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Mobile Payment Systems: Legal and Regulatory Challenges Best Practices for Minimizing Risks and Liabilities With Wireless Financial Transactions

THURSDAY, FEBRUARY 9, 2012

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Today’ s faculty features: Duncan B. Douglass, Partner, Alston & Bird, Atlanta Jarrett Helms, McKinsey & Company, Atlanta

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Jarrett Helms, Payypments Practice Expert McKinsey & Company

Duncan Douglass, Partner Alston & Bird LLP

CONFIDENTIAL AND PROPRIETARY Any use of this material without specific permission of McKinsey & Company and Alston & Bird is strictly prohibited Defining the U.S. Mobile Payments Market GCI-AAA123-20110606- There are numerous forms of mobile payments, we will concentrate on using the mobile device at the traditional point-of-sale

Traditional POS Mobile Commerce “Near Field NFC Communication” based POS purchases Other Mobile Payment processing POS POS from a mobile device (e.g., card swipe “l“sleeve ”) NFC alternatives (e.g., SMS, barcodes, “bump”, Bluetooth, etc) Mobile purchase of digital content (e. g., music, books, games, apps, etc) The use of a mobile Money device to initiate bill Transfer & Bill Digital payment or money Pay Content transfers Mobile e- Mobile purchase of commerce physical goods and services (e.g. shopping via a bb)rowser or app)

SOURCE: Team analysis McKinsey & Company | 7 GCI-AAA123-20110606- A rich ecosystem of mobile payment services is evolving that will benefit from mobile wallet capabilities

Potential mobile wallet applications EXAMPLES Alternatives to the traditional card / cash In-person based POS retail card / experience (e.g., NFC, cash Payment processing bar codes, etc.) alternative from a mobile Mobile Mobile didevice (e.g., card Incentives POS Deploying coupons, swipe “sleeve”) offers, etc. via mobile Mobile device (e.g., location Wallet based offers) Mobile purchase of Banking P2P / digital content (e.g., and bill social music, books, pay games, apps, etc) Enabling online E- banking and bill Commerce payment via mobile “check- Services that device out” streamline the ability to pay for mobile / ecommerce transactions initiated via mobile

SOURCE: McKinsey Payments Practice McKinsey & Company | 8 GCI-AAA123-20110606- Mobile payments themselves are unlikely to generate significant new payments revenues …

US Mobile Payment Transaction Value1 % of merchant terminals that are NFC enabled Billions Cash displacement 60 100% Existing card-based spend via mobile

50 44 0 40 44 BN represents less 30 than 1% of total card 30 0 50% spend

20 44 8 29 10 0 0 1 2 8 In general, mobile payments will 0 simply shift the form factor of a 201112 13 14 15 2016 card transaction from a plastic card to the mobile device. This does not change the economics of the base transaction

1 includes only NFC based transactions originated in the US 2 Effectively zero volume; mobile NFC pilots may have generated some volume

SOURCE: McKinsey US Payments Map, team analysis McKinsey & Company | 9 GCI-AAA123-20110606- …So why is there a big fuss over mobile payments? Mobile payments offer more opportunities to attackers than incumbents, threatening direct consumer relationships for issuing banks and providing new revenue streams for entrants ILLUSTRATIVE Area of change:

Card controlled by an issuing Consumerbank Merchant Terminal Processor Network Issuer

Loaded into

E-wallet controlled by any of the following:

1 Optional

SOURCE: Team analysis McKinsey & Company | 10 GCI-AAA123-20110606- Integrating digital wallets into mobile devices presents many opportunities to improve customer experience and generate new revenue streams

Key opportunities for in-person mobile payments: NFC Example Mobile components 1 Provide enabled devices 3 Develop ad / loyalty platforms Telco’s Groupon / Scoutmob Handset manufactures Issuing Banks NFC chip manufacturers Card Networks Mobile OS developers EXAMPLES

Transaction flow

NFC Coupons / Contactless Payment Consumer Enabled e-Wallet Rewards & Merchant Terminal Processing Device Loyalty1

Merchant offers1

2 Develop e-wallet 4 Develop POS systems Telco’s Google / Apple ViVOtech Issuing Banks Coupon providers Card Networks The mobile payments ecosystem PayPal promises a richer shopping experience Other 3rd parties for consumers, with real-time, contextual information and offers. 1 Optional

McKinsey & Company | 11 SOURCE: Team analysis GCI-AAA123-20110606- New technologies and functionalities have lead to new purchase & payment related products and applications for the mobile device…

Hype around mobile payments tends to be blurred together with hype over other mobile based products and services, but some payments applications are coming online Couponing / Rewards

Location Mobile based ticketing marketing

Transaction Mobile POS based marketing

NFC

SOURCE: Team analysis McKinsey & Company | 12 GCI-AAA123-20110606- …But further convergence among these new applications is likely, and could create a powerful tool for consumers and merchants alike

The next generation of payments applications could combine the functionality of several existing mobile products to create a more integrated and compelling product

Marketing Money Savings Mobile Payments New Application

Location based Budgeting marketing applications ++E-walle t = New Coupons / combined NFC Transactional Rewards application based marketing

McKinsey & Company | 13 SOURCE: Team analysis GCI-AAA123-20110606- Driving consumer and merchant adoption is a classic “chicken or the egg” conundrum… you can’t get one without the other The two-sided market dynamics in payments have historically made it very difficult to build new payment systems. Mobile is no exception. A network effect is needed. A network effect depends on: Achieving a network effect for mobile payments is hampered by both real and perceived hurdles:

1. Enough consumers using A▪ Basic concerns: mobile to make it – Failure of contactless cards to achieve adoption compelling for merchants – Lack of a single standard for mobile payments to adopt – Low, but growing penetration of smartphones 2. Enough mobile enabled – Consumer perception of security merchants to make B▪ Consumer payment preferences and behaviors: adoption meaningful for – The mobile wallet will need to allow for the same basic consumers payment preferences that consumers have today C▪ Cost benefits to the merchant: – Merchants want to know that enough consumers will demand mobile payments, that it merits upgrading their existing systems, and implementing new marketing programs

The most problematic hurdle is simply the lack of a clear value proposition for both merchants and consumers. Mobile payments are not necessarily faster, cheaper, or more reliable; and on their own they may not provide enough value for consumers or merchants to shift payment behavior. To be successful they must partner with other value added products

SOURCE: Team analysis McKinsey & Company | 14 GCI-AAA123-20110606- The competitive stalemate over mobile is beginning to thaw… or is it?

Numerous ppylayers are movin g forward , but in different directions

Company Description Implications

•A joint venture between AT&T, T-Mobile, and Verizon Wireless •The Telco response to mobile payments •Establishes an “open” mobile wallet via NFC enabled •Theoretical reach of 200MM US consumers smartphones across all major card networks on the three largest networks

•Google brought the first consumer available NFC capable •Google is keen to make sure that they phone and wallet to market continue to own every form factor for web •Hold patent for proximity based searches allowing GPS-based based searches couponing and marketing •Google could leverage their patent to •DliNFCDeveloping NFC-bdbased coupons w ithIiith pottillltentially close ou ttht other par ties wan titting to •Newly released Android Honeycomb OS leverages tablet deliver GPS-based couponing computers in addition to regular mobile devices

•Apple stalled in implementation of NFC into the iPhone5 with •Goes against conventional wisdom that NFC potential plans to create their own NFC technology in 2012 is the agreed upon standard •iPad creates even more demand for “micro-payments” •Preexisting database of accountholders gives •Large base of credit cards from iTunes accountholders Apple a significant jump on other e-wallet providers •PayPal takes alternative route to breaking into mobile payments •Goes against conventional wisdom that NFC space is the agreed upon standard –Recent acquisition of Fig Card to obtain contactless •The simplicity /lower cost of the USB device payment terminal alternative via USB device that plugs into may allow PayPal to gain an advantage POS terminals allowing merchants to accept NFC payments •Potential to incorporate GPS-based •Acquires Where.com, a GPS-based loyalty coupon app couponing into NFC payments •Mobile payments with PayPal account more secure •Reach of 98 MM active accounts •Rebuffs a $6 BN buyout offer from Google •Partnerships with mobile application •Growing rapidly with 40 million subscribers currently companies indicates movement to develop •Partners with CardStar,,pp an iPhone app that consolidates and their own mobile wallet organizes consumers’ loyalty cards, to offer targeted couponing •Reach of 40 MM global consumers interested •Global expansion with acquisitions worldwide (e.g. Berlin, Chile, in mobile couponing China, India, Japan)

SOURCE: Internet, team analysis McKinsey & Company | 15 GCI-AAA123-20110606- Backed by major brands, consumer and merchant applications are emerging to test demand for mobile payment technologies at the POS

Value proposition Revenue Model Partners

Additional ad verti si ng An e-wallet integrated Consumers will be able and marketing spend Consumer into a marketing to store all the example platform which will allow documents from their wallets into one mobile app as well as receive, store, and redeem coupons/offers at the POS

Value proposition Revenue Model Partners

Mobile application that Merchants can integrate Merchant fee Merchant allows users to pay for this payment app with example a restaurant or bar tab their POS system using an app on their allowing for more smartphone convenient and efficient transactions resulting in increased sales

SOURCE: Corporate websites, team analysis McKinsey & Company | 16 GCI-AAA123-20110606- NFC is the front-runner standard for mobile payments, but other alternatives exist, causing marketplace confusion & investment delays

Ease of Likelihood of Standard Used by Pros/Cons integration adoption ▪ Industry consortium ▪ Pro: Has the most momentum behind it, including: Visa, and is already deployed FC MasterCard,,, Isis, ▪ Con: Necessitates hardware upgrades for NN Microsoft, Sony the merchant

▪ Pro: No contactless terminal needed Used globally, but ▪ ▪ Pro: No smart phone needed MS no current US SS ▪ Con: Clumsy and slow to use systems

▪ Pro: Only needs a USB plug-in, making integration easier

sonic ▪ PayPal

aa ▪ Pro: No card information is stored or shared ▪ Sparkbase ▪ Con: No phone signal, no payment Ultr

ode Amazon ▪ Pro: Easiest to integrate of any solution

cc ▪ ▪ Con: Works best for closed loop accounts Bar

▪ Apple has been unclear about their release of an NFC enabled iPhone, and there are le p p ▪ Apple rumors tha t they may dldevelop an Ap alternate standard. This uncertainty ? ? promotes market stagnation

SOURCE: Team analysis McKinsey & Company | 17 GCI-AAA123-20110606- The scramble for mobile acquisitions has started primarily with e-wallets Valuations of mobile companies are extremely high and large industry players are making the first major moves in the mobile payments arena

4/28/2010: PayPal acquires 5/17/2011: SK C&C USA 6/13/2011: NuWallet 7/7/2011: Zong is FigCard as a means of launches Corfire with mobile introduces mobile payments purchased by eBay in a bypassing NFC hurdles and wallet platform based on NFC solution that allows users to continuing effort to build more directly working with technology make online purchases via PayPal a full scale mobile POS merchants to provide a their mobile devices more offering able of competing streamlined payment efficiently by storing the in the POS experience consumers information within the app

April May June July 2011

5/11/2011: Visa announces plans to launch NFC based mobile wallet to be launched 6/13/2011: Payfone partners with Verizon in Fall 2011 Wireless to develop new mobile payment system for Verizon customers enabling 5/26/2011: Release of Google online purchases from smartphones, Wallet with Google Offers tablets, and PCs through various 5/27/2011: PayPal sues Google payment methods. indicating similar mobile wallet development by PayPal

SOURCE: Press releases, corporate websites McKinsey & Company | 18 GCI-AAA123-20110606- The definition of success in mobile payments will change over time, and is dependent on a company’s position in the ecosystem

Near Term Mid Term Long Term

▪ Develop a product ▪ Gain consumer ▪ Retain dominance in ▪ Form alliances/ adoption market space by partnerships ▪ Increase product surviving industry ▪ Establish product in awareness consolidation the market space ▪ Improve and continue ▪ Maintain consumer ▪ Obtain a consumer to develop product base with most up-to- base date couponing services

Next 12 months 1 -2 years 2 years +

Continuum

Marketer – Success is Issuer – Success is building market share to maintaining close customer drive revenue growth relationships, not necessarily driving new revenue

SOURCE: Team analysis McKinsey & Company | 19 GCI-AAA123-20110606- Although many players are interested in developing e-wallets, all are constrained by avoiding significant trade-offs with their core businesses Stakeholder Key Ecosystem Assets Constrained by … Players Issuers ▪ Trusted brands as payment ▪ Maintaining share of wallet account and instrument – “stay relevant for every providers payment”

Telco’s ▪ UICC / OTA provisioning ▪ Mobile subscriber market ▪ App’ preload share ▪ Supported devices ▪ Driving data revenues

Handset ▪ Device feature set (NFC chip) ▪ Maintaining handset market m’facturers ▪ Embedded secure element share

Mobile OS ▪ App’ store / preload ▪ Maintaining OS market share developers ▪ Source code / SDK to drive application / license ▪ Application processor revenue

Payments ▪ Wallet eligibility ▪ Maintaining overall transaction / networks ▪ Existing e-wallet userbase wallet share growth

Marketing / ▪ Existing user base ▪ Need to generate advertising (()consumers / merchants) / Advertising impressions (access to as consumer interest many networks as possible) platforms ▪ Key patents Retailers ▪ Acceptance ▪ Sales volume ▪ Existing e-wallet userbase Payment ▪ Existing e-wallet userbase ▪ Maintaining existing user / intermediaries transaction base

SOURCE: Team analysis McKinsey & Company | 20 GCI-AAA123-20110606- Competitors are adopting varied e-wallet strategies based on current strengths and placement in the market Current and future mobile wallet applications: le pp Exam

Intermediary Lone Wolf Coalition Open Platform

Characteristics: Characteristics: Characteristics: Characteristics:

▪ Continue to provide ▪ Unique stand-alone ▪ Attempt to ▪ Create an open intermediary platforms consolidate efforts of wallet for other processing ▪ Leverage loyal user like parties (issuers, developers to

Strategy ▪ Leverage existing base to extend telcoms) leverage walle t base to move rewardltfds platform ▪ BdBroad reac hbdh based ▪ BdBroad reac hbdh based to POS ▪ Drive cross-sell of on consumer base on smartphone ▪ Move e-commerce other products or sell ▪ Keep known ownership capabilities to bricks- access to others quantities in control ▪ Drive ad or app’ and-mortar revenue

SOURCE: Team analysis McKinsey & Company | 21 REGULATION OF MOBILE PAYMENTS IN THE U.S. GCI-AAA123-20110606- Mobile Payments Operating Models

Bank-Driven Model – Financial institution offers account access through mobile device-initiated transactions • Transactions are processed over traditional payment networks/channels • Funding source is payor’s DDA, line of credit or prepaid account with the financial institution Mobile (MPSP)-Driven Model – MPSP offers mobile payment capabilities to its service users (which may include small merchants) • Transactions are processed over MPSP’s systems • MPSP may access existing customer funding source held at/issued by a third party (e.g., a DDA or payment card) or may establish a dedicated funding account Mobile Network Operator-Driven Model – Mobile network operator offers mobile payments capabilities for purchases using mobile devices associated with its wilireless ne twor k • Transactions are processed over the operator’s wireless network • Charges appear on payor’s wireless bill and/or are funded on a prepaid basis

McKinsey & Company | 23 GCI-AAA123-20110606- Overview

• As contemplated and piloted to-date, mobile payments initiatives in the U.S. have largely leveraged existing payment and funds transfer methods and operating models

• The regulatory regime applicable to existing methods and models thus likely governs mobile payments analogues

• The Regulatory picture becomes less clear in certain operating models that may become prevalent in the future

• FlMbilNtkOtMdlhtFor example, Mobile Network Operator Model where customer purchases of third party goods/services are reflected on the customer’s wireless bill

• IdiltfIncreased involvement of non-bkbanks may pose en hance d regulatory and supervisory challenges

McKinsey & Company | 24 GCI-AAA123-20110606- Mobile Device: Just Another Form Factor?

• In many respects, mobile device-initiated payments are functionally the same as existing payment and fund transfer methods – the principal innovation being the new form factor

• Mobile payment transactions that rely on traditional retail payments funding sources (DDA, line o f cre dit, prepa id accoun t) are like ly su bjec t to the same regulatory requirements as their more traditional predecessors

• Regulators have not generally provided formal interpretations that existing regultilations app ly to mo bile paymen ts, btthtbut the tex t an dhitd histor ica l application of those regulations point to this conclusion

• The recent spate of legislative/regulatory activity applicable to retail payments generally has broad applicability and will likely apply equally to mobile payments (and in some cases do so expressly)

McKinsey & Company | 25 GCI-AAA123-20110606- TILA/Regulation Z

• Applies in relevant part to any person that issues a credit card and who regularly extends credit to consumers primarily for personal, family or household purposes • A “credit card” is “any card, plate, coupon book, or other single credit device that may be used from time to time to obtain credit.” • A mobile device that accesses a line of credit for funding transactions is most likely a credit card for TILA/Regulation Z purposes, and the issuer of the device (and extender of related credit) is most likely a creditor for TILA/Regulation Z purposes

McKinsey & Company | 26 GCI-AAA123-20110606- EFTA/Regulation E

• Generally applies to “any person that directly or indirectly holds an account belonging to a consumer, or that issues an access device and agrees with a consumer to provide electronic fund transfer services” • “account” means a consumer asset account • “access device ” means “a card, code, or other means of access to a consumer’s account . . . that may be used by the consumer to initiate electronic fund transfers” • A mobile device that can be used to initiate electronic fund transfers from a consumer asset account ( e.g., a DDA) i s most lik el y an access d ev ice for EFTA/Regulation E purposes and the issuer of the mobile device (and the holder of the account, if different) is most likely subject to the EFTA/Regulation E

McKinsey & Company | 27 GCI-AAA123-20110606- Bank Secrecy Act/ AML Requirements

• Financial institutions, including money services businesses (MSBs), are subject to various requirements designed to detect and prevent money laundering and terrorist financing activities

• Banks are expressly covered by BSA requirements

• Many MPSPs are subject to BSA compliance obligations as money transmitters (i.e., MSBs)

• Mobile network operators, depending on their role in facilitating funds transfers, may also be subject to regulation as MSBs if they satisfy the definition of a money transmitter or operator of a credit cardtd system

McKinsey & Company | 28 GCI-AAA123-20110606- State Money Transmitter Laws

• Govern the activity of non-depository money service (funds transfer) providers lik e money t ransmitt ers, ch eck cas hers an d currency dea lers

• Except to the extent that a bank agent exemption may apply, MPSPs and mobile network operators responsible for funds transfers (including P2P transfers and prepaid funding models) may be subject to state licensure

McKinsey & Company | 29 GCI-AAA123-20110606- Gramm-Leach-Bliley Act

• Applies to financial institutions, as broadly defined • Privacy Rule – requires FI to disclose to customer its policies regarding disclosure of customer’s non-public information with affiliates and non-affiliates • Safeguards Rule – requires FI to develop standards to protect customer information • Applicability of GLBA to non-bank mobile payments provider will vary with the model, but should apply to mobile payments entities in parallel to its applicability to providers involved in more traditional payment channels

McKinsey & Company | 30 GCI-AAA123-20110606- Dodd-Frank Act • Title X - Consumer Financial Protection Act and the creation of the Bureau of Consumer Financial Protection with authority to regulate non-bank providers of consumer financial products and services

“Financial Products” include:

• Extending credit

• Issuing stored value or payment instruments

• “providing payments or other financial data processing products . . . including payments made through an online banking system or mobile telecommunications network”

• Durbin Amendment restrictions on exclusive network arrangements will likely impact all participants in the evolving mobile payments marketplace • New coverage of cross-border remittance transfers under the EFTA/Regulation E will impact all mobile-initiated remittances to foreign receivers

McKinsey & Company | 31 GCI-AAA123-20110606- New FinCEN Prepaid Access Rules

• FinCEN’s new prepaid access rules characterize all “providers of prepaid access” as MSBs will pull additional non-bank participants in pre-funded mobile payments schemes under federal supervision for AML compliance • FinCEN has defined “prepaid access ” very broadly, to include any “electronic device or vehicle, such as a card, code, electronic serial number, mobile identification number or personal identification number.”

McKinsey & Company | 32 GCI-AAA123-20110606- Review of Mobile Payments Operating Models Through the Regulatory Lens • Bank-Driven Model • Bank typically holds funding account and uploads traditional credit, debit or prepaid card account number (or account identifier for ACH applications) to mobile device (which may be a contactless sticker) • Full complement of existing payments laws should apply in the mobile context • MPSP-Driven Model • If transaction funding accounts are held at traditional financial institutions, regulatory framework should apply in the same way as it applies to payment service providers operating i n th e i n ternet space t od ay (MPSP may b e su bjec t to EFTA/R egul a tion E an d is likely an MSB/MT but should be able to avoid broader regulation because MPSP is acting as a service provider) • If MPSP holds funding accounts (e.g., on a prepaid basis) or extends credit, MPSP should be subject to broader federal and state regulations, similar to those that would apply to a ban k or prepa id prov ider per form ing s im ilar func tions (a lbe it no t pru den tia l oversight) • Mobile Network Operator-Driven Model • If transaction funding accounts are held at traditional financial institutions, operator may be subjjqyjgect to certain MSB/MT requirements and may be subject to EFTA/Regulation E requirements (if issuing the access device), but will generally be characterized as a service provider • If the operator holds a prepaid funding account, it will be subject to broader federal and state regulation; if the operator posts mobile payment transactions to the customer’s wireless bill,,p the operator may be subj ect to TILA/Re gulation Z or ma y be sub ject onl y to Truth-in-Billing Requirements and related FCC regulation (this point is subject to debate)

McKinsey & Company | 33 GCI-AAA123-20110606- Mobile Payments Models May Present Enhanced Regulatory Challenges

• Compliance concerns – Even where non-bank mobile payments providers are subject to federal and state regulations, mobile network operators and MPSPs are often not familiar with payments/financial services legal requirements such as consumer protection laws, BSA/AML obligations (including KYC), state money transmitter laws, and other compliance requirements • Credit/liquidity risk concerns – Displacement of traditional financial institutions, which are subject to prudential oversight, by non-bank mobile payments companies may increase credit and liquidity risk in the payment system • Federal regulatory authorities have been monitoring the mobile payments space but have yet to identify the market is separate or unique from other payment systems

McKinsey & Company | 34 GCI-AAA123-20110606- Regulation of Mobile Payments – Continuing the Discussion

• While mobile ppyayments remain in the formative sta ges in the U.S. , consider whether regulators should be encouraged to begin addressing the issue through interpretive guidance • Is there a risk that an under-reggpyypulated mobile payments system develops in the U.S.? • Consider whether the existing (and evolving) regulatory framework is suited to regulate the enhanced role non-banks are playing in mobile paymenttillidlthtilbttilts, particularly in models that involve substantial disintermediation of traditional financial institutions • Is regulation of mobile payments principally a consumer protection issue (CFPB)? • Are there safety and soundness issues that should be addressed in non-bank driven models?

McKinsey & Company | 35 Conclusion / Questions GCI-AAA123-20110606- For more information, contact:

Jarrett Helms Duncan Douglass Payments Practice Expert Partner 66878-221-233020 404-881-7768 [email protected] [email protected]

McKinsey & Company | 37