EU payment regulation – Raising questions

Recent payment regulation, interchange proposals in Europe and the revision of the

Payment Services Directive will have a significant impact on business strategies for all stakeholders going forward – reports PCM editor, Victoria Conroy.

In July 2013, the European Commission (EC) adopted a package including a new Payment Services Directive (PSD2) and a proposal for regulation on interchange fees for card-based payment transactions. As PCM outlined in its last issue, the interchange caps proposed by the EC caused widespread consternation within the payment industry and beyond. What has been less clear is the combined impact that interchange caps and the PSD2 will have on the industry.

According to the EC, the revised PSD brings a number of new important elements and improvements to the EU payment market, by facilitating the use of low-cost internet payment services by including within its scope new so-called payment initiation services. Consumers will also be better protected against fraud, possible abuses and payment incidents and increased consumer rights when sending transfers and money remittances outside Europe or paying in non-EU currencies. The PSD2 will also promote the emergence of new players and the development of innovative mobile and internet payments in Europe for sake of EU competitiveness worldwide.

The timeline for introducing EU regulations differs depending on the legislation concerned – for instance, the proposed regulation on interchange fees for card-based payment transactions are the most direct form of EU law.

As soon as they are passed, they have binding legal force throughout every EU member state, on a par with national laws. Meanwhile, the proposal for the PSD2 will have to be adopted by the European Parliament and the Council of the EU; i.e. the EU legislator.

The EC counts on the European Parliament (Economic and Monetary Affairs Committee or ‘ECON committee’) and the Lithuanian Presidency [of the Council of the EU] to launch the negotiations work on the measures as soon as possible after the summer with a view to reach an agreement on the EC’s proposals by spring 2014.

This timeline seems ambitious but it is assumed that this tight planning reflects the EC’s desire to have the ‘payments legislative package’ adopted by the EU legislator prior to the European Parliament elections in 2014. Based on that timeline and considering that the EC proposes that EU member states are given two years to implement this revised EU Directive into national law, the forthcoming PSD2 could take effect at the earliest in 2016 once the European Parliament and Council of Ministers agree on common text.

Unbundling of schemes and processing

According to analyst Zilvinas Bareisis of consultancy Celent, the impact of interchange

caps and unbundling of schemes and processing will vary market by market. “It will be interesting to see the actual interpretation of this recommendation. A similar requirement is one of the fundamental tenets of the SEPA cards framework: ‘a scheme should implement a separation of SEPA card schemes’ brand governance and management from the operations that have to be performed by service providers and infrastructures without any possibility for cross-subsidisation.’ Visa’s and MasterCard’s position has always been that they meet these requirements by not mandating their processing services and having separate pricing for scheme and processing services.

“However, some commentators believe that this time the Commission might want to go further and impose legal separation of the schemes, processing assets and potentially even issuing and acquiring side of the business, which would have far reaching consequences to most players, from Visa and MasterCard to American Express to local debit schemes to even banks. Given the lack of clarity in how this might be implemented so far, we expect a lot of lobbying on all sides in the coming months and years until the outcome is settled.”

Meanwhile, John Casanova, partner at law firm Sidley Austin, said: “PSD2 is a response to many of the criticisms, suggestions and issues that have been raised in respect of PSD1 and the wider regulation of payments in the EU. Much of the PSD2 regulation has, therefore, already been trialled and anticipated by the payments industry.

“Like PSD1, the second iteration regulates virtually all payment services within the EU including debiting and crediting of payment accounts, money transmittal and card issuing and acquiring. PSD2 attempts to improve legal clarity and level the playing field for market participants while ensuring transparent and secure services for customers.

“The basic scope of the second Directive has been extended such that transparency and information requirements, which only applied previously to transactions executed wholly within the EU, now apply to payment transactions involving third countries in any currency, as long as one of the payment service providers is located within the EU.

“In terms of entities that must be authorised by their ‘home’ EU member state, as a bank, e-money institution or payment institution, prior to providing payment services, PSD1 has several exemptions that are no longer available in PSD2. The ‘commercial agent’ exemption, which generally precludes those negotiating the sale of goods and services from the authorisation requirements, has been amended to limit its application to providers that are acting only for either the payee or the payor but not both. Thus, it will no longer apply to payment service providers running e-commerce platforms.

“PSD2 introduces a new regulated payment service that would bring third parties providing data or payment initiation services which access payment accounts held with other PSPs under the scope of the regulation. Such third-party service providers would be required to be authorised and supervised as a payment institution. This will make them subject to increased security requirements.”

Peter Jones, a payment industry consultant, added: “The detailed rule changes indicate a longer-term plan to radically change the structure of card payments in Europe. Some now suggest the EC has gone too far and is proposing changes that may permanently alter the EU’s card business model. The most important proposal is a plan to enforce the separation of the network brand/membership from the processing infrastructure, a change understood to be directed at the international card schemes. The two major schemes have already made substantial internal changes, but because of the complexity of the carve-out, complete separation has been difficult to achieve.

“If separation is mandated, the consequences for schemes (and four-party applications of three-party schemes) will be very significant. Inevitably, their networks will move from mono- to multi-brand processing and thus have potential to become common carriers for all forms of electronic payments across the EU. Scheme and processor separation will also fundamentally change the networks’ operational models and approaches to members.

Strong lobbying ahead

“The interchange caps include marketing/assessment fees and – more importantly – rebates, thus limiting the ability of card schemes to increase fees, bid for new card issuer business and cross-subsidise processing revenues. Domestic debit schemes with MIF will also suffer reductions (25%, for example, in Germany and France). As rates are harmonised, the low-price advantages of domestic over ICS brands will disappear.

“Given their high investment in innovation and the powerful value-added network features, however, the schemes have a distinct advantage. Domestic schemes will have to invest substantially to compete, which makes it likely that some EU domestic schemes will give up and join the four that have already exited the market.

“In the immediate term there will be strong lobbying by the bank and merchant sectors. The legislation is ambitiously targeted for approval by Q2 2014, ahead of the EU elections, which might not be achieved. Longer term, the new regulations will undoubtedly change the shape of the EU’s cards model. Potentially, by 2017, scheme costs may be higher than the MIF revenues received by some issuers. Cards may no longer be the primary instrument of choice to displace cash. ACH and non-bank alternative payment methods may become increasingly attractive. Changing the cards business rules may appear simple, but watch out for severe collateral damage,” Jones added.

Speaking at the MasterCard Prepaid conference in September 2013, Christoph Baert, regulatory affairs counsel at MasterCard Europe, said of the draft interchange regulation and revised PSD that they were “the most drastic regulatory intervention ever seen, coming on top of competition law enforcement, not just on interchange but covering a range of business rules. The text is open for diverging interpretations and there is a period of huge uncertainty ahead.”

Ahead of the PSD2’s implementation by member states, Baert said that there would be a period of intense lobbying ahead, “which could make things better or worse”. What is of note is that the unbundling of schemes and processors proposed by the EC would mean that authorisation and clearing messages would be separated with the possibility of being processed by different processors, which could in theory mean that the interchange caps could be circumvented by domestic processors on domestic transactions.

In relation to the impact of the interchange caps and the PSD2, Baert said that there is no doubt that issuers’ economics are under threat, along with opening processing competition of domestic schemes and on co-branded cards.

“There could be a change of paradigm in the role of schemes, from mere facilitators of payments to full service providers. There could be an opportunity for schemes to play much more active roles in developing and enabling new products and services.”

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