The new UK Payment Systems Regulator - overview and impact on innovation
This article was created for payments compliance and first published by them on February 12 2015.
The UK is pioneering a specialist regulatory focus on payments and e-payments to ensure that it remains the European capital for payments and so that it can also assume a world leader position in new areas of payments innovation (eg. virtual currencies).
The current payments infrastructure and landscape (particularly in the UK and the USA) is based largely on the processes and structures agreed by major banks in order to deal, largely, with banking requirements and innovations of the last century. For example, the major UK payments card schemes (Visa and MasterCard) arose as a result of card innovation, particularly credit card, and inter-bank arrangements by a number of banks initially in the United States in the 1950-60’s.
The established processes of payments clearing, settlement, reconciliation and processing are built around systems and processes agreed by and suited to major counterparties who are usually vertically integrated into the relevant payment systems. Access to major clearing systems also requires sponsorship by a small number of major clearing banks. Unsurprisingly this state of affairs is counter-productive to genuine innovation by competitive and disruptive market players since it makes the emergence of new payment solutions difficult, costly and unnecessarily complex.
Financial services authorisation is the easiest hurdle?
As an e-payments lawyer it is necessary to point out to new clients seeking financial services authorisation that their hard work is really only getting started if and when they obtain financial services authorisation. This comment often surprises the less experienced.
Leaving aside the ever increasing regulatory and compliance obligations, the costs and difficulties for new payments companies start to multiply when they wish to do business using their authorisation, for example, they:
- need to consider payment issuing or acquiring permissions and relationships
- may now need to factor in the licensing and collateral costs and processes for dealing with the card schemes and card processors
- will need to find willing banking partners to receive and hold client and trading account funds (no mean feat in the current climate!)
- may need loading and redemption pathways requiring additional relationships with yet other payment partners
- will likely also require relationships to deal with FX transactions
In short, and assuming they are able to access the payment systems and counterparty relationships they will need, new payments players have to work very hard and be super smart to make a profit once every other participant takes its slice of the transactions.
If you add any cross-border e-commerce element to your payment program the costs and difficulties rise more significantly, even in Europe where it is subject to some degree of harmonisation including under the Payment Services Directive and the 2nd E-Money Directive. The complexity and multiplicity of participants, payment systems and regulatory structures in each country creates even greater barriers to entry and makes many good payment solutions unprofitable which further reduces innovation and increases the importance of financing to get scale (for this reason emerging payment operators coming in from the USA have an advantage over home-grown European innovators).
The existing regulatory architecture also shows its age with some strange anomalies, for example, despite their fundamental influence and importance to worldwide payments MasterCard and Visa have not yet squarely fallen within a defined financial services authorisation category in the UK (or most places elsewhere) and yet they set the rules of access and engagement for the world’s commonly accepted branded payments cards. The same issue arises in respect of major card processors.
Structural Reform & Review
In ‘advanced’ Western economies the existing old legal framework and payments infrastructure has evolved with some work-arounds seeking to enable customers to access new payment products devised for new demands (e.g. the authorisation of electronic money products), however structural problems persist:
“innovations in payments are found at the consumer-facing end. However, innovation within payment systems, at the Operator and infrastructure levels, appears to have been at a slower pace with change often driven by external (sometimes political) pressure” (PSR CP14/1 - A new regulatory framework for payment systems in the UK, para 56)
At some point the old infrastructure shows its age and institutional biases and it breaks down, we are at such a point and the payments landscape in so called ‘advanced economies’ is ripe for review and restructuring to better enable new entrants and solutions. The proposed new EU Payment Services Directive (PSD2) is looking to deal with some of these and the UK has responded to this challenge by establishing the new UK Payment Systems Regulator (PSR).
The PSR published a consultation in November 2014 (PSR CP 14/1), which sets out the PSR’s vision and proposed regulatory approach. Responses to the questions raised in the Consultation were required to be submitted by 12 January 2015 - there has been over 40 public responses (and many more confidential responses) from a wide range of UK and international companies and associations.
The PSR is set up as a subsidiary of the Financial Conduct Authority. The PSR’s aim is to ensure payment systems and the regulatory framework operate in the best interests of service users and the wider UK economy − promoting rather than constraining innovation and competition.
The initial remit of the PSR is:
- to promote effective competition in the markets for payment systems and for services provided by those systems, including between Operators, PSPs and also Infrastructure Providers, in the interests of service‑users
- to promote the development of and innovation in payment systems, in particular the infrastructure used to operate payment systems, in the interests of service‑users
- to ensure that payment systems are operated and developed in a way that considers and promotes the interests of service‑users
Who will be regulated by the PSR?
Under the new PSR regime HM Treasury will specify those payment systems and participants within the same (such as payment service providers) that the PSR will regulate. This approach allows the UK Government agility and adaptability to focus its remit and activities to meet new challenges and also new payments systems that may gain common acceptance. Initially the PSR will regulate the main interbank payment systems, namely Bacs, CHAPS, Faster Payments Service (FPS), LINK, Cheque and Credit Clearing (C&CC) and Northern Ireland Cheque Clearing (NICC) and MasterCard and Visa.
It is important to note that regulated payment service providers (e.g. banks, e-money issuers and payment institutions) will continue to be authorised by the FCA (for banks they are dual regulated by the PRA) and so must comply with FCA and PRA prudential and conduct of business requirements. The PSR therefore adds a market regulator on top of much of the existing regulatory environment for the payments sector.
PSR as an economic regulator
The PSR is therefore being set up as an economic regulator to better manage macro-issues that go across the whole payments industry and impact the wider economy. The PSR has broken these requirements down as follows:
- strategic development of industry collaboration and innovation
- regulation of key concerns relating to ownership, governance and control of, and access to, payment systems.
- high-level behavioural standards for industry participants
- detailed proposals relating to monitoring, enforcement and dispute resolution.
- market reviews into the provision of Indirect Access to payment systems, and into the ownership and competitiveness of infrastructure provision
PSR Initial Policy Proposals
“Operators of [some] regulated payment systems must provide…objective, risk-based, and publicly disclosed Access Requirements, which permit fair and open access.” (PSR Policy Proposal, Paper 4)
The initial policy proposals include the following key points:
- Setting up a new Payments Strategy Forum with broad representation of industry and service-users.
- Launch a market review into the competitiveness of infrastructure provision commencing by April 2015.
- Ownership, governance and control of payment systems
- All Operators (i.e. the regulated payment service systems specified by HM Treasury) will be required to ensure service-users are appropriately represented in decision-making
- Conflicts of interest will need to be addressed in respect of vertically integrated banks and Operators
- Operators will be required to report to PSR on compliance with our service user direction annually
- Direct access to payment systems:
- Operators must provide access on objective, risk-based, and in some cases publicly disclosed Access Requirements, which permit fair and open access.
- All Operators must report on compliance with their relevant access rule annually
- Indirect access to interbank systems
- Sponsor Banks must publish information on the sponsor services they offer (including access criteria and processes). Industry will develop a PSR-approved Code of Conduct.
- PSR will launch a market review into Indirect Access, commencing by April 2015.
- Interchange fees
- PSR will engage with relevant authorities on the proposed EU Interchange Regulation.
- Regulatory Tools
- PSR will introduce Principles on expectations of industry behaviour.
- Industry must work with PSR in an open and ongoing basis.
- Issuing Powers and Processes Guidance.
The PSRs wide-ranging powers are established by the Financial Services (Banking Reform) Act 2013 (Banking Reform Act). Its powers include:
- the ability to amend agreements including the fees relating to access to payment systems
- ordering the disposal of interests in the operator of a payment system
- requiring banks to enter into agreements with other institutions to process transactions on their behalf
- investigating and imposing fines (e.g. based on revenue or payment volume) or other sanctions
- use of competition powers to enable access to payment systems and to manage conflicts relating to vertical integration
- launching investigations in response to consumer complaints or super-complaints from market participants or industry bodies
- conducting wider market conduct and function reviews
- undertaking further action pursuant to ensuring that the regulatory objectives are met
Regulated Electronic Money and unregulated emerging payments
The initial objectives, scope and purpose of the PSR is highly commendable. However, the initial policy proposals also leave significant room for further actions that are required for the PSR to enable a properly functioning and innovative payments sector.
Within new areas of regulated payments innovation such as the EU regime for issuing electronic money (a continuing and increasingly obvious misnomer given the rise of virtual currencies), the UK under the FSA took the lead as the most supportive, pragmatic and adaptable regulatory environment. This regulatory stance has often been necessary to encourage operators to take advantage of the European Union’s intention to encourage alternative payment providers under the E-money Directives and the Payment Services Directive (which also need to be consolidated). In many cases other EU Member States have not been so encouraging and difficulties with understanding the underlying EU law relating to, e.g., what is ‘e-money’ and what are ‘payment accounts’ in addition to difficulties in accessing payment systems and making use of passporting permissions have meant that the sector requires a constructive and supportive regulator.
In addition to the PSR’s UK macro-regulatory position it will be interesting to see the extent to which it will become involved in working with the FCA on significant cross-border legal and regulatory uncertainties. Cross-border trade issues are macro-issues. The PSR’s relationship with the EBA and regulators in other jurisdictions will therefore be crucial to achieve macro-level objectives. There is also real need for a payment specialist regulator within the EU to take up the challenge of being a European advocate for emerging payments with Member States and to help the European Commission, Parliament and Council to structure payments laws and processes that meet stated objectives, are technologically neutral and take account of emerging innovations.
In addition to regulated alternative payment service providers there is also the need for the PSR to look at and identify the opportunities and risks relating to new currently unregulated payment networks and currencies. These new providers and solutions allow transfers of value using non-fiat currencies (known as virtual or crypto-currencies) and will often also involve mediation between virtual and fiat currencies. In fact reviewing and pioneering the regulation of virtual currencies and encouraging their use and acceptance might lead to quicker and easier results to meet many of the PSR objectives than expending all its effort and time to try to move the attitudes of major market counterparties who will be loathe and slow to change their complex and established systems and processes.
Currently the UK (and most of the EU) takes the view that virtual currencies do not constitute funds under either the Payment Services Directive or the E-money Directive, to date they are largely unregulated. However, given that the meaning of money ultimately derives from its acceptance and use it is only a matter of time before such virtual currencies are deemed to be recognised forms of money that require regulatory oversight and supervision. Someone somewhere has to take the lead on this issue to help these innovations flourish whilst protecting consumers from security breaches, fraud, pyramid sales schemes, insolvency etc. The smart players in the virtual currency sector are also looking for such a regulatory home.
The introduction of a PSR puts the UK in a good position to maintain its place as the preferred EU jurisdiction for payments companies. However given our interconnected and technology driven world, the next phase must include widening the PSR’s initial scope. This widening of scope will be fundamentally necessary for the PSR to meets its objectives of a healthy, open, innovative and competitive market for all payments.