“The FSA and e-purses”

Presentation on e-money to the Smart Card Networking Forum

24 September 2003

Dominic Peachey - Financial Services Authority Issue One: What is e-money? Definition of electronic money under UK law.

“Electronic Money” means monetary value, as represented by a claim on the issuer, which is:-

 stored on an electronic device

 issued on receipt of funds

 accepted as a means of payment by persons other than the issuer Storage on an electronic device could include:

 Magnetic stripe cards

 Smart cards

 Mobile phones/palm pilots/PDAs

 PC hard drives or servers

 Inter-active digital radio and TV sets

 Digital watches

 etc Electronic money has to be prepaid

 It must always be backed by a “float” equal to the outstanding sum of issued e-money.

 This float must be invested in a narrow range of high quality liquid assets

 An e-money issuer is forbidden to grant credit.

 Electronic money may not be issued at a discount. To be “electronic money” the payments product must also fulfil the functions of traditional money, that is, it should be:

 A store of value

 A unit of account

 A medium of exchange

To be “electronic money” the payments product must also be capable of acceptance as a means of payment by at least two separate legal entities.

So traditional phone cards and company canteen cash cards would be exempted. Issue Two: What is the FSA and what drives it? Background to the FSA

 Unitary UK financial regulator established in 1998

 Derives its powers from the Financial Services and Markets Act 2000

 Regulates on a “risk-based approach”

 Has the power to authorise and to ban firms and individuals

 Issues a detailed Handbook of Rules and Guidance

 Is a prosecuting authority in respect of criminal offences defined by FSMA The FSA’s Regulatory Objectives

 Market Confidence

 Public Awareness

 Protection of Consumers

 Reduction of Financial Crime Market Confidence

 This means maintaining confidence in the UK financial System

 “Financial system” includes both markets/exchanges and regulated activities like issuing e-money

 Regulating the issuers should encourage people to start using e-money

 This should encourage more e-money firms to establish in the UK

 But the negative is failure or fraud in unregulated businesses

 Is this a price worth paying to encourage innovation? Public Awareness

 This means promoting public understanding of e-money

 It includes awareness of benefits and risks involvedin issuing e-money

 It also includes provision of appropriate information/advice on e-money

 FSA believes that “forewarned is forearmed”

Educating the public about the risks and opportunities thrown up by e- money should lead consumers to behave more rationally

 FSA consumer website aims to contain relevant messages Protection of consumers

 This means securing the appropriate degree of protection having regard to:

 The risks inherent in e-money

 The experience/expertise of individuals using e-money

 Consumers’ need for advice/information about a new product and

 The general principle that consumers should take responsibility for their own decisions

 Consumer protection is achieved through prudential rules……… ……………..as well as through detailed conduct of business standards Reduction of financial crime

 This means reducing the extent to which it is possible for an authorised firm to be used for a purpose connected with financial crime

 Difficult to use UK banking system for criminal purposes

 e-money may be attractive to money launderers but danger of detection probably makes it too risky

 Small issuers offer limited scope for serious criminal activity (?)

BUT WE SHALL REMAIN VIGILANT Section 2 of FSMA makes FSA “have regard to” seven matters:

 Efficient and economical use of resources

 Responsibilities of managers

 Regulation should be proportionate to perceived risks

 Facilitating innovation

 Maintaining a competitive international position for the UK

 Minimise adverse effects of our actions on competition

 Desirability of facilitating competition among those we regulate Issue Three: What is the e-money directive? The e-money directive

 Formulated in 1998 at time when only smartcard and PC based schemes were understood as e-money

 and the Regulated Activities Order (SI 2002/682)

 Implemented into UK law on 27 April 2002

 In urgent need of revision to give clarity to the e-money scene in 2003

 Due to be reviewed in 2005

 European elections in 2004 may delay matters Issue Four: What is the difference between loyalty points and an e-purse?  I am continually being asked this question.

 I have not attempted to define loyalty points which could follow a variety of different business models

 Conceptually I feel that loyalty points are something different from e- money

 But each scheme must be examined in accordance with its underlying criteria

 A loyalty points scheme could be devised that crossed the e-money threshold  Do the loyalty points represent monetary value or something else?

 Are they stored on an electronic device?

 Are they issued on receipt of funds or merely as gratuitous confetti?

 Are they accepted as a means of payment by persons other than the issuer?

 It should be possible for the scheme promoter to design the loyalty points in such a way that they do not fall under the definition of e-money. Issue Five: What is the difference between stored value (à la ITSO) and an e-purse? Stored Travel Rights

 I have visited the ITSO website

 They define “stored travel rights” but not so far as I can see “stored value”

 “Stored travel rights” are denominated in units of distance, points or “some other network proxy”

 But never as cash

 So this is completely different to the concept of “e-purse” Stored value

 Where prospective passengers load money onto an electronic device and

 Receive stored monetary value that they can then spend on transport tickets and

 That stored value is only receiveable as a means of payment by the company that issued it

 No e-money is created and

 There can be no question of a regulated activity being undertaken e-purse

 Where prospective passengers load money onto an electronic device and

 Receive stored monetary value that they can spend on transport tickets and

 that stored value is receivable as a means of payment by undertakings other than the issuer

 e-money has been created and

 regulatory consequences occur Issue Six: Waivers from regulation Waiver from regulation

The European E-money Directive permits the competent authorities to grant waivers from regulation to small e-money schemes. These are:

 any scheme where the total outstanding e-money liabilities are not usually exceed € 5 million and never exceed € 6 million;  any scheme that only operates among the members of the same corporate group and whose total e-money liabilities never exceed € 10 million.  any scheme where the e-money is accepted as a means of payment by no more than 100 merchants operating within a limited local area or having a close financial or business relationship such as a common distribution or marketing scheme.

All waivered schemes must observe a consumer purse limit of €150. Guidance for Local Authorities that want an e-purse on their citizen card

 Decide whether your scheme could be e-money or not:

 Is monetary value stored on an electronic device?  Have you received funds from the public in exchange for the issue of e-value?  Is the e-value acceptable by undertakings other than the issuer?

 Decide whether it might qualify for a waiver

 Speak to the FSA before deciding to implement anything “Limited Local Area” as defined in the UK means

 a shopping centre  airport  railway station  bus station  educational campus or

 an area not exceeding 4 square kilometres Small e-money issuer certificate

This might be achieved for a local authority e-money scheme either:

 by taking advantage over the overall (€5 million) exemption limit or

 by applying under the third limb which means:  e-money accepted by not more than 100 persons  operating within a limited local area  such as an educational campus or other area not exceeding 4 square kilometres  overall scheme limit of €10 million. The small e-money issuer certificate imposes no obligations on the e- money issuer other than the obligation to tell the FSA:

 How much e-money is outstanding under the scheme every six months

 Whether the conditions, under which the certificate was issued, still apply. Full authorisation

 Once a small scheme has outgrown the criteria for waiver it will either have to seek authorisation or cease trading

 Authorisation will require compliance with the FSA’s rules and guidance on e-money contained in our e-money source book (“ELM”).

 This represents a big step change from operating under a small e-money issuers certificate

 So be prepared Issue Seven: What are the consequences for regulated e-money firms? Capital

 This represents the owners’ permanent investment in the business

 It will take the form of Ordinary Shares or Subordinated Debt

 Minimum of Euro 1 million (or equivalent - say £700,000).

 Or 2% of outstanding e-money liabilities (if higher than Euro 1 million) Purpose of capital

 To maintain the business as a viable going concern

 To overcome expected or unexpected difficulties (eg losses)

 To sustain its infrastructure

 To help secure ability to redeem outstanding e-money

 To help maintain public confidence in business Management of the e-money float

 The “float” represents the funds received from the public in exchange for the issue of e-money.

 Our rules are designed to protect the public’s investment by ensuring it is held in highly liquid, low risk assets.

 This means cash, or securities issued by governments, parastatal institutions (EC or ECB guaranteed), multilateral development banks, local authorities or sight deposits with zone A credit institutions. Limitations on activities

 Only e-money issue and closely related ancillary activities (accounting and administration and

 Issuing and administering other means of payment

 But excluding the granting of any form of credit

 May not own shares in any other business

 May not issue e-money at a discount Systems and controls

 Business to be directed by at least 2 individuals

 Guidance on good systems practice

 “Know Your Customer”;

 transaction authentication [to prevent unscrambling];

 authorisation controls for all systems, databases and applications;

 protection of data integrity;

 prevention of fraud;

 audit trails;

 customer and transaction confidentiality) Redemption, Information Requirements and Purse limits

 e-money must be redeemed at the holder’s request

 but it is possible to give the e-money an expiry date (> 1 year).

 only reasonable charges may be levied on redemptions

 information on redemption rights, liabilities in the event of loss etc must be given in writing and in a readily comprehensible form.

 consumer e-money devices must have purse limits (maximum £1,000) unless lost consumer e-money purses can immediately be frozen and the contents recovered. Issue Eight: Outstanding issues with Europe The e-money directives oblige the Commission to report to the European Parliament and the Council of Ministers

This report to be delivered not later than 27 April 2005 and to cover:

 Consumer protection measures

 Capital requirements

 Waivers

 The possible need to prevent interest being paid on funds received in exchange for electronic money. The European directives were drafted in 1997 when everybody thought e- purses would be held on smartcards or on PCs (hard drives or servers)

No account was taken of mobile phones as a possible e-money platform

This gives rise to a problem separating e-money from prepaid airtime

This issue is currently preoccupying the Commission and the EU’s e- money experts (in a group called “GTIAD”)

If GTIAD come up with an acceptable formula, the FSA will update its perimeter guidance

If GTIAD fails to agree, further European legislation may be called for

GTIAD is also looking at transport smartcards and e-travellers cheques on the same basis Issue Nine: Miscellaneous Problem Areas Who would operate your e-money scheme?

 You the individual local government unit?

 As an authorised e-money issuer?  Under a small e-money issuer certificate?

 A “WELMI” (Wholesale Electronic Money Issuer)?

 An outsourced e-money issuer (eg Mondex)?

 A bank or building society with an e-money permission? Orphan funds

 Frequently occur where people use e-money cards for short periods

 Overseas tourists  Students  Cards left in redundant coat pockets

 FSA rules allow you to place a minimum “sell by” date on e-money = currently one year from creation

 Thereafter unclaimed “orphan funds” revert to the account of the issuer

 You should advertise the “sell by” date to avoid disappointment How to keep it outside financial regulation

 Establish one party as the issuer of electronic value

 Ensure that the same party is the only one that can accept electronic value at points of sale

 Once electronic value has been spent, make sure that, if the retail receipts are apportioned among third parties, there is no traceability back to the pattern in which the e-money was originally spent.

 Resist the blandishments of third parties to join the scheme Useful references

 FSA website - www.fsa.gov.uk

 FSA Handbook of Rules and Guidance - ELM and AUTH Appendix 3

 HMSO - for Regulated Activities Order - www.hmso.gov.uk

 UK Legislation - Statutory Instruments 2002 No 682

 EU website - www.europa.eu.int

 e-money directives 2000/28/EC and 2000/46/EC Application Procedures

For full Authorisation

 Go to FSA website - www.fsa.gov.uk

 Navigate through: “Authorisations”, “Forms”, “Miscellaneous Forms”, “Application Pack - Part IV Permission”

 In case of queries, telephone Authorisation Enquiries on 020 7066 0082

 Our Authorisation Department are happy to hold pre-application meetings where necessary Application Procedures

For Small E-money Issuer Certificate

 This is not yet available at our website, so………

 …….telephone 020 7066 0488 or e-mail [email protected]

 We can send a copy out by e-mail

 In case of queries, telephone Authorisation Enquiries: 020 7066 0082

 Remember that small issuers must still submit semi-annual returns ELM annex 2R - Form ELM-SI