes in technology and business structure in mind. As it is not possible to predict with any certainty the ways in which present and future electronic money systems will develop,
976 Including for example, those digital wallets that have stored value capacity. 243 the RBA should retain its declaratory power and use it to determine which entities should be captured by regulation.
The Payment Systems (Regulation) Act 1998 (Cth) should be amended to embed a transparent process for assessment of applications to designate payment systems. Changes should be required to follow a formal application process, with publication of determinations and reasons for each determination, and should incorporate a review process through or similar to that of the Australian Competition Tribunal.
2. REVIEW AND CLARIFY THE REGULATORY PERIMETER
The current regulatory framework does not adequately incorporate such emerging products as digital wallets. Many digital stored value facilities are not captured by the regime at all. As the current regime is based on a number of exemptions and declarations, it does not capture all stored value facilities and its application to particular facilities is frequently uncertain, particularly in circumstances of facilities that are neither supervised by APRA nor classified as limited or guaranteed facilities.
Effective digital wallet systems in Australia offer significant potential to lift productivity. As familiarity with their use grows, they may confidently be expected to promote economic growth. Regulation should support their entry and development.
I support AusPayNet’s submission to the FSI that recommends examination of the ‘regulatory perimeter;’ that phrase describes determination of the part of the population whose operations fall within the prudential and conduct framework in its present terms,977 in order better to manage the risks presented by new entrants and existing operators that are currently outside the regulatory ambit.978 Challenges are raised particularly when firms outside the regulated financial sector perform financial-
977 David Murray, Kevin Davis, Craig Dunn et al, ‘Financial System Inquiry Interim Report,’ above n 509, 3-98. 978 Australian Payments Clearing Association, Submission No. 2 to the Financial System Inquiry in Response the Interim Report, above n 504, 10. 244 type functions.979 A tiered regulatory system along the lines proposed herein could capture all products capable of storing value separate from their payments function and would bring new entrants and issuers whose operations are currently outside the regulatory perimeter within some level of regulatory coverage. Such a new regime, with the benefit of experience gained from the current purchased payment facility regime, should be drafted in terms that are technologically neutral, thus promoting a more technologically-advanced payments environment.
Digital wallets like PayPal Australia that hold stored value assessed as influential to payments system stability would presumably be dealt with in the top regulatory tier. A middle tier would regulate stored value digital wallets currently outside the regulatory perimeter that are assessed to have a lower threat to systemic stability. As those facilities develop and grow to hold larger consumer balances they would automatically move into the top regulatory tier, strengthening prudential regulation and reducing risk to the payments system. A lower tier free from prudential requirements would capture those products that do not pose significant systemic risk yet are too large to fit within a regulatory exemption. The existing exemptions for products with limited value and use should remain. Regulation embracing all services, including those using alternative mediums of exchange would generate innovation and confidence in and within the payments system.
As firms such as retailers and telecommunications companies issue financial-type products but are outside the financial services regulatory framework, the boundaries between service provider accounts and deposit-taking have become blurred. The regulatory perimeter for stored value products needs to be better defined and a determination made as to which products operating outside the prudential and conduct framework need to be brought within it.
979 David Murray, Kevin Davis, Craig Dunn et al, ‘Financial System Inquiry Interim Report,’ above n 509, xli. 245 3. INTRODUCE A GRADUATED SYSTEM
I respectfully agree with APRA’s recommendation that its prudential regulatory regime should apply only to large and widely used payment systems, and propose that the current conditional PPF regime should remain the top regulatory tier, attracting the highest level of prudential regulation.980 A middle tier would apply lower prudential requirements to those facilities assessed as having some systemic risk. A third lower, non-prudential tier should be designed to fill the regulatory grey area between the present limited exemptions and those facilities subject to prudential regulation.
Replacing the existing system of exemptions with a graduated three-tier framework with the level of risk attaching to a product determinative of its level of regulation would establish a more proportionate regime. A graduated regime would provide a clear regulatory path for growth, supporting innovation and would clarify regulation of Australia’s stored value payments system. By graduating functional frameworks in this manner, new entrants currently required to either enter the ADI regime or work within a low value exemption would be provided with a regulatory path for development. A tiered regime would ensure that regulation would continue largely risk-based and targeted at those areas where it is most needed.981
To keep pace with digitisation and remain stable and resilient, financial institutions need to be innovative. Graduated payments would encourage the entry and development of smaller providers while managing the systemic risk presented by larger facilities. A graduated prudential framework with two clear thresholds for APRA regulation and a third non-prudential tier would provide a system designed to encourage smaller stored value facilities to grow, so that even were they to outgrow the limited-value or limited participant exemption they might continue to avoid regulation as an ADI.982
980 Should PPFs be separated from the ADI regime, this tier is unlikely to continue to be called the conditional-ADI regime, but for ease of understanding I have chosen to use the term currently in use in this case. 981 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 144. 982 Productivity Commission, Business Set-up, Transfer and Closure, above n 405, 233. 246
A graduated regime would offer service providers a choice between three tiers. The highest tier might reduce the present liquidity requirements, with other prudential requirements strengthened. The middle tier should maintain the 100% liquidity ratio requirement but overall should lessen compliance costs by lowering other prudential requirements. A third tier without prudential requirements would reduce barriers to new market entry, providing opportunity for aspiring entrants; as new providers and more products enter the market, improved competition, choice and efficiency are likely to follow.983
Such an approach would permit stored value facilities to trade off compliance costs with competitive neutrality in a manner suited to their business models, tailored to an extent not possible under the present generalised legislation, rather than have regulation decide these matters for them.984
The appropriate threshold for regulatory capture of substantial facilities into the top tier purchased payment facilities regime would identify those entities that are classified as widely-used payment systems. ‘Widely-used payment systems’ should be defined as those with more than 50 payee groups and annual transaction values over $100 million, and those with more than five payee groups and annual transaction values over $500 million. The middle tier of prudential regulation would capture those entities that hold more than $50 million of stored value and/or which enable individual customers to hold more than $1000. Entities which hold less than $50 million would not be subject to prudential regulation, but would be made subject to ASIC’s ePayments Code. Those entities that hold less than $10 million would continue to operate within the existing low value exemption and be subject only to the provisions of the ePayments Code tailored to low value facilities.
983 Deloitte Access Economics, ‘Regulatory Treatment of PayPal Australia,’ Submission No. 3 to the Financial Systems Inquiry in Response to the Final Report,’ above n 157, 15. 984 Murray, David, Dunn et al, ‘FSI Final Report,’ above n 26, 166. 247 In addition to the proposed value thresholds, a variety of factors should be taken into consideration when making a decision as to that tier within which a particular facility should operate. Consideration should be given to factors other than the volume or total amount of funds held by a facility. Were these set as the sole threshold criteria, an associated risk of regulatory gaming involving designing of products to avoid regulatory triggers would be likely to arise. To discourage this, regulators defining gradations should apply functional thresholds based on assessments of level of risk rather than on value-based thresholds.985 Criteria for risk assessments should include the number of potential users, their assessed levels of sophistication, the total of funds potentially at risk, maximum values that might be stored, whether or not depleted value may be recharged, whether or not the stored value may be withdrawn as cash, whether there is to be a ‘use-by’ expiry date and the general risk profile of the digital wallet or other facility holding the relevant stored value.986 Where the appropriate regulatory tier is not apparent the risk profile could be assessed by APRA and/or ASIC on a case-by-case basis. To avoid issues of transparency arising the criteria that are to be used to make such determinations should be made publically available by each regulator.
This Thesis contends that irrespective of the thresholds chosen, regulators should design a new regime that applies only to purchased payment facilities of substantial scale. Exempting smaller stored value facilities from prudential regulation without requiring them to operate within the existing limited purpose and/or limited value exemptions would afford them opportunity to develop.
4. SEPARATE STORED VALUE REGULATION FROM THE ADI REGIME
The RBA observed that other comparable overseas jurisdictions have a ‘light-touch’ regime for stored value facilities, and recommended that as purchased payment facilities do not offer credit and generally have simpler balance sheets than do other
985 Deloitte Access Economics, ‘Regulatory Treatment of PayPal Australia,’ Submission No. 3 to the Financial Systems Inquiry in Response to the Final Report,’ above n 157, 16. 986 Interview conducted by the author in Sydney in May 2017. 248 ADIs, Australia should simplify its regulatory regime.987 The RBA noted that regulation of stored value facilities and ADIs do not need to be in the same terms and has suggested that the system of authorising PPFs as ADIs and subjecting them to lesser supervision than non-PPF ADIs might be seen as undermining the integrity of the ADI framework.988 These views are supported by APRA989 and, with respect, are adopted by me.
I support also the views expressed by the RBA submission that where stored value balances are not high regulation is largely a consumer protection issue, and that ADI- style regulation may not be needed.990 I propose that stored value facilities upon reaching a certain size or degree of influence or becoming large and widely used facilities, could opt to graduate into the prudential regime. ASIC could continue to oversee stored value facilities in all tiers of the regime, but only those products in the two highest tiers that have greater interactions with other financial institutions and greater systemic influence would be subject to oversight by APRA. On this approach, facilities issued by ADIs such as the Visa Travelex Cash Passport would continue to be regulated as ADIs. This would remove the need for the RBA to designate payments systems, while leaving in place the existing RBA power against the possibility of an unforeseen type of payment emerging.
Such a legislative scheme should focus on the function of the facility as a holder of stored value, rather than on its payments function. New legislation specific to stored value facilities that separates stored value facilities from the ADI regime should be drafted to capture both emerging and existing products.
987 Reserve Bank of Australia, Submission No 2 to the Financial System Inquiry Committee, above n 754, 9. 988 Ibid. 989 Australian Prudential Regulatory Authority, Submission No 2 to the Financial System Inquiry in Response to the Interim Report, above n 952, 65. 990 Ibid; Reserve Bank of Australia, Submission No 1 to the Financial System Inquiry Committee, March 2014, above n 464. 249 5. INCREASE CONSUMER PROTECTION
Increasingly widespread adoption of electronic payments throughout the Australian community necessitates consistent and clearly-worded consumer protection. Industry self-regulatory models may lack credibility and public confidence, and may lack effective enforceability.991 I recommend that the operation of the ePayments Code be made mandatory for all stored value facilities. This will ensure a minimum level of consumer protection for all payment products without the necessity for particular regulatory requirements.
Mandating subscription to the Code would afford greater security to business partners and consumers and ensure that providers meet the minimum standards set out therein. To build consumer confidence and trust while avoiding over-regulation, regulation of the financial system must be characterised by fair treatment. A mandatory Code should be expanded to better protect consumers.
The Australian Financial Services licence (AFSL) regime for non-cash payment facilities should be narrowed so that only service providers providing access to large, widely- used payment systems are required to obtain an AFSL. In accordance with the proposed system, these are the facilities that would fall within the top regulatory tier.
A digital wallet that acts as a holder of stored value, i.e., that enables customers to store funds in the wallet for the purpose of making and receiving payments, should be regulated as a non-cash payment facility; if it meets the definition of a widely-used payment system, it should be required to hold an AFSL. If it does not, the aggregate value of its stored value funds should determine into which regulatory tier it falls. I support the proposal that to remove the present necessity for a discretionary decision by the RBA to designate a payments system, the Payments System (Regulation) Act should be amended to include a wider, clearer definition of ‘payments system,’ and
991 Krystine Lumanta, ‘ASIC says self-regulation is a balancing act,’ (29 September 2014) Financial Observer (online) < http://www.financialobserver.com.au/articles/asic-says-self-regulation-is-a- balancing-act>. 250 should require all widely-used systems to apply for a licence before commencing operations.
6. ADDRESS COMPETITIVE NEUTRALITY AND INNOVATION
This Thesis advocates a regulatory system that promotes competitive products in domestic and global markets based on flexibility, proportioned according to levels of risk that applies a consistent framework for similar activities. A graduated system would promote competitive neutrality for similar stored value products issued by purchased payment facilities providers and other ADI service providers. Liquidity requirements should be lowered for service providers who comply with prudential requirements and demonstrate strong risk management, including protection of its stored value float and minimisation of operational and insolvency risk.
Smaller providers, a cohort that includes the majority of recent start-ups, are in competition with banks and other major financial institutions: The present regulatory system disadvantages these smaller players, who frequently encounter difficulty in raising liquidity sufficient to overcome barriers to new market entry and make subsequent market success considerably more problematic. Lowering liquidity requirements for the lower tier of prudential regulation, and providing an opportunity to operate on a smaller scale without attracting any prudential regulation would decrease the competitive disadvantage faced by smaller companies. Greater competition would increase the number and quality of products available, giving consumers more options to find the product best suited to particular needs, benefitting the market overall.
Regulating for stability and greater innovation may require different regulatory approaches. A graduated approach is an appropriate system to achieve both market stability and innovation, and to promote each of those objectives would permit different weighting to be accorded the three tiers. To ensure that the regulation is commensurate with the risk involved the highest tier should prioritise stability; the
251 lowest tier should prioritise market access and the middle tier strive to attain a balance and conduit between the two.
7. RETHINK THE ROLES OF THE REGULATORS
A regulatory system clear in its application and ambit is crucial to the payments system, as is public confidence in its functionality. Users must be able to rely on the promises made by the issuers of their payments products.992 Were an issuer to fail consumers will readily regard other issuers with mistrust and are likely to lose some faith in the system as a whole.993 All elements of the payments system are heavily interdependent; each participant must be able to rely on an accepted and understood role in others to make payments reliably and promptly when called upon.994
I propose that the roles of the relevant regulators should be reconsidered. Where there exists a diversity of authorities responsible for oversight of the system, as in Australia, a stored value facility may not fit unarguably within the jurisdiction of only one, or indeed into that of any of the authorities. There may be overlap in regulation, or there may be ambiguity as to which (if any) authority is responsible for the facility.
I propose that the approach of multiple regulators provides the approach best-suited to payments regulation in Australia. For the regulation of stored value facilities, a mixed regulatory approach is most suitable in terms of providing adequate protection against risk, while allowing products to develop organically. For example, low value or developing products might be regulated by a wait-and-see approach, while larger, more widely-used products could be captured by in-advance regulation.
992 Alan Tyree, ‘Regulating the Payment System – Part 3: Financial Stability’ (1999) 10 Journal of Banking and Finance Law and Practice 236. 993 Bollen, ‘Best Practice is the Regulation of Payment Services,’ above n 2, 147. 994 Ibid. 252 This Thesis does not support the recommendation that one regulator oversee all stored value facilities in Australia.995 None of the three current supervisors is particularly well-placed to oversee the stored value system; much of the current lack of clarity has arisen because the role of each in regulating stored value facilities is not specified in their regulatory design. The RBA has stated that it is not well placed to authorise and supervise individual purchased payment facilities, a role markedly different from its regulatory supervision of retail payments.996
It may be possible to preserve the benefits of the twin peaks style of regulation while simplifying the current system. Were regulation to be shared between the two regulators APRA and ASIC, the complexity of the current regime would be lessened and no other major changes to the current structure would be required. The RBA would need to use its declaratory powers only in abnormal cases where an unforeseen new product is introduced to the market that does not fit within the proposed system. To reduce the burden on providers of dealing with multiple regulators and parallel regimes a clearer, co-ordinated regime should be introduced.
A collaborative committee which includes regulators and members of industry such as the Australian Payments Council or Council of Financial Regulators could be charged with coordinating the actions of the existing regulators, streamlining existing regulation, avoiding loopholes and regulatory overlap and reducing unnecessary burden on both regulators and regulated entities. Establishing one point of contact for industry and regulators would lessen the burden on regulated bodies by minimising overlap and duplication in reporting and oversight.997 This institution would take the role of supervisor, rather than of single regulator to fit in with the existing multiple- regulator structure and would avoid the complications associated with multiple diverse regulatory objectives.
995 For example, Reserve Bank of Australia, Submission No 2 to the Financial System Inquiry Committee, above n 754, 9. 996 Ibid 10. 997 Michel Flamée, Paul Windels, ‘Restructuring Financial Sector Supervision: Creating a Level Playing Field,’ (2009) 34(1) The Geneva Papers on Risk and Insurance – Issues and Practice 9, 14. 253 8. CONCLUSION
The use of cash and cheques is declining and eftpos is rapidly losing market share.998 Stored value payment methods, through smartcards, wearable devices and digital wallets are increasing in use and changing the Australian and global payments systems.
In the rapidly evolving environment of stored value payments, a flexible regime is needed to identify, capture and regulate all products effectively and equally. Stored value payment methods have the potential to challenge traditional payment methods, but in Australia, they are hampered by current regulations that limit their ability and incentive to develop. The payments system is unnecessarily complex, its compliance burden does not fall evenly upon all issuers, it does not adequately support innovation and application of its consumer protection provisions is uncertain.
Shortcomings in the current legislation became apparent following the original attempt to deal with disparate products within one all-encompassing legislative scheme. The consequent complexity of the regulations, an awkward attempt to categorise all products falling within the ambit of the legislation as either ADIs or exemptions to ADIs, and the increasing inability of the provisions to remain relevant in the face of rapid technological change have rendered the existing scheme outmoded and largely unresponsive to Australia’s advanced economy.
A regime with three tiers separate from the existing ADI regime is the best model for stored value facilities in Australia. To reduce uncertainty in a rapidly evolving payments system with a diverse range of products the ideal regulatory regime should be grounded in simplicity, not complexity. The introduction of three regulatory tiers, in addition to regulatory exemptions with clearly defined criteria will simplify and clarify stored value payments.
998 Productivity Commission, ‘Competition in the Australian Financial System Final Report,’ above n 176, 465. 254 The upper tier should regulate products that are determined to be ‘large and widely used’ and should retain the existing provisions of the present conditional ADI licence regime. The middle tier should capture those products that do not have the size and influence of large and widely used systems but are sufficiently large to require some level of prudential regulation. It should lower existing prudential requirements and remove the present obligation to obtain an AFSL. These top two tiers should be overseen by APRA. Products in the third tier should not be subject to prudential regulation, but should be required to comply with the provisions of the ePayments Code and should be supervised by ASIC. Existing limited use and low value regulatory exemptions should remain in order to allow smaller facilities to develop. Regulation should encourage products to progress as they grow from the lowest tier into the middle tier, and from the middle tier to the highest. Removing the regulatory grey area that currently exists for stored value facilities from the regulatory regime would improve clarity and competitive neutrality between issuers within each tier.
In order to provide an adequate level of consumer protection, compliance with the ASIC ePayments Code should be made mandatory for all stored value facility issuers, retaining the present tailored requirements for low value facilities. Such a regulatory framework should obviate the need for the RBA to involve itself in the regulation of stored value facilities.
In order to monitor developments in the market and assess the impact and compliance burden of existing regulation, an organisation such as the Council of Financial Regulators should be appointed to oversee regulation of the payments system. By minimising regulatory loopholes or grey areas as they emerge the creation of such a role could preserve the benefits of co-regulation and the twin-peaks model. To achieve more proportionate regulation stored value facilities must be permitted flexibility within their regulatory regime to capture products operating outside the regulatory perimeter, and thus minimise risk to consumers and the payments market. A flexible regulatory regime would allow products to be designed primarily around the relevant regulatory gaps or requirements, rather than around the needs of the market.
255 Absent some new product emerging with even greater advantages, it may be predicted that digital wallets will over time become the dominant device for electronic payments in Australia, driven by techfin companies and the millennials’ preference for the latest technologies. This Thesis is concerned with the actions of regulators in the intervening time, and how they will respond to the changes. Whether banks, fintechs or techfin companies lead innovation, regulators need to prepare for a digital economy or risk the new generation of payments products operating without appropriate regulation, potentially weakening the functioning of the payments system and the stability of the wider economy.
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