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SEPA or payments innovation: a policy and business dilemma
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DOC 0605/11 NBI
SEPA or payments innovation: a policy and business dilemma
Table of contents
Abstract
1- Executive summary 2- Introduction 3- The innovator‘s dilemma – a view from other industries 4- Policy makers and legislators: impulse for payments innovation, or imprimatur? 5- What academics have to say about payments innovation 6- A sample of views from the supply and the demand sides – with a sample of products and services
7- Conclusion: assessment of how international principles and academics‘ findings and recommendations are reflected in European policy makers‘ approach 8- References and acknowledgements 9- Annexes
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Abstract
This Working Paper brings together a comprehensive picture: what policy makers and regulators in markets at – ceteris paribus – comparable stages of evolution have to say about payments innovation, what models academics have formulated in this respect, the conclusions they draw, and what aspirations are expressed and solutions introduced by the demand and supply sides of the market.
This Working Paper first compares public policies and related action in the European Union, the United States, Australia, and Canada. It asks why policy makers and/or legislators are concerned about payments innovation, how they define payments innovation, and how they see their role in making payments innovation happen. The Working Paper assesses the effectiveness of the different approaches against the relative efficiency achieved by each payment system (as measured in terms of non-cash payment transactions per capita).
This Working Paper then reviews recent academic research on payments innovation. This includes the definition of investment strategies for payments innovation, the segmentation of innovation into technology innovation and service innovation, the drivers for providers to innovate, the 3 conditions required for market adoption of new payment instruments, and the 5 possible cooperation models between market participants. The Working Paper then assesses the policy pursued by European policy makers and regulators against the conclusions from academic research.
Finally this Working Paper reviews a range of aspirations expressed in recent surveys and consultations by the demand and supply sides of the market. The Working Paper also scans recent news releases for evidence of where the ―centers‖ for payment innovation are and how they are moving. The Working Paper concludes with an analysis of the various market drivers, and an assessment of the capability of the European policy makers and regulators in making them work for both the market integration and innovation objectives.
Keywords: SEPA, payments innovation, e-commerce, mobile payments, risk, business model, interchange, payment system efficiency, market integration policy, payments regulation and legislation
About the author: Norbert Bielefeld is Deputy Director Payment Systems at ESBG – WSBI ([email protected])
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1- Executive summary ―I believe innovation is the most powerful force for change in the world. People who are pessimistic about the future tend to extrapolate from the present in a straight line. But innovation fundamentally shifts the trajectory of development‖1.
Clearly, innovation is in the air. From the everyday life of technology companies it has moved to the agendas of policy makers, who would often see in innovation a way out from the current economic crisis. The payments market is no exception, even for the casual observer: that market has been brimming with innovations for several years now, although that same observer may associate innovation with companies whose names wouldn‘t have crossed his/her mind only a decade ago: Amazon, Google, PayPal, Alipay... But even the European Central Bank acknowledges that ―although banks are often accused of not being very innovative in the field of retail payments, most innovations are offered by banks directly or indirectly‖2.
However almost no day passes without a European policy maker or regulator musing about how much more innovative banks should be in payments. With the SEPA migration Regulation soon approved by the European Parliament, the ―Single Euro Payments Area‖, aka SEPA is definitely entering a ―Phase 2‖, and the payments innovation topic is likely to be centre-stage for some time. This Working Paper contributes to the policy and business debates to come by presenting a comprehensive, comparative picture, not only of the European payments scene, but also of what policy makers and regulators in markets at – ceteris paribus – comparable stages of evolution have to say about payments innovation, what models academics could formulate and what conclusions they draw, what aspirations are expressed and what solutions are introduced and adopted by the supply and demand sides of the market.
Policy-makers and legislators‘ approaches to payments innovation: a comparison
This Working Paper first compares public policies and related action in the European Union, the US, Australia, and Canada. It asks why policy makers and/or legislators are concerned about payments innovation, how they define payments innovation, and how they see their role in making payments innovation happen. This Paper finds that policymakers and regulators all see payments innovation as instrumental to sustain the competitiveness of their economies. Some outside Europe are concerned of falling behind, which sounds surprising knowing that Europe trails the 3 other countries retained here for comparison purposes in terms of payment system efficiency by 70 to 90%3. In the 4 economies compared concerns about privacy and data protection are also expressed at various degrees, as is the need for mitigation of payment system fraud. In Europe however one cannot but be left with the feeling
1 Bill Gates, Innovation with Impact, Note for the November 2011 Cannes G20 meeting. 2 European Central Bank October 2011 Report on the results of the e-SEPA survey on payments innovation in 2010 33 On the basis of non-cash payment transactions per capita, computed with data made available in 2010 by the BIS and the ECB (reporting year: 2009) 5 ------
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that the competitiveness goal is secondary to the market integration objective, and that the latter even ranks below European authorities‘ experiments4 in formulating competition policy.
This Paper further finds that whilst there is what may be called a shared intuition that payments innovation will continue to unfold further in the ―e- and m-space5‖ (including at times what are called ―value added services‖), European policymakers and regulators would go as far as sketching the solutions they wish to see, and spell out how they should be delivered, whilst in the 3 other countries under review authorities first base their interrogations on thorough market assessment and wide industry and public consultations. This Paper finally confirms steep differences between policy makers and/or legislators roles in making payments innovation happen. In Europe – although the European Central Bank intends to only be a ―catalyst‖ - the European Commission is quick to take on a regulatory mantle. In essence the European regulator not only sets the reform agenda for the banking payment industry but also determines resource allocation, and decides whether resources may be remunerated, or not. In sharp contrast the American, Australian and Canadian policy makers take what is mostly a facilitator approach: ensuring that the appropriate issues are debated in the appropriate forum, based on good information, at the right moment, and only legislating when there is consensus about the approach, or in exceptional situations, as a last recourse.
Academics and payments innovation: an overview of recent papers
This Working Paper then reviews recent academic research on payments innovation. From this, we shall retain that the relationship between innovation and regulation is both complex and dynamic. As new technologies, products and business models develop, new markets and market failures may emerge requiring changes to the existing regulatory framework. Innovation is influenced by how regulation is designed, implemented and enforced. Policy makers and regulators are more likely to help innovation if they provide businesses with flexibility as to how policy outcomes are delivered, clearly inform about future changes well in advance, specify desired outcomes which cannot be easily achieved using existing technologies and business practices, stipulate clear requirements, impose minimum compliance costs, and complement other government market-based and regulatory-based policies which promote innovation. The relationship between regulation and innovation is ambiguous when it comes to e.g. competition: whilst the prohibition of anti-competitive behavior encourages innovation by reducing barriers to entry for new firms, and allowing a free choice of strategy and business model, the same regulation may restrict innovation by preventing businesses from collaborating closely at the ―R&D‖ stages via certain organizational structures or agreements which could facilitate the transfer of knowledge and technologies. Academic research also categorizes investment strategies for payments innovation (decrease cost, increase revenue, acquire customers, and retain customers), segments innovation into technology innovation and service innovation, and formalizes the drivers for providers to innovate (on one side entry into new business areas - either improving or changing the underlying technology, possibly offering a superior product, serving new niche markets, or introducing a marketing revolution - on the
4 The European Commission stresses that the investigation it launched in september 2011 into the European Payments Council is the first one under the new “EC Guidelines on horizontal cooperation agreements” 5 E-payemnts and mobile payments 6 ------
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other financial innovation - to obtain a first mover advantage either to access an untapped market, or provide a product or process improvement to an existing market). Academic research also formalizes the conditions for new payment instruments market adoption (overcoming the chicken and egg problem and security and liability issues, providing superior benefits to most participants, and not decreasing net benefits to any participant in a given payment segment) and the possible cooperation models between market participants (light, mobile centric, bank-centric, partial-integration model, and full integration). The partial-integration and full-integration models are the most costly to develop, yet the most efficient to serve a mass-market, implying that the light model is better suited to introduce innovation, but will be restricted to niche markets.
Academic research also introduces a generic transaction model (where the buyer and the seller go through 3 processes: an agreement, payment, and delivery) and proposes a segmentation of payment solutions based on the behaviour of buyers and sellers in order to optimize the use of existing payments services and improve them, and develop new ones. When processes become disconnected (e.g. with new channels) the perceived transaction risk is affected, impacting cost and pricing. Yet another academic paper analyzes the consequences for innovation of inverting the business model for payment cards, i.e. moving through the ban or limitation of interchange from a ―merchant pays‖ model to a ―consumer pays‖ model. Whilst sharply reducing interchange does not eliminate innovation (as service providers adapt and adjust types of payment innovation) overall investment into payment innovation cannot but decrease as it is far more difficult to extract revenues from the consumer side than from the merchant side. The shift in business model will also hinder the emergence of new payment systems and providers and direct innovation to ―chargeable‖ areas of the payment business. All these academic findings are relevant for the SEPA and payments innovation discussion, as they point to necessary pre-conditions for the development of innovation and market adoption, highlight the reality of innovation emerging in niche markets first, under clear economic conditions, the criticality of cooperation between various groups of stakeholders, yet the difficulty in organising it and the costs to be incurred, the necessary enhancement of governance arrangements, the need for incentives to all parties concerned, the correlation of transaction risk with payments innovation, the drain that regulating interbank remuneration imposes on capital and motivation to innovate. Unfortunately none of the preceding has been acknowledged by European policy makers and legislators. Views from the demand and supply sides, and a sample of products and services Finally this Working Paper reviews a range of aspirations expressed and solutions introduced by the demand and supply sides of the market. According to a 2010 survey the European banking industry sees payments innovation developing in the ―e―-space, respectively e-payments, business-to-business e- invoicing, and business-to-consumer e-billing. A major consultancy reports that 84% of respondents to their survey view mobile as a very important development at the very beginning of its deployment curve, with dependency on proprietary operation systems and incomplete migration form internet-based to App-based transactioning a key issue. Mobile banking would also force a rethinking of the value chain, with players capable of moving quickly across the value chain becoming able to capture larger parts of the revenue stream. Another supply side study positions risk as the key driver for transactional behavior, and stresses consumers‘ natural ―status quo‖ bias which forces new products providers to either lower the degree of change demanded, and/or to evidence a manifold increase in perceived benefits. That study also finds that the absence of productive cooperation between financial institutions and mobile network operators is due to difficulties around branding in cooperative models, the debate of who owns the customer, and the difficulty to arrive at a workable revenue sharing model. As expected the demand side is not concerned with payments innovation as such, but rather with the shortcomings experienced, and expectations to mitigate these. For example e-merchants want to see 7 ------
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addressed consumers‘ lack of confidence, privacy concerns, and lack of trust in web merchants. To that end e-merchants formulate 10 recommendations, covering online authentication, the harmonization of dispute and charge-back handling, the introduction of interoperable online banking solutions, e- mandates for pan-European direct debits, interoperability of pre-paid card solutions, clarification of the legal status of overlay service providers, the development of cross border cash-on-delivery methods and of payment methods dedicated for the phone and the tablet including e-authentication options, and finally using e-authentication solutions to fight fraud and improve the buyer experience. Another European trade association highlights the link between the take-up of online trading and the penetration of internet amongst households in different European countries, and acknowledges that e- merchants should accept multiple payment instruments to reflect the different local payment habits.
Consumer views are illustrated by a Dutch Central Bank survey showing that only 7% of the Dutch buying online did not purchase cross-border for a payment related reason. 75% of consumers were able to use their preferred payment instrument. Payment methods‘ safety and costs were found satisfactory, with speed and ease of use even more so. User dissatisfaction centers on the cost of credit cards. The ―perfect‖ cross border online payment solution protects personal and payment data, confirms payment immediately, uses an existing online banking application with no transaction fee, and allows to reverse payment, or pay after reception. As to the European consumer association it recently listed 9 problems consumers would face when purchasing online, of which only 3 to some extent are related to payments: choice of interoperable, secure means of payments (ranked problem n. 4), reimbursement (ranked problem n. 6 – actually meaning dispute resolution when products or services are defective), and data protection and privacy online (ranked problem n. 8).
Finally a scan of recent news releases confirms that the distinction between the e- and the m-worlds is thinning, with innovations (at payment product and customer interface levels to increase convenience, at back office process level to reduce costs) allowing e-payments to be generated either from a mobile device or a stationary device - proximity, contactless payments remaining of course a different segment altogether. In these spaces both size and reach matter, players (none from the banking industry) able to create communities of tens of millions of users have an edge and attempt to influence technology adoption through vertical integration, whilst smaller participants go for interoperability, and remain on the market‘s or value chain‘s fringes. But to date there are very few cooperative approaches – and fewer even involve banks (the latter rather leveraging an existing innovation than truly hitting the market with a complete innovation).
In conclusion
The worldwide payments landscape will be significantly transformed during this decade6. The volume of non-cash payment transactions is set to be multiplied by 2,5, but there will be huge differences by region. Western Europe will see the slowest growth of all (with only a 60% increase by 2020), whilst Asia Pacific is set to be double the size of Western Europe by that date, and Latin America will be breathing down Europe‘s neck. Although North America will grow at a slower pace than either Asia
6 See Annex 1, data from the Boston Consulting Group‘s January 2011 ―Wining after the storm‖ study 8 ------
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Pacific or Latin America, in 2020 it will still be 1,7 times bigger in terms of non-cash payment transactions than Western Europe.
This provides a clear indication as to where the attention of developers and software providers will shift to. But as non-cash payments are good indicators of economic efficiency, this projection also vindicates European policy makers and legislators interest in payments innovation. But is their approach well- guided, could Europe beat the odds and narrow in the coming years the widening gap with competing economies? Little comfort will be gained when trying to answer this question from the experience of the past decade. In the 10 years since the introduction of the physical euro, in the field of payments no less than 2 European regulations and one Directive have been promulgated and are in force, with a further regulation soon to be approved by the European Parliament. This massive legislative disruption however on one side did nothing to make Europe more efficient (as shown later in this Working Paper, there is - in terms of non-cash payment transactions per capita - an 80% efficiency gap with the United States, and a 60% efficiency gap with e.g. Australia or Canada), on the other, legislation did little either to overcome the fragmentation of the European payments landscape so often bemoaned by policy makers and legislators. In 2010 there are still (for reasons which can be easily accounted for) significant differences between European Union countries as to which payment instrument, and to what extent, is being used for what purpose7.
This baseline, and lessons from our comparative reviews of policy makers‘ approaches as well as analysis of academic research, strongly suggest that something is amiss with European policy makers‘ and legislators‘ approach to payments innovation. Or, to paraphrase Bill Gates8, that approach is in dire need of a shift in trajectory. Could it be that these European policy makers and legislators who want at the same time market integration (the ―Single Euro Payments Area‖, aka SEPA) to occur, consumer protection to achieve new milestones, and of course competition law to fully apply, are over-ambitious for the region‘s own good?
7 See Annex 2, data from the 2011 ECB ―Blue Book‖ – data for 2010 8 See quote page 5 of this Working Paper 9 ------
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Indeed: Achieving market integration (of 17 countries – eurozone only – or soon up to 28 countries – the whole of the European Union) requires legal harmonization, according to European policy makers, although one could observe that the existing differences in legislation between US States certainly haven‗t prevented the US to function as an integrated market. Legal harmonization is disruptive, lengthy, and costly for the supply side (transposing the 2007 Payments Services Directive cost the banking industry several tens of billion Euros). Politically, European market integration – which is not in big demand on the consumer side, which seems quite satisfied with available national payment solutions – has to be bought with enhanced consumer protection. The latter translates into regulating prices9 and massively shifting responsibility and liability away from consumers and onto payment service providers10. For the demand side this crystallizes in the equation: future payment services = lower prices + what I‘m used to, a view that no policy maker tried to resist so far. The European legislator did not show to be convinced that its own actions can trigger the ambitioned market integration and drive down consumer prices. He therefore added on top of the above legislative construct a layer of competition legislation that disrupts proven business models. That same competition legislation artfully maintains uncertainty as to the level of cooperation permitted on the supply side, thus constraining market acceptance and achievement of critical mass for new cooperative solutions. The combined effects of ambitious legal harmonization, drastic consumer protection, business model disruption and constraints on industry cooperation are visible in what payments innovation Europe sees – or rather, doesn‘t. In spite of the financial strain of the above described legislative construct on
9 See dispositions to that effect in Regulation 2064/2001, Directive 2007/64, Regulation 924/2009, and the pending ―SEPA migration‖ Regulation 10 Also see to that effect the Regulations and Directive mentioned under Footnote 8 10 ------
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payment service providers, there are numerous individual initiatives to continuously enhance existing services and processes, and introduce new technologies and products. ―3-corner‖ models, proprietary solutions are in vogue. However large, pan-European solutions are not forthcoming so far.
The working assumption unfortunately must be that the European policy makers‘ and legislators‘ approach leads to a misallocation of information, funding, and resources. For industry providers the whole issue revolves over making innovation profitable. As to end-users (consumers, merchants), the only question is: how relevant is this to me? In other words what type of innovation are we looking for? The one that gives a competitive advantage to a market participant, the one that gives an economy a competitive advantage? Or the one that brings more convenience, and lower prices, to users? Ultimately, over the medium term, the 3 need to be reconciled. What‘s standing in the way should ―only‖ pertain to customer behavior, security and privacy concerns, infrastructure challenges, and ensuring there is a level playing field.
The European Union positioned payments innovation as one of its key objectives. In that it is not different from the other economies we compare it too. However the European Union‘s pursuit of payments innovation comes with an embedded, dual handicap: first – as we demonstrated above - the European Union in effect pursues 4 objectives at the same time, second the European Union enters the payments system efficiency contest as a far 4th to the United States, Australia, and Canada. To win the competition against such odds would require extraordinary political and business acumen and will. Oddly the European Union policy makers seem content with bowing to the lowest common denominator for citizen satisfaction, i.e. no increase in prices and no change in practices – at a time when the rest of the world is ready to take on board the consequences of a profound transformation of the transaction context, and the related payments landscape. Indeed, ―payments innovation is at an inflection point, the internet and mobile have ignited innovation‖11.
Would-be providers in the European market therefore vindicate the academics‘12 conclusion that ―payments innovations are generally more successful when they utilize existing infrastructure and initially target profitable niche markets‖, in other words that innovation is about ―Walled Gardens13‖, not only because of the use of technology, but as a necessity because of policy makers‘ short- sightedness. Indeed, after many years of calling for SEPA governance, European policy makers are still light-years away from the approach taken by their counterparts in more efficient economies, i.e. establishing independent payments system policy bodies, and informing the development of policy through independent research and wide, effective consultation.
There is e.g. a need for an effective ―European Payments System Board‖ that brings together policy makers, and the supply and demand sides. Equally, the targeted separation of scheme and processing activities generates new obstacles (new blocks of vested interests) to innovation, which policy makers
11 D. S. Evans, Presentation to 20. May 2010 Federal Reserve Bank of Chicago Conference on ―Payments Innovation in the Wake of the Financial Crisis‖ 12 Chakravorti & Lubasi (2006) 13 Berniers-Lee‘s blog on the Register, 20th November 2010 11 ------
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are ill-equipped to deal with, at a time where the differences between card and mobile markets are not well understood. Also, the European Commission‘s regulatory approach is pushing the payments system towards bilateral arrangements, recognized in other payments systems (e.g. Australia) as obstacles to innovation and access. Finally processing overcapacity (a by-product of SEPA post the 2014 migration) will impact innovation, as the clearing processing architecture transits to bilateral relationships, constraining the appetite for innovation.
Furthermore there is no coherence at European level in public policy with respect to the place of cash. On one side, policy makers promote the development of innovative payments and instruments, yet on the other the same policy makers are lenient to take any measure which could reduce the Union‘s dependency on cash as payment instrument, or which could help in externalizing the cost of cash to the actual users14. On the contrary the European Commission issued in March 2010 a ―Recommendation on the legal tender of the euro‖ that i.a. states that ―banknotes and coins should be accepted for their full face value to pay for debts‖, ―payments in cash should be the accepted rule‖, they can ―only be refused because of the 'good faith' principle - for example, if the retailer does not have enough change‖, ―it should be the rule to accept high denomination banknotes‖, and that ―no surcharges should be imposed on payments in cash‖. It should come as no surprise then that cash usage continued to develop in the European Union, with the eurozone ratio of cash to GDP rising to 2,4 times that of the US in 2011 (from only 25% more in 2002). The annual societal costs of cash on European society have been estimated at over EUR 85 billion.
Clearly, the European policy maker and legislator can no longer extrapolate the future from the present in a straight line. Neither payments innovation nor economic efficiency should be a foregone hope for Europe, provided the policy maker and legislator shift to attitudes that acknowledge both the dynamics and the challenges at stake. Costs cannot be legislated away, innovation cannot be mandated. A future- prone electronic payments policy should have for foundation: To formulate a comprehensive, long term industrial policy for payments, To move away from systematic, ex ante legislation, To grant an e.g. 5 year legislation holiday, allowing for the massive legislative disruption of the past 10 years to be assimilated and produce its effects, To tone down any public support of cash, and its acceptance as payment instrument by public administrations and related entities, To reassess the market situation in 2017.
Stabilizing the legal environment will create certainty, which will entice more new entrants as well as existing providers to formulate business cases and vie even more with innovative approaches. As a certain degree of legislative harmonization has already been achieved (in spite of e.g. the 32 waivers embedded in the Payment Services Directive) innovative solutions will gradually pull customers
14 In addition measures that could reduce the cost of cash processing are phased in very slowly. It took the European Commission 10 years to pass a Regulation (still to be promulgated) to allow professionals to transport euro cash across borders within the eurozone. 12 ------
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towards less national, more multi-country – if not always immediately pan-European – offerings, thus bringing about the ambitioned internal market. Of course the policy maker and legislator should continue to monitor the evolution of the market and assess on an ongoing basis – if required – why some expected effects would not materialize.
Maybe some rebranding could help to communicate such a new approach. Since 2002, the ―S‖ in SEPA stands for ―Single‖. As demonstrated above, the integration and efficiency objectives are incompatible, at least cannot be achieved in the same timeframe. So let‘s make the ―S‖ stand for ―Smart‖ (with SEPA the ―Smart Euro Payments Area‖), and privilege innovation, in order to make Europe more competitive on the world scene.
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2- Introduction Understanding how payment innovation occurs is critical, because the European Union would seem to be trailing other, key developed countries in terms of usage of non-cash payment instruments. The latest available data15 show that the EU‘s 189 non-cash transactions per capita per year pale in the face of 314 such transactions for Canada, 316 for Australia, and even 359 for the United States. With 199 non-cash transactions per capita per year the eurozone fares only marginally better than the EU as a whole. In an environment where payment systems are significant determinants for overall economic efficiency, this is not a comfortable message for any keen supporter of the European cause.
This Working Paper hence wants to take a distance from stereotypes, from just grabbing the most recent fad, and instead look at solid foundations for moving ahead. It is well known – yet not well understood by all - that customers do not ―buy‖ payments. Certainly no customer would ―buy‖ a payment transaction just because someone deems it ―innovative‖. Customers want value, which for payments translates into convenience and security. In today‘s fiercely competitive marketplace there is no payment service provider (or, to speak everybody‘s language, account holding bank – although a few payment institutions new also vie for customer attention) in its right mind who would dare not to deliver on customer‘s expectations and demands in this respect. Yet the European policy maker and regulator appears convinced that the European payment industry is withholding innovative payment products from greedy customers.
On the basis of recent experience16, there is a non-negligible risk that a desperate European legislator mandates the implementation of a commodity version of M-PESA or PayPal onto the European demand and supply sides. Hence the purpose of this Working Paper is to consolidate a wide view of recent developments in key areas of the payments world, in order to look at innovation from the perspective of the demand side, and its core expectations in a changing world, from the perspective of the supply side (who is the supply today, who will it be tomorrow?), to see whether these can be reconciled with the demands of policy makers, and whether regulation wouldn‘t negatively impact any of the above.
With this objective in mind this Working Paper followed the following methodology: In Chapter 3 we first take a look at academic findings from other (neither banking, nor payments-related) industries, and suggest a – admittedly hypothetical at that stage – bridge to the payments industry; In Chapter 4 we try to understand how policymakers in regulators view payment innovation. To that end we of course analyze what European policy makers have said and written about payment innovation in the past 2 years. But we also contrast the views from Europe with views expressed at the same moment (since end 2009) by policymakers and regulators in Australia, Canada, and the United States.
15 2009 ECB and BIS statistics 16 E.g. the SEPA migration Regulation – see Technical Requirements, Article 4 and Annex 14 ------
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In Chapter 5 we review recent academic research on payments innovation, and contrast the academics‘ findings with the approaches of policy makers and regulators in the European Union, Australia, Canada, and the United States. In Chapter 6 we look at recent research investigating demands and expectations on the supply and demand sides, as well as a range of recent product and service announcements, in order to look for correlation and gaps with the direction or guidance provided by policy makers and regulators, and the hypothesis formulated by academics. Chapter 7 concludes, Chapter 8 lists our references and acknowledgements.
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3- The innovator’s dilemma
Already at the end of the ‗90s Harvard Business School associate professor Clayton M. Christensen researched why even well managed companies implementing new technologies and providing good customer service fail. He finds that such companies usually place too much emphasis on customers‘ current needs, and by doing so fail to select the technologies which will support customers‘ unstated or future needs. This phenomenon is called ―disruptive technology‖. As opposed to ―sustaining technology‖, where incremental improvements coupled with survival of the fittest lead to gradual product improvement, the essence of disruptive technology is that it has the potential to create completely new value propositions. C. Christensen also finds that new products based on such disruptive technology cannot immediately compete with established products.
On the basis of his research C. Christensen formulates 4 principles for disruptive technologies: Traditionally customers, not management determine resource allocation. This may tilt product management, including innovation, towards what the largest customer are prepared to pay for. Small markets cannot fulfill the growth needs of large companies. They can however fulfill the growth needs of new small companies. Markets that do not exist cannot be analyzed. The ultimate application of disruptive technologies cannot be foretold. Technology supply does not always equal market demand. Speed of technological progress is usually bigger than speed of customer demand.
This means that disruptive technology is usually unlikely to appear within large companies and established market players – unless a certain number of steps are made, within such a company or market, by market players, or by other parties. This concept is enlarged by C. Christensen who coins the concept of disruption innovation, describing a process by which a product or service emerges in simple applications at the bottom of a market and moves up-market, displacing established competition.
Source: The Innovation Dilemma, C. Chistensen
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Returning now our attention to the payments market, and describing the latter as being defined by 4 drivers:
Policy, legislation, regulation Technology Supply (by payments service providers, and other direct or indirect suppliers of products and services) Demand (from all classes of customers),
we may extend C. Christensen‘s concept and not only consider the effects of disruptive technologies, but also disruptive legislation (or quasi-legislation in the form of policy making). The internal market policy, and related legislation, may be considered as disruptive events.
This would suggest that payments innovation in SEPA is first about disruptive legislation (which may, or may not, leverage disruptive technology). How established and new market players deal with both, and which value their actions deliver to their customers, and society as a whole (e.g. by enabling the EU economy to become more efficient – although for some actual or potential players the EU market only represents a fragment of a global endeavor) will not only be a function of how players are managed and behave, but also what they are allowed to do, or not, and whether European legislation applies to them, or not.
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4- Policy makers and legislators: impulse for payments innovation, or imprimatur?
4.1- Summary
In this Chapter we analyze existing and draft legislation as well as public policy and working papers from policy makers and legislators in several parts of the world (European Union, United States, Canada, Australia) to answer the following questions: Why are policy makers and/or legislators concerned about payments innovation? How do policy makers and/or legislators define payments innovation? How do they see their role in making payments innovation happen?
We look at the European Union first.
Policy makers (e.g. ECOFIN17) have spelled out a scope and an objective for payments innovation. In their sights are online electronic payments or e-payments and mobile payments (m-payments), as well as value added services such as e-invoicing. The objective is to have innovative payments solutions developed to underpin an efficient and competitive European economy, and in addition significantly contribute to the modernization of public administration.
To this the Eurosystem adds the objectives of supporting growth in e-commerce and mitigating rising concerns about internet payment fraud. The Eurosystem‘s emphasis is on e- and m-payments, which are narrowly defined: ―e-payments‖ only applies to the process where the payment is integrated with online shopping – a mere online initiation of a credit transfer does not fall under this definition, nor do e.g. offline payments, such as cash on delivery, nor does electronic bill presentment and payment, as no simultaneous shopping or purchasing takes place). M-payments are classified into contactless (aka: face- to-face or proximity – yet excluding contactless card payments - and remote payments). Hybrid solutions are classified by the Eurosystem according to a customer‘s perception, i.e. when initiation of a mobile payment via a mobile handset takes place online and authorization is given via the mobile phone, then the transaction is considered a mobile payment.
The Eurosystem furthermore defines at a fine level of detail how e.g. e-payments should be delivered: - All e-payment schemes in SEPA meeting the minimum criteria defined by the EPC enrolling in the framework; - Each bank in SEPA being a member of (at least) one e-payment scheme enrolled in the SEPA e- payments framework; - Each account holder in SEPA being able to make SEPA e-payments; - The SEPA logo being used by the enrolled e-payment schemes provides a consistent user experience throughout SEPA).
17 The European Economic and Financial Affairs Council 18 ------
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With respect to security requirements, only in the first half of 2011 did the Eurosystem establish a forum of overseers, payments system experts and supervisors to issue recommendations to the market, with an announced initial focus on identification and authentication for remote card payments, no repudiation, protection of personal security features, and ―overlay services‖18.
Of the 12 Single Market Priority Actions published by the European Commission in April 2011 (all actions holding in common the goal of creating growth and jobs by better exploiting the potential of the Single Market), 4 relate to payments, namely intellectual property rights, consumer empowerment, digital single market, and public procurement. Intellectual property is utterly relevant also to payments and payments-related standardization. The mention of consumer empowerment heralds further attention to consumer protection, also in e-commerce (yet it must raise concerns as to the possible use of payment systems as a customer-merchant dispute resolution mechanism, a step the European legislator already tried to take with an early version of the Payment Services Directive). The digital single market action point announces several legislative initiatives (review of the e-Signature Directive to ensure mutual recognition of electronic authentication across the EU to strengthen confidence in electronic transactions, ensuring that transactions are secure, work across borders and are recognized by all sectors of activity, are cheap and easy-to-use, with a strict control by transaction parties). Finally public procurement is to be enehanced in order to ensure that it works across borders in a seamless way.
Over time additional objectives are being expressed, e.g. in April 2011 by the Eurosystem adding financial inclusion to the goals to be pursued with innovation in retail payments. In the same speech the Eurosystem alluded to the possibility of Central Banks entering the fray of retail payment processing, thus adding competition to suasion and legislation as drivers for market players. However, when the European banking industry wrote in June 2011 to the European Commission, expressing concern over the perceived lack of coherence between the goals pursued by DG Internal Market, and feedback received from DG Competition, the President of the Commission swiftly replied that such coherence should not be doubted. But at the end of September 2011 DG Competition announced (leveraging a rather feeble complaint) the opening of an investigation into the EPC‘s work on standardisation in the field of online payments (the latter being defined widely that e.g. remote card payments too would fall within the scope of this investigation), an investigation that according to many observers of the European payments scene would have as immediate effect to stall whatever cooperation exists on the supply side – although most policy-makers call for cooperation in order to prevent fragmentation and promote rapid acceptance of innovation.
Late October 2011 the European Central Bank then published its Report on the results of the e-SEPA survey on payments innovation it conducted in 2010. Although the Report does not claim to present any scientific research on payment innovation in the European Union – owning both to the ―by invitation‖ approach of the survey, and the rapid pace of innovation – there is no suggestion that the
18 ―Overlay service providers‖ usually impersonate account holding consumers and re-sue their electronic banking access to initiate credit transfer instruction to settle web purchases 19 ------
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findings were used to progress policy-making above and beyond the stance that has been heard for many years: it would be better if any innovation was pan-European, if there was more cooperation in the market place to achieve critical mass more rapidly, if open standards were used, …. Unfortunately, no consideration as to what policy-makers and/or regulators should do to facilitate such developments is being provided, an opportunity missed.
Finally, the European Commission postponed to probably early January the publication of its Green Paper to be entitled ―Towards an integrated European market for cards, internet and mobile payments‖. It is expected that this Green Paper will be open for public consultation. On the basis of an unofficial early draft, the Green Paper could discuss the following 5 topics: how to accelerate payments market integration, achieve a transparent and cost effective pricing of services, standardization, interoperability between service providers, and payments security. Unfortunately, the draft Green Paper fails to bring much forward any of the objectives pursued by the European Commission, be it market integration, payment innovation, consumer protection, or even competition. This is not because the questions raised by the draft Green Paper are invalid as such: this has much more to do with the timing of this exercise. In a few days, Europe will be entering the 10th year of the SEPA project, and no less than 3 Regulations and a Directive have already been promulgated. The questions raised in the draft Green Paper, and the Green Paper initiative itself, must be assessed against this background. Clearly, European policy makers and regulators in effect still consider SEPA more as a laboratory for policy instruments rather than an essential development for the European economy. Then, to benchmark their policy makers‘ and regulators‘ approach to payment innovation with Europe‘s, we have retained 3 countries. Admittedly, none of these countries faces the market integration challenge of Europe. Equally, in 2 of these countries, the banking landscape is highly concentrated, with 3 to 4 institutions accounting for the bulk of retail and commercial payment activity. However all 3 countries report (far) more non-cash payment transactions than Europe, which would suggest they have experience in dealing with payment dematerialization, hence – implicitly - innovation:
Australia Canada EU euro EU 27 US19 Non-cash 316 314 199 189 359 transactions per capita
Source: ECB Blue Book and BIS Red Book, 2010 (data for 2009)
In the United States, no single, consolidated view has been expressed by the policy maker or regulator with respect to payment innovation. Yet the efficiency of the US payment system cannot be doubted, not only at the sight of the above figures, but also when knowing that in the US cash in circulation as a percentage of GDP decreased to half the level of Europe, when 5 years earlier it was only 25% less.
19 Some will be quick to point out that cheque usage still is widespread in the US. This is true, but since the Check 21 legislation most cheques are truncated at point-of-sale, and only data is processed. 20 ------
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Work performed by the Federal Reserve Bank since January 2010 on mobile payments, and including the consultation of multiple types of stakeholders, allows nevertheless to infer a policy approach: In essence the Federal Reserve Bank confirms in January 2011 its working assumption expressed 12 months earlier that there is no case at this stage for regulatory intervention. Furthermore the Federal Reserve Bank concludes that nudging the market to agree to a roadmap at this point in time could stifle innovation: the excessive coordination which would be required by a cooperative approach is a threat. The Reserve Bank also recognizes that notably the influence of legislation and regulation on payment systems means that there cannot be any single agenda for market participants. The Bank finally acknowledges that regulation may cut away at sources for investment – assuredly an issue for innovation. Research and dialogue with a wide range of stakeholders confirm that – when looking at an ―open mobile wallet‖ as a desirable deliverable – cooperation between providers is needed. Value is seen in: - Using ubiquitous platforms as rails (e.g. Automated Clearing Houses), - Securing transactions with dynamic data authentication, - Using standards which allow for global interoperability, building trusted service managers which provide interoperable and shared secure elements used in the mobile phone. Whilst NFC emerges as the device preferred by market participants to support an open mobile wallet, it is recognized that economic incentives will be required to remove uncertainty for merchants. Generally speaking the Federal Reserve Bank also recognizes that competing offerings have value for innovation, although they will endanger achieving critical mass. Without doubt standards need to be developed and implemented widely to support security, privacy, compatibility, and interoperability. In this respect a single security solution supporting both contact and contactless transactioning could generate economies of scale, and at the same time facilitate rapid acceptance. It will be critical to bring consumers on board in order to avoid any perpetuation of current ―zero liability‖ policies which only result in a flood of transaction repudiations which prove very costly both for merchants/retailers and the banking system.
The national strategy for trusted identities in cyberspace published by the US Administration in January 2011 assigns a responsibility to government to address the rise in online fraud, identity theft and misuse of information. That strategy defines the desired target ecosystem as relying on privacy protection, voluntary participation, and interoperability. Identity interoperability and privacy protection should deliver user-centric solutions, allowing individuals to select the interoperable credentials most appropriate to support every transaction they contemplate.
More recently (mid November 2011) the Federal Reserve Bank of Atlanta (holding US-wide responsibility for retail payment systems) held a Symposium to, in light of the many legislative and regulatory changes affecting the payments industry, look at ―how and when government should intervene in today's highly dynamic marketplace‖. The Symposium consisted of 5 sessions: changes in regulatory oversight and self-governance, law enforcement challenges, the need for better fraud data, changes in the US regulatory environment, and payment laws and regulation in a dynamic payment environment. This debate has relevance also in the context of the emerging discussion in Europe about the relation of non-supervised, non-regulated services providers to the payments system and customer – in particular: consumer – services. The rich contributions to this Symposium – by both government and market participant representatives – on one hand highlighted the complexity of the emerging payment environment (with e.g. no less than 45 different types of service providers supporting 21 ------
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cardholders, issuers, and acquirers), on the other the uncertainty that the maze of state laws creates for payment system users and providers to discern their rights and obligations with respect to a particular payment transaction. Payment industry representatives however count no less than 214 new or changing regulations trickling down from what is known as the 2010 Dodd-Frank Act – and any positive effect of these on payment risk and fraud is still outstanding. With experience from Europe it can be soothing to hear that whilst meaningful legal harmonization will likely require substantial federal legislative intervention, this is an area where [the US] ―Congress has not always demonstrated understanding or finesse‖.
As to Australia it is currently going through a strategic review of innovation in its payments system launched by the Reserve Bank of Australia. This review bases on a comprehensive study of consumer payments behaviour performed last year. The current market consultation should lead the Reserve Bank of Australia to release conclusions end 2011 or early 2012. The objective of the Reserve Bank of Australia is to identify areas where the payments system may not meet today the needs of end users, or could lag behind in 5 to 10 years. The consultation document clearly spells out the objectives of an efficient payments system for end users, and the related attributes for payment system design. Both contactless and mobile payments are considered as new payment methods.
The Reserve Bank of Australia discusses the process for and the governance of innovation (proprietary and cooperative innovation) and highlights traditional obstacles (inertia, asymmetry of interests), yet is most concerned with coordination issues on the supply side, noting that the regulator could provide certainty when legislation prevented co-operation. The Reserve Bank of Australia also discusses the cost of innovation, and accepts a mechanism to redistribute costs and benefits needs to be found.
The gaps identified by the Reserve Bank of Australia‘s discussion document are the transmission of data with payments, timeliness of payments, timing and availability of funds, real time confirmation of payments, ease of addressing payments, person-to-person payments, mobile payments, and standards. Electronic purses are not considered a matter of priority. Each of the identified gaps should be assessed on the basis of the following questions: how widespread is the demand for the innovation in question and how significant would the impact be, are there any specific impediments to that innovation occurring e.g. barriers to entry, co-ordination problems, technological constraints, is there a case for public intervention?
In December 2011 the Reserve Bank of Australia released a revised position (―Standard‖) regarding merchant surcharging on credit and debit cards. Since earlier last decade card schemes could not prevent merchants from applying a fee or surcharge for card acceptance, but as concerns raised that a number of merchants recover an amount significantly in excess of the cost of acceptance, the Reserve Bank of Australia consulted and then announced that card schemes will be allowed to limit the level of surcharges (based on the ―reasonable‖ cost of card acceptance) that merchants may levy. It is worth noting that in justifying its decision the Reserve Bank of Australia highlights that it does not believe that preventing surcharging for online payments would lead to efficient outcomes – as it would inhibit the ability of any emerging payment system with lower acceptance costs to compete.
Like Australia, Canada currently conducts a strategic review of its payments systems, with recommendations to be submitted to the Ministry of Finance by the end of 2011. The starting assumption of the strategy review is that the information revolution and digital economy will radically change the way Canadians pay, but that the responses should be country-specific, rather than copied from abroad. In scope for the Canadian payments system strategy review are all existing and emerging payments instruments, ―anything used to buy and sell things‖. A significant concern expressed in the 22 ------
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review in that Canada could fall behind in the innovation and efficiency of its payments system, therefore the focus should be on mobile payments (in which Canada is not a player currently) and electronic invoicing and payments (which will assist in moving away from cheques). The present market consultation proposes that 4 distinct challenges have to be solved for Canada to become a leader in payments: increasing fairness in debit and credit card networks (which points to the perception that acceptance could be far more significant if pricing and other conditions better reflected a balance of rights and responsibilities), updating the regulatory and governance structure, improving online authentication, security and privacy, and transitioning to a digital economy.
Regarding the issue with debit and credit card networks the consultation document is unconvinced that interchange regulation would do much to reduce consumer prices. It however points at the wide array of debit and credit products as being potentially a disadvantage for merchants, and at network competition creating unintended consequences (i.e. driving interchange upwards, rather than downwards). Regarding the regulatory and governance structure, the consultation document proposes to clarify the legacy ―patchwork of legislation‖ currently ruling payments, and proposes that merchants and consumer groups find an effective forum to work together with payments service providers to resolve issues. Regarding online authentication, security and privacy, the consultation document points to clear requirements for improvement and identifies potential solutions (2- and 3-factor authentication), with a necessity to balance fraud reduction for merchants and privacy protection for consumers. Finally regarding the digital economy, the consultation paper designates the government as the key culprit for a continued high reliance on cheques.
The consultation paper then develops 12 principles to address the above challenges. Some of them are rather obvious and can be found in other systems as well (competition and innovation, user access and efficiency, transparency and choice, security, privacy, consistent standards, neutrality by function, proportionality), others stress dimensions which policy makers and regulators in other regions seem to have lost sight of: fairness and accountability (with costs to accrue to market participants who receive the associated benefits, unless another party chooses to bear these costs), minimal regulation (with regulation only occurring when the open market and industry standards fail to deliver on market related principles), independence and conclusiveness (with the governance of the payments system not being controlled by a minority of stakeholders), and framework adaptability (with a robust industry governance, yet flexible enough to remain relevant over time). These principles allow to formulate a governance framework composed of payments legislation, an industry self-governing organisation (with the objective to have most problems in the payments system solved by industry participants), a basic payment infrastructure, and a payments oversight body (and independent body, consisting of a small cross-section of independent experts, in charge of both policy and compliance).
All 4 payments systems (European Union, United States, Australia, Canada) reviewed hold in common interrogations about developments in the field of e-payments and mobile payments, the level of authentication, privacy, and security that should be achieved in a digital economy, and the realization that successfully addressing at least these questions will be instrumental for the future efficiency of the economies concerned. Approaches considered by policy makers and regulators in the United States, Australia, and Canada however rely on extensive market research and public consultation. By contrast the European Union‘s approach is not very informed by market research, and public consultation appears to be used as part of a formal process, rather than an opportunity to truly engage into a wide debate. Equally the United States, Australia, and Canada all recognize the value of sound business models to motivate market participants, and innovation, whereas the European Union puts greater value on consumer protection, also when it comes to pricing (resulting in an absence of pricing transparency). In addition to consumer protection the European Union pursues 2 high level goals, 23 ------
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payments innovation and internal market integration, and looks to applying competition law in an indiscriminate manner across the whole Union. In practice the pursuit of these 4 objectives leads to conflicting policies, threatening the delivery of either. More details about the policy makers and regulators approach to payment innovation in respectively the European Union, the United States, Australia, and Canada can be found in the section hereafter20:
4.2- European Union
In this sub-section we review what European policy makers and regulators have said and written about payment innovation over the past 2 years (i.e. post the transposition deadline for the Payments Services Directive, and the coming into force of Regulation 924/2009). Their positions are presented in chronological order.
ECOFIN 2nd December 2009 The Council of European finance ministers issued a statement on SEPA at the end of its 2nd December 2009 meeting. Regarding the space beyond core credit transfers, direct debits, and payments with cards, ECOFIN ―acknowledges the importance of equal treatment between electronic and paper invoices for value added tax purposes as well as the importance of developing innovative payment solutions underpinning an efficient and competitive European economy and therefore calls upon industry to deliver solutions for online electronic payments (e-payments) and for mobile payments (m-payments) and on banks and payment service providers to develop and actively market attractive e-payment and m-payment services thereby fostering alternative channels for the initiation and reception of payments; …recognizes that SEPA can significantly contribute to the modernization of public administration and the e-Government Action Plan as well as to the efficiency and growth of the wider European economy by developing value-added-services such as e-invoicing and invites the industry and the Commission to accelerate the work to realize an interoperable e-invoicing framework as a matter of urgency‖.
ECB - 7th SEPA Progress Report - 2010 In its latest SEPA Progress Report to date, the Eurosystem justifies its call for secure and efficient online payment solutions to be offered throughout SEPA by the strong growth of e-commerce, the corresponding growth in online payments, and rising concerns over the substantial increase in fraud for card payments on the internet. The Eurosystem is not concerned by the long term goals expressed by the banking industry in this respect, but by the slow progress in this field. The Eurosystem sees the 3 existing, prominent online banking-based e-payment solutions‘21 ―proof of concept‖ as the most promising initiative, and expects these to be open to requests of other communities and schemes, should any wish to join. Furthermore the Eurosystem wants the banking industry to provide SEPA- wide online e-payment solutions. The Eurosystem however acknowledges that the large number of stakeholders to be involved in the m-payments dossier makes the development of widespread m-
20 The source of the information is always shown, either in this section directly, or under Chapter 8: References and Acknowledgements, at the end of this Working Paper
21 Eps (Austria), iDEAL (The Netherlands), giropay (Germany) 24 ------
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payment solutions more complex, the entrance of new service providers being driven by the lack of an adequate service offering from banks, whilst the Eurosystem would have expected the development of specific payment mechanisms for the online world.
The Eurosystem‘s definition excludes payments that are merely initiated by the payer via his/her online banking application (i.e. without being integrated into the process of online shopping). Therefore, a credit transfer which was submitted by the payer in his/her online banking application would, for instance, not be considered as an online e-payment in accordance with this definition. The same holds true for traditional offline payments, for example cash on delivery. For the same reason, the (electronic) payment of an online invoice (Electronic Bill Presentment & Payment, EBPP) is not considered an e- payment, because no simultaneous online shopping process takes place. No differentiation however is made between the device (desktop PC, laptop, netbook, mobile handsets) and/or the service technology used to access the internet. As long as the payment data is transmitted and confirmed via the internet, it is considered as an online e-payment and not an m-payment.
As to m-payments they are classified by the Eurosystem into contactless and remote payments. For contactless payments, the payer and the payee (or the payees‘ terminals, for example, vending machines, parking meters, and public transport ticket dispensers) are in the same location (for which reason they are often also referred to as proximity payments), whilst for remote payments, this is generally not the case. However with its definition the Eurosystem excludes contactless card payments (also using e.g. NFC technology) not initiated through a mobile device but through a payment card. Payments using the internet as a transmission channel are not qualified as m-payments even if they are executed via a mobile handset. In the case of hybrid solutions, which are initiated online (e.g. by entering the mobile phone number) and authorized via the mobile phone (e.g. after entering a PIN into the handset), the customer‘s perception should prevail and the payment should be considered as a mobile payment.
The Eurosystem highlights that the European Commission‘s Digital Agenda for Europe calls for setting a date for moving to a single market for online payments, to be achieved by eliminating regulatory barriers and facilitating electronic payments and invoicing, dispute resolution and customer confidence. The Eurosystem stresses that card payments, which are still the instrument most widely used for online payments, are – without the application of additional security procedures such as dynamic authentication – clearly not the most suitable payment method for remote payments. The Eurosystem furthermore endorses the view expressed in September 2009 by the EPC Plenary when it decided to create full reachability for consumers through i) all e-payment schemes in SEPA meeting the minimum criteria defined by the EPC enrolling in the framework; ii) each bank in SEPA being a member of (at least) one e-payment scheme enrolled in the SEPA e-payments framework; iii) each account holder in SEPA being able to make SEPA e-payments; iv) the SEPA logo being used by the enrolled e-payment schemes provides a consistent user experience throughout SEPA. The Eurosystem however notes that these goals can neither remain entirely optional nor be made mandatory by EPC decisions, leading to a coordination problem and a wait-and-see approach by the majority of market participants. In this respect the early 2010 EPC consultation revealed that part of the European banking communities fear that the development of attractive e-payment solutions will diminish their revenue streams from the payment cards business and therefore prefer to continue with card-based solutions for online payments.
EC‘s 12 Single Market Priority Actions – April 2011 On 13th April 2011 the European Commission presented its twelve Single Market priority actions to boost growth and increase consumer‘s confidence - to be achieved for end 2012. The projects rank from mobility for citizens to social entrepreneurship and should all help to complete more rapidly the 25 ------
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European Single Market. The projects have in common that they focus on creating growth and jobs by better exploiting the potential of the Single Market. All barriers and obstacles to its growth and competitiveness should be removed through these measures. The President of the European Commission added that most of these proposals carry ―no price tag‖, as they are about generating new opportunities and becoming future-proof. As a focus area of the Single Market, SEPA and payments are central to several of these actions: 1. Intellectual property rights: ensure that Europe remains an area of creation and innovation through the revision of intellectual property legislation to allow actors to develop their commercial models. European legislation will combat piracy and counterfeiting more effectively by e.g. increasing the role of the European Observatory of Counterfeiting and Piracy, and improving coordination between authorities. IPRs also have particular relevance for standardization: European payment standards and schemes should be available for usage without any undue royalty barrier. 2. Consumer empowerment: creation of an alternative, out-of-court and affordable dispute resolution process to increase the consumer‘s confidence when purchasing abroad or over the internet. A special focus will be on the protection of consumers of retail financial services especially in regards to the transparency of bank fees. The market should remain vigilant that dispositions to protect e- Commerce consumers are realistic and proportionate. 3. The digital single market: provide the players of the Single Market with appropriate and safe tools to develop their online activities through an adequate legislation (review of the e-Signature Directive) ensuring the mutual recognition of electronic authentication across the EU. The objective is to strengthen the confidence in electronic transactions as a necessary prerequisite for a Digital Single Market ensuring that transactions are secure, work across borders and are recognized by all sectors of activity, but are inexpensive and easy-to-use, with transaction parties being strictly controlled. A deliverable should be an e-Commerce Directive implementation which deals with challenges such as security of online payments, personal data protection or micro-payments. 4. Public procurement: a revised and modernized public procurement legislative framework allowing public utility purchasing managers to support socially responsible and environmentally-friendly approaches through. This should motivate cross-border responses by European Payment Service Providers to tenders from national public administrations and similar entities. End 2012 the Commission will take stock of progress and present its program for the next steps.
ECB-ÖNB Retail Payments Conference – May 2011 In her closing address to this conference Ms Tumpel-Gugerell22 wished to retain i.e. the following messages: The financial crisis has shown that Europe benefited from the integration and innovation achieved so far, but there is still considerable room for more.
22 At the time a member of the ECB‘s Executive Board 26 ------
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Retail payment integration is not about the harmonization of payments behavior, but about the harmonization of instruments, standards, rules and systems. Moreover, there is country evidence that the cost of cash can be substantial and there is room for efficiency gains. Retail payments fraud could have societal impacts on the use of different payment instruments. Customers‘ readiness for change is not to be taken for granted, even when the benefits of an integrated retail payments market are obvious. The operational involvement of central banks in retail payment processing is still intensively discussed. Innovation in retail payments not only makes our everyday lives more convenient by offering easier access to payment instruments, it might also be an opportunity to close the gap between unbanked and banked population. Innovation could be a tool to increase financial inclusion.
EC/ECB discussion paper - May 2011 SEPA Council The innovation theme featured on the agendas of the 2nd and the 3rd SEPA Council meetings. During the latter it was decided that a major part of the December 2011 meeting (since, postponed to February 2012) would be dedicated to innovation (and the other part to governance). In preparation SEPA Council members were requested to respond to a short consultation on an ―inventory of the challenges and concerns for online e-payments‖. Views on the following questions are to be provided: What is the relevance of e-commerce for your constituency? What are the major challenges e-commerce in Europe is facing? What are the characteristics you expect from online e-payments? Please qualify which of the already existing solutions do meet the expected characteristics best (1=fully meets the expectation, 5=does not meet expectations at all)? Please explain for every type of solution, what features/characteristics you especially like/dislike. a) Traditional card payments (i.e. card details are given to the merchant) b) Card payments making use of 3D-Secure (e.g. Verified by Visa or MasterCard Secure Code) c) Online Banking based e-Payments (e.g. iDEAL) d) Overlay Payment Services (e.g. SOFORTbanking) e) Wallet solutions (e.g. PayPal) f) Voucher solutions (e.g. paysafecard) Please identify the three most important weaknesses (if any) identified for the existing solutions, which to overcome should be a top-priority? How could your constituency imagine contributing to meet the challenges identified? Do you have any specific requirement/preference as regards the legal status of the service provider(s) (i.e. bank, electronic money institution, payments institution)? How should the governance of online e-payment solutions ideally look like? Does your association consider it necessary to be involved in the governance? If yes, how could this involvement look like (e.g. involvement in the ownership, user groups, etc)? Which other e-commerce related activities – apart from online e-payments – would justify an integrated European approach? The EC-ECB Secretariat provided for the 3rd meeting in June 2011 a discussion paper. The latter largely echoes the points made in the ECB 7th Progress Report, yet provides additional data. On average 69 % of all individuals in the EU27 are internet users and 53 % of all individuals use the internet (almost) every day. Despite a general upward trend, the number of internet users ranges from around 40 % (RO, BG, EE) to 90 % (SE, NL, LU, FI, DK). Nearly 60 % of internet users in the EU27 shopped online in 2010; the proportion of e-shoppers among internet users ranged from as much as 79 % in the United 27 ------
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Kingdom to as little as 9 % in Romania. However, the vast majority of online e-commerce was still taking place domestically, with only 8 % of online shoppers in the EU buying from another country. 60 % of attempted cross-border internet shopping orders would fail due to technical or legal reasons such as the refusal of non-domestic credit cards. Furthermore the most important reason for not purchasing online was on-line payment security concerns.
Hence the discussion paper proposes that - although not the sole reason (see Digital Agenda for Europe) - the lack of adequate payment solutions adversely affects the realization of even higher e- commerce growth, both within and across Member States. The problem would have two interlinked dimensions: i) non-availability of online e-payment solutions for consumers and/or merchants (at domestic and/or cross border level); ii) shortcomings of existing payment solutions offered (e.g. lack of efficiency or security).
The discussion paper defines the consumer perspective based on a study performed by the Dutch Central Bank23. Protection of personal and payment data is seen by far as the most important requirement. 35 % want to receive an immediate payment confirmation and 32 % want to pay using their online banking application. The discussion paper also notes that although it is understandable that consumers do not want to pay transaction fees (31 % said so), these could be charged for good reason (i.e. high merchant service charges for specific credit card brands). As to merchants they ask for 3D- Secure to become more user-friendly. To reduce the charge-back risk, merchants seem to prefer payment solutions based on (SEPA) credit transfers – with online-banking based e-payments (OBeP) as the most viable solution, which should be offered cross-border too. The discussion paper proposes that the SEPA direct debit offers for the first time an electronic version of the mandate. The discussion paper also recommends that merchants when relying on new Payment Service Providers (PSPs) should pay attention that these are properly licensed. Finally the discussion paper recommends that merchants, instead of requiring harmonized cross border cash on delivery methods, should contribute to a phasing- out of this payment method (i.e. comparable to the ambition to reduce cheque volumes).
As to payment service providers the discussion paper proposes that no incumbent PSP can be forced to offer online payment solutions, irrespective of whether card or online banking based, to its customer. On the other hand, new PSPs must not be prevented from offering their services, as long as they are properly licensed and adequate oversight is ensured. However, from a European policy perspective all payment service providers are encouraged to offer efficient, low-cost, secure and readily available online payment instruments. Therefore the discussion paper recommends that i) card transactions making use of secure payment protocols should be promoted by PSPs, ii) existing infrastructure (e.g. online banking) should be leveraged for the introduction of online payment services; iii) interoperability should be facilitated by the use of international and/or European standards and the development of a European frameworks or rulebooks; iv) existing OBeP-services should leverage the SEPA Credit Transfer and offer their services cross border within SEPA.
23 Also referred to under Section 6.3.2 of this Working Paper. 28 ------
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The discussion paper also notes that both the European Commission and the European Central Bank are concerned by the emergence of a multitude of schemes and standards across a number of Member States, which will hamper the development of secure cross-border e-commerce in the EU, while consumers in other countries will have to continue to rely on non-adequate payment services for online purchases (e.g. cash on delivery). The policy makers‘ vision is that a customer should be able to use his/her online e-payment method (based on online banking or secure card payments) also for online e- payments outside the home country.
European Commission response to EPC (10th August 2011)
End June 2011 EPC wrote to President Barroso and Commissioners Kroes, Almunia and Barnier to express concern over the lack of coherence in the Commission‘s policies, that on one side push the SEPA and innovation agenda, yet on the other keep the payment industry cooperation vehicle (i.e.: EPC) under constant threat of investigation by European competition authorities and complaints by any market (or: would-be) participant. The Commission responded on 10th August 2011. The letter highlights that ―with SEPA, the Commission intends to create and strengthen the internal market in payments, and more broadly, thereby improve the functioning of the internal market for goods and services as well as create a platform for future innovation‖. The Commission affirms that internal market policies and competition law are fully complementary and necessary to ensure that European consumers and business are ―offered pan-European payment services which are efficient, affordable, and innovative, also in the areas of e- and m-payments and cards‖.
European Commission‘s DG Competition investigation of EPC (September 2011)
How much internal market policies and competition law effectively complement each other came to light on 22nd September 2011 when DG Competition informed EPC of the opening of a formal investigation. The latter covers EPC standardization work underway in the field of online payments, and in particular EPC‘s alleged refusal to admit Payments Network AG (a non-supervised, non-licensed software provider) to participate in EPC‘s work on an e-payments framework, and more generally to work underway on online payments. DG Competition refers to ―practices‖ by EPC which, if they were confirmed by this investigation, could restrict competition in the online payments market and cause prejudice to not only existing but also potential competitors of EPC members, and to online customers. The extension to ―potential competitors‖ shows that DG Competition casts a wide net, and reference to online payments in general means that e.g. card-not-present payments, so not only traditional online payment schemes but also card schemes, are in scope of this investigation. Furthermore the opening of an investigation prevents national competition authorities from exercising the rights granted them by Art. 101 and 102 of the EU Treaty; in other words, any exemption to the strictest interpretation of competition rules would have to be decided from then onwards by the European competition authority.
DG Competition cannot but be aware that Payments Network AG, a German provider of overlay payment services, does not meet the published criteria for membership of EPC, or participation in a Working Group. Indeed Payments Network AG is (at least at the time of writing this Working Paper) neither a credit institution nor a payment institution. Furthermore, although EPC indeed organized a ―proof-of-concept‖ pilot of its prototype of a potential e-payments framework involving 3 online payments service providers (eps, Giropay, iDEAL), it had made very clear that the limitation of the pilot to 3 participants does not mean that the framework would not be open in future.
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Clearly DG Competition appears to have been on the look-out for an alibi to intervene in the market. DG Competition had announced several times over the past 3 years that it considered standardization a strategic issue for Europe (the still open ―EMV‖ case against EPC being a first illustration thereto). The immediate practical effect of DG Competition‘s investigation will however be that collaborative work on standards and common solutions will slow down even more, not only with respect to online payments, but across the board. The main winners of such a situation will be those working on proprietary approaches (aka: 3-corner models), be they newcomers to the payment scene, or existing, large players already today. Whilst DG Competition might have been gunning for getting a lot of the former with its move, in effect it may well get more of the latter. Contrary to its allegations it may be doubted that bringing forward the internal market is an objective for DG Competition. Yet another casualty of this investigation will be the European banking payment industry‘s governance model: EPC‘s governance had already been ripe for a fundamental revamp for several years, but many were afraid to engage the EPC‘s ―office holders‖, yet it is hard to imagine how it could survive this additional mishap coming after the debacle of the SEPA migration Regulation. A positive consequence however for the banking industry of this investigation is that – unlike what happened with the SEPA migration Regulation – the European Commission has to comply with legal proceedings to bring the investigation to a close. However this process could take several years, and available appeal options could again delay any certain outcome for many more years. Again, SEPA wasn‘t very high on the agenda of those who instigated this investigation. Speech by DG Competition Commissioner Almunia on ―Building Europe‘s future payments market‖ (Brussels, 12. October 2011)
This speech asserts that ― a single payments area is [...] necessary to give a boost to the Digital Agenda‖, with ―...better electronic forms of payment as one of the targets of this Agenda‖. This speech is a crafty cocktail of positive yet also far more disputable statements. On the positive side: The common currency has cut costs and increased price transparency; The proposal that ―regulation, self-regulation and competition enforcement at EU level should team up to spur the evolution of the industry‖; The conclusion that ―...we have probably reached the limits of strict self-regulation in the development of a Single European Payment Area...‖; The Commissioner acknowledges that ―the banking industry has been requesting for years ...the clarity and predictability...‖ that the SEPA migration Regulation will provide with respect to phasing out national systems; The further acknowledgement that ―One central issue will be a reliance on more competition- friendly business models‖ has 2 positive aspects: first, that business models are indeed central to innovation, second that there can be more than one business model. Far more disputable: The view that ―Today, cross border transactions within the euro area continue to be more difficult and often more expensive than national payments‖, a view that even the Commission‘s 2006 review of Regulation 2560/2001 could not substantiate; The view that ―payments are one of the main barriers for the growth of e-commerce‖ – this is contradicted notably by the input of demand side stakeholders into the Commission‘s October 2010 consultation on the revision of the e-commerce Directive; Once again a Commission official reduces SEPA to ―a self regulatory project run by the banking sector to make cross border payments in euro as easy as domestic ones‖, a positioning with the sole objective to set the context for further regulatory intervention; 30 ------
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References to a need for ―more competition-friendly business models‖ and to ―Eliminating unwarranted rents‖ confirm that the Commission definitely views the existing business-model (interchange) as competition-unfriendly – in the absence of any transparent, context-related assessment, i.e. as a matter of policy. A distinction should be made between a business model, and some of its occurrences: do you ban cars, because some drivers speed? (Mr. Almunia‘s statement is hardly mitigated by his later acknowledgement that ―...this does not mean that collective interchange fees are unjustified in themselves; it is rather their level which is a matter of scrutiny‖ - knowing that DG Competition will scrutinize any level other than 0); The European card market is – unfortunately as usual with this Commission – described in a rather inaccurate way (over-emphasis on credit cards, the role of schemes, cardholder vs merchant effects,...).
What is missing from the speech: The plain statement that ―all major recent global [e-payments] initiatives are non-European‖ suggests that the European supply side is solely responsible for this situation. A comparative review of the landscapes, the policy and the regulatory frameworks that support non-European initiatives would provide the Commission with useful guidance as to key success criteria; One would have expected that with notably the Commission putting pressure on the banking industry to develop innovative payments there would be more in the speech than the ―...need to launch a reflection on the best instruments to move forward with initiatives in card payments and innovative and mobile payment systems‖, in particular as the consequence of DG Competition‘ recent investigation will be to stall much of the work underway in these fields; The Commissioner blames banks for preventing ―the cooperation [...] in order to access and verify payers‘ accounts‖ to take place. It is very surprising that no mention is made neither of security requirements (except in the context of standardization), nor of the obligations deriving e.g. from the Payments Services Directive, nor the opportunity given by the same Directive for payment accounts to be opened and maintained by properly supervised institutions; Finally, in a speech so largely devoted to cards, it is surprising that there is no reference to cash. True enough, this would have compelled an acknowledgement of the many distortions that the Commission‘s legislation and recommendations with respect to cash, and the European Central Bank‘s practice, introduce into the payments market.
European Central Bank – Report on the results of the e-SEPA survey on payment innovations in 2010 – October 2011
The findings from this survey of the European Central Bank – performed in the course of 2010 - were only released in late 2011. Although the document looks much like a report on a market survey – and as such should have been presented in Chapter 6 of this Working Paper – the European Central Bank places its findings in the perspective of what can be expected in the future, and what this means for policy-makers. Hence this Report has its place in the present Chapter.
The Report acknowledges that ―the numerous different actors in this [the retail payments] market, aware of the potential, are constantly developing and deploying new products and services‖, and that ―although banks are often accused of not being very innovative in the field of retail payments, most innovations are offered by banks directly or indirectly‖. The Report also concedes that any comprehensive overview becomes quickly outdated. The European Central Bank shows an interest for the ―way‖ people make payments – rather than the overall efficiency of the payment system. The Report provides of course a definition of e-SEPA, ―an integrated payments market in which payment 31 ------
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service providers make use of advanced information and communication technology when offering payment-related services, building on the core SEPA payment instruments‖, a definition which could be seen on one side as extending the role of the ECB beyond strictly payments, on the other as keeping the topic alive forever, as information and communication technologies will continue to advance.
The ECB survey was performed in 2010, 4 years after the last such survey. The European Central Bank proposes a set of qualitative criteria for assessing whether specific emerging services qualify as e-SEPA services, yet admits that its e-SEPA categorization is rather subjective. It also admits that the Report is about e-SEPA, not payment innovation, and that both concepts are not the same, with the expectation that over time e-SEPA services will become commonplace and not be considered any longer as innovative. The Report however attempts to define payment innovation, accepting that a clear definition is a challenge, due to the diverse payments landscape prevailing in Europe, which e.g. leads some to deem innovative a feature long-implemented in another country. The Report proposes to distinguish between ―technology push‖ innovations and ―customer-centric‖ innovations, observing that ―the objective technological leap of an innovation does not necessarily contribute to its success‖. Briefly reviewing some academic literature the Report also notes that most innovations generally are advancements of existing product lines, with only 10% being disruptive innovations.
The Report then discusses the importance of network externalities, stressing both direct and indirect network effects, and noting that the latter are important for retail payments users. However the Report fails to discuss the specificities of person-to-person payments, and their implications for the spread of innovative payments means (even though a small ―case study‖ is dedicated to person-to-person payments in a social network). The Report discusses two-sided market theory, and acknowledges that most studies found that consumers adopt specific payment instruments because of their perceived costs, security, ease of use, provided ability to control spending, and other network related factors.
To perform the survey, the European Central Bank called on the National Central Banks of the Eurosystem to send a questionnaire to the providers they identified in their country – hence, this survey is provider- and EU-only. A total of 81 providers reporting 118 services responded. Whether this survey is representative could be challenged, as Greece is the euro country reporting the biggest number of innovations, at least twice as many as countries such as Germany, France, or the Netherlands. The European Central Bank grouped the innovations reported into 5 categories: - Internet payment innovations (with no differentiation being made between the device – desktop PC, laptop, netbook, mobile handset) and/or the service technology used to access the internet); - Card payment innovations; - Mobile payment innovations; - Electronic bill presentment and payment; - Security and infrastructure innovation. Most innovations (66%) were reported in the area of internet and mobile payments. In terms of providers, 42% of the innovations captured by the Report are provided by banks, 10% by payment institutions, 5% by electronic money institutions, and 9% by a combination of either banks, non- payment service providers, and/or card schemes. Whilst the Report notes that there would be ―a general trend observed in recent years, i.e. the growing importance of non-banks, and their multiple roles in retail payments along the whole payment processing chain‖, no justification is being offered for the immediately ensuing conclusion that ―the lack of an adequate e-payment service offering from banks may have contributed to the entrance of these new non-bank service providers‖. Whilst the Report also notes that most solutions reported are proprietary solutions, the immediately ensuing suggestion that there is ―the need to increase cooperation among the different shareholders‖ would 32 ------
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carry greater weight if an attempt to analyze why innovations are first proprietary had been proposed….
The Report then moves to considering stages in the innovation lifecycle. Whilst proposing that there are 7 stages in a typical product lifecycle (i- development phase, ii- pilot phase, iii- early stages of adoption, iv- growth phase, v- maturity phase, vi- decline phase, vii- phasing out), it notes that most of the innovations were reported to be in the growth phase – which actually could just signal a positive thinking on the part of their owners. Noting that internet-related innovations are more advanced than mobile payment innovations (most of the latter being still in the development, pilot or early stage phases), the report attempts to account for that difference – in the absence of any sustaining third party study - through the fact that high-speed connections for mobile phones were developed later than for fixed-line internet. Regarding the degree of innovation as perceived by providers and users, the Report shows providers being more optimistic than users, with 57% of the former defining the level of their innovation as ―medium‖, whilst 56% of the latter define the level of innovation delivered as ―low‖.
Attempts by the survey to identify the beneficiaries of innovation show advantages to be fairly balanced between payers and payees in terms of ease of use, speed, costs, and security – a finding still to be taken on board by European policy-makers and legislators! Regarding the share of innovation related to each step in the payment process chain, the Report suggests that almost every innovation affects the payment step, whilst 75% also affect the pre-payment step, and 72% the post-payment one – findings that differ from the (admittedly more random, and not EU-only) survey of recent innovations we compiled – please see Chapter 6.4 of this Working Paper. In terms of payment situations, 65% of the innovations reported have to do in one way or another with online purchase – the next most quoted category being bill payment, with 34%. As to settlement, whereas distinctions can be made between prepaid, real time, and post-paid, it was found that 48% of innovations support only one type of settlement, whilst all others support at least 2 types – none supporting all types.
By way of conclusion, the European Central Bank notes that a large share of the reported innovations are only designed and developed for a domestic market within one country within the EU, and it doesn‘t expect a substantial share of these innovations to survive in the long run. The European Central Bank suggests that to reach critical mass providers intensify their marketing efforts, extend the geographic coverage and/or find partners for cooperation, and establish interoperability with other solutions. The European Central Bank also notes that a number of developments are seeking to address network externalities. These can be distinguished according to the level of cooperation required from the different stakeholders to overcome diversity and fragmentation. The European Central Bank sees 3 levels: - First, bridging services, which allow different payment systems to co-exist; - Second, initiatives to ensure the interoperability of systems; - Third, initiatives aimed at creating joint platforms based on commonly agreed and ideally open and transparent standards. The European Central Bank admits that ―a large number of innovative services and providers is not a matter of concern – on the contrary it might even be beneficial for competition and future development – a fragmented market based on proprietary, walled-off solutions is definitely a concern‖, which leads the ECB to resort to its well known stance about the necessity for ―true European solutions‖ to be provided ―in the interests of developing and innovative integrated payment market in Europe‖ – there is however silence as to what policy measures are/should be contemplated to facilitate the emergence of such a market.
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This, and the fact that no attempt had been made to correlate the reported innovations and the level of market dematerialization, are the shortcomings of this Report.
European Commission (draft) ―Green Paper‖: ―Towards an integrated European market for card, internet and mobile payments‖ (November 2011) During 2010 DG Competition coordinated a dialogue between 5 of its Directorates and representatives of market participants against the background of SEPA e-, cards, internet and mobile payments – aka ―SECIM‖. The stated objective of this dialogue was to uncover any obstacle that would exist to a faster development of what the Commission continues to call ―modern means of payment‖. During this dialogue the Commission consulted informally both the demand and supply sides of the market. In December 2010 the supply side was given an informal feedback and presented with a long list on ―obstacles‖ of various nature, most of them either unrelated to payments, or beyond scope for the supply side, certainly in the context of a coordinated approach. Before the summer of 2011 it emerged that the Commission was working on a ―Green Paper‖ on these topics. This paper was first due for release on 7th December, at the last moment its release was postponed to 11th January 2012. The following section is based on the end November 2011 version of an official draft of this Green Paper. This paper proposes that ―secure, efficient, competitive and innovative electronic payments are crucial for consumers, retailers and companies to enjoy the full benefits of the Single Market‖. The SEPA project is positioned as a first, important milestone in this context, as it should act as a springboard to a competitive and innovative payments market by fuelling the take-off of integrated and secure payment innovations, and incentivizing non-euro currencies to build on the SEPA standards and rules. Unfortunately, already in its introduction the draft Green Paper features by now traditional misconceptions of the Commission, by blaming the fact that ―less than 10% of EU Consumers are currently shopping on the internet across borders‖ on deficiencies in payment security and efficiency, whilst a study financed by the Commission itself24 paints a completely different, evidence-based picture for the reasons for which consumers are wary of shopping cross-border. The draft Green Paper suggests that more market integration brings more competition (from market access by new entrants cross-border, to a challenge to the alleged dominance on international card schemes), more choice and transparency for consumers (with the Commission hitting at ―hidden costs‖ that would drive consumers to use the mose expensive payment method, although the Commission never mentions the impact of cash), more innovation (under the premise that the scale effects of an integrated market provide new initiatives with opportunities for cost savings and/or increased revenues), and more payment security and customer trust (bringing to remote payments what has been achieved at point-of-sale). The draft Green Paper then reviews the various payment instruments on offer and highlights their shortcomings from the perspective of the Commission, taking again a strict silo approach and obliterating the responsibilities of cash (and its promoters) in the massive cross-pricing occurring in the market. When at all data is used by the Commission with little coherence and relevance, e.g. the alleged lack of success of mobile payments in Europe is compared to transactions values in North America, and
24 The September 2011 European Consumer Centers‘ Network‘s ―Online cross-border mystery shopping – State of the Union‖, also referenced and discussed later in the present Working Paper 34 ------
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the number of mobile payment users in Asia Pacific. The Commission‘s review of the current landscape ends with the statement that ―the lack of a concrete European framework addressing main concerns, such as infrastructure requirements, inter-operability, security and the collaboration of the relevant market participants, risks to perpetuate a fragmented m-payments market in Europe‖ – a statement which sounds very much like the justification of an impending regulatory intervention. The draft Green Paper then proposes to consider 5 sets of requirements that ―need to be met‖:
Transparent Interoperabil Accelerate and cost- Standardisa ity between Payments market effective tion service security integration pricing of providers services
MIFS Consumer – Card payments Interoperability in Cross-border merchant the m-payment acquiring relationship domain transparency E- and m- payments Co-badging / Co- branding Interoperability in Rebates, the e-payment surcharging and domain Access to settlement other steering systems The various Merchant – service dimensions of Compliance with provider SCF interoperability and relationship competition
Information on availability of funds
Dependence on payment card transactions
As such, these, and their proposed components, call for the following, preliminary observations: a) Accelerate market integration: - Multilateral interchange fees: the Commission‘s by now traditional language about interchange fee for cards is extended to three-party schemes and also commercial cards (i.e. payment cards issued by companies for use by their employees). The Commission i.a. remains deaf to lessons from the US implementation of the ―Durbin legislation‖, which shows25 that 76% of the retailers have not passed on to consumers any savings from the mandated reduction in interchange, with consumers paying on average 1,7% more for the same product or service after implementation of the legislation than before. - Access to settlement systems: the conditions are clearly defined by the Payment Services Directive – which took 7 years from inception to promulgation. Obviously the Commission wishes to challenge a Directive in force for barely 2 years.
25 December 2011 Research by the Electronic Payments Coalition 35 ------
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- Cross-border acquiring, co-badging, co-branding, separation of card schemes and card payment processing, compliance with the SEPA Cards Framework (SCF): clear principles on these topics have been formulated in the SCF and published already in March 2006. Whilst for obvious reasons the European Payments Council cannot be the enforcer of these principles, neither the European Central Bank nor the Commission have shown any eagerness to do so up to now. - Information on availability of funds: here again banks who comply with their regulatory and legal obligations regarding customer security and privacy are presented in a negative light. b) Transparent and cost effective pricing of services: The Commission continues to bemoan an alleged lack of transparency in pricing of payment services, but did nothing in the past decade, on the contrary26, to make costs more transparent. The impossibility in many instances to price products and services differently also in function of the payment instrument used much affects the consumer/merchant relationship. c) Standardisation: The Commission also continues to take a vertical view of the standardization issue, oblivious that much of the service providesr ability to progress is already constrained on one side by payment legislation, on the other by lingering uncertainty as to the application of competition law. - Card payments: the ability of the payment industry to progress standardization of several domains such as terminal-to-acquirer have been constrained by conflicting signals received from policy makers and competition authorities. The Commission continues to promote migration towards a single merchant interface, without any consideration on one side for e.g. either the permissibility or the costs of the required coordination, on the other for the compatibility of such an objective with the introduction of continued innovations – which the Commission calls for in parallel. The draft Green Paper also discusses the acquirer-to-issuer domain, suggesting that the remedy to the current – allegedly – unsatisfactory situation is a full separation of card scheme and card processing. Whilst this approach features in the 2006 SEPA Cards Frameowrk, in a 2011 context the question as to how much has changed with the emergence of mobile payments needs to be asked first. With respect to certification, the Commission seemingly endorses 2 ―market- driven‖ initiatives without discussing neither their representativity nor their governance. - E- and m-payments: the Commission appears to reduce e- and m- payments to contactless and internet originated transactions, a simplification which will not help to assess whether, and which, policy approaches could be required in these increasingly complex segments. d) Interoperability between service providers: The Commission stresses that ―cooperation is a key requirement in a network industry‖, yet would not make any distinction as to the specifics of innovation, and their interplay with cooperation and coordination. - Interoperability in the m-payment domain: here the Commission is not able to overcome its contradictions. It admits that this market still is in ―its infancy‖, yet bemoans the ―fragmentation through proprietary solutions‖. - Interoperability in the e-payment domain: the Commission on one side suggests (without providing any evidence) that non-bank services have been prevented by the European payments
26 See March 2010 EC Recommendation on Legal Tender 36 ------
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Council to participate in work on the interoperability of existing e-payment schemes, on the other that ―an overall EU wide scheme‖ should be the desired objective. - The various dimensions of interoperability and competition: suggested dimensions are on one side the freedom for customers to use payment instruments from issuers irrespective of location, and for merchants to freely choose their acquirers, and on the other the differences (also from business model perspectives, and their implications?) between three-party and four-party schemes. e) Payments security: Most surprisingly the Commission here makes no reference to the Eurosystem‘s ―SecuRe Pay Forum‖ established at the bginning of 2011 to formulate recommendations to the market in the field of security of payments requirements. The SecuRe Pay Forum is currently expected to release its first recommendations (on online payments) at the beginning of 2012. The draft Green Paper also lauds the progress achieved thanks to the industry-led implemtation of EMV – yet fails to mention that the European Commission‘s competition case against the European Payments Council for recommending the use of EMV is still not closed. Finally, whilst customer data privacy certainly is a constant concern for both users and providers, it is a difficult issue to raise in the context of a payments debate, as it crosses many domains. Thus the preliminary evaluation of this draft Green Paper unfortunately must be that it will fail to realize any of the objectives pursued by the European Commission, be it market integration, payment innovation, consumer protection, or even competition. This is not because all questions raised by the draft Green Paper are invalid as such: this has also to do with the timing of this exercise. In a few days, Europe will be entering the 10th year of the SEPA project, and no less than 3 Regulations and a Directive have already been promulgated. The questions raised in the draft Green Paper, and the Green Paper initiative itself, must be assessed this background. European Commission DG Markt/Council/Parliament – SEPA migration Regulation – Status December 2011
On 20th December 2011 the European Parliament, Council and Commission concluded their ―trialogue‖ and agreed the text of the ―SEPA migration Regulation‖ that will be submitted for formal approval to the European Parliament Plenary in the first quarter of 2012. Baring last minute developments the Regulation could be published in the Official Journal in the 2nd quarter of 2012. The cornerstones of this Regulation (on the basis of a provisional text agreed on 16th December at the level of the permanent Member State representatives) are: Existing, national euro credit transfer and direct debit schemes must be discontinued by 1. February 2014. For non-euro Member States the dispositions will apply by 31st October 2016 – unless the euro is introduced before 31st October 2015. Large value payment systems are not in scope of this Regulation. All payment service providers who currently accept national euro credit transfers and direct debits must immediately (i.e. after the promulgation of the Regulation) accept pan-European ones (this obligation only applies to direct debits which payers are consumers). Both creditors and debtors then must accept such transactions sent or received to/from a payment service provider located in another SEPA country. Such ―reachability obligation is postponed to 31st October 2016 for non- euro Member States‖. The Regulation goes further than the Payment Services Directive in specifying payment service user, notably consumer, rights. The Regulation also defines the standards to be used for executing pan- European credit transfer and direct debit transactions, and several other key features of the
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corresponding schemes. The European Commission has been granted powers to evolve these standards and features in future. After 1st February 2014 payment service users can no longer be compelled to provide their BIC data for national payments, and after 1st February 2016 for cross-border payments. The Regulation bans interchange for ―regular‖ cross border direct debit transactions from 1st November 2012, and for same country transactions from 1st February 2017 on – cross-border and same country being defined (consistently with Regulation 924/2009) from the perspective of the location of the payment service provider, not the payment service users‘ (i.e. ―cross-border‖ means that both payments service providers are located in different Member States, ―national‖ means that both are located in the same Member State, the location of the payment service users being indifferent). Whilst very few of these changes will be perceived as additional value by customers, the outcome of the 12-month debate27 on the Regulation holds key messages which the banking payment industry must take heed of: Both governments and the elected European legislator accept that key features of the core credit transfer and direct debit products be cast in law, and only evolved by law. This spells the end of ―self-regulation‖ (termed ―co-regulation‖ by some) pursued by the banking industry since 2002. Both governments and the elected European legislator accept the disruption of the successful ―creditor pays‖ business model for direct debits and show no concern as to ripple effects on consumer pricing and innovation – probably with the confidence that further legislation will redress any from their view undesirable spill-over. Both governments and the elected European legislator implicitly state that the advent of SEPA must be financed by the supply side, with the demand side protected from any visible consequence. The de facto regulation of SEPA pricing means that also the additional costs of non-SEPA related obligations (e.g. FATF) cannot be passed through to end-users either. Throughout the legislative process neither governments nor the elected European legislator showed much interest for the demonstration that the Commission‘s impact assessment and arguments were skewed, at best. Dogma proved an easy sell in the current climate, and payment transaction management was considered at par with credit risk and financial stability.
4.3- Contrast with other payment systems
4.3.1- United States
In the United States no over-riding public policy approach to payment innovation has – to the best of our knowledge – been expressed. However at the beginning of 2011 2 papers have been issued, respectively by the Federal Reserve Bank, and by the US Administration, from which a view as to how innovation is treated by the policy maker and legislator can be derived. These papers on one side concern mobile payments, on the other trusted identities in cyberspace. Interestingly, the Federal
27 Which admittedly one shouldn‘t expect to be overturned during the trialogue, or through the European Parliament Plenary vote 38 ------
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Reserve Bank of Atlanta organised in November a symposium on ―the role of government in payments risk and fraud‖, on which we also report.
a) Mobile payments
In January 2010 the Federal Reserve Bank convened key mobile industry stakeholders in order to learn whether the Central Bank could facilitate the evolution of mobile payments, explore how to collaborate on common issues, and generally encourage growth and innovation whilst minimizing risk for the payment system. That Roundtable concluded that there was no case for regulatory intervention at that stage.
Since, the Federal Reserve Banks of Atlanta and Boston convened 5 times an informal working group of key players in the emerging mobile payments ecosystem (mobile carriers, issuing and acquiring banks, card brands, payment processors, credential manufacturers, trade associations, mobile software vendors, handset manufacturers) to formulate a vision regarding the future of POS mobile payments in the United States. The group recognized early on that cooperation between providers is essential as customers want to see homogeneous solutions – as they do for other payment channels. The group concluded that the foundational components of success are: - defining the environment in scope as an ―open mobile wallet‖ (substituting for a check, cash or a card) supported by NFC technology, - using ubiquitous platforms that leverage existing ―rails‖ such as Automated Clearing Houses, - secured by dynamic data authentication, - compliant with standards that allow for global interoperability, - with Trusted Service Managers overseeing the provision of interoperable and shared security elements used in the mobile phone. The group noted that going forward the regulatory oversight model would need to be better understood. The group however advised against formulating a ―roadmap‖ this early in the evolution process, as this could stifle innovation. The group also recognised that today‘s payment system environment may be affected by a number of factors including legal and regulatory activity – making it difficult to move to a single agenda.
Although 18% of US households do not have a bank account the group does not anticipate that the unbanked will be the take-off point for mobile payments. It is rather the smart phone (owned by 34% of US consumers, a population growing at 17% p.a) that will kick-start mobile payments and mobile banking. The group took the approach that ―mobile payments for physical goods and services e.g. POS and transit imply the use of NFC contactless technologies‖ which are not yet prevalent in the US. The appeal of NFC is seen in it not being a new technology and working with existing hardware, secure elements and communication protocols. But stakeholders concerned ―must have the economic incentives to adopt it‖, e.g. uncertainty for merchants regarding the future infrastructure, and risk mitigation technology, must be removed. Participants in the group also required greater clarity with respect to consumer protection issues e.g. identity management, cyber-security and prepaid mobile accounts. This call for clarity led the Federal Reserve Bank to begin dialogues with the various federal regulatory agencies involved in mobile transacting with the first objective of identifying regulatory gaps.
Having defined the NFC contactless technology enabled mobile wallet embedded in the handset as storing secure payment and identity information and providing a secure access channel to payment services, the group‘s vision is to achieve ubiquity through a wallet open to all card networks and ACH transactions, working across all carriers and accepted at all POS terminals. The group recognises the value of competing proprietary offerings with respect to innovation but sees them endangering the 39 ------
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development of critical mass. Regarding business models the group sees 3 basic models co-existing: an operator-centric model, a bank-centric model, and a collaborative model – each model being utilized in turn depending on the type and value of a purchase, and the payment venue (physical POS, remote POS or internet). Of course the collaborative model requires setting up a neutral, third-party entity that manages or works with all the parties in the mobile payment ecosystem. The group however recognised again that excessive coordination could be a threat for innovation.
The group also recognises that current contactless card and mobile NFC deployments are not true mobile wallets as they constrain consumer choice and utility. As payment capabilities are a qualifying factor in the business case there is a need for standards covering security, privacy, compatibility and interoperability. There is however caution that the necessary deployment of NFC-enabled handsets and POS terminals (or an upgrade of the latter) requires an enormous amount of synchronization and market collaboration which is difficult to achieve in the absence of a ―participative forum‖. The absence of such a body in the US could also be an obstacle to the analysis of applicable global standards, and the development of an overarching standard for a trusted service manager. The group therefore expects that for the next 3 to 5 years there will still be an array of initiatives to monitor, provide input into, and assess for deployment.
In this context the group‘s approach to giving a role to the consumer in helping to secure the future mobile environment is interesting. A plan to get consumer buy-in on shared responsibility for risk management is viewed as essential to avoid the ―zero-liability‖ policies of e-commerce which result in a flood of repudiated transactions and ―friendly fraud‖. At this point in time it is thought that consumer buy-in will be achieved mostly through education – which also calls for some form of collaboration.
The group also discussed obstacles to implementation of open mobile wallet solutions. Cost of change obviously features as a prominent obstacle. The group notes that both merchants and financial institutions in the US have long resisted to upgrade the payment infrastructure from magstripe to smart cards and PINs. That the cost of PCI compliance could exceed the cost of actual fraud does not help in this context. The conundrum therefore is to decide whether both contact and contactless options in cards need to be supported for some time – an expensive option – or whether a migration to mobile NFC could not make a build up of chip and PIN redundant (the related Federal Reserve Bank Working Paper actually describes EMV as an ―aging, interim technology‖). These notwithstanding, the bigger obstacle is seen as being the ―consumer‘s comfort with the status quo‖. Finally the Working Paper admits that as regulatory impacts are cutting away at many sources of card revenue and the practices that make that revenue possible, conventional payment industry providers will be concerned about the need for incremental investments. But merchant representatives within the group strongly voiced the view that payment capabilities might establish the basis for a new payment paradigm infrastructure, but not the primary revenue model per se – i.e. payment fees should not constitute the financial foundation for a mobile transaction system.
b) Trusted identities
The US Administration announced in January 2011 a national strategy for trusted identities in cyberspace. This strategy has been formulated throughout 2010. This strategy recognizes that cyberspace has become a crucial component of the US critical infrastructure and that government holds a responsibility in addressing the rise in online fraud, identity theft and misuse of information. The strategy offers that one mitigating approach will be to increase the level of trust associated with identities in cyberspace. It is proposed that this will be best achieved by the development of an identity
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ecosystem that allows individuals, organizations, services and devices to trust each other as a result of authoritative sources establishing and authenticating their digital identities.
This identity ecosystem will be rooted in privacy protection, voluntary participation, and interoperability. It will allow participants to share only the information necessary to complete a given transaction. That information could differ widely according to the type of transaction involved. The identity ecosystem will support identity portability between multiple service providers and recognize a variety of credential and identification media types. The identity ecosystem‘s interoperability and privacy protection will provide for user-centricity: individuals will be able to select the interoperable credential which is the most appropriate for every transaction they contemplate. This will remedy individuals‘ current perception that they have little control over their own personal information, and the perceived failure in a number of instances of service providers to provide adequate identity assurance.
The scope of this US Administration strategy is squarely to establish and maintain trusted digital identities, focusing on transactions involving the private sector, individuals, and governments, and addressing also the international nature of many such transactions. Individuals will have the choice of obtaining identity credentials from either public or private identity providers, and will be able to use these credentials for transactions across a variety of sectors requiring different levels of assurance (e.g. health care, financial transactions, social transactions). It is interesting to note that – in opposition to approaches contemplated by the European Commission - this strategy does not call for the establishment of a national identification card.
The US Administration strategy is rooted on a set of 4 Guiding Principles: identity solutions will be secure and resilient, interoperable, privacy enhancing and voluntary for the public, cost effective and easy to use. The strategy‘s vision statement is that ―individuals and organizations utilize secure, efficient, easy to use and interoperable identity solutions to access online services in a manner that provides confidence, privacy, choice and innovation‖. The targeted identity ecosystem will be composed of 3 layers: an execution layer (to conduct transactions), a management layer (to apply and enforce the rules defined by the governance layer), a governance layer (which enables non-affiliated entities to trust each other‘s digital identities, with a governance authority establishing the criteria for assessing and certifying accrediting authorities, and controlling the rules for trust marks that indicate a service providers‘ standing as a participant within the identity ecosystem). As a result, the targeted identity ecosystem will feature at a minimum the following characteristics: Individuals and organizations will be able to choose the providers they use and the way they conduct transactions securely; Participants can trust one another and have confidence that their transactions are secure; Individuals can conduct transactions online with multiple organizations without sacrificing privacy. Identity solutions are simple for individuals to use and efficient for providers. Identity solutions are scalable and evolve over time. The US Administration strategy sets 4 goals and objectives (develop a comprehensive identity ecosystem framework, build and implement interoperable identity infrastructures aligned with the common identity ecosystem framework, enhance confidence and willingness to participate in the identity ecosystem, ensure the long term success of the identity ecosystem). The strategy concludes with a commitment to action notably by federal agencies.
c) The role of government in payments risk and fraud 41 ------
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The Federal Reserve Bank of Atlanta (holding US-wide responsibility for retail payment systems) held mid November 2011 a Symposium to, in light of the many legislative and regulatory changes affecting the payments industry, look at ―how and when government should intervene in today's highly dynamic marketplace‖. The Symposium consisted of 5 sessions: changes in regulatory oversight and self- governance, law enforcement challenges, the need for better fraud data, changes in the US regulatory environment, and payment laws and regulation in a dynamic payment environment. We highlight some of the presentations hereafter. This debate has relevance also in the context of the emerging discussion in Europe about the relation of non-supervised, non-regulated services providers to the payments system and customer – in particular: consumer – services.
The FDIC (Federal Deposit Insurance Corporation) provided an overview of the US regulatory structure, covering financial institutions, technology service providers, payment system networks, with however payment processors falling outside the regime. Already in 1979 the US established an inter- agency body, the Federal Financial Institutions Examination Council (FFIEC) to prescribe uniform principles, standards and report forms for examination of financial institutions. In 2011 the FFIEC issued an ―Authentication Supplement‖ to its 2005 Authentication Guidelines. This supplement notably requires regular risk assessment updates, the use of multifactor authentication at least for commercial accounts, and layered security for all high risk accounts. Customer awareness should also be enhanced, notably financial institutions must explain to customers the protections provided, and those not provided, relative to electronic funds transfers.
Visa‘s contribution featured an interesting map of the US payments landscape, identifying no less than 45 different types of service providers supporting cardholders, issuers and acquirers.
Source: presentation by Visa to the 17th/18th November 2011 Federal Reserve Bank of Atlanta Symposium 42 ------
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The thrust of the presentation was on the priority to be given to security – that alone can sustain trust and enable growth. Although global fraud rates have been continuously decreasing since 1992, a multi- layered strategy (―prevent, protect, respond‖) is deployed in partnership with all stakeholders. In addition, Visa looks at leading and executing risk strategies for emerging products and entities. Visa notably emphasizes the need to protect vulnerable account data. It i.a. requires its clients to register their third party agent with Visa (over 2,300 unique third party agents have been registered so far in the US). The applicable due diligence requirements are based on the FFIEC Guidance. Visa works with standardization and industry organizations (notably the Electronic Transactions Association – ETA) to drive security and fraud prevention objectives. The key challenges identified by Visa with respect to rationalizing government oversight were: - The need for supporting greater accountability for all parties that store, process or transmit cardholder data (in particular PINs). - Clarifying oversight of payment processors or other providers; - Acknowledging the need for multi-layered risk management, and taking into account diverse business environments. - The absence of a level playing field between large and regional debit networks with respect to fraud controls and risk compliance programs. - Recognizing the effectiveness of self regulation.
The Consumer Financial Protection Bureau (CFPB) advocates a finance market place ―where customers can see prices and risks up front and where they can easily make product comparisons, and in which no one can build a business model around unfair, deceptive or abusive practices‖. The role of the Bureau i.a. is to collect, research, monitor and publish information relevant to the functioning of markets to identify risks to consumers and the proper functioning of such markets. The CFPB will choose the most efficient and effective tool for any particular policy challenge requiring CFPB action.
The CFPB has enforcement authority over any ―covered person‖ who either offers or provides a ―consumer financial product or service‖, defined as: - Transmitting or exchanging funds, - Selling, providing, or issuing stored value of payment instruments, - Providing check cashing, check collection or check guarantee services, - Providing payments or other financial data processing products or services to a consumer. For the time being (as no CFPB Director has been confirmed by Congress yet), the scope of the Bureau‘s enforcement authority over non-depository institutions is uncertain. The CFPB has already been authorized to examine large depository institutions and other ―covered persons‖ who are larger participants in the market for consumer financial products or services. The CFPB is required to issue a ―larger participant rule‖ at the latest by 21st July 2012. In that context the CFPB is soliciting market input as to: - Which markets to cover in an initial rule (money transmitting, check cashing, prepaid cards), - The criteria and thresholds to apply in order to define a ―larger participant‖, - Which data to use in measuring such criteria.
The US Department of Justice presented an overview of the most salient payment fraud occurrences (as of March 2011). Of note are phishing attacks worldwide, with some 43.000 targeting unique domain names, of which 28% were registered maliciously by phishers, and the bulk of the remaining compromised or hacked. In addition the malicious use of sub-domain registration services nearly doubled in the 2nd half of 2010, and accounted for the majority of phishing in many Top Level Domain names. The average and median uptimes of phishing attacks rose throughout 2010 (with an average 43 ------
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uptime of 73 hours – the longest for any period over the last 3 years). The US Internet Crime Complaint Center also registered a string of attacks. E.g. in April 2011 compromised online banking credentials of US businesses were used to send unauthorized wire transfers to Chinese economic and trade companies located near the Russian border. The typical scenario is the one where the computer of a person within a company who can initiate funds transfers on behalf of the US business is compromised by either a phishing e-mail or by visiting a malicious website, with malware harvesting the user‘s corporate online banking credentials. Mass-marketing fraud is actually on the uptake (examples provided include a city in Romania designated as a key node for internet fraud, as well as a telemarketing scheme dismantled in June 2011 - with arrests in Cambodia, Indonesia, Malaysia – to purchase goods that were never sent, make funds transfers from bank accounts, or pay non-existent traffic or court summonses). The key points of vulnerability were identified as being mass-marketing techniques, counterfeit financial instruments, money transfer services, and money laundering.
The Federal Reserve Bank presented statistics on payments fraud. Of interest are notably the share of data breaches by sector (between Jan. 2005 and Dec. 2010), where non-bank payment processors, retail and commerce, and government (and to a much lesser extent, insurance and financial services) dwarf any other sector in terms of compromised records.
BITS (the Financial Services Roundtable, a banking industry organization) presented its views on the impacts of current regulatory efforts on fraud and risk. It sees an estimated 214 new or changing regulations trickling down from the 2010 Dodd-Frank Act, with 194 regulatory updates and 20 ―new‖ rules directly affecting US financial institutions. Whilst the Durbin amendment (that caps interchange for debit cards) allows for an increase in interchange rates for investing in fraud countermeasures, it is questioned whether such increase will be sufficient to justify investment. It is furthermore questioned whether alternate payments will be treated equally with respect to regulation and reporting. BITS thus promotes commitment to 2-way public-private risk and fraud information sharing provided such information is timely and actionable, and increased funding for law enforcement at international, national, state and local levels to investigate cybercrimes and create better deterrents becomes available. It concluded with the recommendation to re-examine business strategy and make hard decisions regarding how to allocate scarce resources without sacrificing profitability, customer service or innovation.
A partner in a legal firm stressed that it is increasingly difficult for payment system users and providers to discern their rights and obligations with respect to a particular payment transaction. Furthermore, payments system innovation outpaces the scope of the current legal framework, so that certain existing payments laws begin to look obsolete. It was proposed that any harmonization effort should be approached with 4 objectives in mind: - Establish certainty and clarity of participant rights and responsibilities within payment types; - Promote consistency of participant rights and responsibilities within payment types - Protect the flexibility of payment processing (to enable the utilization of the most current and efficient technologies); - Develop sufficiently broad payments system laws to permit innovation with unnecessary regulatory interference or constant need for amendment. Thus payments law harmonization could be achieved either through the harmonization of consumer protections, or the harmonization of provider rights and obligations. Options include: - The harmonization of existing federal consumer protections (consistent – transaction originator identity - rather than payment instrument-based consumer protections for certain payment types) across electronic payment types (ACH, debit and card) e.g. error resolution procedures, initial disclosure procedures, periodic statement requirements, consumer liability for unauthorized 44 ------
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transactions. This would reduce compliance costs for providers of multiple consumer payment products. This could however prove disruptive for providers. - Establishing a single, harmonize federal consumer protection regime across all payment types. Significant differences in the origins and uses of payment types may however justify different treatment (e.g. cash-funded wire transfers as opposed to account-funded electronic funds transfers). - Establishing a federal regime creating baseline solvency and financial soundness requirements to mitigate default by payment services providers (similar to current state money transmitter laws). Whilst this would protect payments system users, create a more level playing field between bank and non-bank payment services providers, and leave intact (provided legislative intervention is limited) most private network rules and bilateral agreements governing payments systems, it could stifle innovation due to enhanced financial barriers to entry. - Establishing a uniform set of inter-provider rights and responsibilities for payment services providers. Existing private system rules may not allocate rights and responsibilities in a manner that maximizes social and payment system user welfare (with debatable examples including card interchange and allocation of fraud and data security risk). However network and association rulemaking is usually more effective at aligning with incentives and market dynamics. Also, legislative and regulatory schemes are relatively inflexible at adapting quickly to innovation and payments system evolution. - Creating a new federal legal regime covering all payment types and all users and providers. Such an end-to-end revision of existing payments laws would be very disruptive to providers. In conclusion any meaningful harmonization will likely require substantial federal legislative intervention in an area where Congress has ―not always demonstrated understanding or finesse‖.
The Company Counsel of Wells Fargo described what he called the US payments law patchwork affecting the processing of payments and the distribution of rights and responsibilities, and the challenges it raises: - Consumers and small businesses have limited pre-presentation control over charges against their accounts – either how or when they are originated, or in what form they are presented. - For some payment devices the paying institution has no ability to distinguish an authorized charge from an unauthorized one. - The rights and responsibilities of the various parties to a payment transaction can vary significantly, depending on the form of the payment instruction or order that they issue, process or pay. - These rights and responsibilities, and whether they may be varied by agreement, now sometimes depend on the form of the payment instruction or order received – regardless of what sort of payment instruction or order was originally issued. The recent proliferation of non-financial institutions participating in the payment process as intermediaries has: - Outpaced the definition and distribution of rights and responsibilities in payment systems law; - Created confusion concerning the credit risk associated with these participants; - Resulted in a confusing patchwork of state laws concerning the charging of fees and the application of escheat and money transmitter statutes. Equally the proliferation of electronic payment devices and systems has strained the definition and structure of rights and responsibilities under existing law.
An illustration is provided by the analysis of intermediary risk in Person-to-Person payments. These may be electronic, yet they‘re not cash, so that until the value comes to rest in a financial institution account of the intended recipient the right to receive payment is treated as an unsecured debit obligation, owed by the issuer or intermediary who has promised to deliver the value. Person-to-Person systems that include traceable, centralized records of the movement of values are, with respect to 45 ------
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consumer transactions, subject to the protections of Regulation E, including the right to disclosures, the protection from unauthorized transactions, and the right to periodic statements. Regulation E defines a financial institution as 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 funds transfer services‖. Intermediary risk in Person-to-Person payments includes intermediary insolvency (triggering issues such as: allocation of loss for in-process transactions, protection from third party claims, application of FDIC insurance, the structure of suspense or processing accounts), and intermediary processing (triggering issues such as: transaction tracking, payment confirmation, misdirected payments, responsibility for periodic statements, the application of money transmitter statutes, auditing and control standards – who stands in for the FDIC and CFPB with non-financial institution players?).
4.3.2- Australia
The Reserve Bank of Australia undertook in 2010 a thorough study of consumer payments behaviour which is being used as input to the strategic review of innovation in the Australian payment system which the Reserve Bank of Australia launched mid-2011 via a consultation paper. The scope for the review is retail payment systems. This process should lead to final conclusions being released by the Reserve Bank of Australia at the end of 2011 or early 2012 (none were available at the time of closing the present Working Paper). The Reserve Bank of Australia justifies upfront this exercise by the fact that the evolution of payment systems in recent decades provided considerable public benefit and continues to do so. At the same time the Reserve Bank is concerned that any reduced willingness or capacity to embrace innovation in any country will in a rapidly changing environment leave it behind others. Therefore the strategic review aims to identify areas where the Australian payment system may not meet the needs of end- users today, or could lag behind in 5 to 10 years. The strategic review also aims to identify the factors that may affect the environment for innovation. The Reserve Bank of Australia consultation document then describes the objectives of an efficient payment system. As to end-users, the attributes valued are timeliness, accessibility, ease of use (for both the payer and the recipient), ease of integration into other processes (as payments are rarely made in isolation), safety and reliability (with the working assumption that good system design often is the more fundamental solution), and low and transparent prices. Accessibility has 3 dimensions: the ability to access the payments system when and where required, the availability of accounts on which payments can be made, and the fact that cross-border functionalities become almost as required as national ones. Regarding low and transparent prices the Reserve Bank of Australia stresses that this is intended to mean that both prices and the system‘s attributes need to be transparent, so that user choices can be well informed. The related desirable attributes for payment system design then are: efficient design, security and robustness, interoperability, open access, risk management, ease of adaptation to changing needs. The Reserve Bank of Australia consultation document also provides an overview from the 2010 consumer payment survey. Comparisons with a prior study performed by the Reserve Bank of Australia in 2007 are also made. The 2 key conclusions from the 2010 survey are: The payment patterns identified in 2007 still hold. Cash remains the dominant instrument for payments below AUD 40, cards are the dominant one for payments up to AUD 500, and other
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methods (including internet/telephone banking, cheques and BPAy – an Australian proprietary method) are important for payments above AUD 500. But these patterns have evolved over the last 3 years, with a significant decline in the use of cash and cheques, cash being substituted by debit cards, and ―eftpos‖ (electronic funds transfer at point-of-sale) and scheme debit gaining market share.
The consultation paper then proposes to explain these patterns. The most important drivers for consumers‘ choice of payments instruments are what they are carrying with them, as well as transaction speed and the ability to use own funds – as opposed to borrowing. Although only 2% of payments were made using internet/telephone banking, they accounted for 9% of payment value. Furthermore this small share of online payments should not be interpreted as Australian consumers not being comfortable with current online payment methods. 80% of consumers have bought goods and services online, and 60% of consumers with internet access have at some time made an online transfer. However there is concern about the risk of fraud, and greater privacy is in demand too.
Both contactless and mobile payments are considered in the study as ―new‖ payment methods. Only 3% of respondents have made a contactless payment (mostly with values between AUD 20 and 50) in the month prior to the survey, and less than 10% had made a mobile payment at any time (mainly for purchasing ring tones, games or phone applications – in essence in a ―closed loop‖ mode).
The environment for innovation is then discussed by the Reserve Bank of Australia consultation document. The document acknowledges the constant stream of innovation in a number of areas (online payments, EMV, contactless cards, emergence of person-to-person mobile payments), yet points out the transmission of additional data with payments and near or real time transfers as 2 areas where anticipated demand is not met. According to the Reserve Bank of Australia, the distinction to be made between proprietary innovation and cooperative innovation is accountable for this gap. A proprietary approach to innovation will always impact the scope of innovation. According to the Reserve Bank of Australia it is less problematic for innovation to have a single, commercially focused decision-making body for a payment system (e.g. card schemes which can implement innovation through mandates).
From a theoretical perspective, the traditional obstacles to innovation are highlighted: inertia, and the fact that often 2 different groups of end users (e.g. merchants and consumers) need to be convinced simultaneously. The Reserve Bank of Australia however is more concerned with coordination issues on the supply side of payment markets. User demand for a high level of compatibility can drive co- operation, also through bilateral agreements between financial institutions as demonstrated in Australia (although the small number of meaningful financial institutions in the country would account for bilateral agreements being sufficient). The Reserve Bank of Australia however acknowledges that dominant firms have incentives to avoid compatibility. From the literature the consultation document retains the following policy recommendations with respect to innovation: Standards are an important mechanism for solving coordination problems. Public policy can support and if necessary strengthen standards-setting organizations. Voting rules of industry bodies could be changed to reduce the power of vested interests – e.g. by adding independent directors or allowing majority voting. Incomplete standardization – e.g. through translation services for incompatible technologies – should be allowed. Another option is to standardize early, before vested interest can develop.
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Finally policy makers could mandate the use of a particular standard when industry participants are resisting the compatibility of network goods. This however should only happen when standards are likely to be long lasting. Even so, setting performance standards must always be preferred to setting technical standards.
The Reserve Bank notes that the Australian experience would seem to corroborate the theoretical framework. Significant co-operative innovations have been difficult to achieve with key stakeholders often unable to reach agreement, which led to some forms of external intervention (e.g. for the creation of the RTGS, for the reform of the ATM system, for the creation of the retail payment system – COIN). This experience suggests that consideration should be given to the industry‘s governance arrangements. In Australia 2 bodies stand out with respect to the payment industry. There is first APCA (Australian Payments Clearing Association), making decisions about the co-operative aspects of payment systems through rules governing payment clearing, and second the Payments System Board, with an overarching mandate to promote safety, stability, competition and efficiency. APCA however has no formal decision-making role in relation to significant elements of the payment industry as a whole. Nevertheless it should be noted that APCA‘s governance allows for collective representation of smaller participants, and that the votes of members with larger shares are constrained. Furthermore retailers are represented on its committee for the Consumer Electronic Clearing System.
How to meet the cost of innovation is another issue. System-wide innovation will generally impose costs on some participants, and provide benefits to others. Unless a mechanism to redistribute benefits and costs can be found, such innovations require some form of mandating in order to proceed. The Reserve Bank of Australia notes that the banking industry suggested that co-operative innovation will be given the best chance of proceeding if both the ‖industry case‖ (including overall net benefits to end-users and industry participants) and the ―business case‖ (including how the benefits and costs are distributed) are clearly articulated. The Reserve Bank of Australia finally recognizes that there are situations where co-operation cannot deliver innovation, so that public sector intervention becomes required (e.g. with the RTGS system).
The consultation document recognizes the impact of the applicable regulatory framework on innovation. In Australia also, competition and consumer protection legislation place constraints on the ways in which industry participants can co-operate. The Reserve Bank of Australia asserts that it is not the intention of such legislation to prevent co-operation, and whenever needed the Payments System Board will regulate to provide legal certainty, substituting for an industry solution which would have been possible in the absence of competition concerns. The Reserve Bank of Australia however would like to identify alternative governance arrangements to give industry bodies such as APCA the capacity to achieve co-operative outcomes, supported by the Reserve Bank of Australia, without the need for the latter to regulate. (It is interesting to note that when reviewing international models for industry governance the Reserve Bank does not quote the European Payments Council – although it refers to CPA, Iberpay, ZKA, PASA South Africa, the UK Payments Council, and the Dutch National Forum on the Payments System).
The consultation document concludes on the governance issue by raising a number of questions: Do current governance arrangements adequately promote payments system innovation? Are the needs of payments system users and non-regulated payment service providers adequately considered in decisions about the direction of the payments system? Are there ways of altering current governance structures to make innovation easier? Are there ways of altering current governance structures to take more account of the views of end-users?
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Could a new decision making body with broad representation of payments system participants, service providers and end-users provide a better strategic focus for the payments system, taking adequate account of costs and the public interest? How could such a body have the capacity to reach decisions across a diverse group of members? Could such a group make binding decisions and how could they be enforced? Could formalisation of a broader mandate for APCA, coupled with broader representation, provide better industry-wide outcomes? What role should the Reserve Bank of Australia and the Payments System Board play in setting the reform agenda for the industry? Have concerns about breaches of competition legislation prevented the industry from achieving greater co-operative innovation? What approaches are suggested to deal with this in a way (that does not undermine the intent of the existing competition legislation? What are the advantages and disadvantages of each?
The Reserve Bank of Australia consultation document goes on to discuss whether the current structure of clearing and settlement rules and arrangements is the most conducive to innovation. The Reserve Bank of Australia‘s view is that the latter should allow relatively straightforward access to players with new products and new business models. The Reserve Bank of Australia recognizes that a subset of institutions wishing to provide a new type of retail payment with different characteristics to those currently cleared through APCA would have difficulties for being accommodated by APCA. This leads the Reserve Bank of Australia to also question whether the delineation currently existing between system-specific rules, APCA clearing rules and Reserve Bank of Australia rules relating to e.g. eligibility are appropriate, logical, and provide the right degree of flexibility. Along the same lines the Reserve Bank of Australia looks into system architecture and recognizes that it impacts both access and capacity to innovate. It sees the decentralized governance and the architecture of the Australian payment system (based on bilateral arrangements) as being potential obstacles to access and innovation.
The Reserve Bank of Australia consultation document closes with a shortlist of innovation gaps in the Australian payments system. It proposes that each of the gaps be assessed on the bases of the following questions: How widespread is the demand for the innovation in question and how significant would the impact be? Are there any specific impediments to that innovation occurring e.g. barriers to entry, co- ordination problems, technological constraints? Is there a case for public intervention? The shortlist of gaps – compiled as a result of the first consultation round with stakeholders – comprises the following: The transmission of data with payments (an issue closely linked with the objective of integrating payments systems with other processes, notably for businesses – and related to electronic bill presentment and payment, also referred to as e-invoicing. Timeliness of payments – which has at least 2 dimensions: those receiving payments want to have access to funds as quickly as possible, with retail merchants wishing to receive a real time confirmation. Timing and availability of funds – recognizing though that for many payments delayed availability is not a great concern. Real time confirmation of payments: this is grounded on the view that for many merchants it is not immediate access to funds that is important, but immediate confirmation that an irrevocable instruction to pay the funds has been made and that the funds are indeed available at the payer‘s account. 49 ------
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Ease of addressing payments (this is a specific issue for Australia – and a number of other countries – who have not yet implemented IBAN or a similar solution). Person-to-person payments (this again may be specific to Australia, the Reserve Bank judging that efficient person-to-person payments have been slow to develop, and calling for a user friendly, universal person-to-person electronic payment system in Australia). Mobile payments: the Reserve Bank of Australia categorises mobile payments in function of the interface used (either SMS, or mobile internet payments, or contactless transactions), and the source of funding for the transaction (either a range of traditional payment instruments, or through telecommunication companies expanding their role as holders of stored value or providers of credit). The Reserve Bank judges that currently there are no particular impediments to the development of mobile payments in Australia. Electronic purse systems: the Reserve Bank of Australia notes that there are relatively few cases where electronic purse systems have developed independently from e.g. transport ticketing systems, so that e-purse would not be a priority for the Australian policy maker. Standards: the reflections of the Reserve Bank of Australia focus on ISO 20022 and propose that the adoption of this framework would improve the compatibility of the Australian system with overseas systems.
In December 2011 the Reserve Bank of Australia released a revised position (―Standard‖) regarding merchant surcharging on credit and debit cards. Australian regulation (―Standards‖) earlier last decade ensured that card schemes would not prevent merchants from applying a fee or surcharge for card acceptance. As concerns raised that a number of merchants would recover an amount significantly in excess of the cost of acceptance, the Reserve Bank of Australia in 2011 launched a public consultation on the way forward.
In its December 2011 conclusions, the Reserve Bank of Australia announced that card schemes will be allowed to limit the level of surcharges (based on the ―reasonable‖ cost of card acceptance) that merchants may levy. The merchant‘s cost of acceptance is defined as including yet not being limited to the applicable merchant service fee. It can be determined in reference to: - The merchant‘s cost of a particular card transaction, - The average acceptance cost for that merchant of all cards, - The average cost to that merchant of accepting a subset of credit cards. Merchants may choose to recover their costs for card acceptance by applying either a different surcharge for each different card type, or a single surcharge rate for all cards, or for a particular scheme, or for some combination. Merchants may apply a surcharge on an ad valorem or flat fee basis.
It is worth noting that in justifying its decision the Reserve Bank of Australia highlights that it does not believe that preventing surcharging for online payments would lead to efficient outcomes – as it would inhibit the ability of any emerging payment system with lower acceptance costs to compete.
4.3.3- Canada
The Canadian payment industry is also conducting a strategic review of the payment system, with the target of submitting recommendations to the Minister of Finance by the end of 2011 (though none were available at the time of closing the present Working Paper). The debate is supported by a discussion paper (―The Way we Pay – Transforming the Canadian Payments System‖) and a research paper (―Scenarios for the Future of the Canadian Payments System‖).
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The discussion paper‘s starting assumption is that ―the information revolution and the advent of the digital economy will bring massive change to the way we pay – albeit in ways and degrees which will differ from country to country‖. Therefore the discussion paper also recommends that payment innovation taking place in other countries should not be copied, rather, responses to the challenges facing the Canadian system must be developed.
The scope of the discussion paper is the transfer of value in a broad sense: included are traditional payment instruments (cash, cheque, debit and credit cards) as well as ―modern‖ ones (gift cards, reward points, virtual currencies, used online, as much as automated funds transfers, in essence ―anything used to buy and sell things‖). The discussion paper therefore analyzes in particular mobile and contactless payments, integrated electronic invoicing and payments solutions, and looks into digital identification and authentication, and how much existing laws and codes, and governance models, in Canada and around the world, affect payments.
A significant concern of the discussion paper is that Canada could fall behind in payments system development in terms of both innovation and efficiency. It proposes that attention focuses on mobile payments and electronic invoicing and payments. It recognizes that Canada is not yet a player in mobile payments and suggests that this is not due to customer disinterest but to getting the bank and telecommunication industries working together. As to electronic invoicing and payments the challenge clearly is to move away from cheques, a progress which may be hindered by a batch-based clearing system which had been designed for paper.
For Canada to become a leader in payments the discussion paper identifies 4 distinct challenges: Increasing fairness in debit and credit card networks, Updating the regulatory and governance structure, Improving online authentication, security and privacy, And transitioning to a digital economy.
With respect to debit and credit card networks the discussion paper recognizes that while consumers are free to choose payment methods merchants must absorb different costs, including for security. The discussion paper however notes that it has not yet been shown that different interventions around the world to limit interchange fees have had any direct effect on consumer prices. Nevertheless the discussion paper offers to look into whether point-of-sale debit should be controlled so that prices stay low, whether network competition is causing unintended consequences, and whether merchants are disadvantaged in the end by the wide choice existing with credit and debit card practices.
With respect to the regulatory and governance structure the discussion paper recognizes that also in Canada payments are governed by a ―patchwork of legislation‖, the result of piecemeal responses to economic changes, which may hamper competition and innovation. Such regulation also becomes obsolete as it focuses on financial institutions, whilst payments are no longer the latter‘s exclusive domain. Whether payment service providers may introduce innovation with or without government review, and/or stakeholder consultation, affects their competitive position. Regarding stakeholders the discussion paper notes that payments stakeholders such as merchants and consumer groups do not have an effective forum in which to work together with payments service providers to resolve issues.
The discussion paper also leaves the reader in no doubt as to the necessity to enhance online authentication, security and privacy. The paper suggests that 2-factor authentication could be a
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solution, with three-factor as a possible next step. It also points to the balance that needs to be found between fraud reduction for merchants and privacy protection for their customers.
With regard to transitioning to a digital economy, the discussion paper laments the weight of cheques and related processes in the Canadian economy, and notes that government is directly responsible for 20% of them. In closing this list of challenges the discussion paper also mentions financial literacy as an essential consideration in any transition plan: ―any changes to our system must take into account people most vulnerable to them‖.
Extensive consultation with stakeholder groups enabled the Task Force for the Payments System Review to develop 12 principles to provide guidance in addressing these challenges: 1) Competition and innovation: the payment industry is open and competitive, participants have the ability to innovate. 2) User access and efficiency: all consumers, including merchants, business, and governments have access to effective, affordable payment options. 3) Transparency and choice: rules, responsibilities, risks and costs are clear, participants have necessary information and tools, payors and payees can choose among a variety of payment forms without undue penalties. 4) Fairness and accountability: costs accrue to market participants who receive the associated benefits, unless another party chooses to bear these costs, all sides understand the associated risks. 5) Security: all vital technologies and processes are secure and reliable, payors and payees have confidence in the payments system. 6) Privacy: payors own their personal (or organizational) information, and can determine how it is used, payors need only disclose information necessary for a given payment. 7) Consistent standards: rules for domestic payments are consistent to ensure efficiency, domestic standards facilitate global interoperability. 8) Minimal regulation: regulation occurs only when the open market and industry standards fail to deliver on market related principles. 9) Neutrality by function: standards and rules are based on the activity performed, not the institution performing the activity, rules apply consistently across function. 10) Proportionality: protection takes into account risk involved transaction type and dollar value. 11) Independent and conclusive: governance of the payments system is not controlled by a minority of stakeholders. 12) Framework adaptability: industry governance is robust, yet flexible enough to remain relevant over time. These principles led the Task Force to formulate a Governance Framework to respond to the regulatory and governance challenges, a framework on which all stakeholders are invited to comment. The proposed framework is composed of 4 components: - Payments legislation: inclusive, functional, and proportionate payment-specific legislation should be introduced. Mandatory membership in the new self-governing organization for all players would be provided for by this legislation. The key objectives of this new legislation would be to open competition, provide for user protection, and minimize systemic risk. - An industry self-governing organization (SGO): the Task Force believes that most problems in the payments system can be solved by system participants. Thus an SGO, self funded and self governed, including all payment players, should be tasked with e.g. developing standards in emerging technologies, and establishing codes of conduct for business practices. Industry members are expected to show leadership, hence the SGO‘s organization, agenda and operation should be left to the SGO. 52 ------
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- A basic payments infrastructure: the existing Canadian infrastructure needs to be upgraded to fully accommodate digital payments, including online features that allow for greater data transfer and digital identification and authentication. In addition the degree of concentration of ownership and control of payment networks needs to be reduced, open access must be enabled, the vehicle must facilitate the funding of infrastructure investment, and a user-pay model must be developed to sustain the infrastructure. - A payments oversight body, in charge of both policy and compliance: an independent public payments oversight body – consisting of a small cross-section of independent experts - will be established to monitor evolution in payments and provide advice during the transition to a digital economy. This body would hold regulatory responsibility to address non-compliance and allow for recourse.
An interesting part of the consultation documentation is the presentation of 4 possible scenarios for the future of the Canadian payments systems. These are predictions, not preferences. These scenarios developed by a dedicated Roundtable are primarily defined and differentiated by a set of key uncertainties, the 2 most critical ones being (according to the members of the Roundtables): - How well aligned is the Canadian payments ecosystem? - How rapid is consumer adoption and user adoption?
Thus, these 2 sets of uncertainties result in the definition of 4 scenarios for the course to 2020:
(Source of chart: Canadian Task Force for the Payments System Review: The Way we Pay – Transforming the Canadian Payments System – July 2011) These 4 scenarios are defined as follows:
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―Groundhog Day‖ (fragmented ecosystem and moderate consumer adoption): this scenario assumes tomorrow is a continuation of the past, leaving Canada behind much of the rest of the world. ―Tech-tonic shift‖ (fragmented ecosystem and rapid consumer adoption): technology companies such as Google, Apple and social networking sites develop alternative payments platforms and become major players. Government is slow to regulate and competition is fierce, leading to high consumer adoption and cheap new technology platforms. The proliferation of new financial services and applications to address specific needs is phenomenal. ―Canada Geese‖ (aligned ecosystem and moderate consumer adoption): a strongly aligned payments system over the course of this decade reduces friction, yet players are not necessarily inclined to implement new technology, and the cost of standards and regulatory requirements slows innovation. The payments system evolves on the basis of gradual shifts through evidence-based reform and road-tested technologies. ―Own the podium‖ (aligned ecosystem and rapid consumer adoption): coming together, the industry is able facilitate the rapid development of a set of standards in particular for privacy, security, digital identification and authentication, and mobile payments. The principles that Canadians ―own their own data‖ and the accompanying robust digital identification and authentication systems that are developed enable rapid consumer adoption. Lessons learned in payments can be ported to other industries, such as health. By 2020 Canada as a global leader in payments will export expertise and systems to the global economy.
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5- Review of academic research
1. Summary Admittedly any selection for inclusion in this Chapter will be perceived as arbitrary, if only because of the number of pieces which are excluded. To mitigate somewhat this perception of arbitrariness, we have limited references to authors who have been mentioned (in papers, or conferences) by policy makers or overseers. A few are presented here, by alphabetical order of their authors. Even if the one or the other piece has been developed with either mobile or cards as background, the conclusions are independent from any given payment instrument. We begin by reviewing a paper developed end 2008 by the British Ministry for Entreprise and Regulatory Reform. What drew us to this paper is that it takes a cross-industry approach to the challenges of innovation. It is however not so much a ―governmental‖ paper as the outcome of a wide consultation, and the authors take responsibility for the views they express. The paper finds that the relationship between innovation and regulation is both complex and dynamic. As new technologies, products and business models develop, new markets and market failures may emerge requiring changes to the existing regulatory framework. The paper notably finds that the impact of regulation on innovation is influenced by the way in which new proposals are designed, implemented and enforced. Evidence shows that policy makers and regulators are more likely to support innovation, or avoid hampering it, if they provide businesses with some flexibility as to how desired policy outcomes are delivered, clearly inform businesses about future changes in the regulatory framework well in advance, specify desired outcomes which cannot be easily achieved using existing technologies and business practices, stipulate clear requirements, reducing the possibility of misinterpretation, impose minimum compliance costs, and complement other government market-based and regulatory-based policies which promote innovation. In general regulation is a response to market failure which occurs in 4 instances: market power, under- supply of a good/service, externalities (with an under-supply of goods/services which could deliver benefits, and an over-supply of goods/services which would impose wider costs on society), and asymmetric or incomplete information. Standards can complement or substitute regulation, in particular standards can help to address information failures and/or market co-ordination failures. The paper finds also that the relationship between regulation and innovation is ambiguous when it comes to e.g. competition. Pro-competitive regulation that prohibits anti-competitive behavior encourages innovation by reducing barriers to entry for new, more innovative firms, and by allowing firms to choose more freely the strategy and business model which best facilitates innovation. Yet the same regulation may restrict innovation by preventing businesses from collaborating closely at the ―R&D‖ stages by preventing certain organizational structures or the forming of some agreements which could facilitate the transfer of knowledge and technologies. The work of S. Chakravorti (formerly with the Federal Reserve Bank of Chicago) is often referred to by many academics. He identifies 4, not necessarily mutually exclusive investment strategies for payments innovation (decrease cost, increase revenue, acquire customers, and retain customers), and divides innovation into technology innovation and service innovation. Drivers for providers to innovate are on one side entry into new business areas (either improving or changing the underlying technology, possibly offering a superior product, serving new niche markets, or introducing a marketing revolution), on the other financial innovation (to obtain a first mover advantage either to access an untapped market, or provide a product or process improvement to an existing market). As to new payment instruments 3 conditions are required for their market adoption:
Overcoming the chicken and egg problem and security and liability issues,
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Providing superior benefits to most participants, Not decreasing net benefits to any participant in a given payment segment. The work of S. Chakravorti has been leveraged by notably Bourreau & Verdier who, focusing on mobile payments, define 5 cooperation models between banks, mobile network operators and payments systems and study the incentives for banks and mobile operators to invest in mobile payments, and the incentives for consumers and merchants to adopt the technology. They conclude that of the 5 cooperation models (the light, the mobile centric, the bank-centric, the partial-integration model, and the full integration model), the partial-integration and full-integration models are the most costly to develop, yet they are the most efficient to serve the mass-market. The light model will be most suited to introduce innovation, but it is restricted to niche markets. In their findings they concur with Chakravorti & Lubasi (2006) in that ―payments innovations are generally more successful when they utilize existing infrastructure and initially target profitable niche markets‖.
As to D. Evans, his most recent paper analyzes the consequences for innovation of inverting the business model for payment cards, i.e. moving through the ban or limitation of interchange from a ―merchant pays‖ model to a ―consumer pays‖ model. The paper is US- and card-centric, but parallels with the discontinuation of interchange for SEPA direct debits and its impact on innovation do exist. Evans accepts that sharply reducing interchange does not eliminate innovation (as service providers adapt and adjust types of payment innovation) but that overall investments into payment innovation will decrease as it is far more difficult to extract revenues from the consumer side than from the merchant side. Finally Evans postulates that the shift in business model could hinder the emergence of new payment systems and providers and will direct innovation to ―chargeable‖ areas of the payment business.
Flecher, Jennequin and Lorenzi take the telecommunications sector as the background for their research into the relationships between innovation, investment and regulation. This paper is interesting too as the 2-sided nature of the telecommunications industry has often been likened to the payments industry. Governments have since long intervened in the telecommunications sector because of its importance to society and the economy – again a strong parallel with the payments industry. The paper looks for answers as to whether regulatory policy needs changing in order to foster long term innovation and investment. The paper notes that regulators aim not only at allocative efficiency but also at the development of efficient competition. It demonstrates that competition law contributes to efficiency gains yet does not necessarily foster effective competition. The paper proposes 3 possible scenarios for regulating the telecommunications sector in the future. A first option would be to adapt the ex ante regulation policy to past and current changes – but long term positive effects are by no means guaranteed. A second option is to replace ex ante with ex post regulation – an option not seriously considered by regulators for the time being. A third option consists of taking into account the macro-strategic dimensions of developing the telecommunications sector at national and international level, and the importance of technology businesses at national level, i.e. developing a vertical industrial policy, possibly drawing on assistance from the State and relying also on social cultural and technological policies.
Liezenberg et al. propose a segmentation of payment solutions based on the key drivers of transactions i.e. the behaviour of buyers and sellers in order to optimize the use of existing payments services and improve them, and develop new ones – in short innovate. Liezenberg et al. introduce a generic transaction model (where the buyer and the seller go through 3 processes: an agreement, payment, and delivery) and propose that the risk at the heart of any transaction is well balanced when agreement, payment and delivery occur at one time, in one place, but that with new channels such as internet or 56 ------
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mobile, agreement, payment and delivery become disconnected in time, and risks for buyers and sellers unbalanced, leading to the development of multiple payment and delivery methods. These disconnected processes affect the perceived transaction risk, notably with respect to its payment and delivery components. Liezenberg et al. conclude that payments solutions with low risk come at higher costs than non-guaranteed payment solutions – assuming that cost and usability considerations are secondary to risk assessment, meaning that perceived risk is the determining factor for the choice and use of a payment transaction, with both seller and buyer seeking to optimize risk exposure in relation to payment instrument cost and usability. The authors stress that whilst payment segmentation is achievable within a transaction context, a generic segmentation irrespective of context is not possible. All these findings have relevance for the SEPA and payments innovation discussion:
The conditions necessary for the development of innovation and market adoption are well defined and must be present. Throughout academic papers the reality of innovation emerging in niche markets first, under clear economic conditions, is highlighted. The criticality of cooperation between various groups of stakeholders, yet the difficulty in organising it, and the costs to be incurred, point to a necessary enhancement of governance arrangements, and the need for incentives to all parties concerned. The correlation of transaction risk with payments innovation shows that payments service users in low risk transaction contexts will subsidize payments service users in higher risk transaction contexts, in short, grocery buyers subsidize internet gambling (and many other, seemingly more acceptable remote and virtual purchase and payment situations). The drain that a regulation on interbank remuneration imposes on capital and motivation to innovate has been evidenced. Unfortunately none of the above has been acknowledged by European policy makers and legislators. So either the SEPA experience will defy academic conclusions, or….
2. BERR (UK Department for Entreprise & Regulatory Reform) Economics Paper No. 4: Regulation and Innovation: evidence and policy implications (December 2008) Strictly speaking this is not an academic paper. It is the output of a joint project executed by the UK Department for Innovation, Universities and Skills together with the Department for Business, Entreprise and Regulatory Reform, and the ―Better Regulation Executive‖. Other stakeholders consulted during the development of the BERR paper include the Confederation of British Industry, the manufacturer‘s organization EEF, independent regulators as well as the British Standards Institute and the London School of Economics. The paper stresses that the views expressed therein are those of the authors and should not be treated as government policy. The BERR paper is interesting in so far that it takes a transversal, industry independent approach to the question of regulation and innovation. In doing so it is able to leverage the experience gained from multiple business sectors through an extensive review of the evidence on regulation and innovation. The paper finds that the relationship between innovation and regulation is both complex and dynamic. Regulation directly or indirectly affects the nature and direction of innovation as well as the ways in which businesses innovate. As new technologies, products and business models develop, new markets and market failures may emerge requiring changes to the existing regulatory framework. The paper notably finds that the impact of regulation on innovation is influenced by the way in which new proposals are designed, implemented and enforced.
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Changes in the regulatory framework would not immediately and directly bring about changes in innovation. Regulation can affect innovation on both the supply side and the demand side of the innovation system. Evidence shows that policy makers and regulators are more likely to help beneficial innovation, or avoid hampering it, if they:
Provide businesses with some flexibility as to how desired policy outcomes are delivered; Clearly inform businesses about future changes in the regulatory framework well in advance; Specify desired outcomes which cannot be easily achieved using existing technologies and business practices; Stipulate clear requirements, reducing the possibility of misinterpretation; Impose minimum compliance costs; Complement other government market-based and regulatory-based policies which promote innovation. The paper positions the motives of why policy makers and regulators are keen on innovation in ways which are very similar to what we found previously: raise productivity, reduce the gap with other industrialized countries, in particular the United States. The paper recognizes that firms innovate for a number of reasons, which include to gain a competitive advantage, comply with new regulatory requirements, mitigate the impact of regulations, reduce compliance costs. Innovations can be both technological and non-technological in nature, and are either radical (resulting in completely new processes or products) or incremental. There is also ―hidden innovation‖, when businesses e.g. develop new organizational structures, business models, new management practices, or combine existing technologies and processes in new ways. Innovation in services (or even the public sector) is often misunderstood because much of it is hidden innovation. Formally, the 2005 OECD-Eurostat Oslo Manual distinguishes between 4 types of innovation: process, product, marketing, organization. The paper also presents findings from research into innovation. Actually 33% of businesses in the financial intermediation sector develop product innovation (NESTA 2008), 24% of the same are involved in process innovation (also NESTA 2008). The same research finds that the number of businesses in the financial intermediation sector involved with ―wider innovation‖ (i.e. new marketing strategies, new advanced management techniques, new organizational structures, new corporate strategy) ranges from 18 to 31% (the lowest rating going actually to new advanced management techniques). Overall the financial intermediation sector is only overtaken by the ―computer and related‖ sector (as should be expected), for process innovation by the research and development sector, and for product innovation by both the ―computer and related‖ sector and the research and development sector, whilst coming neck to neck with the manufacturing sector. Regarding barriers to innovation the 2008 NESTA survey quotes compliance with regulation, which is viewed as a major barrier by businesses providing services in low and medium technology sectors. In general regulation is a response to market failure which occurs in 4 instances: market power, under- supply of a good/service, externalities (with an under-supply of goods/services which could deliver benefits, and an over-supply of goods/services which would impose wider costs on society), finally asymmetric or incomplete information. Standards can complement or substitute regulation, in particular standards can help to address information failures and/or market co-ordination failures. The paper elaborates on why the relationship between regulation and innovation is complex: changes in the regulatory framework do not immediately and directly bring about changes in innovation. There are several examples. Lowering barriers to entry for new businesses may incentivize existing players to 58 ------
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develop new products and improve their processes, so that ultimately would-be entrants find it hard to get a foothold. Strengthening intellectual property rights may increase the rewards from successful development, this may be achieved by lengthening patent protections or by increasing speed to market. Regulations altering the relative cost of innovation may impact businesses‘ decisions about their choice of innovation inputs (e.g. investment in software, or marketing, or advertising). On the supply side regulation may result in a shift in investment away from infrastructure into services resulting in new products (e.g. in the UK telecommunications sector new products such as innovative call plans and bundling of fixed and mobile phone services). The relationship between regulation and innovation is ambiguous when it comes to e.g. competition. Pro-competitive regulation that prohibits anti-competitive behavior would encourage innovation by reducing barriers to entry for new, more innovative firms, and by allowing firms to choose more freely the strategy and business model which best facilitates innovation. Yet the same regulation may restrict innovation by preventing businesses from collaborating closely at the ―R&D‖ stages by preventing certain organizational structures or the forming of some agreements which could facilitate the transfer of knowledge and technologies. The paper also notes that regulations which successfully deliver economic, social and environmental policy objectives may adversely affect the pace and nature of innovation – a view to be kept in mind when looking at the interplay of the SEPA internal market project and the policy makers accent on innovation in payments. The paper finally observes that the relationship between regulation and innovation is dynamic, as technological and non-technological innovation may lead to the emergence of new markets, and market failures, which in turn will require changes to the regulatory framework. The paper provides the specific example of the telecommunications sector (as demonstrated by Brousseau in 2000 in his ―The link between regulation and innovation: some preliminary remarks‖) where the digitalization of transmission changed the structure of the sector from a natural monopoly one to one in which operators had ―normal‖ cost structures, driving policy makers to introduce a more pro- competitive regulatory framework which pulled new operators into the industry, spurring innovation in the form of new products. The figure below represents the conceptual model of the links between regulation and innovation.
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(from the December 2008 BERR Economics Paper No. 4 on “Regulation and innovation: evidence and policy implications” – page 22) This model is inspired by 2 important frameworks used by government to guide and inform policy making. A first framework leverages the 5 drivers of productivity growth, as regulation is one of the instruments governments can use to deliver economic objectives. The second framework is the ―Rationale-Objective-Monitoring-Evaluation-Feedback‖ (or: ROAMEF) model of policy appraisal and evaluation. The model above thus begins with defining the policy objective (either an economic objective or a social or environmental objective), then assumes that government decides to use regulation (rather than e.g. taxation or public spending) to achieve it. Regulation may translate either into new regulation, revision of existing regulation, or removal of existing regulation (i.e. de-regulation). Regulation may entail the use of alternatives such as self-regulation (e.g. voluntary codes of conduct). The different changes in the regulatory framework alter the total stock of government policies (regulatory, taxation, spending) and the scale and nature of interactions between them. Of course changes in any of the other productivity drivers (competition, skills, investment, enterprise) of the innovation system may also affect policy outcomes such as productivity or social and environmental objectives. The paper finally tries to confront the question as to whether regulation promotes or hinders innovation. The authors analyzed the handful of studies which provide insight into the factors which influence the impact of regulation on innovation. They find 5 influencing factors: the degree to which regulation prescribes particular behaviors as well as outcomes, the extent to which businesses can comply with regulation using existing technology and practices, the amount of advance notice, the amount of remaining uncertainty surrounding the future regulatory framework, and the costs of complying with 60 ------
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new rules and requirements. Regulation can be either prescriptive-based, or performance or outcome- based. The latter allow businesses greater flexibility in how the desired outcome is achieved, and can encourage innovation, provided that the activities of businesses are appropriately encouraged and where necessary enforced. However performance-based regulation may also discourage innovation when e.g.; the development of new technologies does not guarantee compliance and may even result in financial penalties. The authors of the paper concur with Ashford et al. (1985) that regulation-based stringency is the most important factor influencing technological innovation, a regulation being stringent when businesses need to significantly change their behavior or develop new technology in order to comply. Time is a further important variable: if businesses are given too little time to comply this may result in inferior technological, economic and social outcomes. The timing of standards also has an impact. The paper quotes Standards Australia (2007), which found that ―if a particular product or technical standard is imposed too early in the process of developing a new product, then the effect on innovation may be negative. On the other hand, a standard that comes along too late may result in unnecessary costs or duplication of “lock in technologies that were not the most efficient and potentially detrimental to innovation‖. The paper then discusses the impact of regulation on innovation inputs and outputs. It suggests that the opportunity cost of allocating limited resources to complying with regulation could imply ―lost‖ innovation – the amount of which is a function of whether compliance costs are one-offs or recurring, and whether businesses can rebuild their funding capability following compliance. Lost innovation will also be inversely proportional to the size of the businesses affected by compliance. The BERR paper concludes with some practical ideas aimed at helping ensure that policy makers, analysts and regulators fully consider the potential impact of new regulatory proposals at all stages of the policy development process:
Policy makers and analysts could consider using an ―innovation filter test‖ to identify at the very start of the policy development process the potential impact of proposals on innovation. Subject to this filter test, policy makers and analysts could consider as part of their appraisal of new (de-) regulatory proposals the potential impact on innovation. The assessment should include the following questions: - Do proposals have the potential to promote or hamper innovation? - Do proposals interact and overlap with the stock of regulations and other instruments? - Is innovation likely to influence the effectiveness of proposals? - What is the regulatory approach being adopted? - Do the proposals create any potential trade-offs? - Are the proposals likely to be updated frequently? A voluntary checklist of principles should be developed which regulators and practitioners could use to help promote innovation. This would include: - How regulation may impact on beneficial innovation activity. - How interaction with the stock of existing regulations may affect innovation. - Whether regulatory approaches that are outcome-focused and technology-neutral are favored. - How implementation and enforcement can promote innovation. - The effects of timing of regulation on innovation. Further evaluation work should be carried out on the effects of regulation on innovation and the impact that innovation has had on policy outcomes using some recent examples of (de-) regulation as case studies.
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3. M. Bourreau & M. Verdier: Cooperation for innovation in payment systems: the case of mobile payments – February 2010 In their working paper the authors analyse the development of mobile payments as an innovation and propose that 5 cooperation models between banks, mobile network operators and payments systems have emerged or could emerge to support this market. They also study the incentives for banks and mobile operators to invest in mobile payments, and the incentives for consumers and merchants to adopt the technology.
The authors first note that in developed countries mobile payment solutions will have to compete with well accepted debit and credit cards and other means of payment. But specific issues and problems may also account for the slow development of mobile payments: low customer willingness to pay for the service, technical and standardisation hurdles, lack of incentives from mobile operators and banks, problems of coordination between the different types of suppliers, security and privacy issues.
For the purpose of their working paper the authors define mobile payments as the process by which 2 parties exchange money using a mobile device (such as a mobile phone, wireless device, computer or PDA) in return for goods or services. To ensure that peer-to-peer money transfers (which have caused an increase in the use of the mobile phones for exchanging money) are not excluded the working paper will focus on ―mobile money transfers‖. This definition however excludes all other banking services which can be provided through mobile devices – such as account information or portfolio management services – that do not involve money transfers. Furthermore, money transfers with a mobile device are classified into remote payments and proximity payments.
The working paper then reviews examples of mobile money transfers and the main players involved, and tries to size the markets for mobile payments solutions in both developed and developing countries. Finally the paper focuses on mobile payment devices as innovation in developed countries payments systems in the latter are not only characterized by the 2-sided nature usually stressed in the economic literature but also by the presence of economies of scale and network effects, which provide strong incentives for standardisation and cooperation between competitors. The authors also consider that banks play a significant role in the payment industry, and wonder whether – should mobile payments become widely used at POS - non-banks who are neither experienced with deposit management nor ATM network management would be able to provide credible services.
The working paper goes on by reviewing the incentives to innovate by the various stakeholders. To do this the paper uses the 4 generic incentives to invest or innovate in payments systems identified by Chakravorti & Kobor (see below in our Working Paper). The authors consider that mobile operators will be interested neither by cost reductions (as they are not yet active in mobile payments) nor by customer acquisition, but are interested in increasing revenue streams and retaining customers. As to banks, they will be very interested in the potential for cost reduction (mobile payments having lower handling costs than cash or cheques, yet the potential for cost reduction could be limited should mobile payments substitute card payments). Banks would also be interested in increasing revenues, attracting new customers, and protecting their market share for deposits. Both groups on the supply side are however faced with significant investment requirements, the cost of coordination, and regulatory uncertainty.
On the demand side the success of mobile money transfers will depend on users‘ incentives for adoption. To switch to proximity payments consumers must see value in substituting existing payment instruments with contactless payments, and merchants must invest in the related new interfaces. For both the value of POS contactless payments is speed and convenience, mobile phones holding in this 62 ------
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respect an advantage over cards as to send, receive, and present information. For consumers the adoption incentives will also be price and security perception. Yet some market research28 outlines that changing customer behaviour remains anyhow the more potent, stand-alone obstacle. Merchants too see cost and security as incentives, as well as additional benefits such as consumer information or mobile couponing. Generally the absence of common standards will slow down the investment and acceptance processes. However economic theory suggests that merchants may be ready to pay a higher fee than the benefit obtained because of the strategic interaction between merchants in the retail market.
The authors finally define 5 business models possible for cooperation between banks, mobile network operators, and payments systems: The light model The mobile centric model The bank-centric model The partial-integration model The full integration model Each business model is characterised by the respective degree of dependency or cooperation between the 3 categories of payers. The partial-integration and full-integration models appear to be the most costly to develop, yet they are the most efficient to serve the mass-market. The light model will be most suited to introduce innovation, but is restricted to niche markets.
Prior to discussing the cooperation models the authors describe how a mobile payment solution is organized, dividing it into 3 ―inputs‖, i.e. a mobile phone, a bank account, and a mobile platform, and considering that the mobile phone is the more essential input. The adoption of a business model for any mobile payments solution requires a choice as to how much to depend on either the handset manufacturer, the mobile network operator, or the bank. Mobile payments solutions can be developed either without the cooperation of mobile network operators and handset manufacturers, or based only on a payment card, or based on a co-operation between existing payments platforms. This approach leads to the definition of 6 different possible business models. Having discarded the option where the mobile payment service provider owns a bank or is a bank and bypasses the mobile network operator and payment platforms, the authors arrive at the 5 co-operation models referred to above.
Each business model depends on the degree of involvement of each of the 3 players defined earlier:
Degree of dependency or Bank MNO or handset Payment platform cooperation with a… manufacturer Light model weak weak Weak Mobile-centric model weak strong Weak Bank-centric model strong weak Strong Partial integration model Strong strong Weak Full integration model Strong Strong Strong
28 Ondrus et al. 2009 63 ------
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The authors also agree with Chakravorti & Lubasi (2006) that ―payments innovations are generally more successful when they utilize existing infrastructure and initially target profitable niche markets‖. 4. S. Chakravorti & E. Kobor : why invest in payment innovation ? – June 2003 This Working Paper from a staff member of the Federal Reserve Bank of Chicago provides (based on interviews with market participants and a review of relevant economic literature) a framework to study the creation and adoption of payment innovations in the context of strategic decisions by payment providers. The paper organizes contemporary payment innovations by innovator and by payment provider strategy. The conclusion is that successful payment and payment-related innovations tend to follow a predicable life cycle called the innovation time line. In scope for this discussion are payments defined as transfers of money – at the time the relevant form of money was defined as a balance in an account at a bank. Sellers and buyers holding such accounts with different banks trigger the need for interbank settlement systems, also called payments systems. The latter are interpreted broadly, including value added services complementary to the payment per se (e.g. account aggregation or electronic presentment of bills are bundled with payment services). The authors propose to divide payment innovations into either technology innovations or service innovations, the former modifying an existing process or product, or creating a new one, the latter changing the product or process without necessarily involving a change in the underlying technology. The authors further propose that there are 4 investment strategies for innovation: decrease cost, increase revenue, acquire customers, and retain customers. These are not necessarily mutually exclusive. Technology Service Innovation Innovation
To decrease cost
To increase revenue
To acquire customers
To retain customers
Cost reductions may be either immediate (by introducing simple technology or process changes) or may take years to realize. Revenue increase can be achieved by either introduction of new products and/or differentiating customers. Technology may be mobilized to increase a customer base through niche products or service enhancements to a relatively homogeneous core product. Customer retention is often seen as more effective than trying to attract new customers. New products or services aimed at
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customer retention generally include a ―stickiness‖ dimension which involves explicit or implicit switching costs. New services may be introduced at or below costs in order to gain acceptance. The paper then reviews the types of institutions creating or adopting payments innovation: banks, non- bank innovators, non-bank data processors, joint ventures and consortia. The paper then moves to discussing the innovation timeline, considering that the rationale for investment in innovation changes over time as a function of opportunity and necessity. Any successful innovation is said to face 3 distinct phases as it matures, stretching from the introduction of proprietary technology to succumbing to commoditization, with profit expectations declining over this timeline. The economic literature identified 2 main strands for providers to innovate. One focuses on entry into new business areas (with new firms either improving or changing the underlying technology, possibly offering a superior product, serving new niche markets, or introducing a marketing revolution). Another strand of literature – albeit much smaller) focuses on financial innovation. In this both banks and non- banks use innovation to obtain a first mover advantage either to access an untapped market, or provide a product or process improvement to an existing market. First movers may enjoy a competitive advantage based on lead times, learning curves, and/or barriers to entry. Generally banks tend to leverage innovation internally, whilst non-banks tend to licence it to others. When followers enter the market in their turn, consumer benefits may increase if these competitors not only imitate but improve on the original innovation. Yet the best strategy may yet be a delayed response, provided one can climb the learning curve rapidly. In a third phase innovators will seek economies of scale. When technology moves from innovation to commodity, competition shifts from product differentiation to product cost and service. Cost-laggards can usually lower their cost base by turning to outsourcing. The authors recall that 3 conditions are required for the market adoption of new payment instruments: - Overcome the chicken and egg problem and security and liability issues, - Provide superior benefits to most participants, - Not decrease net benefits to any participant in a given payment segment Already in 2003 the authors noted that only few banks were able to finance ongoing research and development efforts – a situation which most probably has only degraded further by now. Therefore in- process technology will usually be acquired, or developed with partners, or through taking equity interests in innovative firms. Innovators naturally face higher risks than those using proven technology, and hence the former will expect rewards in terms of revenues (and also brand awareness). Rewards can be earned through customer prices, but also through patents, trademarks and copyrights, legal protections which reduce competitive forces and erode product revenues and investment recovery. Patent protection has been granted e.g. for business methods and process protection29, rather than technological innovations. The paper closes with proposing a profit matrix dividing the market for payment technologies into 4 cells: successful niches, weak niches, mass-market success, and commodities. The paper notes that
29 E.g. Amazon‘s one-click check out, Open Market‘s online shopping basket 65 ------
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successful payment innovation often relies on some form of barrier to entry holding back competitors for some time, such as proprietary technology (the latter meaning also unique service offerings, and customized processes). Weak niches will be characterized by weak demand, successful niches by effective payment innovation meeting strong existing demand. In the latter competition is characterized by stronger customization. The key elements of mass-market success are economies of scale and scope, with straight through data processing promising potential situation rents – yet for very few players only. The last cell is commodities, an example being back-office functions. In theory, strategic investments are made to increase profits. This will hardly apply to SEPA, where investing is an obligation in the context of a public good objective. 5. Payments innovation and interchange fee regulation : commentary of the June 2011 D. S. Evans paper
The well-known economist David Evans just published a research paper which analyzes the consequences for innovation of inverting the business model for payment cards, i.e. moving through the ban or limitation of interchange from a ―merchant pays‖ model to a ―consumer pays‖ model. Evans‘ paper is of course US-centric: however parallels with the discontinuation of interchange for SEPA direct debits and its impact on innovation do exist.
Evans argues that cards interchange (or: ―merchant pays‖) led to drastic innovation bringing considerable benefits to merchants and consumers. He admits that proving the converse i.e. that these benefits could have been achieved without interchange or with much lower interchange, would be near to impossible – a thought not even considered by DG Competition when they argue in favour of direct pricing. Considering the shift to a ―consumer pays‖ model Evans accepts that sharply reducing interchange would not eliminate innovation, as service providers adapt and adjust types of payment innovation. On the contrary, there could be a flurry in the number of innovations, but overall investments into payment innovation will decrease as it is far more difficult to extract revenues from the consumer side than from the merchant side. Finally Evans postulates that the shift in business model could hinder the emergence of new payment systems and providers – whereas the European Commission expects quite the opposite – and will direct innovation to ―chargeable‖ areas of the payment business.
Evans then reviews the ―merchant pays‖ model and concludes that in both three-party and four-party systems merchants pay most of the charges, whilst consumers pay little (and generally do not pay for transactions). Four-party systems adopted the interchange model of three party systems. Evans notes that the ―merchant pays‖ model is common not just for payment card systems but also for e.g. shopping mall owners, e-commerce sites, advertising supported media. In his view 2 recently introduced variants to the ―merchant pays‖ model are intermediation services e.g. for restaurant reservations and couponing. Evans concludes that not only the cards business but also totally different businesses in unrelated markets, and new entrants with no market power at all, have adopted the ―merchant pays‖ model, which would point to some fundamental market dynamic.
Evans goes on by reviewing the role of the ―merchant pays‖ model in innovation. Innovations succeed when their customers (individuals and merchants) perceive they provide value. The guiding economic principle is that a multi-sided platform can exist when the value it generates covers its costs as well as the subsidies to be paid by one side to the other. Evans notes that over several decades, in multiple countries, entrepreneurs opted for the ―merchant pays‖ model rather than the ―consumer pays‖ model, with empirical evidence that the latter would hardly have led to the innovations brought to market. This
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―revealed preference theorem‖ would of course hardly apply to payments in SEPA, where the legislator is prone to determine which innovation should be delivered yet would not allow new, substitute services to be priced higher than existing services – thus annihilating value perception (and of course disincentivizing payment service providers, who have to be committed through legislatively mandated ―reachability‖).
Finally Evans discusses the impact of a ―consumer pays‖ model on innovation and investment. He first notes that recent regulatory interventions (in many countries) have reduced interchange levels by far more than price regulations imposed on public utilities or state-owned enterprises, thus impacting the relative prices for the two sides (consumer and merchant), rather than overall price levels. Such intervention drives the inversion of the ―merchant pays‖ model, but due to generally elastic demand on the consumer side payment service providers find it difficult to replace interchange revenue by increasing prices and/or reducing services. For service providers considering innovating, a reduction in interchange raises both their pre-innovation and post-innovation marginal costs, which reduces the incentive to innovate (in perfect correlation with elasticity of demand). Applied to the context of the SEPA migration Regulation, this finding means that with powerful alternatives to direct debits there will be very little incentive to invest in direct debits (again, beyond meeting the reachability obligation).
Both empirical evidence and economist studies across industries show that regulation has a negative effect on innovation. Evans notes that the price regulation of the US check system triggered much process innovation (to reduce providers‘ costs) yet almost no product innovation (until very recently, e.g. mobile phone-based electronic check capture). Similarly interchange regulation disincentivizes the emergence of new four-party systems, of course because of reduced profits prospects, yet mainly because of the inability to make use of relative prices to create critical mass. Evans concludes that even if all systems in a relevant market were subject to the same interchange cap newcomers would be at a competitive disadvantage as they would be lacking the means to incentivize consumers and unable to offer better prices to merchants. This would suggest that regulators promoting more competition grant cap exemptions to newcomers, thus triggering wider competition issues. Of course Evans‘ conclusion here is of little import in the context of SEPA direct debits: by mandating the discontinuation of legacy schemes, and imposing reachability, and capping consumer prices, the European legislator addresses – in theory – every possible acceptance hurdle.
Evans recognizes however that whilst reduced profitability prospects reduce overall innovation, the latter as such does not necessarily stop: it will rather change direction, and move to other services, which could then be bundled with account management in order to retain or increase value. Whilst Evans‘ intent is not to assess in his paper the social value of payment cards vs other payment methods, he disproves the view that less innovation in cards is good, as this would either lead to greater use of cash and cheques, or suggest that innovation should be through government-controlled payment systems – neither option is a palatable prospect.
6. Flacher, Jennequin and Lorenzi: Innovation, Investment and Regulation: What are the Options for Regulation in the Near Future? 4th quarter 2006 This is another interesting paper because it has been written against the background of the telecommunications sector, an industry which because of its 2-sided nature has often been likened to the payments industry, but which is also an industry with a different landscape and drivers. Because of the importance of the telecommunications sector to the economy and society, governments intervene by both imposing specific obligations on operators (in terms of e.g. pricing, interconnections, and
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access) but also refrain from any intervention when market solutions are considered more efficient. The Flacher-Jennequin-Lorenzi paper aims at determining whether regulatory policy needs changing in order to foster long-term innovation and investment. To that end their paper reviews the origins and limits of telecommunications legislation, postulates how regulatory policy should look in the future, and suggests 2 possible ways for regulating the sector in the future. The paper recalls that regulation aims to develop or stabilize an economic or social system. A benchmark tool to assess how this is achieved is Pareto efficiency, indicating whether scarce resources are well allocated (i.e.: can the situation of an economic agent be improved without negatively impacting that of another economic agent?). This benchmark is interesting because it is independent from any welfare function (always dependent on a subjective and political decision) and is theoretically linked to the notion of perfect competition (a sufficient condition for achieving allocative efficiency). But beyond allocative efficiency regulators also want to develop effective competition, as monopolies have no incentive to reduce costs (i.e. achieving productive efficiency), and as competition is supposed (but this has never been proven) to produce new, more efficient types of markets and firms. The paper focuses on effective competition as an enabler of allocative and productive efficiencies and both ex ante and ex post regulation (the application of common competition law) are considered. The latter limits market power and thus contributes to allocative efficiency gains but it does not necessarily foster effective competition. In addition ex ante regulation may be required to introduce effective competition into an infrastructure market where economies of scale and scope and network externalities hand an advantage to existing players. The authors describe the telecommunications sector as consisting of 2 layers, first infrastructures (in the broadest sense), and second services provided to consumers. The infrastructure should be provided to competitors at reasonable, non-discriminatory rates. 2 types of tools can then be used to achieve effective competition: market structure regulation, and price regulation of wholesale and retail markets. In this environment ex ante regulation30 is conceived as a transitory form of regulation before full and free competition takes hold. The regulator‘s choices will determine whether the market is exposed to efficient or inefficient entry, whether operators are encouraged or not to innovate, and whether global welfare increases or decreases. Ex ante regulatory intervention has been criticised. Neoclassical theory has shown that fostering competition market by market can be counter-productive when looking at the general equilibrium. Furthermore the persistence of market failures may justify the persistence of regulation, triggering new issues. In telecommunications major changes were already introduced before liberalization, therefore to question the effects of competition and regulation is a valid approach. To answer it the paper proposes to distinguish between incremental and radical innovation, with incremental innovation aiming at horizontal differentiation, and radical differentiation corresponding to a qualitative rupture. Existing research31 shows that ex ante regulation of infrastructure delays investment by competitors able to take
30 In line with Cave‘s ladder of investment theory, where the regulator first sets low access prices to an infrastructure to prompt market entry from competitors. When the latter have developed their business infrastructure access prices are increased to incentivize competitors to build their own infrastructure, and so on, the results of such policy remaining uncertain for market participants. 31 Jorde, Sidak & Teece (2000) 68 ------
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advantage of incumbents‘ investments – mandatory unbundling being a transfer of benefits from the investor to competitors. As for investment into radical innovation further research32 shows that low unbundling rates can lead to under-investment into any new infrastructures since competitors will prefer to rent rather than build. The paper promotes the view that these theories have been corroborated by empirical analysis: after over a decade of liberalization of the telecommunications sector increased competition does not guarantee an improvement in productivity. The same analysis shows that R&D spending by incumbents fell significantly. The paper then proposes 3 possible scenarios for regulating the telecommunications sector in the future. The first option would consist of retaining the same policy but adapting it to past and current changes – but the authors have demonstrated that long term positive effects of ex ante regulation are by no means guaranteed. The second option is to replace ex ante with ex post regulation – as maintaining ex ante regulation initially meant as transitory would mean regulatory failure. This second option would not seem to be seriously considered by regulators for the time being, though. The third option consists of taking into account the macro-strategic dimensions of developing the telecommunications sector at national and international level, and the importance of technology businesses at national level, in other words developing a vertical industrial policy, possibly drawing on assistance from the State and relying also on social cultural and technological policies33. Interestingly the authors highlight that ―limiting concerted industrial policies at European level is more debatable‖ as imperfect competition can justify an industrial policy34 to on one side achieve economies of scale, compete at international (i.e. non-European) level and reduce the revenues of monopolies or oligopolies, and on the other as it is necessary to acknowledge that comparative advantages find their source not only in technical or factor allocations, but also in a country‘s or region‘s history and its strategic and technical choices. Equally industrial policies can fight destructive or ruinous competition, where ―prices […] do not chronically or for extended periods of time cover costs of production, particularly fixed costs35‖. The paper goes on to discuss the difficulty of regulating both existing and emerging markets (the latter in the sense of new technologies or new processes being introduced). Whilst ex post regulation should apply to the existing infrastructure/existing service segment, for emerging services (either existing infrastructure/new service/market, or new infrastructure/new service/market) a distinction should be made between new services according to whether they complement or substitute existing services. Where they complement regulation should encourage their development. Where they substitute funding the infrastructure is a real problem. The authors note that for the time being European regulation does not formulate any industrial policy and fosters competition on the retail market due to asymmetrical regulation of the wholesale markets. The likely consequence is discouraging investment into new infrastructure. Finally, with respect to the new infrastructure/existing service market, a
32 Bourreau & Dogan (2005) 33 Of course the authors had individual countries in mind when formulating these options. At first sight it would seem however that the « third option » appraoch would be perfectly applicable against the background of a single, internal market objective. 34 The authors refer to Krugman & Helpman, 1985, to support their statement. 35 OECD 1993 69 ------
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conflict exists between the principle of technological neutrality and the principle of not regulating emerging markets. These dilemmas could be resolved by 2 approaches to regulation policies. A first approach is the temporary absence of regulation so that market participants are able to book returns on their investments. The combination of such ―regulation holidays‖ followed by ex ante regulation, should effective competition not be achieved, could deliver positive results36. The second approach – compatible with the ―regulation holidays‖ approach – is to implement an industrial policy favouring the development of new infrastructures and services. Such policy is investment- rather than competition- oriented and should be understood as a contract between the regulator and the (dominant) operator(s): asymmetrical ex ante regulation would be suspended provided that negotiated goals are met. The paper concludes that the asymmetrical ex ante model chosen by Europe to regulate the telecommunications sector should be abandoned, fist because by essence it should only be a transitory model, second because it threatens the long term development of the sector. Ex ante regulation decreases the value of investing: it decreases benefits for incumbents, and it increases the value of waiting for competitors. Moreover, it distorts investment, driving it towards incremental innovation to the detriment of investment in R&D and infrastructure. 7. C. Liezenberg, D. Lycklama, H. Smorenberg: understanding buyer and seller behavior for improved payment product development In a 2007 article for the Journal of Payments Strategy & Systems the authors propose a new approach to the segmentation of payment solutions based on the key drivers of transactions i.e. the behavior of buyers and sellers. The authors suggest that a better understanding of these drivers will allow to optimize the use of existing payments services and improve them, and develop new ones – in short innovate. To make their point the authors first introduce a generic transaction model, where the buyer and the seller go through 3 processes: an agreement, payment, and delivery. Payment and delivery follow on the agreement, however the order may vary according to the place and time of transaction. The paper proposes that the risk at the heart of any transaction is well balanced when agreement, payment and delivery occur at one time, in one place. With new channels such as internet or mobile, however, agreement, payment and delivery become disconnected in time, and risks for buyers and sellers become unbalanced, leading to the development of multiple payment and delivery methods. These disconnected processes affect the perceived transaction risk, notably with respect to its payment and delivery components. The transaction context can be further defined by 4 generic factors: - Timing: when payment and delivery are not simultaneous, 3 types of timings appear:
36 The authors refer to Baake et al. (2005) and Gans & King (2004) to support their statement. 70 ------
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- Location: can be physical or virtual. Distanced and virtual locations increase the perception of risk. - Relation: a dynamic distinction (potentially changing over time) can be made between anonymous, known and trusted relationships. Repetitive transactions lead to a higher level of trust than incidental ones. - The characteristics of the product delivered: a distinction can be made between the product value (low vs high), and the product substance (virtual vs physical). The value of the product strongly determines the perception of risk. High value products require more payment guarantees than do low-value products. As risk is about perception, timing of payment is crucial to the default risk balance between buyer and seller. Using timing and the other factors the authors develop a Transaction Context Model defining the total risk of a transaction as a function of the separate risks affecting the 3 components of a transaction, the risk of each component being determined by the risk associated with the 4 situational factors (timing, location, relation, product characteristics). A general conclusion is that payments solutions with low risk come at higher costs than non-guaranteed payment solutions – the authors however assuming that cost and usability considerations are secondary to risk assessment, meaning that perceived risk is the determining factor for the choice and use of a payment transaction. This implies that both seller and buyer will seek to optimize risk exposure in relation to payment instrument cost and usability. These different situations generate the so called Transaction Contexts Model and allow the authors to score the different situations in function of risk, cost and usability for both the seller and the buyer. The authors‘ conclusion is that whilst payment segmentation is achievable within a transaction context, a generic segmentation irrespective of context is not possible. We would submit that existing legislation and regulation in the EU annihilates any such segmentation (being payment instrument agnostic, forcing similar guarantees for the payment system user, and generally fixing price irrespective of risk). This means that payments service users in low risk transaction contexts will subsidize payments service users in higher risk transaction contexts, in short, grocery buyers subsidize internet gambling (and many other, seemingly more acceptable remote and virtual purchase and payment situations). Is this a desirable outcome for a policy maker?
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6- A sample of views from the supply and the demand sides – with a sample of products and services
6.1- Summary Available research focusing on the supply side provides insight as to where the banking industry sees payments innovation developing. An overwhelming majority of bankers interviewed for a 2010 survey mentioned the ―e―-space, respectively e-payments, business-to-business e-invoicing, and business-to- consumer e-billing. A poll of payment experts worldwide performed in January 2011 by a provider of global applications based on open-loop prepaid card schemes makes for interesting insight. New entrants, followed by technology providers, are viewed as best at driving innovation, Asia will by a wide margin show the most innovation, ―low value‖ payments are the type to see the most innovation, competitive pressure is the strongest driver of innovation, and cost reduction the weakest, the main barriers are the absence of internal ―champions‖ and budget constraints, and ideas for innovation that will not guarantee customer uptake are generally rejected. A recent study by a major consultancy makes the point that there are steep differences between mobile banking and mobile payments, with 84% of respondents to their survey viewing mobile as a very important development, yet at the very beginning of any deployment curve, and with significant systemic obstacles to overcome. Technology is viewed as a key issue, with current dependency on proprietary operation systems and incomplete migration from internet-based to App-based transactioning. The study also finds that mobile banking forces a rethinking of the value chain, with players able to move quickly across the value chain being able to capture larger parts of the revenue stream. A third supply side paper, whilst proposing a somewhat different definition of mobile payments, stresses that risk is the key driver for transactional behavior, with perceived risk determined by the timing and location of the agreement between parties, payment, and delivery, and the relation between the parties (anonymous, or known, or trusted), the value and substance of the purchased product mattering as well. The paper assesses the likelihood of success for mobile payments in a number of contexts, confirming that consumers have a natural ―status quo‖ bias which forces providers of new products to either lower the degree of change demanded from the consumer, and/or to evidence a manifold increase in the perceived benefits of the new service. The paper also discusses technology options (including for the location of the Secure Element) and concludes with assessing the reasons for the absence of productive cooperation between financial institutions and mobile network operators. These range from difficulties around branding in cooperative models, to the debate over who owns the customer, and the difficulty to arrive at a workable revenue sharing model. On the demand side a European association of e-merchants very recently issued a position paper on online payments highlighting the barriers to address to better respond to consumers‘ needs. These are lack of confidence in online payment methods, privacy concerns (consumers accept the need for identification to enable delivery of goods or services, yet want to be able to do this with the right set of personal data, affecting consumer‘s privacy as little as possible), and lack of trust in web merchants (with consumers expecting fair agreements, conditions and delivery, whether or not supported by possibly international trust marks). The e-merchants position paper then discusses payment issues grouped into 5 clusters (cards and fraud, bank payment schemes, non-bank payment services, mobile channel devices as an alternative to the PC, and online identity and authentication) and closes with a set of 10 recommendations. These pertain to enhancement of online authentication, harmonization of 72 ------
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dispute and charge back handling, the introduction of interoperable online banking e-payments solutions, the deployment of e-mandates for pan-European direct debits, interoperability of pre-paid card solutions, a legal clarification for the status of overlay service providers, the development of cross border cash-on-delivery methods, and of payment methods dedicated for the phone and the tablet including e-authentication options, and finally using e-authentication solutions to fight fraud and improve the buyer experience for credit transfers, direct debits and credit cards, including through the mobile channel.
A further submission by a European trade association (to a recent European Commission consultation) rightsizes the role of payments in e-commerce, linking the take-up of online trading to the penetration of internet amongst households in different European countries, and designating the market segments where e-commerce is most developed (ticketing, travel and holiday accommodation, clothes, sports goods, books, CDs and electronics). It acknowledges that there are different local habits when it comes to payment instruments to be used, and accept that e-merchants should adapt to their customers‘ expectations – although benefit is seen in a standardized European online payment solution(s). Beyond indirectly calling for greater competition on the acquiring bank side the association records no negative experience with e.g. small amount payments. Views from consumers are illustrated by 2 inputs. A recent survey of the Dutch Central Bank of customer behavior for payments of cross-border online shopping first sized the market in the Netherlands (with 71% of the Dutch buying something online in 2010, yet 82% of them not making a cross-border purchase, but only 9% of whom for a payment related reason). The Dutch domestic cooperative e-payment solution was used in 65% of situations, and 75% of consumers said they were able to use their preferred payment instrument, although for their most recent cross-border web purchase 55% of Dutch would have used a different payment method had all payment instruments been accepted. The Dutch are generally satisfied with the safety of the current payment methods, and with the costs of the different methods, yet even more satisfied with the speed and ease of use (with users‘ perception of speed correlating with their perception of ease of use). When surveying user dissatisfaction rather than satisfaction, then costs stand out, with 30% dissatisfied about the cost of credit cards. The ―perfect‖ solution for cross border online purchases would feature protection of personal and payment data (50%), immediate payment confirmation (35%), paying using existing online banking application (32%), not paying a transaction fee (31%), and the ability to reverse the payment, or pay after reception.
Further insight as to consumer requirements is provided by the European consumer association response to a recent European Commission consultation. Of the 9 problems consumers would face when purchasing online only 3 to some extent concern payments: choice of interoperable, secure means of payments (ranked problem n. 4), reimbursement (ranked problem n. 6 - actually dispute resolution when products or services are defective), and data protection and privacy online (ranked problem n. 8).
Finally the following developments stand out from an admittedly non-scientific scan through news releases over the past 6 months: Huge communities (in the tens of millions, and counting) can be created rather rapidly on the internet, as shown by social networks and/or gaming sites. So far no payment service provider has yet been able to attract such numbers of users. Does it imply this is an impossible feat to achieve?
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Both size and reach matter. This is why providers either go for interoperability or for vertical integration (as shown by the most recent alliances of Microsoft and Google with handset manufacturers). Amongst the flurry of announcements there are very few cooperative approaches – and fewer even involve banks (and then the latter rather leverage an existing innovation than truly hit the market with a complete innovation). There is a lot of competition at technology level, which is of course a challenge for the development of standards, and interoperability. Innovations are occurring at payment product level (to increase convenience), customer interface level (to increase convenience), at back office process level (to reduce costs). Gradually the distinction between the e- and the m-worlds is thinning. Many innovations are about e-payments generated either from a mobile device or a stationary device. Of course proximity, i.e. contactless payments are a different segment altogether.
6.2- Views from the supply side Fraunhofer’s European Trend Survey – Banks and Future 2010 – survey of the European payments market Parts of this survey completed in the winter 2009/2010 are dedicated to European banks and schemes‘ views on innovation for future growth. The Fraunhofer survey has signification as banks from 15 European countries responded (even if the composition of the respondents‘ group does not reflect market reality, with 53% being classified as commercial and specialized banks, 20% as cooperative banks, and only 14% as savings banks). It should be further noted that 20% of respondents managed over 3 billion payment transactions per year, 25% less than a 100 million, 18% over 3 billion card transactions, and 34% less than 100 million such transactions. 75% of respondents stated that increase in productivity (through cost and process optimization) was their most important challenge for 2010. Regarding which innovations will be leaders in the payments business, e-payments (e.g. online banking based e-payments) came out as top-of-mind for 85% of respondents (compared with 48% one year earlier). Business-to-business e-invoicing came second with 69% of responses (compared with 44% one year earlier). Business-to-consumer e-billing came third with 65% (only slightly changed from 56% one year earlier). Contactless m-payments, contactless cards, and m-payments came 4th, 5th and 6th, with respectively 52% (compared to 31%), 50% (compared to 35%) and 50 % again (compared to 29%). According to the authors of the study at that time the fact that the EPC seemed to have almost completed an E-operating model and an E-payments Framework strongly influenced the respondents in their ranking, and accounts for e-payments overtaking e-invoicing, even though the latter continued to gain attention. Regarding technological advances, 64% of respondents see these occurring in the area of security and mobile technologies, closely followed by contactless technologies (55%). Ixaris Payments Innovation 2011: The Global Jury Decides – January 2011 Report Ixaris, a provider of global applications based on open-loop prepaid card schemes, convened a ―jury‖ of 22 payments experts living in Australia, Belgium, Brazil, Canada, China, France, Korea, Malta, the Netherlands, Nigeria, Pakistan, Spain, Switzerland, the UK and USA and polled their views on a set of 74 ------
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10 questions. For the purpose of this exercise innovation was defined as turning an invention or new concept into commercial success, being more than just an evolution of an existing product or service, and not being confined to technology. The following results and views emerged:
Who is best at driving innovation? New entrants lead the pack here, followed by technology providers, card schemes, and processors. Retail banks, with half the votes of new entrants, rank last (just after retailers). Retail banks are viewed as ―prisoners of the status quo‖, and generally ―banks, processors and card associations in the role of enablers and distributors of innovation, than actual creators‖. Which regions will show the most innovation? Asia tops the ranking by a wide margin, followed by North America. The jury however believes that whilst many of the Asian innovations will be adopted elsewhere, the North American ones are not so exportable. Africa and Latin America tie for third place, whilst Western and Central and Eastern Europe rank last. The jury rated Europe as having ―become sclerotic, burdened with regulation and short of cash‖. Which payment types will see the most innovation? ―Low value‖ (i.e. less than EUR 15,00) and micro-payments (i.e. less than EUR 3,00) clearly win this poll, as smaller payments are seen as still operating with big inefficiencies. It is acknowledged however that e.g. building a business case for micro-payments remains a challenge, but ―evolution of payment technology moves more slowly the higher the payment value‖. What is driving innovation? Competitive pressure garnered most votes, and cost reduction the least. Regulatory pressure moved up into 4th place (from last in the previous poll conducted in 2008). One juror redefined innovation as ―the opportunity to make a profit from the places where the banks and payment schemes have walked away‖. What are the main barriers to innovation? Topping the league are the absence of internal ―champions‖ and budget constraints. But ―no vision and no ownership are the big inhibitors, budget constraints are just an excuse‖. Intriguingly regulation was deemed having the lowest impact on innovation (yet more so in the US). Why are ideas for innovation rejected? The main reason would be the inability to guarantee customer uptake, which shows why innovation is driven more by new market entrants. One juror commented that ―the barriers set by many banks are impossible to surmount…but not even their existing business lines would pass such tests‖. Where will innovation be targeted in 2011? The clear winner is improved product access, capitalizing on the explosion in smartphone and tablet markets: ―the world is going mobile and somehow it‘s more than a channel. It is a revolution and it can easily disconnect banks from payments‖. Which stakeholder has the greatest influence on payments innovation? 2/3 of the votes went to third-party innovators and developers, with customers and in-house product teams trailing far behind. However, ―realizing that you have been left behind by your competitors usually focuses your attention‖. Which organizations stand out as the most likely payments innovators in the coming years? PayPal maintained its leading position from the 2008 survey, whilst mobile operators and social networking platforms appear for the first time. What is the largest missed revenue opportunity in the payments industry that innovation could address in 2011? A number of avenues were suggested by the jury, including payment for virtual goods, cross-border B2B and B2C payments, migration from physical to e-money, more flexible cross-border remittances, and context specific rich payments.
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KPMG: Monetizing mobile – How banks are preserving their place in the payments value chain – July 2011 In the survey published mid-2011 KPMG proposes a strict distinction between mobile banking and mobile payments. It defines mobile banking as platforms that enable customers to access financial services (such as transfers, bill payments, balance information and investment options). Mobile payments are defined as the process of using a hand-held device to pay for a product or service, either remotely or at point of sale. The survey notes of course that this market is driven by the global uptake of mobile phones, but it highlights sharp differences: e.g. in the United States smartphones have been the greater catalyst for adoption, and the number of smartphones deployed will surpass that of traditional mobile phones by the end of 2011. The survey also notes that 20% of Generation Y has already used their mobile phones to make purchases. As to retail and commercial banks the question is no longer whether mobile banking and payments will be important: 84% of respondents to the survey already say they will. To reap these opportunities banks will have to overcome both internal and external challenges, noting though that the bigger obstacles (the development of standards, the roll out of technologies, the adoption of services, how to work with new and emerging value chain partners, how to endorse new revenue sharing models that properly acknowledge each player‘s role in delivering mobile services) are systemic and thus largely beyond the control of banks individually. Furthermore the road to mobile services is fraught with risk as a combination of nascent technologies, unproven demand, fractured approaches, and the lack of standards and networks. The only certainty would appear to be that mobile banking is becoming mainstream (as stressed by 2/3 of respondents to the KPMG survey) – even if today there is just no right or wrong path to creating a mobile solution. Most services today provide basic information services such as balance updates, payments alerts and account transfers. However a number of banks have started to incorporate mobile payments solutions as well (e.g. peer-to-peer payments and remittances). The key expectations from banks actively engaging in mobile banking and payments are to gain competitive advantage and differentiation. Bank innovators seek to build an early presence to attain a range of other qualitative and quantitative opportunities, such as gaining experience and insights which could be valuable, even critical, into barriers and opportunities, or in-house technical and strategic experience. Such insights will directly inform the approach to the next steps. Bank innovators also believe they will achieve greater customer loyalty and satisfaction, and a reputation for customer- centricity. These can be leveraged for e.g. cross-selling, whilst building customer comfort for mobile financial transactioning. Not all bankers though are convinced. KPMG met at least one banker who stated that the case for ubiquity of banking improving value for customers still had to be made. The biggest consideration for bankers entering that market though revolves around technology. To-date the simplest approach would seem to be the adaptation of existing internet platforms to meet mobile standards (in essence, a mobile wireless application protocol or WAP site which can be securely viewed on mobile devices). The advantage of WAP sites for customers is that they deliver a consistent access across multiple devices whilst mostly maintaining the same look, feel and functionality as a ―classical‖ internet banking portal. The customer experience too does not change much, the customer being still requested to enter passwords and unique identifiers to access his/her account.
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Platform-specific applications (aka: ―Apps‖) deliver a unique and dynamic user experience combining ease of use with dynamic content. They also allow to place a brand onto a user‘s device, thus increasing brand visibility, and awareness. However today most ―Apps‖ are developed to operate on specific operating systems and thus carry a high development cost for banks. But this has not yet prevented platform-specific applications to quickly gain traction in a number of markets, to feed the customers‘ appetite for smartphone-based apps‘, driven by banks‘ desire to retain their customer base. At the same time a number of banks continue to offer basic SMS services as a primary stepping stone for customers who do not have application-compatible handsets – although SMS are losing traction due to safety concerns and high consumer charges. The study sees technology as both an enabler and a barrier, owing to the many competing technologies and localized standards as a sign of the distance separating us from a truly global market. The study distinguishes mobile banking technologies (SMS text, mobile browser, custom applications) from mobile payments technologies (NFC companion devices, embedded NFC, SMS text, and voice). All have one or several uses, and their respective pros and cons. Admittedly, NFC is capturing a lot of attention nowadays, it is however hampered from wide-spread adoption by a number of critical and massive challenges, such as the necessary update to merchant networks, and the fact that there are a number of competing methods to enable NFC payments, each with its own unique challenges and considerations for banks. A key consideration however is that mobile banking forces a rethinking of value chains. The KPMG study found that players are moving quickly across the value chain to consolidate positions and capture larger parts of the revenue stream. In essence the typical payments value chain is being shortened, and new constituents replace traditional ones. It is anticipated that e.g. payment processors will play a more significant role in the mobile banking and payments environment of the future, with many already working with alternative providers such as PayPal to extend their reach into this new market. At the same time banks learn to work with new partners such as mobile network operators. On the whole, however, mobile banking is not an end-state in and of itself, but rather the stepping stone to the emerging world of mobile payments. Telecom Paper – Innopay Research paper 2009
Mobile payments as such differ significantly37 in user experience and business model from mobile banking or mobile authentication. The bundling of payments with other processes such as ordering and delivery creates confusion and slows development. Therefore it is proposed to define a mobile payment as ―a payment (transfer of funds in return for a good or service) where the mobile is involved in the initiation and confirmation of the payment. The location of the payer is not important: he may or may not be “mobile” or “on the move” or at Point of Sale‖, whereas mobile banking is defined as ―access to banking functionality (query + transaction) via the mobile phone. This includes the provision of part or all of the banking functionality already provided by banks over the Internet in the form of online banking‖. This approach to definitions implies that the initiation of a transfer within a bank‘s mobile banking environment is not classified as mobile payment but viewed as
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a feature of mobile banking. Actually the large majority of the applications deployed today simply use the mobile phone to initiate an order, receive delivery, and/or authenticate the consumer.
The paper then discusses situations in which mobile payment (as defined above) could be successful. It identifies risk as the key driver for transactional behavior, with perceived risk determined by the timing and location of the agreement between the parties, payment, and delivery, and the relation between the parties (anonymous, or known, or trusted). The value (high vs low) and substance (physical vs virtual) characteristics of the product purchased matter as well. The paper then assesses the likelihood of success for mobile payments as defined above in a range of contexts, from buying ring tones to e.g. public transport and initiating a remittance transfer. The paper reviews reasons for which innovation may fail, focusing on behavioral aspects: the ―status quo bias‖ leads consumers to overvalue current benefits, ―loss aversion‖ means that a new product not only must be better but its perceived benefits must outweigh the perceived loss of not using any longer an existing product. Therefore lowering the degree of change demanded from the consumer is key to successful adoption. Another approach could be evidencing a manifold increase in the perceived benefits provided by mobile payments.
The paper then reviews recent technical developments and their implications. Contactless technology can be divided into 2 categories, vicinity and proximity technology. Radio frequency identification (RFID) would support both, but remains a one way communication, a limitation resolved with near field communication (or: NFC). The latter can be used even when the enclosing device has a depleted battery, or is switched off. In addition there have been significant advances with respect to the speed at which data is transferred, and through encryption the security of the data transferred. However the market for NFC-enabled phones is still in an early stage of development. Currently mass deployment is not foreseen prior to 2012, but past predictions have proven overoptimistic. In the short term, for a number of applications, NFC stickers may represent a stopgap solution – knowing also that such stickers may be fitted onto any device, not only a mobile phone. However the perceived lack of security of NFC technology may continue to act as inhibitor. Other technologies include SMS with its store- and-forward functionality hampered by lack of encryption and lack of proof of delivery. A final option is Unstructured Supplementary Service Data (or: USSD), a standard for transmitting information over GSM signaling channels. It is network-dependent and mostly used to query available balances in pre- paid GSM services. It is the base for some payment services such as Mobipay in Spain. Gradually an ecosystem for Point-of-Sale NFC mobile payments emerges, with chip and handset manufacturers, Secure Element issuers, service providers, Trusted Service managers and Mobile Network Operators as key stakeholders. The key questions in this ecosystem are: Where should the Secure Element for the payment application be located? Which stakeholder fulfils the role of Trusted Service Manager for management of the payment application and associated services?
There are 3 main options for locating the Secure Element: either on the universal integrated circuit card, or on a separate chip or smart card on the phone, or embedding the Secure Element in the phone itself. Equally there are 4 main options for the provision of the Trusted Service Manager function, either the Mobile Network Operator centric-model, the Financial Institution centric model, the Collaborative model, or the Independent Entity model. The paper finally discusses the GSMA proposed ecosystem, and remarks that the latter may not be accepted on a wide scale by financial institutions because of a risk of disintermediation from the consumer, because it is a closed model restricted to the reach of the mobile operator, and because it does not provide for an easy to use solution for the update of the Secure Element.
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Having reviewed lessons, trends and issues from the analysis of several pilots and initiatives, the paper discusses possible reasons for the absence of productive cooperation between financial institutions and mobile network operators. These range from difficulties around branding in cooperative models, to the debate over who owns the customer, and the difficulty to arrive at a workable revenue sharing model. However standardization initiatives such as GSMA, Mobey Forum, NFC Forum and EMV Co try to address non-interoperability threats. 6.3- Views from the demand side 6.3.1- Merchants E-payments Merchant Initiative: position paper on online payments in Europe (June 2011)
The position paper lists 10 issues, with 6 of them being quite well addressed if better mechanisms for online authentication of and authorization by consumers were available. Such e-services would reduce card fraud, reduce usage barriers with consumers, and last but not least, enable new payment services based on the SEPA instruments (both credit transfers and direct debits). According to the paper these findings are in line with Action 3 of Europe‘s Digital Agenda (2010).
Merchants request the industry to improve the missing e-identity component in a generic and customer friendly way. It should be noted that the position paper proposes that ―allowing free market forces to drive the evolution in the European payments landscape is the best possible way of moving to a more perfect model‖.
Merchants endorse the EC‘s assessment of consumer needs, and propose that the barriers to address are: Lack of confidence in online payment methods; Privacy concerns (consumers accept the need for identification to enable delivery of goods or services, yet want to be able to do this with the right set of personal data, affecting consumer‘s privacy as little as possible). Lack of trust in the web merchant: consumers expect fair agreements, conditions and delivery, whether or not supported by (international) trust marks.
The position paper then discusses payments grouped into 5 clusters: a) Cards and fraud - Merchants‘ concern about the SCF perceived ―oligopoly‖ outcome; - Cards have important flaws for web transactions: fraud is caused at various levels. The cardholder‘s ability to reverse a transaction is viewed as the corollary of the scheme to authenticate a card user on the web. Merchants want transaction finality, its absence increases merchants‘ costs for dispute handling. - As card details have monetary value, merchants have to invest in safeguarding them (e.g. PCI DSS) - 3DSecure (supposed to address the ―it wasn‘t me‖ factor) needs improvement: it neither protects against nor prevents charge backs, it is an extra step in the check out process, with an additional password (reducing order conversion because of fatigue and password loss), clear communication is missing…. - Dispute management needs standardization: dispute handling is very costly as it requires merchants to communicate with acquirers, payments service providers, and buyers, often on
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the basis of incomplete or inaccurate information. Furthermore the underlying communication processes between acquirers, PSPs and schemes are not standardised. b) Bank payment schemes: - Merchants see opportunities for new payment developments based on the SCT and SDD Schemes. - SCT is viewed positively since there is no charge back risk. It could evolve into OBeP (Online e-banking) included in the check out process, redirecting the buyer to his bank‘s site, where the transaction is authorized with his online banking credentials. E.g. IDEAL, giropay, eps, and Secure Vault Payments/US, Canada, Colombia, Poland. Non- interoperability is an issue, even it was addressed, caution would be required with respect to ―proper pricing models‖. - SDD has online potential, however buyer‘s right to cancel credit entries eight weeks after, and collection of payment five days after transaction occurrence do not support one-off e- commerce payments and lead to the same issues as with card charge backs and fraud. As SCT, SDD was not designed for the web. c) Non-bank payment services: distinction is to be made between: Wallet systems: used for micro and macro payments. Buyer‘s account with a provider is funded by a bank account or credit card. Problems with charge back rules, non harmonized. Pre-paid solutions: a way to ―use cash on the web‖. Buyers can convert cash in physical stores. Many prepaid options available, hardly any interoperability unless co-branded by ICS. Overlay services: the strong security debate about consumers providing their online banking credentials to third parties is acknowledged by the Merchants Initiative. These however encourage banks to ―open up their accounts for third party merchant services‖….. Cash on delivery: cash still is the most popular payment method in a number of countries where internet banking and other instrument penetration is low. The development of cross border cash delivery methods is required. d) Mobile channel: mobile device as alternative to the PC when it comes to e-commerce. Yet not every online payment method is applicable for a mobile device. Payments methods optimized for mobiles, going beyond the native app store payment options and the keying in of credit card details, are required. These would benefit from generic e-authentication solutions. e) Online identity and authentication Online identities vary from verified credentials to unverified credentials with stored preferences. Initiatives where these identities can be leveraged for e-commerce are welcome by merchants. Absence of interoperability is again an issue.
The merchants‘ position paper concludes with 10 Recommendations: Recommendation 1: enhance 3D Secure, notably by including authentication methods already in use, such as bank passes, mobile phones, other secure tokens Recommendation 2: harmonize dispute handling to improve resolution speed and consumer satisfaction Recommendation 3: develop an interoperable, cross-border OBeP solution Recommendation 4: e-mandates should enable SDD and other direct debit solutions, and support one-off as well as recurring payments. Recommendation 5: harmonization of charge back handling for wallet systems. Recommendation 6: greater standardization and interoperability of prepaid card solutions Recommendation 7: banking industry and regulators to clarify the status of overlay providers Recommendation 8: develop cross border cash on delivery methods
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Recommendation 9: develop payment methods dedicated for the phone and the tablet including e- authentication options Recommendation 10: use e-authentication solutions to fight fraud and improve the buyer experience of credit transfers, direct debits and credit cards, including through the mobile channel.
Response to the European Commission’s public consultation on the future of electronic commerce (EMOTA – European e-commerce and Mail Order Trade Association – 15. October 2010) EMOTA‘s response right sizes the role of payments in e-commerce. It first links the take-up of online trading to the penetration of internet amongst households in different European countries. It designates tickets, travel and holiday accommodation, clothes, sports goods, books, CDs and electronics as the sectors where e-commerce is most developed. Less developed sectors are furniture, bedclothes, and food (except in the UK and Portugal). It points out that delivery of goods or services is not a problem per se. E-merchants also acknowledge that there are different local habits when it comes to payment instruments to be used, and e-merchants accept the need to adapt to their customers‘ expectations. They however remark that there would be benefit in a standardized European online payment solution, or solutions. They see the level of acquiring bank charges as being possibly further influenced by greater competition, otherwise they have no negative experience with e.g. small amount payments which could not be processed profitably due to too high bank charges. An issue highlighted is that the provision of revolving credit can be difficult owing to different laws on credit across Member States. O’Reilly Radar Report on ePayments: emerging platforms, embracing mobile, and confronting identity – Summer 2010
The report considers that players are confronted with 3 overriding trends in payment technology:
The rise of payment platforms: as consumers become more comfortable storing their financial information online with brands they trust, the traditional checkout process that asked buyers to enter e.g. a credit card number is becoming obsolete. The mobilization of money: mobile commerce will connect not only a consumers‘ purchasing history but activities and locations as well. The significance of online identity: consumers are likely to purchase on the same platform where they have an existing identity and are spending time doing other things. Consumers however want to maintain control over which online services have access to distinct aspects of their identity. 6.3.2- Consumers European Consumer Centers’ Network “Online cross-border mystery shopping – State of the Union” Report, September 2011
The European Consumer Centers‘ Network (or: ECC-Net) is financed by the European Commission and each EU Member country. It comprises centers in each of the 27 EU countries (and now covers EEA countries as well).
The purpose of the mystery shopping exercise (with actual purchases and deliveries carried out) undertaken by ECC-Net in early 2011 was to gauge the key obstacles to the Commission‘s stated goal of having 20% of the EU population buying cross-border online by 2015. A total of 305 online cross- 81 ------
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border purchases were made across the EU – in ECC-Net‘s view a representative sample. Product categories purchased were the ones designated as the most popular in the Commission‘s Consumer Conditions Scoreboard: clothing, sporting goods, household goods, books, music CDs, DVD firms, video or computer games, non-downloadable computer software, electronic equipment, products for personal care. Websites were selected from a list of 40 web traders by country submitted by each ECC. Web traders had to accept at least credit or debit cards as means of payment, and operate in at least two languages. The objective was to test whether web retailers grant consumers the required protection when they purchase online, and whether retailers comply with EU legislation. What legal warranty issues were not tested, returns and reimbursements in accordance with the Distance Selling Directive38 were. Services were not part of the mystery shopping exercise because this could have given rise to concerns about the right of withdrawal and added limits to the test of return and reimbursement. Highlights of the shopping exercise are: - Many web traders still prefer only to sell products to their domestic market. - It is sometimes difficult for a consumer to be sure from which country the web trader operates. In 9% of the cases the country (domicile) of the web trader was not easy to find, and in 3% it was not available at all. - In 10% of the purchases the mystery shopper had to search for the web trader‘s name (in 2% of the cases it was not available at all). In 11% of the cases the web trader‘s physical address had to be searched for, and in 3% it was not available at all. - For 43% of the purchases the web trader‘s registration number was not available at all. N 8% of the cases no phone number could be found, and in 12% of the cases no e-mail address. - Only 61% of the web traders offered more than one language (a big improvement however over a similar 2003 Report where the figure was only 24%). - In 91% of the cases the first price presented to the shopper included all charges except delivery costs – however in 34% of all cases, it was not clear whether VAT was included in that price. - In 95% of cases credit cards were means of payment accepted by web traders (ECC-Net advises consumers to pay with a credit card when shopping online, in order to increase their protection in case of fraud, non-delivery, etc…). - In 65% of cases a debit card or equivalent bank card was accepted. In 43% of cases a bank transfer was possible. In 51% of cases payment through various online payment methods was offered by web traders. In 6% of cases payment ―upon receipt of an invoice‖ was possible. - In 20% of cases payment by cash on delivery was possible – the consumer not having to pay until the item is delivered. - The amount of time taken by web traders to draw down the proceeds from the purchase largely depends on their individual management practices. ECC-Net‘s study reveals that 90% of the web traders withdrew the payment by credit card within the first week after the order was placed. 62% of the goods were delivered within one week after the credit card had been charged, and a total of 89% within 2 weeks. - In 7% of the cases the final amount paid by the mystery shopper was not the expected price. Unexpected costs are generally linked to cross-border purchases, such as currency fluctuations and conversion costs, uncertain tax levels, and (for EEA countries) custom clearance dues.
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- Unexpected bank fees played a role in only one instance (an EEA consumer was charged a fee when receiving a refund from a web trader). In one non-eurozone country several instances of consumers being charged extra when using their credit card (―surcharging‖) were reported. - For 20% of purchases no privacy policy was available (although even when such a policy is available its details may be difficult to find). Concerns regarding consumers‘ personal data are one of the main reasons for consumers to refrain from buying online. This seems to be a generic issue, not specific to cross-border transactions. - Very few web traders were found to use trustmarks – an electronic label on the website that is in some way connected to consumers‘ rights and confidence. A trustmark was only displayed in 17% of the purchases.
This wide-ranging, recent, and obviously independent survey clearly demonstrates that – in opposition to what is repeatedly claimed by the Commission – it is not payments that stand in the way of a development of online commerce, whether domestic or cross-border within the European Union.
De Nederlandse Bank survey of customer behavior for payments of cross-border online shopping (conducted in January 2011): 71% bought something online in 2010. 82% of Dutch who bought online did not make a cross border purchase, 9% of whom for payment related reasons. For paying domestically iDEAL was used in 65% of situations (Acceptgiro 13%, credit card 8%, credit transfer 7%, others marginal). 75% of consumers said they were able to use their preferred payment instrument. A different mix is used for cross border online purchases: 58% use credit card, 25% PayPal, 14% credit transfer. But if all payment instruments had been accepted at their most recent cross-border web purchase, 55% of Dutch would have used a different payment method. Actually 40% would have used iDEAL, and 6% Acceptgiro. The Dutch are generally satisfied with the safety of the current payment methods used and preferred for cross border online shopping. Note: the credit card is perceived as the least safe. Overall people are satisfied with the costs of the different payment methods, yet they are even more satisfied with the speed and ease of use. Note: the credit card is perceived as the most expensive payment method. Note: the credit transfer is perceived as the least easy to use, and iDEAL the easiest. There are only small differences in the ease of use perception of PayPal, Acceptgiro, and credit cards. Users‘ perception of speed correlates with their perception of ease of use. When taking the reverse view, i.e. surveying user dissatisfaction rather than satisfaction, then costs stand out, with 30% dissatisfied about the cost of credit cards (and 13% about the latter‘s safety. Almost no dissatisfaction is recorded for iDEAL (2% re. safety, 1% re. cost of use, 6% re. costs, 0% re. speed. Features of the ―perfect‖ solution for cross border online purchases: - The most important requirement: protection of personal and payment data (50%); - Immediate payment confirmation (35%); - Paying using existing online banking application (32%); - Not paying a transaction fee (31%); - Ability to reverse the payment, or pay after reception (of goods, services).
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In its response to this consultation, the European association of consumer associations stresses that it believes the 2000 e-commerce Directive to have achieved a fair balance between all interested parties. BEUC would be looking for a clarification of some provisions of the Directive, and is opposed to any deeper revision. BEUC identified 9 problems which consumers would face when purchasing products and services online. Of these, only 3 could concern – to some extent – payments. These are: Online payments (ranked problem n. 4): according to BEUC the consumer would face 3 types of issues when paying online: a) The lack of different means of payment – in effect, choice - and discriminatory charges – which in effect are levied by merchants, and often bear no relation to transaction charges levied for the use of a given payment instrument, b) Lack of interoperability between the means of payment offered – in effect the difficulty for a consumer to use a payment instrument he or she is used to buy cross border, c) Security problems, with consumers perceiving as a burden that they have to verify that a connection through a safe internet protocol is established, use and update anti-malware programs, and change passwords frequently. Reimbursement (ranked problem n. 6): this is actually more about dispute resolution when products or services are defective. Data protection and privacy online (ranked problem n. 8): most consumers would not be aware that their data when surfing on the internet may be collected by a variety of actors (internet service providers, web browsers, merchants, social network platforms….).
Whom do consumers trust for m-payments?
A poll in July 2011 of US consumers shows that 37% of respondents trust Visa with mobile payments, compared to 36% for both MasterCard and American Express. However only 23% trust Apple, 22% Microsoft, 20% Google and 12% Facebook. PayPal is trusted by 34%.
In parallel a GfK poll across 9 countries found that financial service providers have the highest level of trust (48%), consideration and preference when it comes to m-payments. Mobile and telecommunication brands received significantly lower levels of trust with respect to financial transactions, with brands such as PayPal, Nokia and Apple scoring just around 10%.
6.4- A (rather random) sample of players, and their products and services There can be obviously no attempt at presenting an exhaustive list here! This section reviews recent developments announced by a number of well known names, but it also captures interesting developments by newcomers. Note: inclusion in the list hereafter is not meant to suggest that ESBG endorses the solution presented, or has validated any claim made by a provider. Just by alphabetical order (a snapshot closed as of end October 2011):
AliPay (China) had (December 2010) 550 million registered users and processed 8,5 million transactions per day (over 3,1 billion per year, worth USD 80 billion, close to PayPal‘s 92 billion). For the real world Alipay has implemented a substitute to NFC by generate a unique barcode on a user mobile phone that a merchant can read using its own smartphone camera, with the system then drawing funds from the user‘s credit card or prepaid AliPay account.
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Apple has changed the way that consumers purchase and consume music, shifting the unit of measure from USD 18,00 for an album to USD 1,29 for a single. In doing this Apple has captured 28% of the US music sales market (2010 data). In doing so Apple also positioned the iTunes store (which amassed over 150 million customers over 8 years) as a common platform where users can via a single click buy audio books, rent movies and TV shows, audit university classes, or purchase software for their mobile devices. These services are accessible from both the consumers‘ laptop and their iPhone. Thus Apple managed to disrupt the recording industry, cause TV networks to rethink the value of their programmes, and took sales away from retailers inside their own stores. Several patents indicate that Apple is looking at the iPhone as a purchasing device in real-world stores
Amazon Payments had an early lead in the payments arena but would seem to have squandered it by reserving its technology for its own use. For a fixed transaction fee merchants outsource the complications of how to receive payments (from credit cards, bank account or other payments systems). Amazon still holds data for over 150 million customers, and its Kindle e- book is an appealing hardware-front end for future media, and maybe other, sales.
American Express is one of several established players showing interest in virtual currencies. It actually filed in October 2011 a patent for a system and method to use loyalty rewards as a currency to purchase items from participating merchants. Currency credits from converted loyalty points may also be applied to stored value cards, online digital wallet accounts and other, similar schemes.
Bobber Interactive won the ―Best in Show‖ award at the spring 2011 Finovate event. It is a Facebook application that allows prepaid users to check balances and track recent purchases and spending, set savings goals and earn cash rewards. The application uses animated pictures and videogrammes to increase loyalty and even leverages viral mechanisms to enable posting to a friend‘s Facebook page. The business model of Boober is based on referrals to e-commerce websites (which pay up to 15% depending on the item) but most revenue should ultimately come from interchange.
Boku expands m-payment offering in France via new deals with Bouygues Telecom, SFR: the partnership offers 32 million French customers the ability to pay for digital goods and services using their existing wireless service account, with the charge appearing on the carrier invoice. The service, dubbed ―Internet + Mobile‖, allows consumers to pay up to EUR 10 per transaction with their mobile phone number via an integrated 2-click process.
Buyster, a French mobile payment company, launched mid-September 2011 and aims to improve payment transaction security over the internet and provide a payment platform suitable for m-commerce. The company is owned by Atos Origin, Orange France, SFR and Bouygues Telecom (25% each). On Buyster a bank card is associated with a mobile phone number. Paying with dual authentication on the internet is possible using a fixed or mobile phone. No bank details are disclosed over the internet. Buyster is available free of charge for all mobile devices, regardless of the mobile network operator.
Citi launched its Virtual Card Accounts in more countries outside the US (now totaling 60 countries and 17 different currencies). The service is aimed at the corporate world to manage accounts payable using single use commercial card account numbers. Product enhancements 85 ------
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deliver more powerful controls and better reporting capabilities for clients. Citi‘s online payments strategy is based around the provision of an API that can provide the processing backbone, as well as the banking license, for the likes of PayPal and other new payment providers.
ClearXchange is a joint venture of major US banks (Bank of America, JPMorgan and Wells Fargo) that joined forces to develop a clearing house for person-to-person online payment transfers via mobile or e-mail. The platform will enable customers to send money to each other directly from their online bank account using just an e-mail address or a phone number. Unlike PayPal, users do not have to establish a new account outside their primary bank to receive funds. The founding banks own the venture which could be expanded to other institutions in the future.
Cofidis Mobile is one of several examples of innovative positioning. As subsidiary of a French mutualist bank specializing in consumer credit, Cofidis now also distributes mobile telephony packages. Further French banks are due to join the fray soon, with one of them including the distribution of smartphones which would not be subsidized by a mobile network operator any longer.
Facebook (over 700 million users) is a recent entrant to the payment platform space but its huge member base immediately turns it into a serious contender. Facebook launched Facebook Credits, a system resting on PayPal and enabling members to load and store value on their accounts for purchasing things on Facebook. Up to now Credits could only be used for purchasing virtual objects or accessing online gaming (with the US public interest Consumer Watchdog claiming that Facebook controls over 50% of the USD 2,1 billion market for virtual goods offered in social gaming), but now users could be allowed to set up storefronts. Facebook‘s mall is called ―Payment‖, has 60.000 retailers and is adding 400 a day. The online mall could be combined with a credit system such as Zynga, for which Facebook credits must be used. Recently a suit was filed against Facebook in the US on the grounds that only Facebook Credits were accepted for participation into online gaming. In response Facebook is said to have revised the terms of its virtual money, yet only allowing developers to offer cheaper prices for games playing on other platforms as long as the player is not logged into Facebook. Developers are still required to exclusively use Facebook Credits to sell virtual goods in their games – and pay a 30% fee for all transactions. In a separate development Facebook announced early August 2011 that it will add mobile security features to enable its users to respond immediately should their accounts be accessed without their permission. Users will have the ability to remotely reset passwords and use the website‘s social reporting tool on the company‘s mobile website and native applications. Users will be able to choose any e-mail address or phone number to have their new password sent to and the website will provide several ways of identifying the user‘s account. In yet another separate development Facebook announced a partnership with American Express through which Amex cardholding members could pay for Facebook ads using membership reward points – further evidence of Facebook moving into being a clearer for virtual currencies.
Google Checkout: Google goes to some length to convince the market that it is not competing in the same space as other payment providers and does not aspire to be a payments platform. However Google Checkout is available at several hundred thousand merchant sites, and boasts tens of millions of buyers. According to most recent press reports Google wishes to acquire the
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handset manufacturing division of Motorola for a paltry USD 12,5 billion in cash. Market analysts say that although the nascent mobile-payments business doesn‘t seem to be the major driver for Google in this acquisition, payments using NFC could be spurred as software companies, phone manufacturers and mobile communication software companies jostle for a piece of the cake. The acquisition makes a lot of sense in the context of Androïd having 39% of the mobile operating market, and Motorola being an endorser of Androïd since 2007 (Androïd is running second to Apple in third-party applications). This opens the perspective of Google becoming a vertical integrator of solutions, including payments, and pitching it against Apple and Microsoft-Nokia. Google Wallet is a free of charge mobile application that will turn a mobile phone into a wallet. It stores virtual versions of existing plastic cards on the mobile phone, along with coupons, and eventually, loyalty and gift cards. Google‗s intention is that Google Wallet will be an open mobile wallet holding all the cards and coupons kept in a leather wallet today. Whilst Google Checkout enables merchants to accept and process online payments, Google Wallet enables users to tap and pay at physical, brick and mortar stores. At launch Google Wallet will support two credit cards (Citi® PayPass™ eligible MasterCard® credit cards and the Google Prepaid Card - a virtual card powered by MasterCard and Money Network®, funded with any existing plastic credit cards, to tap and pay immediately after funds are added). In time all cards kept in a wallet today should be supported. Security for Google Wallet is provided through an NFC antenna only activated when the screen is powered on. Even if the antenna is on and in proximity of a reader, payment credentials can only be transmitted from the Secure Element to a payment terminal if a Google Wallet PIN is entered. The same rules that apply to unauthorized use of a plastic credit card apply to unauthorized use of a credit card stored in Google Wallet. Many banks apply a $0 liability policy for unauthorized use. As to merchants, they pay card-present rates and do not incur any additional charges for payments via Google Wallet. To accept contactless payments, a terminal must be ISO 14443 or 18092 standard. These terminals will usually contain the universal contactless symbol. For system partners Google Wallet is ―open‖ in 3 ways: - Google Wallet supports many payment instruments, with the goal to create virtual versions of all the plastic cards that exist today. - Google Wallet establishes APIs that issuing banks can develop so that integrating payment instruments into Google Wallet becomes a reasonably straightforward process. - Google Wallet establishes APIs to enable transfer of offers, loyalty programs, receipts, etc…. at the point of sale.
Intuit distributes GoPayment through Verizon shops: GoPayment consists of an application and physical card reader that plugs into the audio feed of an Apple, Android or blackberry device. Merchants can thus accept payments through phones and tablets. The GoPayment application is free of charge, and there is neither a monthly nor a transaction or cancellation fee. Users however pay a 2,7% rate for each transaction (compared to 2,75% with Square). Alternatively a USD 12,95 a month version reduces the transaction rate to 1,7%.
iZettle, a Swedish start up positioned by some as the Square of Europe, announced in August 2011 that its iZettle App for iPad, iPhone and iPod touch was available on the Swedish App Store. iZettle is a mobile payment application providing users with the ability to take credit and debit card payments anytime, anywhere. The App is simple to set up, with consumers and businesses downloading the app onto an iPhone or iPad and creating an iZettle account. A physical person could start taking payments within 5 minutes of registering, a business would 87 ------
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require 24 hours. Credit checks are compulsory for businesses, KYC and AML rules are applied for private individuals by the outsourced acquiring bank supporting iZettle. With the card reader transactions limits are EUR 2.500 per transaction and EUR 5.000 per day for businesses, and EUR 1.500 per transaction and EUR 3.000 per day for individuals. Without the card reader (using the app by manually entering the card number) the limit is EUR 50 per transaction and per day for both businesses and individuals. No sensitive data is ever stored on the mobile device or iZettle reader, and all data traffic is encrypted. Buyers pay with their credit or debit card, no registration is necessary. The iZettle product is aimed at small businesses and in-home service providers (such as housekeepers, plumbers, gardeners etc…) and at individuals (such as young people) who wish to abandon cash to settle restaurant bills, or casual sporting wagers, or yard sale purchases with no monthly fee. Instead, for each transaction, users will be charged 2,75 percent of the sale plus 1.50 SEK. The iZettle App can be used with or without an iZettle card reader accessory, however using iZettle with the card reader will be more convenient for large and frequent transactions. During the current phase of introduction the company is making 2,000 card readers available free of charge. Security is important and iZettle is EMV (Europay, MasterCard and VISA) approved and compliant with the Payment Card Industry Data Security Standard (PCI-DSS). No sensitive data is ever stored on a device or iZettle reader, and all data traffic is encrypted. iZettle App is available for free from the App Store on iPad, iPhone and iPod touch.
It is interesting to note that Microsoft has recently been pressing the Reserve Bank of Australia to consider adjustments to the domestic payments framework in order to enable consumers to conduct transactions using virtual currencies, such as Facebook Credits or Microsoft Points. Microsoft promotes virtual currencies on the grounds that they avoid multiple card processing and interchange fees for low value or micro transactions. Microsoft actually foresees virtual currencies moving from a closed loop environment to inter-scheme exchangeability in response to consumer demand.
mpass: this is the name chosen mid-August 2011 by 3 telecommunication providers in Germany (Telefonica Germany, Telekom, Vodafone) to register a joint payment services company. The role of mpass will be to step up distribution and marketing activities, and develop new products in the field of mobile or stationary internet from a mobile phone. The joint venture bets that very soon (―as early as next year‖) consumers will be leaving their credit cards at home and paying by mobile phone instead. The intended key value proposition is that queues are to become a thing of the past, with mobile payments becoming easier, faster and more secure than conventional payments means. It would seem that the main audience for the mpass initiative at this stage is retailers, who are intent on having access to standardised solutions.
Mobuyle: this Mobile Payment Acceptance Solution introduced by Heartland is designed for brick-and-mortar businesses looking for off-premises processing or on-site flexibility. It features electronic signature capture, GPS location capture, merchandise picture storage, and voice authorization capabilities. It enables merchants to accept cards even if they are out of range for cellular coverage of WIFI access with store and forward functionality.
Netswipe: the patent pending Netswipe solution turns a webcam into a secure credit card reader that allows merchants to more easily and efficiently accept payments online. Netswipe enables online card-present-transactions with checking out just like at the point of sale (POS). To
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complete a transaction, consumers briefly hold their credit card in front of their webcam. Through secure videostreaming, the credit card details are recognized and verified. No snapshot image is being taken, no data is stored on the computer that is used for the payment.
NTT Docomo – the giant Japanaese telecom operator – has acquired a controlling stake in a German private bank (Bankverein Werther). This bank shed its traditional activity and transformed into a provider of electronic commerce and payment services. This investment should allow NTT Docomo‘s already existing German subsidiary to leverage the bank‘s banking and credit card licences to expand operator-billing systems (including premium SMS payments), and offer direct debit and credit card payments and a range of settlement options.
PayNearMe is a cash payment network that enables consumers to pay with cash for a wide range of good and services by going to a local store (beginning with any of 6,200 7-Eleven stores across the U.S.) and pay cash at the register for an online purchase, a loan repayment, a bus ticket, or any other number of transactions. It partners with Avangate to offer a full- featured secure eCommerce platform, a partner management system as well as a worldwide affiliate network to enable software companies to sell their products online as well as to manage a distribution network. This allows e.g. sellers of digital content to serve effectively the 25% of U.S. households that don‘t have a credit or debit card and many others who prefer to pay with cash. The PayNearMe network offers real-time notification to merchants when payment has been made at a local retailer so that the goods can be released or unlocked immediately. Merchants can print a detailed receipt at the retailer‘s PoS to deliver custom messaging to consumers. PayNearMe also allows for integration into an on-line reseller‘s payment flow. Consumers are spared from having to purchase pre-denominated, closed-loop stored value cards and potentially wasting unused value or being required to pay fees for prepaid, open-loop cards. PayNearMe is supported by fixed or variable, or both transaction fees that depend upon the nature of the merchant‘s business (merchants can pay fees, or the consumer, or a combination of both). In PayNearMe mobile phones are used as ―tokens‖ – identifiers that point to instructions staged in a system awaiting execution upon payment. Tokens might be barcodes rendered on the screen of a mobile phone, the mag-stripe on a free PayNearMe Card bound to a pending transaction, or a PayNearMe Barcode printed directly on a PayNearMe Slip or even on a utility bill. The most important benefits from a merchant point of view are the zero risk of charge backs and the fact that the settlement occurs in real time. PayNearMe reversed the current prepaid model: rather than asking a consumer to load funds and subsequently ―push‖ them to the merchant, merchants stage a transaction before the customer makes a payment, which makes many processes easier and less expensive for the consumer. PayNearMe also removes the hassle of scratching off a PIN and returning to a website to complete a transaction.
PayPal would seem to be the more visible player in the payment platform space. It offers services to buyers and sellers in 24 currencies and 190 markets. PayPal also offers traditional payment gateway options that neither Amazon nor Google offer. For a fixed transaction fee merchants outsource the complications of how to receive payments (from credit cards, bank account or other payments systems). PayPal‘s focus on payments only may give it – compared to e.g. the platform ambitions of Amazon, Google, or Facebook – a competitive edge. Early July 2011 Paypal announced its intention to acquire Zong, a direct carrier billing operator who enables users to make online purchases for virtual goods using their mobile phone (via a secure PIN generated to users‘ mobile phones through a button on participating merchants‘ websites).
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In a further announcement Paypal introduces a range of e-invoicing APIs that businesses can access directly from their applications, allowing them to create and e-mail invoices, accept card payments, and track and manage invoices and payments. Overall PayPal positions itself as enabling and accompanying the transformation of the shopping experience, both for the retailer and the consumer. Paypal positions itself at the intersection of smartphones, social media, online and offline shopping, and vehicles to the consumer the perception that he/she is in control. The value proposition to merchants is a one-stop shop to engage their customers directly during every part of the shopping lifecycle, e.g. generating consumer demand through location-based offers, making payments accessible from any device (not just the mobile phone), and offering flexibility to consumers after they checked out. PayPal envisions 3 different ways in which a consumer might use PayPal for purchasing in a brick-and-mortar environment: either the PayPal card (a magnetic stripe-only, non-embossed PIN enabled payment card with the PayPal logo, compatible with any existing POS terminal yet not using any of the existing card infrastructure nor necessarily any merchant acquirer), or the ―Empty Hands‖ option (just selecting PayPal as the payment option on a POS terminal and entering a phone number and PIN code, with the funds ebing drawn from the default PayPal payment method set by each customer), or the ―In-Aisle Purchase‖ option (with the PayPal Mobile app as exclusive interface). Paypal furthermore considers granting selected customers the copability of changing e.g; at end of day their funding methods for their PayPal account, and benefit from instalment payments for select purchases. The Paypal supported products through the shopping experience include geo-targeted mobile advertising, barcode scanning, real-time inventory availability checking, mobile and point-of-sale payments, and a virtual wallet for i.a. loyalty and payment flexibility. In October 2011 PayPal announced the launch of PayPal Access giving customers the ability register and then purchase at participating websites with just their PayPal usernames and passwords, thus without any need fro entering separate usernames and password for each new website visited. PayPal assures that customers‘ financial information is not shared with merchants, and that privacy is bult into the system.
Popmoney is a person-to-person payment service that claims to eliminate the hassles of check and cash and to make it simple to send money to anyone just using their e-mail address or mobile number, without having to know their bank account information (admittedly this system has been pioneered in the United States – where, as the International Payments Framework‘s early experience showed, there are a lot of problems when trying to pass payments straight through to a beneficiary account using the latter‘s bank details). Sending Popmoney means just logging to an online bank account and look for Popmoney, and then send money to anyone by using either their e-mail address, mobile phone number, or bank account number. Transaction completions are notified to senders. Receiving Popmoney will involve receiving either an e-mail or text message, then – according to whether the beneficiary‘s bank supports Popmoney or not – logging into the bank account and directing the funds there, or alternatively providing one‘s bank account information at Popmoney.com. Failing any of these, the money will be returned to the sender. Money sent to a bank account will be automatically deposited there. Popmoney security is assured by secure socket layer encryption as well as privacy features. Popmoney is certified by TRUST and VerySign.
Other social networks and communities also grow rapidly, and could develop as platforms for transactions: - Twitter: 25 billion tweets were exchange last year; - Tmblr: 1 billion pages are viewed each week; - Zynga on Cityville went from launch to 100 million users in just 6 weeks. 90 ------
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In France Simpay registered as a payment institution and leverages the new SEPA Direct Debit Scheme to provide an electronically signed direct debit mandate solution. The debtor customer expresses his/her consent to the direct debit arrangement by sending a one-time-digit code on his mobile phone, receiving in return a digitally signed receipt in pdf format which serves as evidence. The French electricity utility will generalize this solution in spring 2014.
Starbucks Card Mobile extends the Starbucks reloadable prepaid card without PIN with an application to load card details on and paying by scanning a code from a phone screen.
At the 2011 Sibos conference 10 innovators had the opportunity to introduce their products. These are: - BillShrink's StatementRewards (in the meantime renamed ―Truaxis‖) creates transaction-based services and analyses customers‘ recurring bills to offer better deals via their online banking sites. - Cellfony claims it offers ―the first anti-malware mobile payment and card reader solution that makes a mobile payment wallet and card reader as simple and secure as a chip and PIN‖. - ChangeIt automates online charitable giving by offering donors a simple and secure way to donate small change to their favourite charitable causes with every debit and credit transaction. - Duo Security's two-factor authentication claims to be ―the simplest and safest way to secure any Internet login or transaction and prevent online fraud and account takeover‖. - FaceCash‘s proposition is that it replaces plastic payment cards, letting you pay with your phone and sign with your face. - GuardTime's software generated keyless signatures provide a provable audit trail for electronic data including proof of time, origin and integrity. - miiCard's user-centric federated identity solution serves as a digital passport, enabling pure online validation that proves "you are who you say you are". - SynerScope claims to be ―the fastest, easiest way to visualize relationships in Big Data event records including web traffic, payment transactions, mobile call records, IRC logs‖. - TransferWise claims to be ―a better way of exchanging currency, allowing you to avoid banks and brokers save the 5% commission they usually collect‖. - Wave Accounting says it offers ―ridiculously easy online accounting for small businesses‖. GuardTime and Truaxis went on to win the competition.
Swipely‘s mission is to save users money at local businesses. It offers users a private experience — in stark contrast to public purchasing-sharing — that rewards them with cash back rewards, loyalty points and extra incentives for sharing reviews on social networks for swiping their credit cards at local merchants.
Visa‘s mobile strategy as presented in August 2011 has 3 prongs. First it looks at NFC to use the mobile phone at a physical store. Increasingly more phones (such as the Androïd) are enabled with NFC chips, turning them into mobile wallets. Visa also joined the ISIS network (an NFC mobile payments network that is a joint venture between AT&T, T-Mobile and
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Verizon, and has struck agreements with American Express, MasterCard and Discover). Visa will notably license the PayWave mobile payment application for integration with the ISIS wallet. Second it is about optimizing the consumer‘s experience in e-commerce by providing for a one-click, simple username and password checkout experience for transactions on the web through a mobile device. This is an area in which PayPal has quite a presence yet Visa sees room here for other players. Visa also announced plans for a digital wallet to allow access to loyalty points, credit cards (including from Visa‘s competitors) and other payment instruments from a mobile phone at point of sale. Third Visa is incorporating value-added services such as real time alerts and contextual services at point of shopping based on a customer‘s location. In addition Visa invested into Square as it sees that company enabling small businesses and independent professions such as doctors, designers, and other merchants accepting payment cards. Square is now processing USD 4 million in mobile payments per day. Square recently launched an iPad application, aimed at replacing cash registers and loyalty cards. Visa executives say that the biggest challenge for mobile payments is the massive amount of industry fragmentation, in terms of mobile operating systems, specific manufactured phones, applications and so on. Keeping pace with supplier innovation on the development side is a major issue even for a company such as Visa.
Vocalink demoed a mobile payment gateway allowing consumers to make payments to a mobile phone number. The gateway is available to the UK banking community, and allows users to instruct an instant bank transfer identifying the beneficiary via a proxy such as a mobile phone number. This reduces the need the need for users to share bank account details, thus providing greater security on top of convenience.
US-based global payment services company Western Union has expanded its enhanced walk- in bill payments service throughout the US. The national expansion offers US consumers a network of 10,000+ billers for mortgage, auto loan, insurance, credit card, utility, telecomm and cable payments including AT&T and Comcast, plus walk-in access to a network of participating Western Union Agent offices, nationally-known retailers and other locations. The walk-in service aims to provide consumers with access to a new money management tool as well as with increased control over their transactions. Western Union has joined forces with The Pantry, an independently-operated convenience store chain in the SE US to offer the Western Union goCASHSM service, an in-lane money-transfer service from Western Union.
Paying for e-commerce goods at an ATM: on an online store a buyer selects ATM as payment method, then prints the generated barcode and presents it for scanning at an ATM, validating it with his/her PIN code. The ATM prints a receipt (Spanish banks).
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7- Conclusion: assessment of how international principles and academics’ findings and recommendations are reflected in European policy makers’ approach We reviewed and summarized input from policy makers in 4 prominent non-cash payment countries and regions, as well as a number of academic papers, and views from the supply and demand sides, as well as a snapshot of innovation claims.
In this conclusion we assess guidelines formulated by policy makers who pursue innovation for the good of society (taking the Canadian approach as a proxy) with what we perceive is happening in the European Union. We also assess how much of the key findings and recommendations made by academics are reflected in European authorities‘ policy and regulatory approach to payments innovation.
We begin with the 12 principles for a successful payments future – as proposed by the Canadian Task Force on Payment Systems
Proxy principles for the continued Assessment of how these principles are development towards increased efficiency and currently reflected in European Union societal value of an existing payment system developments Competition and innovation: the payment At least the transposition of the Payments Services industry is open and competitive, participants Directive (and the e-money Directive) should have the ability to innovate. ensure that the payment industry is open to registered and regulated payment service providers, be they credit institutions or payment or e-money institutions. All are also granted access to clearing and settlement infrastructures on a same risk, same rights basis. It is however uncertain how much the payment landscape can currently meet the competition ambition and expectations of European policy makers and regulators: - As payment transaction volumes are concentrated in a few Member States, prior to the end date for national schemes it is natural that only little volume will be processed on a Member State-independent basis. - European legislation has materially raised the threshold for entrance into the payments market, due to the many new obligations set on payment service providers by the PSD and the SEPA migration Regulation. In addition these as well as Regulation 924/2009 strongly constrain customer pricing, in many instances preventing providers to charge on a per transaction basis. Newcomers are hard pressed 93 ------
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to identify long term, sustainable business cases – except where existing, blatant inefficiencies can be competed away. - Whilst the ability to innovate certainly exists, that there is widespread motivation to do so is more questionable, for the reasons highlighted above. User access and efficiency: all consumers, Access to affordable payment options certainly including merchants, business, and governments exists. Whether these are effective would be a have access to effective, affordable payment function of a wide distribution of Internet and options. electronic banking capabilities and of public authorities‘ positive approach to disbursing and collecting via non-cash payment instruments. The situation differs widely across Member States, with the most efficient one (Finland) registering 394 non-cash payments per capita, and the least efficient one (Romania) only 23 such payments. In addition the European Commission‘s 2010 Recommendation on the euro as legal tender is hardly the right policy message for greater digitalization i.e. efficiency of the internal payments market. Transparency and choice: rules, responsibilities, The responsibilities of market providers and their risks and costs are clear, participants have customers have been established notably in the necessary information and tools, payors and Payment Services Directive and the SEPA payees can choose among a variety of payment migration Regulation, and they are significantly forms without undue penalties. tilted towards customers. The same legislations provide for obligations with respect to information, notably with respect to costs and risks. With respect to choice, please see the remarks made immediately above. Fairness and accountability: costs accrue to market The European payments market is increasingly participants who receive the associated benefits, marked by pricing regulation, be it for pricing to unless another party chooses to bear these costs, end customers (as already explained above), or at all sides understand the associated risks. interbank level (with e.g. the ban on interchange for direct debits, and the capping of card interchange). As a consequence, the end customer‘s perception of costs and benefits cannot but be significantly distorted, negatively influencing e.g. their readiness to adopt new value propositions (which in the absence of price signals have to offer extremely steep convenience gains). The bias introduced and maintained by the 2- layered pricing regulation philosophy of the European Commission prevents effective customer choice and progress towards a more efficient European payments system.
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Security: all vital technologies and processes are Payment service providers strive to mobilize and secure and reliable, payors and payees have deploy the most appropriate security technologies confidence in the payments system. and processes, in function of transaction environment and value. This approach is complemented by voluntary and legislative redress and compensation mechanisms which to a very great extent annihilate any negative impact for end customers of a disruption in the security value proposition. The efficiency of security arrangements could be significantly enhanced by public authorities agreeing at European level a common set of objectives to be attained by such security arrangements (leaving freedom to market participants as to how they will deliver on these objectives). It is expected that the newly formed SecuRePay Forum of the Eurosystem would formulate such objectives – initially for online payments. The Forum however was only established in the 2nd quarter of 2011. The efficiency of security arrangements could be further enhanced if the European legislator recognized that many security developments now occur within international standardisation organizations as well as global private bodies, and that any insistence about the formulation of European-only standards – as the latest policy twist seems to suggest - will hardly be helpful. Privacy: payors own their personal (or These objectives are certainly met as far as organizational) information, and can determine properly regulated and supervised payment service how it is used, payors need only disclose providers are concerned. However the emergence information necessary for a given payment. of new players – such as ―overlay payment service providers‖, about which the European legislator is surprisingly slow to issue any opinion – does not allow for any blanket statement of comfort in this field, on the contrary. Furthermore, payment service providers cannot be held accountable for data and information capture and retention practices implemented by e.g. merchants and/or social platforms.
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Consistent standards: rules for domestic payments The SEPA migration Regulation to a large extent are consistent to ensure efficiency, domestic establishes common standards and rules standards facilitate global interoperability. applicable at a pan-European level to credit transfer and direct debits from 2014 onwards. There is however a steep gap between these standards and rules, and those implemented for the same instruments (where applicable) by other large payment environments globally. As to payments with cards, whilst on paper a limited set of core standards underpin most domestic and international card schemes, in effect differences in implementation limit straightforward interoperability, although there is a rich offering of switches that act – much effectively so - as bridges between domestic and international schemes. Minimal regulation: regulation occurs only when As highlighted throughout this document, even a the open market and industry standards fail to casual observer of the European payments scene deliver on market related principles. would be hard pressed to describe the regulator as intervening ―only when necessary‖. Legislation and regulation ex ante have become the rule at European level, often in the absence of any independent assessment of their impacts. In effect any reference to market-related principles has disappeared by now, to the extent that the use of any academic model to assess the usefulness of a legislative proposal, or a requirement for such, becomes a genuine challenge. Equally, the weight of legislation leaves little room for whatever may remain in terms of industry action to produce any effect. Neutrality by function: standards and rules are This principle would indeed appear to be applied, based on the activity performed, not the with limitations however due to the many national institution performing the activity, rules apply waivers granted during the transposition of the consistently across function. Payment Services Directive, and the additional ones likely to emerge from the SEPA migration Regulation (with respect to ―niche products‖, and the related providers, e.g. ELV in Germany).
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Proportionality: protection takes into account risk The Payment Services Directive takes a rather involved, transaction type and transaction value. risk- and transaction type-agnostic approach to consumer protection (as for any other matter, in this respect). The Payment Services Directive just provides for (very low value) thresholds applying on one side to the definition of very low value electronic instruments, on the other to the maximum consumer liability in case of loss, theft or fraud perpetuated with a personal identification device. In addition a number of Member States made use of the ability granted by the Payments Services Directive to lift, or vary, these thresholds, always to the benefit of the consumer.
Independent and conclusive: governance of the No formal governance of the payment system has payments system is not controlled by a minority of been established at European (―SEPA‖) level up stakeholders. to now. As far as the supply side is concerned; the European Payments Council has the ambition to fulfill this role. It is fair to acknowledge that in spite of a Charter which gives it the mantel of a democratically functioning body, in practice it is tightly controlled by a minority of institutions, if not physical persons. As to the demand side, no equivalent body exists so far (although an ―end user committee‖ has been formed to formulate common positions vis à vis the EPC on an ad hoc basis). In effect the demand side‘s requirements are generally taken up by the European Commission when it legislates, and the requirements of the supply side are then generally ignored. Clearly there is ample room for better, stakeholder-wide, governance arrangements, a task the newly formed (June 2010) SEPA Council only now wants to consider. The fact that the European competition authority remains completely independent of the SEPA Council does however not bode well of the effectiveness of the SEPA Council‘s ambition. Framework adaptability: industry governance is The European Payments Council has been robust, yet flexible enough to remain relevant over established in 2002. Its Charter excludes for the time. EPC to function as a payments association. The EPC is formally the scheme manager for the SEPA Credit Transfer and Direct Debit Schemes (both the core and the optional schemes). It is also the body developing and evolving these schemes, as well as potentially new ones, and developing guidelines and best practice for cards, cash, e- and m-payments. The positioning of the EPC has
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remained unchanged since its formation. Regarding participants, the EPC acknowledged the payment institutions allowed by the Payments Services Directive, and accepts representatives of these in its bodies (Plenary, Coordination Committee, Working Groups).
The analysis above evidences that the Single Euro Payments Area is in many instances far from applying the principles (or similar principles) proposed by another country (Canada) which not only has already achieved a very high level of efficiency of its payments system (actually the Canadian system is today 70% more efficient than the European payment system), but is already pondering how best to take the next leap forward. It may even come as a surprise to many that actually no similar set of principles has ever been formulated by the European policy makers – the closest one would be the ―May 2006 joint statement by the European Central Bank and European Commission on SEPA‖:
Highlights from academic work Assessment of implementation, transposition by European policy makers As new technologies, products and business The Payment Services Directive and E-Money models develop, new markets and market failures Directive have been issued only recently. There may emerge requiring changes to the existing has not been any new technology development regulatory framework since. Unfortunately, the European competition authority is constraining the type of business models that can be deployed, by in some instances banning interchange, and regulating end-user pricing (at times at a level of 0), thus forcing cross-subsidization. Standards can complement or substitute Notably with the SEPA migration Regulation (to regulation, in particular standards can help address be promulgated in 2012), that spells out technical information failures and/or market co-ordination specifications at a low level of detail (although the failures market had developed and implemented standards and rules addressing the same objective) the European regulator demonstrates its unwillingness to rely on self-regulation to the greatest extent possible. 2 important frameworks are used by government None of these methodologies has been applied to guide and inform policy making. A first one neither to justify policy making and legislation in leverages the 5 drivers of productivity growth, as the field of payments over the past decade, nor to regulation is one of the instruments governments assess their effectiveness. can use to deliver economic objectives. The second one is the ―Rationale-Objective- Monitoring-Evaluation-Feedback‖ model of policy appraisal and evaluation.
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There are 5 factors in the interplay between European payments legislation tends to focus on regulation and innovation: the degree to which behavior rather than outcomes. Whilst the regulation prescribes particular behaviors as well amount of advance notice is usually acceptable, as outcomes, the extent to which businesses can that legislation is generally disruptive in terms of comply with regulation using existing technology business practices, almost by intent so. Legislation and practices, the amount of advance notice, the usually comes with a review clause, which amount of remaining uncertainty surrounding the generally results into further legislation, rather future regulatory framework, and the costs of than a balanced assessment of the effectiveness of complying with new rules and requirements. the initial legislation. Costs of complying with new rules and requirements are usually disregarded, and/or justified by claims of ―public good‖. 5 business models for cooperation between banks, Although the European policy maker and mobile network operators, and payments systems regulator generally recognizes that cooperation on are proposed: the light model, the mobile centric the supply side is required to achieve product model, the bank-centric model, the partial- acceptance and economic benefits, the uncertainty integration model, the full integration model. Each maintained by competition authorities as to the business model is characterised by the respective permissibility of such cooperation, the pricing degree of dependency or cooperation between the regulations in force, and attacks on inter-payment 3 categories of payers. The partial-integration and service provider cost recovery models mean that full-integration models appear to be the most most innovations develop in the context of either costly to develop, yet they are the most efficient to light or provider-centric models. serve the mass-market. The light model will be most suited to introduce innovation, but is restricted to niche markets. Three conditions are required for the market Given the pricing regulation in force for most adoption of new payment instruments: overcome European payment services, and the legislated the chicken and egg problem and security and shift in consumer protection, the externalisation liability issues, provide superior benefits to most of the benefits offered by innovations becomes participants, not decrease net benefits to any much more of a challenge, impacting pace of participant in a given payment segment. adoption. A ban or a sharp reduction in interchange means This is the pending risk as a consequence notably shifting to a ―consumer pays‖ model. Reducing of the SEPA migration Regulation. The potential interchange would as such not eliminate impacts will have to be tracked and assessed innovation, as service providers adapt and adjust between now and 2014-2015. types of payment innovation. There could even be a flurry in the number of innovations, but overall investments into payment innovation will decrease as it is far more difficult to extract revenues from the consumer side than from the merchant side. This shift in business model could hinder the emergence of new payment systems and providers, and will direct innovation to ―chargeable‖ areas of the payment business.
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Regulation aims to develop or stabilize an This methodology has not been applied over the economic or social system. A benchmark tool to past decade, neither to justify policy making and assess how this is achieved is Pareto efficiency, legislation in the field of payments, nor to assess indicating whether scarce resources are well their effectiveness. allocated (i.e.: can the situation of an economic agent be improved without negatively impacting that of another economic agent?). For effective competition to be an enabler of As evidenced by the 2 Regulations (and another allocative and productive efficiencies both ex ante one soon to be promulgated) and the Directive and ex post regulation (the application of common transposed over the last decade, the European competition law) are considered. The latter limits legislator clearly favors ex ante regulation. market power and thus contributes to allocative efficiency gains but it does not necessarily foster effective competition. In addition ex ante regulation may be required to introduce effective competition into an infrastructure market where economies of scale and scope and network externalities hand an advantage to existing players. Dilemmas could be resolved by 2 approaches to Neither approach has been considered by regulation policies. A first approach is the European policy makers and regulators. temporary absence of regulation so that market participants are able to book returns on their investments. The combination of such ―regulation holidays‖ followed by ex ante regulation should effective competition not be achieved could deliver positive results39. The second approach – compatible with the ―regulation holidays‖ approach – is to implement an industrial policy favouring the development of new infrastructures and services. Such policy is investment- rather than competition-oriented and should be understood as a contract between the regulator and the (dominant) operator(s): asymmetrical ex ante regulation would be suspended provided that negotiated goals are met. Payments solutions with low risk come at higher The European regulator does integrate this costs than non-guaranteed payment solutions – dimension when constantly raising the bar of the authors however assuming that cost and applicable consumer protection through usability considerations are secondary to risk regulation, whilst at the same time preventing
39 The authors refer to Baake et al. (2005) and Gans & King (2004) to support their statement. 100 ------
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assessment, meaning that perceived risk is the providers to externalize the related costs, due to determining factor for the choice and use of a applicable pricing regulation. payment transaction. This implies that both seller and buyer will seek to optimize risk exposure in relation to payment instrument cost and usability.
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8- References and acknowledgements
This Working Paper draws significantly on the following documents and sources (by alphabetical order)
BERR (UK Department for Business Enterprise & Regulatory Reform) Economics Paper No. 4: Regulation and Innovation: evidence and policy implications (December 2008) N. Bielefeld: ―The Single Euro Payments Area: can innovation be mandated‖, in Journal of Payments Strategy and Systems, Volume 5 Number 3, September 2011 M. Bourreau & M. Verdier: Cooperation for innovation in payment systems: the case of mobile payments – February 2010 Canadian Task Force for the Payments System Review: The Way we Pay – Transforming the Canadian Payments System – July 2011 S. Chakravorti & E. Kobor : why invest in payment innovation ? – June 2003 C. M. Christensen : The Innovator‘s Dilemma EC DG Markt/Council/Parliament – SEPA migration Regulation – Status August 2011 European Central Bank 7th Progress Report on SEPA European Central Bank – Report on the results of the e-SEPA survey on payment innovations in 2010 – October 2011 European Commission (draft) ―Green Paper‖: ―Towards an integrated European market for card, internet and mobile payments‖ (the official Green Paper is now expected to be released for public consultation in January 2012) European Commission response to EPC 10th August 2011 European Commission‘s DG Competition letter to EPC announcing the opening of an investigation (22nd September 2011) European Commission: speech by DG Competition Commisioner Almunia on ―Building Europe‘s future payments market‖ (Brussels, 12. October 2011) European Consumer Centers‘ Network: Online cross-border mystery shopping – State of the Union (September 2011) Response to the European Commission‘s public consultation on the future of electronic commerce (BEUC, 5. November 2010) Response to the European Commission‘s public consultation on the future of electronic commerce (EMOTA – European e-commerce and Mail Order Trade Association – 15. October 2010) European Commission and European Central Bank : Innovation in retail payments – Background paper for the May 2011 SEPA Council ECOFIN Declaration on SEPA 2nd December 2009 D. S. Evans : Payments innovation and interchange fee regulation - June 2011 Federal Reserve Bank of Atlanta Symposium on „The role of government in payments risk and fraud― – 17th & 18th November 2011 Federal Reserve Bank White Paper on mobile payments – January 2011 www.finextra.com D. Flacher, H. Jennequin, J.-H. Lorenzi: Innovation, Investment and Regulation: What are the Options for Regulation in the Near Future? Communication & Strategies no. 64, 4th quarter 2006
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Fraunhofer‘s European Trend Surevey – Banks and Future 2010 – Survey of the European payments market Ixaris Payments Innovation 2011 Report – January 2011 KPMG: Monetizing mobile – How banks are preserving their place in the payments value chain – July 2011 C. Liezenberg, D. Lycklama, H. Smorenberg: understanding buyer and seller behavior for improved payment product development, in Journal of Payments Strategy & Systems, Volume 1 Number 3 O‘Reilly Radar Report on ePayments: Emerging Platforms, Embracing Mobile, and Confronting Identity - 2010 www.paymentsnews.com Reserve Bank of Australia: Strategic Review of Innovation in the Payments System – Issues for Consultation – June 2011 Reserve Bank of Australia: Findings and Conclusion of the Consultation on Surcharging Standards - December 2011 Telecom Paper – Innopay Research paper 2009 US Administrtaion national strategy for trusted identities in cyberspace – January 2011 Viewpoint Learning: Scenarios for the Future of the Canadian Payments System – Report 2011
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9- Annexes Annex 1: Evolution of payments worldwide 2010 – 2020 (on the basis of data provided in the Boston Consulting Group‘s January 2011 ―Winning after the storm‖ study) Evolution of payment transaction volumes (in billions transactions) 2010 - 2020 North Latin Western CEE Asia Middle Rest of Total America America Europe Pacific East the Africa World Volumes 117 29 78 12 65 4 1 306 2010 Volumes 207 109 125 30 213 38 29 751 2020 Increase 77% 276% 60% 150% 228% 9x 29x 145% Share of 38,3 9,5 25,5 3,9 21,2 1,3 0,3 100 total 2010 Share of 27,6 14,5 16,6 4 28,4 5 3,9 100 total 2020
Evolution of payment revenues (in billions USD) 2010 - 2020 North Latin Western CEE Asia Middle Rest of Total America America Europe Pacific East the Africa World Revenues 160 71 147 40 140 29 2 589 2010 Revenues 285 195 276 97 534 132 60 1579 2020 Increase 78% 175% 88% 143% 281% 355% 29x 168% Share of 27,2 12 25 6,8 23,8 4,9 0,3 100 total 2010 Share of 18 12,3 17,5 6,1 33,8 8,4 3,8 100 total 2020
Evolution of retail payment transaction volumes (in billions transactions) 2010 - 2020 North Latin Western CEE Asia Middle Rest of Total America America Europe Pacific East the Africa World Volumes 97 21 65 9 46 3 1 242 2010 Volumes 176 82 105 24 147 34 23 591 2020 Increase 81% 290% 62% 167% 220% 10x 23x 144% Share of 40% 8,7% 26,9% 3,7% 19% 1,2% 0,4% 100 total 2010 Share of 29,9% 13,9% 17,9% 4% 24,9% 5,9% 3,5% 100 total 2020
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Annex 2: Usage of several payment instruments across European Union countries
Credit Transfers & Direct Debits (per capita) Euro Countries Non-Euro Countries 240,0 220,0 200,0 180,0 160,0 140,0 120,0 100,0 80,0 60,0 40,0 20,0 0,0
FI IE IT SI AT BE CY DE ES FR GR LU MT NL PT SK BG CZ DK EE GB HU LT LV PL RO SE EU 27
Credit transfers Direct debits
Card Transactions & ATM Withdrawals (per capita) Euro Countries Non-Euro Countries 240,0 220,0 200,0 180,0 160,0 140,0 120,0 100,0 80,0 60,0 40,0 20,0 0,0
Cards ATM Withdrawals
Source: ECB “Blue Book” 2011, data for 2010 105 ------
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ESBG – The European Voice of Savings and Retail Banking ESBG (European Savings Banks Group) is an international banking association that represents one of the largest European retail banking networks, comprising about one third of the retail banking market in Europe, with total assets of over € 6.900 billion, non-bank deposits of € 3.000 billion and non-bank loans of € 3.600 billion (all figures on 1 January 2011). It represents the interests of its members vis- à-vis the EU Institutions and generates, facilitates and manages high quality cross- border banking projects. ESBG members are typically savings and retail banks or associations thereof. They are often organised in decentralised networks and offer their services throughout their region. ESBG member banks have reinvested responsibly in their region for many decades and are a distinct benchmark for corporate social responsibility activities throughout Europe and the world.
European Savings Banks Group - aisbl Rue Marie-Thérèse, 11 B-1000 Brussels Tel: +32 2 211 11 11 Fax : +32 2 211 11 99 [email protected] www.esbg.eu
Published by ESBG - December 2011
The views expressed in this Working Paper are the responsibility of the author and are not to be regarded as representing the views of ESBG Members.
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